Actions for Corporations to Obtain the Benefits of Amendments to the Texas Business Organizations Code

Public & Private Texas Corporations: Affirmative Elections to Make in Governing Documents Now

Public and private Texas corporations must amend their certificate of incorporation or bylaws to opt-in to the benefits of some provisions of S.B. 29:

• Defending Against Derivative Suits: Public Texas corporations¹ may adopt a minimum share ownership percentage for individual shareholders or groups of shareholders in order to institute or maintain a derivative proceeding. The threshold may not exceed three percent of a company’s outstanding shares.

• Codification of the Business Judgment Rule: As discussed hereafter, S.B. 29 codifies the business judgment rule. The business judgment rule applies automatically to public Texas corporations, but private Texas corporations may opt into this provision by including in their governing documents a statement affirmatively electing to be governed by TBOC 21.419.

• Waiver of Jury Trials for Internal Entity Claims: Any Texas corporation may amend its governing documents to include a waiver of the right to a jury trial concerning any internal entity claim, defined to include derivative claims and other claims that relate to the internal affairs of the corporation. Texas corporations will now share this right that Texas limited liability companies and limited partnerships already enjoy and that Delaware corporations have in the Delaware Court of Chancery (a non-jury trial court).

• Adopt or Update Exclusive Forum Provision: S.B. 29 permits both public and private corporations to designate in their governing documents a Texas court with jurisdiction over the matter as the exclusive forum and venue for resolving internal entity claims, codifying what practitioners believed would have eventually been a Texas court ruling had any existing exclusive forum provisions been challenged. A corporation without an exclusive forum provision in its governing documents should consider adopting such a provision, including whether the Texas Business Court is a favorable forum.

Next Steps

For corporations incorporated in Texas:

• Educate the board of directors about these changes to the TBOC.
• Discuss whether and how to elect into the benefits of these changes. Amendments to the certificate of formation, if desired, require shareholder approval. Bylaw amendments, by contrast, are usually subject only to board approval (but might be more easily changed through shareholder pressure in the future).
• Consider reaching out to your director and officer insurance provider to see how amendments to the TBOC and elections you may make could affect your corporation’s insurance premiums.
• For public companies, consider whether any updates are needed to your corporation’s public disclosure—for example, in risk factors or in the description of common stock exhibit to your Annual Report on Form 10-K—particularly if your corporation elects the benefits of any provisions of S.B. 29.

For corporations incorporated under the laws of another state:

• Consider updating the board of directors in the ordinary course about the differences in the corporate law frameworks of Delaware, Texas and other states.
• If you have questions about which state of incorporation is best for your company, please reach out to Vinson & Elkins.

Codification of the Business Judgment Rule

One of the most important features of S.B. 29 is the codification of the business judgment rule (the common law rule that presumes that, in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation). Codifying the business judgment rule makes it unlikely that Texas courts will review actions under enhanced scrutiny or entire fairness, two heightened standards of review formally adopted by Delaware courts. No Texas court has adopted a standard of review of board actions similar to Delaware’s enhanced scrutiny or entire fairness, so it is expected that even without this election the business judgment rule will remain the Texas standard of review of a director’s or officer’s corporate decision-making. Nevertheless, electing into this codification reduces the possibility that a court adopts review standards currently in favor in some other jurisdictions.

S.B. 29 also clarifies that the plaintiff bears the burden to prove any claim of breach of fiduciary duty and, for a plaintiff to have a cause of action, the plaintiff must (i) rebut the presumptions of the business judgement rule and (ii) prove both (a) a breach of fiduciary duty and (b) that the breach involved fraud, intentional misconduct, an ultra vires act or a knowing violation of law. This is not merely a restatement of existing case law and is a benefit worth electing to receive.

Books and Records Demands

S.B. 29 modifies the rights of shareholders to inspect the books and records of a Texas corporation in two ways. First, S.B. 29 narrows the records that are subject to shareholders’ books and records demands. The law now states that shareholders making a demand are not entitled to review emails, text messages, similar electronic communications, and information from social media accounts unless the particular communication or information effectuates an action by the corporation. Second, the law alters what constitutes a “proper purpose” necessary to allow inspection of books and records of public Texas corporations, as well as private Texas corporations that elect to be governed by the codified business judgment rule. Books and records demands brought by a demanding shareholder or its affiliate in connection with an active derivative proceeding or civil lawsuit will no longer be considered brought for a “proper purpose.” Instead, demanding shareholders should use a regular discovery process in connection with the proceeding.

Independent and Disinterested Directors

S.B. 29 expressly authorizes the board of directors of public Texas corporations, as well as private Texas corporations that elect into the codified business judgment rule, to form a committee of independent and disinterested directors to review and approve transactions with a controlling shareholder, director or officer. S.B. 29 also allows those corporations to seek an advance judicial determination that the directors on the committee are independent and disinterested with respect to those transactions. Similar provisions have been added with respect to members of committees formed to evaluate a derivative claim.

Limiting the Recovery of Attorney’s Fees

Under TBOC § 21.561, a corporation is required to reimburse the plaintiff in a derivative proceeding if the court finds that the lawsuit resulted in a “substantial benefit” to the corporation. S.B. 29 clarifies that additional or amended disclosures made to shareholders as a result of such a proceeding does not constitute a “substantial benefit,” regardless of the materiality of the disclosures.

Default Voting Rights of Different Classes of Stock

One impediment to Texas incorporation for corporations that desire or need to issue multiple classes or series of shares has been a fairly robust set of mandatory separate class or series voting rights in TBOC § 21.364. S.B. 29 addresses this past impediment by affording corporations greater flexibility in structuring the respective voting rights of classes or series of shares, including for increases or decreases in the authorized shares of a class or series and for voting as a single class across classes or series. S.B. 29 also eliminates mandatory separate class or series voting on fundamental actions or fundamental business transactions.

Texas—A Legitimate Competitor for Incorporations

These reforms to the TBOC aim to create an improved legal environment for corporate governance of both public and private companies in Texas. Against the backdrop of the recent creation of the specialized Texas Business Courts and ongoing efforts to start a Texas-based stock exchange in Dallas, the TBOC amendments (and other amendments proposed in the Texas legislature this year) provide additional incentives for corporations to choose Texas as their state of incorporation. For corporations already in Texas, S.B. 29 provides opportunities for corporations to opt in to new safeguards and possess greater certainty on legal outcomes.

¹ A public Texas corporation is a Texas corporation that “has a class or series of voting shares listed on a national securities exchange.” The TBOC defines a national securities exchange to be both a national securities exchange as defined under Section 6 of the Securities Exchange Act of 1934 (for example, NYSE and Nasdaq) as well as a stock exchange that has its principal office in Texas and has been approved under certain provisions of the Texas securities laws. Note that many public reporting companies are not listed on a national securities exchange or a Texas stock exchange and will not meet this definition.