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The Business Lawyer

Winter 2023/2024 | Volume 79, Issue 1

Changes in the Model Business Corporation Act—Proposed Amendments to Section 2.02 Relating to Officer Exculpation

Summary

  • The Committee has approved, on second reading, proposed amendments to section 2.02 (the “Amendments”), relating to officer exculpation.
  • The Corporate Laws Committee of the ABA Business Law Section (the “Committee”) develops and proposes changes in the Model Business Corporation Act (the “Model Act”). The Committee has approved, on second reading, proposed amendments to section 2.02 (the “Amendments”), relating to officer exculpation, and invites comments from interested persons. Comments should be addressed to Steven M. Haas, Chair, Corporate Laws Committee, Hunton Andrews Kurth LLP, 951 E. Byrd Street, Richmond, VA 23219, or sent to him by e-mail at [email protected]. Comments should be received by April 1, 2024, in order to be considered by the Committee before adoption of the Amendments on third reading.
Changes in the Model Business Corporation Act—Proposed Amendments to Section 2.02 Relating to Officer Exculpation
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Background

As part of its ongoing review of the Model Act’s provisions, the Committee is proposing amendments to section 2.02 to permit a corporation to include in its articles of incorporation a provision to eliminate or limit the monetary liability of specified corporate officers. Previously, the protection afforded by exculpatory provisions in the articles of incorporation was limited to directors.

The Amendments to subsection (b)(4) authorize a provision in the articles of incorporation that limits or eliminates the monetary liability of officers similar to what the Model Act already allows for directors. As with directors, the Amendments do not allow the articles of incorporation to exculpate officers from liability for any financial benefit received by an officer to which the officer is not entitled; acts or omissions that intentionally inflict harm on the corporation or the shareholders; or acts or omissions that involve an intentional violation of criminal law. Unlike the elimination and limitation of liability allowed for directors, however, the Amendments do not permit a provision in the articles of incorporation to eliminate or limit liability of officers for any claim by or in the right of the corporation, including in a derivative proceeding.

The Amendments also add a new subsection (f ), defining the “officers” that may be exculpated. The definition includes an enumerated list of executive officers entitled by statutory default to be covered by an exculpatory provision in the articles of incorporation: president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, secretary, controller, treasurer, or chief accounting officer. The Official Comment provides that the use of “chief ” in the enumerated list of officers is intended to capture the principal officer performing the functions of such office irrespective of that officer’s title. The articles of incorporation may expand or contract this default list of officers. In addition, unless otherwise provided in the articles of incorporation, the board of directors may, by resolution, expand the list of officers entitled to exculpatory protection. The Official Comment to section 2.02 makes clear that the definition of “officer” in section 2.02(f ) applies only to the exculpatory protections provided in section 2.02(b)(4) and not to the use of “officer” elsewhere in the Model Act.

An exculpatory provision for officers will not apply by default. It must be included in the articles of incorporation and will apply only with respect to acts or omissions occurring while it is in effect.

Proposed Amendments

The Committee proposes changes to section 2.02 of the Model Act as set forth below. Changes to the existing provisions are marked with deletions shown by strikeout and additions by underscoring.

§ 2.02. ARTICLES OF INCORPORATION

  • (a) The articles of incorporation must set forth:
    • (1) a corporate name for the corporation that satisfies the requirements of section 4.01;
    • (2) the number of shares the corporation is authorized to issue;
    • (3) the street and mailing addresses of the corporation’s initial registered office and the name of its initial registered agent at that office; and
    • (4) The name and address of each incorporator.
  • (b) The articles of incorporation may set forth:
    • (1) the names and addresses of the individuals who are to serve as the initial directors;
    • (2) provisions not inconsistent with law regarding:
      • (i) the purpose or purposes for which the corporation is organized;
      • (ii) managing the business and regulating the affairs of the corporation;
      • (iii) defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders;
      • (iv) a par value for authorized shares or classes of shares; or
      • (v) the imposition of interest holder liability on shareholders;
    • (3) any provision that under this Act is required or permitted to be set forth in the bylaws;
    • (4) a provision eliminating or limiting the liability of a director or officer to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director or officer, except liability for (i) the amount of a financial benefit received by a director or officer to which the director or officer is not entitled; (ii) an intentional infliction of harm on the corporation or the shareholders; (iii) in the case of a director, a violation of section 8.32; or (iv) an intentional violation of criminal law; or (v) in the case of an officer, any claim by or in the right of the corporation;
    • (5) a provision permitting or making obligatory indemnification of a director for liability as defined in section 8.50 to any person for any action taken, or any failure to take any action, as a director, except liability for (i) receipt of a financial benefit to which the director is not entitled, (ii) an intentional infliction of harm on the corporation or the shareholders, (iii) a violation of section 8.32, or (iv) an intentional violation of criminal law; and
    • (6) a provision limiting or eliminating any duty of a director or any other person to offer the corporation the right to have or participate in any, or one or more classes or categories of, business opportunities, before the pursuit or taking of the opportunity by the director or other person; provided that any application of such a provision to an officer or a related person of that officer (i) also requires approval of that application by the board of directors, subsequent to the effective date of the provision, by action of qualified directors taken in compliance with the same procedures as are set forth in section 8.62;, and (ii) may be limited by the authorizing action of the board of directors.
  • (c) The articles of incorporation need not set forth any of the corporate powers enumerated this Act.
  • (d) Provisions of the articles of incorporation may be made dependent upon facts objectively ascertainable outside the articles of incorporation in accordance with section 1.20(k).
  • (e) As used in this section, “related person” has the meaning specified in section 8.60.
  • (f ) For purposes of subsection (b)(4), unless the articles of incorporation otherwise provide, “officer” means an individual appointed or elected in accordance with section 8.40 as (i) president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, secretary, controller, treasurer, or chief accounting officer of the corporation; and (ii) any officer of the corporation designated by resolution of the board of directors as an “officer” for purposes of subsection (b)(4). The board of directors may from time to time by resolution determine that one or more of the officers designated in accordance with subsection (f )(ii) shall no longer be an “officer” for purposes of subsection (b)(4), but no such resolution shall be effective as to any such officer, or any act or omission of any such officer, prior to the adoption of such resolution.

Cross-References

  • Amendment of articles of incorporation, see ch. 10A.
  • Classes of shares, see § 6.01.
  • Corporate powers, see § 3.02.
  • Duration of corporate existence, see § 3.02.
  • Filing requirements, see § 1.20.
  • Incorporators, see § 2.01.
  • Indemnification, see ch. 8E.
  • “Interest holder liability” defined, see § 1.40.
  • Liability of shareholders, see § 6.22.
  • Powers, see § 3.02.
  • Purposes, see § 3.01.
  • Restated articles of incorporation, see § 10.07.

Official Comment

1. Introduction

A corporation will have perpetual duration unless a special provision is included in its articles of incorporation providing for a shorter period. See section 3.02. Similarly, a corporation with articles of incorporation which do not contain a purpose clause will have the purpose of engaging in any lawful business under section 3.01(a). The option of providing a narrower purpose clause is also preserved in sections 2.02(b)(2)(i) and 3.01, with the effect described in the Official Comment to section 3.01.

2. Required Provisions

If a single class of shares is authorized, only the number of shares authorized need be stated; if more than one class of shares is authorized, however, both the number of authorized shares of each class and a description of the rights of each class must be included. See the Official Comment to sections 6.01 and 6.02. It is unnecessary to specify par value, expected minimum capitalization, or contemplated issue price.

The corporation’s initial registered office and agent must be included, and a mailing address alone, such as a post office box, is not sufficient since the registered office is the designated location for service of process. See chapter 5.

No reference need be made to a variety of other matters such as preemptive rights. See section 6.30 and its Official Comment. Generally, no substantive effect should be given to the absence of a specific reference to such matters in section 2.02. They are referred to in other sections of the Act that usually provide an “opt in” privilege. See particularly the list of optional provisions set forth in parts 4 and 5 of this Official Comment.

3. Optional Provisions

Section 2.02(b) allows the articles of incorporation to contain optional provisions deemed sufficiently important to be of public record or subject to amendment only by the processes applicable to amendments of articles of incorporation.

A. Business or Affairs

Provisions relating to the business or affairs of the corporation that may be included in the articles may be subdivided into four general classes:

  • provisions that under the Act may be elected only by specific inclusion in the articles of incorporation (a list of these provisions is set forth in part 4 of this Official Comment);
  • provisions that under the Act may be elected by specific inclusion in either the articles of incorporation or the bylaws, as listed in part 5 of this Official Comment;
  • other provisions not referred to in the Act, including any provision that the Act requires or permits to be set forth in the bylaws (see section 2.02(b)(3)); and
  • other provisions that are inconsistent with one or more provisions of the Act but are nonetheless permitted by section 7.32 for inclusion in a shareholders’ agreement, if the requirements of that section are met.

B. Corporate Powers

Section 2.02(c) makes it unnecessary to set forth any corporate powers in the articles of incorporation in view of the broad grant of power in section 3.02. This grant of power, however, may be overbroad for particular corporations; if so, it may be qualified or narrowed by appropriate provisions in the articles of incorporation.

C. Par Value

Although par value is no longer a mandatory statutory concept under the Act, section 2.02(b)(2)(iv) permits optional “par value” provisions with regard to shares. Other than being permitted by section 2.02(b)(2)(iv), however, “par value” is not mentioned in the Act. Special provisions may be included to give effect or meaning to “par value” essentially as a matter of contract between the parties. These provisions, whether appearing in the articles of incorporation or in other documents have only the effect any permissible contractual provision has in the absence of a prohibition by statute. Provisions in the articles of incorporation establishing an optional par value may also be of use to corporations which are to be qualified or registered in foreign jurisdictions that compute franchise or other taxes upon the basis of par value.

For a general discussion of capitalization, see the Official Comment to section 6.21.

D. Shareholder Liability

The basic tenet of corporation law is that shareholders are not liable for the corporation’s liabilities by reason of their status as shareholders. Section 2.02(b)(2)(v) nevertheless permits a corporation to impose that liability under specified circumstances if that is desirable. If no provision of this type is included, shareholders have no liability for corporate liabilities except to the extent they become liable by reason of their own conduct or acts. See section 6.22(b).

E. Limitations of Director or Officer Liability

Section 2.02(b)(4) authorizes the inclusion of a provision in the articles of incorporation eliminating or limiting, with certain exceptions, the liability of the directors or officers (as defined in section 2.02(f )) to the corporation or its shareholders for money damages. This section is optional rather than self-executing and does not apply to equitable relief. Likewise, nNothing in section 2.02(b)(4) in any way affects the right of the shareholders to remove directors, under section 8.08(a), with or without cause or the right of the board of directors or an authorized officer to remove officers under section 8.43(b). The phrase “as a director or officer” emphasizes that section 2.02(b)(4) applies to an individual’sdirector’s actions or failures to take action in his or her the director’s capacity as a director or officer, as the case may be, and not in any other capacity. Whether an individual might have liability in a different capacity, such as a controlling shareholder, does not affect the protection provided under section 2.02(b)(4) for acts or omissions in his or her capacity as a director or officer., such as officer, employee or controlling shareholder. However, it is not intended to exclude coverage of conduct by individuals, even though they are also officers, employees or controlling shareholders, to the extent they are acting in their capacity as directors.

The exculpatory protection provided by a provision in the articles of incorporation authorized by section 2.02(b)(4) may only be afforded to the corporation’s directors and its “officers,” as that term is defined in section 2.02(f ). That definition includes any individual identified in the enumerated list of officers, although the articles of incorporation may expand or contract this list or specify a procedure for doing so. The use of “chief ” in the enumerated list of officers is intended to capture the principal officer, appointed or elected in accordance with section 8.40, performing the functions of such office irrespective of that officer’s title. Unless otherwise provided in the articles of incorporation, the board of directors may, by resolution, expand the list of officers entitled to protection. For example, if the applicable provision in the articles of incorporation states that “officers shall be exculpated to the fullest extent permitted by law,” all of the officers identified in section 2.02(f )(i) would be entitled to exculpatory protection, together with any officers identified in a board resolution adopted pursuant to section 2.02(f )(ii). Alternatively, if the articles of incorporation state that “only the chief executive officer and chief legal officer” shall be exculpated, then only those specific officers would be entitled to exculpatory protection and the board would not have the power to expand the list of protected officers pursuant to section 2.02(f )(ii). In every case, to be an “officer” for purposes of section 2.02(f ), an individual must be appointed or elected in accordance with section 8.40. The definition of “officer” in section 2.02(f ) applies only to section 2.02(b)(4) and not to the use of “officer” in section 2.02(b)(6) or elsewhere in the Act.

Shareholders are given considerable latitude in limiting directors’ liability for money damages. The statutory exceptions to permitted limitations of such director or officer liability are few and narrow and are discussed below.

Financial Benefit

Corporate law subjects transactions from which a director or officer could benefit personally to special scrutiny. The financial benefits exception is limited to the amount of the benefit to which an officer or director was not entitled but actually received. Thus, liability for punitive damages could be eliminated, except in cases of intentional infliction of harm or for violation of criminal law (as described below) where, in a particular case (for example, theft), punitive damages may be available. The benefit must be financial rather than in less easily measured and more conjectural forms, such as business goodwill, personal reputation, or social ingratiation. The phrase “received by a director or officer” is not intended to be a “bright line.” As a director’s or officer’s conduct moves toward the edge of what may be exculpated, the director or officer should bear the risk of miscalculation. Depending upon the circumstances, a director or officer may be deemed to have received a benefit that the director or officer caused to be directed to another person, for example, a relative, friend, or affiliate.

What constitutes a financial benefit “to which the director or officer is not entitled” is left to judicial development. For example, a director is entitled to reasonable compensation for the performance of services or to an increase in the value of stock or stock options held by the director; on the other hand, a director is not entitled to a bribe, a kick-back, or the profits from a corporate opportunity improperly taken by the director. See section 8.70 as to procedures for disclaiming the corporation’s interest in a business opportunity by action of qualified directors or shareholders. See section 2.02(b)(6) for optional provisions permitted in the articles of incorporation to limit or eliminate, in advance, any duty of directors and others to bring business opportunities to the corporation. If the corporation declines the opportunity after it has been presented to the corporation by the director or other person in accordance with the provisions of section 8.70(a)(1)(i) or (ii), or if a provision undersection 2.02(b)(6) limits or eliminates the duty to bring the particular opportunity to the corporation, the corporation will have no right to participate in any financial benefit arising from the opportunity if the director or other person pursues or takes the opportunity.

Intentional Infliction of Harm

There may be situations in which a director or officer intentionally causes harm to the corporation even though the director or officer does not receive any improper benefit. The use of the word “intentional,” rather than a less precise term such as “knowing,” is meant to refer to the specific intent to perform, or fail to perform, the acts with actual knowledge that the director’s or officer’s action, or failure to act, will cause harm, rather than a general intent to perform the acts which cause the harm.

Unlawful Distributions

Section 8.32(a) indicates a strong policy in favor of liability for unlawful distributions approved by directors who have not complied with the standards of conduct of section 8.30. Accordingly, the exception in section 2.02(b)(4)(iii) prohibits the shareholders from eliminating or limiting the liability of directors for a violation of section 8.32.

Intentional Violation of Criminal Law

Even though a director or officer committing a crime may intend to benefit the corporation, the shareholders should not be permitted to exculpate the director or officer for any harm caused by an intentional violation of criminal law, including, for example, fines and legal expenses of the corporation in defending a criminal prosecution. The use of the word “intentional,” rather than a less precise term such as “knowing,” is meant to refer to the specific intent to perform, or fail to perform, the acts with actual knowledge that the director’s or officer’s action, or failure to act, constitutes a violation of criminal law.

Claims by or in the Right of the Corporation

An exculpatory provision for officers under section 2.02(b)(4) does not prevent claims, including claims for money damages, by the corporation against the officer, or claims brought derivatively by shareholders against the officer.

F. Director Indemnification

Section 2.02(b)(5) specifically prohibits provisions for indemnification of director liability arising out of improper financial benefit received by a director, an intentional infliction of harm on the corporation or the shareholders, an unlawful distribution or an intentional violation of criminal law. These excepted liabilities for directors parallel those a corporation is not permitted to limit or eliminate under section 2.02(b)(4). See “E. Limitations of Director or Officer Liability” above. Officers are not included in the language of section 2.02(b)(5) because the expansion of indemnification for directors that section permits must be set forth in the articles of incorporation as required by section 8.51(a)(2); section 8.56 allows a similar expansion of indemnification for officers to be set forth also in the bylaws, resolutions or contracts.

G. Business Opportunities

Section 2.02(b)(6) authorizes the inclusion of a provision in the articles of incorporation to limit or eliminate, in advance, the duty of a director or other person to bring a business opportunity to the corporation. The limitation or elimination may be blanket in nature and apply to any business opportunities, or it may extend only to one or more specified classes or categories of business opportunities. The adoption of such a provision constitutes a curtailment of the duty of loyalty which includes the doctrine of corporate opportunity. If such a provision is included in the articles, taking advantage of a business opportunity covered by the provision of the articles without offering it to the corporation will not expose the director or other person to whom it is made applicable either to monetary damages or to equitable or any other relief in favor of the corporation upon compliance with the requirements of section 2.02(b)(6).

This provision may be useful, for example, in the context of a private equity investor that wishes to have a nominee on the board of directors but conditions its investment on an advance limitation or elimination of the corporate opportunity doctrine because of the uncertainty over the application of the corporate opportunity doctrine inherent when investments are made in multiple enterprises in specific industries. Another example is a joint venture in corporate form where the participants in the joint venture want to be sure that the corporate opportunity doctrine would not apply to their activities outside the joint venture.

The focus of the advance limitation or elimination is on the duty of the director which extends indirectly to the investor through the application of the related party definition in section 8.60. This provision also permits extension of the limitation or elimination of the duty to any other persons who might be deemed to have a duty to offer business opportunities to the corporation. For example, courts have held that the corporate opportunity doctrine extends to officers of the corporation. Although officers may be included in a provision under this subsection, the limitation or elimination of corporate opportunity obligations of officers must be addressed by the board of directors in specific cases or by the directors’ authorizing provisions in employment agreements or other contractual arrangements with such officers. Accordingly, section 2.02(b)(6) requires that the application of an advance limitation or elimination of the duty to offer a business opportunity to the corporation to any person who is an officer of the corporation or a related person of an officer also requires action by the board of directors acting through qualified directors. This action must be taken subsequent to the inclusion of the provision in the articles of incorporation and may limit the application. This means that if the advance limitation or elimination of the duty of an officer to offer business opportunities to the corporation is included in the articles by an amendment recommended by the directors and approved by the shareholders, that recommendation of the directors does not serve as the required authorization by qualified directors; rather, separate authorization by qualified directors after the amendment is included in the articles is necessary to apply the provision to a particular officer or any related person of that officer. See sections 1.43(a)(1) and 8.60 for the definition of “qualified directors” and “related persons,” respectively.

Whether a provision for advance limitation or elimination of duty in the articles of incorporation should be a broad “blanket” provision or one more tailored to specific categories or classes of transactions deserves careful consideration given the particular circumstances of the corporation.

Limitation or elimination of the duty of a director or officer to present a business opportunity to the corporation does not limit or eliminate the director’s or officer’s duty not to make unauthorized use of corporate property or information or to compete unfairly with the corporation.

4. List of Options in the Act That May Be Elected Only in the Articles of Incorporation

A. Options with Respect to Directors

  • Board of directors may be dispensed with entirely, § 7.32, or its functions may be restricted, § 8.01.
  • Power to compensate directors may be restricted or eliminated, § 8.11.
  • Election of directors by cumulative voting may be authorized, § 7.28.
  • Election of directors by greater than plurality vote may be authorized, § 7.28.
  • Directors may be elected by classes or series of shares, § 8.04.
  • Director’s term may be limited by failure to receive specified vote for election, § 8.05.
  • Power to remove directors without cause may be restricted or eliminated, § 8.08.
  • Terms of directors may be staggered so that all directors are not elected in the same year, § 8.06.
  • Power to fill vacancies on the board of directors may be limited to the shareholders, § 8.10.
  • Power to indemnify directors, officers, and employees may be limited, §§ 8.50 through 8.59.
  • Prohibition on adoption of bylaw provision under § 10.22.

B. Options with Respect to Shareholders

  • Action by shareholders may be taken without a meeting, § 7.04.
  • Special voting groups of shareholders may be authorized, § 7.25.
  • Elimination or restriction of separate voting groups for mergers and share exchanges, § 11.04, and for domestications, § 9.21.
  • Quorum for voting groups of shareholders may be increased or reduced, §§ 7.25, 7.26, and 7.27.
  • Quorum for voting by voting groups of shareholders may be prescribed, see § 7.26.
  • Greater than majority vote may be required for action by voting groups of shareholders, § 7.27.

C. Options with Respect to Shares

  • Shares may be divided into classes and classes into series, §§ 6.01 and 6.02.
  • Cumulative voting for directors may be permitted, § 7.28.
  • Distributions may be restricted, § 6.40.
  • Share dividends may be restricted, § 6.23.
  • Voting rights of classes or series of shares may be limited or denied, § 6.01.
  • Classes or series of shares may be given more or less than one vote per share, § 7.21.
  • Terms of a class or series of shares may vary among holders of the same class or series, so long as such variations are expressly set forth in the articles, § 6.01.
  • The board of directors may allocate authorized but unissued shares of a class or series of shares to another class or series without shareholder approval, § 6.02.
  • Shares may be redeemed at the option of the corporation or the shareholder, § 6.01.
  • Reissue of acquired or redeemed shares may be prohibited, § 6.31.
  • Shareholders may be given preemptive rights to acquire unissued shares, § 6.30.
  • Redemption preferences may be ignored in determining lawfulness of distributions, § 6.40.

5. List of Options in the Act That May Be Elected Either in the Articles of Incorporation or in the Bylaws

A. Options with Respect to Directors

  • Number of directors may be fixed or changed within limits, § 8.03.
  • Qualifications for directors may be prescribed, § 8.02.
  • Notice of regular or special meetings of board of directors may be prescribed, § 8.22.
  • Power of board of directors to act without meeting may be restricted, § 8.21.
  • Quorum for meeting of board of directors may be increased or decreased (down to one-third) from majority, § 8.24.
  • Action at meeting of board of directors may require a greater than majority vote, § 8.24.
  • Power of directors to participate in meeting without being physically present may be prohibited, § 8.20.
  • Board of directors may create board committees and specify their powers, § 8.25.
  • Board of directors may create safe harbor for consideration of corporate opportunities, § 8.70.
  • Power of board of directors to amend bylaws may be restricted, §§ 10.20 and 10.21.
  • Election of directors may be governed by the optional rules under section 10.22.

B. Options with Respect to Shares

  • Shares may be issued without certificates, § 6.26.
  • Procedure for treating beneficial owner of street name shares as record owner may be prescribed, § 7.23.
  • Transfer of shares may be restricted, § 6.27.