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June 2013

June 2013
From the Colorado Bar Association
Business Law Section

Ed Naylor, Editor
In this issue...

2013 Business Legislation—UCC Amendments, Public Benefit Corporations, and Marijuana

By Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

The General Assembly was extremely partisan in 2013 and dealt with a number of issues that created further partisanship, but fortunately it did not delve much into business legislation. This briefly addresses three of the more significant new Acts relevant to business practitioners: amendments to UCC Article 9, creation of Colorado benefit corporations, and marijuana laws pursuant to Amendment 64. A more detailed summary, presented to a combined meeting of the Tax, Business, Real Estate, and Trust and Estate sections on June 12, is posted online.

Uniform Commercial Code

The 2012 Colorado General Assembly adopted the 2010 Amendments to Revised Article 9 of the Uniform Commercial Code by enacting House Bill 12-1262. But before the bill would become effective on July 1, 2013, the General Assembly discovered that the 2012 bill needed some minor changes. These 2013 changes will also become effective July 1, 2013 via House Bill 13-1284. CLE in Colorado already held a program providing much more detailed information on these amendments, and Chuck Calvin’s materials are available from CLE in Colorado.

A significant focus of the 2012 amendments and the 2013 correction was the name of the debtor to be included on a UCC-1 financing statement to be filed in the public record.

For a debtor that is an entity, the most significant change is the addition of definitions for “public organic record” and “registered organization.” In Colorado, a “registered organization” is an entity (such as a corporation, cooperative, LLC, or limited partnership) that must make a filing with the Colorado Secretary of State (the keeper of the “public organic record” in Colorado). Where a debtor is a non-Colorado entity, the creditor must look to the law of the organizational jurisdiction. § 4-9-301. Where there are no filings required to form the entity, such as a general partnership, the definition is much less precise and care must be taken to ensure the correct names are listed as debtors on the financing statement. Section 4-9-503(a)(5)(B) [eff. 7/1/2013] does state that “if a debtor does not have a name,” the financing statement should include the names of the individual partners, members, etc.

For individual debtors, the original text of Revised Article 9 (§ 4-9-503(a)(4)) provided no guidance and created significant uncertainty among lenders about the name to enter on a UCC-1 financing statement where an individual debtor used a number of different variants of his or her name on writings such as a birth certificate, tax returns, driver’s license, etc. The 2010 Uniform Law Amendments approved by the Uniform Commercial Code’s sponsoring organizations, the American Law Institute and the Uniform Law Commission, clarified the matter and provided states with two options—Alternatives A & B. Colorado adopted Alternative B which specifies that a name would be acceptable for financing statement purposes if it met any one of three formulations:

  1. the individual name of the debtor [this language is the same as existing law],
  2. the surname and first personal name of the debtor, or
  3. if the state whose law applies has issued the debtor a driver’s license or other state-issued identification cards that has not expired, the name shown on the latest unexpired state identification.

Colorado also adopted some non-uniform transition rules found in § 4-9-805 through -809. These provisions state that security interests properly perfected by filing before July 1, 2013 continue in effect until perfection would otherwise lapse (generally five years as set forth in § 4-9-515). Continuation of financing statements filed after July 1, 2013 will not be effective unless the financing statement is amended to comply with the requirements of the law then effective. Importantly, § 4-9-809 states clearly that H.B. 12-1262 determines the priority of conflicting claims to collateral, unless the relative priorities were established before July 1, 2013. Section 4-9-805(b) validates pre-July 1, 2013 financing statements even though they may be ineffective under post-July 1, 2013 law until they lapse.

The Public Benefit Corporation Act of Colorado

After struggling with the “benefit corporation” concept for three legislative sessions (as chronicled by several prior articles in this newsletter), in 2013 the General Assembly passed the “Public Benefit Corporation Act of Colorado” (the “PBCA”) on a strictly party-line vote. The PBCA allows the formation of “public benefit corporations” (“PBCs”). Effective April 1, 2014, the PBCA adds Part 5 to Article 101 of the Colorado Business Corporation Act in Title 7, C.R.S. The new law has little similarity either to the other “benefit corporation” statutes adopted or considered in a number of other states or to the “model benefit corporation act” proposed by B Lab Company of Berwyn, Pennsylvania. Most notably, the PBCA does not require corporations to focus on the “general public benefit” for the good of society and the environment but rather directs the PBC to act in a “responsible and sustainable manner.”

As set forth in § 7-101-503(1), a PBC is a corporation that “is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.” The articles of incorporation of a PBC (a) must set forth one or more specific public benefits, (b) must state that the corporation is a PBC and indicate so in the entity’s name, and (c) must clearly indicate the entity is a PBC in share certificates or the statement required under § 7-106-207.

The term “Public Benefit” is defined in § 7-101-503(2) to mean “one or more positive effects or reduction of negative effects on one or more categories of persons, entities, communities, or interests other than shareholders in their capacities as shareholders, including effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.”

There is a school of thought that a public benefit corporation is necessary because a regular corporation cannot protect its directors on decisions that may intentionally reduce profit or positive cash flow, or otherwise have no direct correlation to the success of the corporation’s business. This is a debate that will continue to play out over time.

The PBCA, in § 7-101-509, makes it clear that it does not create a negative implication against other Colorado Business Corporation Act entities. Any Colorado corporation can still elect in its articles (or by resolution or otherwise) to follow a beneficial purpose outside a pure profit motive and by careful drafting can still protect the business judgment of its directors without electing to be a PBC.

In § 7-101-506(1), the PBCA requires that the Board of Directors “manage or direct the business and affairs of a public benefit corporation in a manner that balances the pecuniary interests of the shareholders, the best interests of those materially affected by the corporation’s conduct, and the specific public benefit identified in its articles of incorporation.” The significant change from a regular corporation is in the balancing of the interests of those “materially affected,” which could include employees, suppliers, and customers, but also neighbors and even competitors. While this requirement does not prioritize certain considerations over others, it does suggest careful drafting of board of directors’ minutes to reflect the “balancing” mandated by the statute. Furthermore, there is no prohibition in the PBCA against shareholders including prioritization of goals in the articles of incorporation. This balancing requirement is the price that a PBC must pay for the statutory protections afforded to directors of a PBC.

Section 7-101-507 requires that the PBC prepare a report and provide it to the PBC shareholders, but there is no requirement that the report be prepared annually or in some other time period. The report (when prepared) must describe:

  1. How the PBC promoted its identified public benefit and the best interests of those materially affected by its conduct;
  2. Any circumstances that have hindered the PBC’s promotion of those goals;
  3. The process and rationale for selecting or changing any third party standard against which the PBC’s performance is assessed; and
  4. A self-assessment of the overall social and environmental performance of the PBC against a third party standard, which does not need to be audited or certified by any third party.

Similar to non-PBCs, shareholders (and only shareholders) of a PBC may enforce the director’s duties under C.R.S. § 7-101-506(1) through a derivative action if the shareholders (individually or collectively) own at least two percent of the PBC’s outstanding shares or (if a public corporation listed on a national securities exchange) the lesser of two percent or shares with a value of at least $1,000,000. C.R.S. § 7-101-508.

The PBCA does not address issues under the Colorado Securities Act (§ 11-51-101 et seq.), which regulates offers and sales of securities in Colorado. Generally, compliance will require disclosure to prospective investors of the public benefit purpose so that investors are not misled into believing that the PBC is a Colorado Business Corporation Act entity with a pure profit motive and a duty of the directors’ to work “for the best interests of the corporation” under C.R.S. § 7-108-401(1). PBCs must also comply with other normal exemption/registration requirements of the Colorado Securities Act and the licensing of broker-dealers, as well as federal securities laws.

The PBCA also does not address issues that may arise for PBCs under the Colorado Charitable Solicitations Act (§ 6-16-101 et seq.), which works §to protect the public’s interest in making informed choices as to which charitable causes should be supported” and “to help the secretary of state investigate allegations of wrongdoing in charities” without discouraging donation or requiring disclosure of confidential information. § 6-16-102. A PBC’s public benefit purpose may fit within the broad definition of a “charitable purpose” and, as a result, the PBC may be considered to be a “charitable organization” required to file reports with the Colorado Secretary of State. In soliciting funds for its public benefit purpose, a PBC, and its investment bankers, should consider whether compliance with the Colorado Charitable Solicitations Act is required and how to accomplish such compliance.

The Colorado PBCA, and legislation for benefit corporations generally, does not and cannot address numerous issues under the Internal Revenue Code. For example, § 162(a) of the Internal Revenue Code authorizes taxpayers to deduct from income their “ordinary and necessary business expenses.” Marketing expenses, including, for example, advertising “organically grown ingredients” or “contributions to local charities,” generally fall within this section. Will expenditures for a public benefit purpose that do not fit within the marketing rubric or which may be excessive when compared to normal marketing budgets be deductible?

The PBC may also be a wholly unsuitable investment for an employee stock ownership plan (an “ESOP”) or other plan governed by the Employee Retirement Income Security Act of 1974 (“ERISA”). As set forth in ERISA § 404 and the regulations thereunder, the primary responsibility of fiduciaries of an ERISA plan is to run the plan solely in the interests of the participants and beneficiaries. What fiduciary will be able to conclude that a PBC that is not being operated solely for profit or for the pecuniary benefit of its shareholders meets the mandated ERISA fiduciary standard of care? Any decision by an ERISA fiduciary to invest in or hold securities of a PBC (or any corporation claiming a purpose other than profit) is likely to be a personally risky decision under current law.

Marijuana

In November 2012, Colorado voters passed Amendment 64, legalizing the cultivation, sale, possession, and use of marijuana subject to some limitations. While legal under Colorado law, marijuana cultivation, sale, possession and use remain illegal under federal law. (21 U.S.C. § 812(c) lists “marihuana” as a controlled substance within the meaning of 21 U.S.C. § 841(a)(1).) Medical marijuana (approved by Colorado voters in 2000) created a growth industry, at least for a period of time, and a number of Colorado attorneys counseled those involved in the industry. It can be expected that Amendment 64 will be an equal boon to businesses, even though many federally-regulated institutions (such as banks and credit card companies) will not deal with marijuana facilities for fear of repercussion under federal law.

The 2013 General Assembly scurried to implement regulations in order to legalize marijuana pursuant to Amendment 64. Six bills were signed regarding marijuana regulations, including: H.B. 13-1042, H.B. 13-1238, H.B. 13-1317, H.B. 13-1318, H.B. 13-1325, and S.B. 13-283. None of these bills answer the question that should be most important to Colorado attorneys who will represent businesses in the marijuana industry: the ethics of representation given that cultivation, sale, possession and use of marijuana are still felonies under federal law. Applicable rules are found in Colorado Rules of Professional Conduct and include:

  • Rule 1.2(d) – a prohibition against assisting a client in conduct the lawyer knows to be criminal; and
  • Rule 5.1(a) – requiring the management of the law firm to make reasonable efforts to ensure each lawyer’s compliance with the Rules; and
  • Rule 5.1(c) – imposing liability on lawyers associated in a law firm if they ratify any violation of the Rules.

While state prosecution will likely not occur as a result of Amendment 64, federal enforcement is still unresolved. Although it is likely that the marijuana industry will become a fertile business field for Colorado practitioners, there remains much uncertainty about risks to attorneys and others involved in the industry. Attorneys must keep these risks in mind.

Are LLC’s Corporations? The Supreme Court Answers “No.”
Weinstein v. Colborne Foodbotics, LLC, 2013 CO 33 (June 10, 2013)

By Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

The Colorado Supreme Court went a long way to clear up some confusion caused by lower courts when, on June 10, 2013, it issued its long-awaited decision in Weinstein v. Colborne Foodbotics, LLC (“Colborne”). The ruling addresses the applicability of corporation law principles to LLCs, and creditors’ rights against LLC members and managers.

The Claims

The plaintiff, a creditor of the LLC, claimed that managers of the LLC authorized distributions to members which resulted in the LLC’s insolvency, thereby leaving it unable to pay the creditor’s claim. The plaintiff asserted two claims:

  • One against the members for receiving an unlawful distribution in violation of C.R.S. § 7-80-606; and
  • One against the managers for their breach of a fiduciary duty allegedly owed to the creditors of an insolvent entity.

Corporate Law Not Applicable to Unlawful LLC Distribution Claims

The trial court granted the defendants’ motion to dismiss both claims, and the Court of Appeals reversed the dismissal. The Supreme Court reversed and reinstated the trial court’s dismissal. In reversing the Court of Appeals, the Supreme Court noted that LLCs are not corporations, and it is improper to apply corporate law to LLCs except in the one instance where the application of corporate law to LLCs was mandated by statute: piercing the veil as addressed in C.R.S. § 7-80-107(1).

The Court of Appeals decision in Colborne was discussed and criticized in this newsletter in February 2010. The Court of Appeals had compared the Colorado Business Corporation Act with the Colorado LLC Act and determined that the distribution provisions were written similarly—comparing C.R.S. § 7-80-606(1) (for LLCs) with C.R.S. § 7-108-403(1) (for corporations). The Court of Appeals then concluded that the corporate case law (Ficor, Inc. v. McHugh, 639 P.2d 385, 393-4 (Colo. 1982)) should be applied to the LLC Act. Ficor reasoned that similar provisions of C.R.S. § 7-5-114(3) of the Colorado Corporation Code (now repealed) were intended to protect creditors and, therefore, creditors as a group had standing to sue an insolvent corporation’s directors for wrongful distributions. In following Ficor, the Court of Appeals chose to ignore the distinction between the corporate form and the LLC form as well as the language of C.R.S. ’ 7-80-606(1) which provides that members receiving an unlawful distribution should be liable only to the LLC.

Citing a Delaware case (CML V, LLC v. Bax, 28 A.3d 1037, 1043 (Del. 2011)), the Supreme Court held that, since “the LLC Act and the Colorado Business Corporation Act are two different statutes with different schemes and purposes, and because a corporate shareholder is not equivalent to an LLC member, the legislature is free to choose a statutory limitation on an LLC’s creditors different from what it chooses for a corporation’s creditors.” The Court held that, absent express statutory authority, an LLC’s creditor may not assert a claim against the members of the LLC for unlawful distribution, and “[w]e construe the statute [the Colorado LLC Act] as written and assume ‘that the General Assembly meant what it clearly said.’” [Citing Pierson v. Black Canyon Aggregates, Inc., 48 P.3d 1215, 1219 (Colo. 2002).]

Claims Against Managers for Unlawful Distributions

In the second claim against the managers for their alleged breach of common law fiduciary duties for approving the unlawful distribution, the Supreme Court again started with the cornerstone of the Court of Appeals’ analysis—another corporate case, Alexander v. Anstine, 152 P.3d 497, 502 (Colo. 2007). In Anstine, the Supreme Court determined that directors of an insolvent Colorado corporation acted as ‘trustees’ for the corporation’s creditors and had a “limited fiduciary duty” not to favor themselves over the corporation’s creditors. In Colborne, however, the Supreme Court again looked at the Colorado LLC Act and noted that the statute specifically provides in C.R.S. § 7-80-404 and C.R.S. § 7-80-705 that managers are not liable to creditors of the LLC and have no fiduciary duty to creditors. Since the Colorado LLC Act did not extend corporate law to LLCs, except as noted above in the case of veil piercing, the Supreme Court refused to extend the Anstine analysis to LLCs.

In reaching this conclusion, the Supreme Court noted that the Court of Appeals had expressly extended the Anstine analysis in the earlier case of Sheffield Srvs Co. v. Trowbridge, 211 P.3d 714, 723-4 (Colo. App. 2009) (discussed in the November 2009 newsletter). The Supreme Court put a nail in Sheffield holding that “[t]o the extent Sheffield holds that an LLC’s manager has a fiduciary duty to the LLC’s creditors, it is overruled.”

Other Avenues for Claims: CUFTA

This does not mean that an LLC’s creditors are without recourse when managers approve distributions which result in insolvency of the LLC. It simply means that neither C.R.S. § 7-80-606 nor common law insolvency duties are the appropriate recourse. As discussed in CB Richard Ellis, Inc. v. CLGP, LLC, 251 P.3d 523 (Colo. App. 2010) (discussed in the July 2010 newsletter), the Colorado Uniform Fraudulent Transfers Act (C.R.S. 38-8-101, “CUFTA”) may be available. CUFTA specifically gives creditors recourse against recipients of fraudulent transfers in three circumstances, the first requiring specific intent, and the other two provisions requiring insolvency:

  • C.R.S. § 38-8-105(1)(a) provides that transfers are fraudulent as to creditors existing at the time of the transfer and future creditors where the debtor makes a transfer with actual intent to hinder, delay or defraud any creditor. C.R.S. § 38-8-105(2) sets forth eleven factors for a court to consider in determining intent, including insolvency as a factor to be considered.
  • C.R.S. § 38-8-105(1)(b) provides that transfers are fraudulent as to creditors existing at the time of the transfer and future creditors where the debtor makes a transfer without receiving “reasonably equivalent value in exchange for the transfer” and
    • Where the debtor was engaged or was about to engage in business or a transaction for which the debtor’s remaining assets were unreasonably small; or
    • The debtor intended to incur (or believed or reasonably should have believed that the debtor would incur) debts beyond the debtor’s ability to pay as they became due.
  • C.R.S. § 38-8-106(1) and (2) provides that transfers are fraudulent as to creditors existing at the time of transfer if the debtor was insolvent at the time of the transfer or became insolvent as a result thereof.

CUFTA (in C.R.S. § 38-8-103(1)) defines insolvency similarly to the LLC Act, stating that a debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets at a fair valuation. Unlike the LLC Act, CUFTA (C.R.S. § 38-8-103(2)) has a second definition for a rebuttable presumption of insolvency: when a debtor is generally not paying debts as they become due.

The Colorado Supreme Court did leave one disturbing note in the Colborne opinion. In its discussion of Anstine, it spoke as if Anstine and the limited fiduciary duty purportedly owed by the directors of an insolvent Colorado corporation to creditors remained extant. In Anstine itself, the Supreme Court noted that, during the pendency of the case the General Assembly adopted an amendment to the Colorado Business Corporation Act (C.R.S. § 7-108-401(5)) which said that “[a] director or officer of a corporation … shall not have any fiduciary duty to any creditor of the corporation arising only from the status as creditor.” It has been argued by this author and others that, to the extent the Anstine decision accurately reflected the common law at the time, the 2006 CBCA amendment specifically overruled that position. In Anstine (footnote 9) and in Colborne (footnote 10) the Supreme Court said that the question was not before it in the case and “we do not answer the question of whether Anstine is still good law.”

The Supreme Court got much right in its Colborne decision. Given the posture of the Colborne case, it was probably correct to leave the limited fiduciary duty of Anstine to another day.

Business Law Section Activities

Reminder: Neither the Mergers and Acquisitions Subsection nor the Financial Institutions Subsection will hold their CLE Breakfast and Luncheon Programs during the summer months of June, July, and August.

CBA-CLE Information

Unless otherwise noted, all programs are at the CBA-CLE offices, 1900 Grant St., Ste. 300, Denver

Microsoft Word Programs—Thursday, June 28

Sign up for one program or take both programs for a reduced fee!

Morning Program: Legal Drafting with Microsoft Word 2007/2010—9 a.m. to Noon

Word courses designed for the general public just don’t address the issues legal professionals face when drafting legal instruments. This course is designed by legal professionals, for legal professionals. We’ll cover legal drafting issues such as automatic paragraph numbering, complex page numbering schemes, tables of contents, footnotes, and paragraph number cross-referencing. Learn how to control Word’s complex formatting attributes and receive sample Word templates for pleadings, contracts/agreements, and trusts and leases. Three general CLE credits are available.

Learn more and register for the morning program, or call 303-860-0608 (toll free 888-860-2531).

Afternoon Program: Microsoft Word 2007/2010—Advanced Techniques—1 to 4 p.m.

This seminar will teach you what is going on behind the curtain so you’ll know exactly how to attack drafting issues and fix or avoid the formatting problems plaguing you now. We’ll cover styles (which grant you full control of formatting), macros (which allow you to automate repetitive tasks), and templates (which are the starting point for the legal documents you draft). Understand these topics and take your word processing to the next level of efficiency. Three general CLE credits are available.

Learn more and register for the afternoon program, or call 303-860-0608 (toll free 888-860-2531).

The Business of Marijuana: Accounting, Tax, and Legal Issues After Amendment 64—Thursday, July 18

In November 2012, Colorado voters passed Amendment 64, which under Colorado law, makes the personal, non-medical use, possession, and limited home-growing of marijuana legal for adults 21 years of age and older. The Amendment to the Colorado Constitution provides for the regulation of marijuana like alcohol, and allows for the lawful operation of marijuana-related facilities. Amendment 64 presents issues of first impression in Colorado and in the United States, as no other state except Washington State has legalized marijuana for non-medical, adult use in the face of federal legal restrictions. This seminar will provide answers to the tax, accounting, and legal implications for people involved in marijuana-related businesses in Colorado.

The program is from 9 a.m. to 4 p.m. Six general CLE credits are available.

View the detailed agenda and register online, or call 303-860-0608 (toll free 888-860-2531).

40-Hour Mediation Training—August 12–14, 26, and 27

In Course Overview:

  • Mediation Models
  • How Mediators Diagnose the Causes of Conflict
  • Conflict Styles: What You Bring to the Mediation Table
  • Stages of Mediation
  • Working with Attorneys in Mediation
  • Cultural Issues in Mediation
  • Coaching Parties to Raise Conflict Constructively
  • Ethical Dilemmas for Mediators

40 general CLE credits are available, including 5 ethics. Learn more and register online, or call 303-860-0608 (toll free 888-860-2531).

Hanging Your Shingle—August 15–17

Starting your own law firm means not only knowing how to practice law, but also knowing how to run a business. Whether you just graduated from law school or have been practicing for many years, you probably have not learned a lot about how to run a business. There is no other program in Colorado that offers this kind of expertise and resources to get your law firm off the ground. This comprehensive seminar is your toolbox for building the career and the life you have envisioned. From writing your business plan to getting a line of credit, from balancing your books to billing hours, from avoiding malpractice to being savvy in social media—you will leave this program with the inspiration, confidence and resources you need to build and control your future. 17 general CLE credits are available, including 4 ethics.

Learn more and register online, or call 303-860-0608 (toll free 888-860-2531).

Recent Homestudies

CBA-CLE Featured Publication

Practitioner’s Guide to CO Business Organizations, Second Edition

The Guide begins with basic topics that a Colorado practitioner should consider in the choice-of-entity process. The book then presents detailed discussions of the numerous types of Colorado entities. Finally, chapters from authors from a wide range of practice areas and expertise address the various aspects of their practice areas that relate to Colorado business organizations.
Managing Editors: Lee Reichert and Allen E.F. Rozansky

For more information or to order books, call 303.860.0608 or 800.860.2531 or click here.

Contributions for future newsletters are welcome —
Contact Ed Naylor at ed.naylor@moyewhite.com or 303-292-2900

This newsletter is for information only and does not provide legal advice.

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