WARNING: New laws affecting Maryland business entities take effect October 1 | Miles & Stockbridge PC

On May 12, 2022, Governor Hogan signed several bills that will affect the formation, ownership and operation of business entities under Maryland law. Below is a summary of the new laws. Most important is the establishment of a legal process for the ratification of defective corporate acts. All changes will take effect October 1, 2022.

1. Ratification of Defective Corporate Acts

During due diligence, it is not unusual to discover that a corporation has issued more stock than it was legally authorized to by its charter or made other governance errors. Early-stage corporations, often without the resources to engage sophisticated financial or legal professionals, may be preoccupied with growth plans or simple survival and neglect basic corporate housekeeping. This type of legal blunder, and others like it, are commonly known as “wrongful corporate acts” and can exist undetected for years in corporations, coming to light at the worst possible time. Examples include:

  • Unauthorized issuance of shares;
  • Failure to approve bylaws by the board of directors;
  • Failure of the board of directors to properly elect corporate officers;
  • Corporate actions taken in the absence of board resolutions authorizing the action;
  • Failure to obtain necessary shareholder approval of a corporate action;
  • Failure to file with the Maryland State Department of Assessments and Taxation (“SDAT”) a required charter document; AND
  • Failure to maintain evidence that the amount was paid to the corporation for shares of stock.

Defective corporate acts can be remedied at common law through a variety of approaches, but not with the certainty that buyers, investors or third-party lenders often prefer.

House Bill 996 / Senate Bill 879 (Chs. 289/ 290) adds a formal process and safe harbor to the Maryland General Corporation Law (“MGCL”) that allows a Maryland corporation to ratify defective corporate bylaws and, when a defective bylaw is so ratified, prevent the act to be void or voidable only by virtue of the defective nature of the act. This change in law creates a process to eliminate uncertainty and, in turn, can be a useful tool where Maryland corporations are the target of an acquisition, investment or financing transaction.

The process set out in the legislation specifies certain information that must be included in a ratification resolution, as well as certain approvals that may be required for ratification. In some cases, submission of validation items to the SDAT may also be required. The requirements outlined in the legislation depend on the nature of the corporate authorization or action that would have been required in the first place for the act in question to be a valid corporate act. The periods when ratification becomes effective and binding on the corporation are also variable based on certain enumerated conditions.

The legislation also provides that compliance with the new process is not the exclusive means of ratifying a defective corporate act and that failure to ratify through such process does not of itself create a presumption that such act is actually invalid or null. Thus, existing common law approaches to ratification are still available. As a counterweight to the formal ratification process designed for the benefit of corporations, the legislation also provides a process for adversely affected parties to contest ratification after application to the courts.

2. Operating agreements and partnership agreements providing for the transfer of an equity interest upon certain events

House Bill 342 / Senate Bill 261 (Chs. 294/ 295) responds to a recent decision by the Maryland Court of Special Appeals in Potter v. Potter, 250 Md. App. 569 (2021). In Potter, the Court held that when a person is subject to Maryland’s wills statute and has an equity interest in an LLC or partnership, a transfer of that equity interest after the person’s death is subject to Maryland’s wills and intestacy laws— it. In effect, the ruling would invalidate a provision often seen in operating agreements and partnership agreements that provides for the transfer of a decedent’s interest in the company to a non-equity holder unless it is drafted and implemented in accordance with the formalities required by the statute. of Maryland on wills (eg, attestation by two credible witnesses). The General Assembly legislation avoids this result by expressly allowing death transfer provisions to be included in an operating agreement or partnership agreement. The new law specifies that, in the case of a posthumous transfer, such provisions are not testamentary (and thus not subject to probate review), thus preserving an important tool for business succession planning.

3. Miscellaneous changes

As it does in many years, the General Assembly, through House Bill 999 / Senate Bill 431 (Chs. 292/ 293), amended certain sections of the MGCL to improve the statute or to reflect advances in corporate governance. Some main points of the bill are:

  • A corporation’s term of existence can now be limited to a specific period and/or conditioned upon the occurrence of a specific event or action (as opposed to a specific, specific period). This will help asset managers, who have long preferred to use Maryland corporations to form certain registered and unregistered funds, allowing maximum flexibility in the duration of the fund’s existence.
  • A director who wishes to object to a proposed corporate action at any board meeting at which the director is present may now, along with other requirements to be met, file his objection in writing by electronic delivery after postponement of the meeting (this request previously had to be satisfied by certified mail).
  • The effective time for the dissolution of a corporation is the latest time that the SDAT accepts the articles of dissolution for registration or the time specified in the articles of dissolution which must not exceed 30 days after the acceptance of the articles of dissolution (previously in effect the time elapsed only subject to acceptance by SDAT).
  • Various provisions of the MGCL, where the existing language applied only to a specific entity, were expanded to apply to entities generally, or to include a specific entity not otherwise covered by the existing language, such as:
  • the treatment of the stock of a corporation as indirectly owned by the corporation if it is held by another corporation in which that corporation owns a majority of the voting stock was extended to apply to other (non-corporate) entities in in which that corporation owns the majority of shares. voting interests.
  • The majority approval required to abandon a proposed consolidation, merger or stock exchange prior to the effective date has been revised to include approval by the governing body of each entity party to the articles of merger (as opposed to the previous listing of only one board of directors or board of trustees).
  • the list of types of economic entities, for which a corporation is allowed to obtain insurance for a person serving in such an entity at the request of the corporation, is expanded to include limited liability companies.

4. Using or maintaining improper or outdated addresses on registered documents

In the files submitted to SDAT, business entities are required to include addresses for various purposes (e.g, the principal business office and the address of the resident agent). Existing law prohibits a governing document or charter document from being filed with SDAT using an address that the entity is not authorized to use for that purpose or that otherwise does not comply with Maryland law. Despite these requirements, SDAT has limited basis to investigate outdated or improper addresses or to enforce compliance. Similarly, in cases where a business sells its property, moves or closes, a new owner of the property has little opportunity to separate the property from the previous business entity, in SDAT records.House Bill 390 / Senate Bill 447 (Chap. 287/ 288), sponsored by SDAT, will change that by allowing a property owner to submit a statement to SDAT when they suspect their address is being used in a business entity that violates Maryland law. Upon receipt of the affidavit, SDAT will notify the affected business of the alleged violation. Businesses receiving such notices will have a period of 45 days to rebut the allegation, and if not rebutted, SDAT may revoke the governing document or charter document in question. In addition to this 45-day response period, the legislation includes procedures for a business to remedy the alleged violation. The legislation was designed to ease the administrative burden as well as the inconvenience to property owners when, for example, service of process is repeatedly carried out on an outdated address. This relief puts the burden back on business entities to monitor the status of addresses in all SDAT files and update them promptly where necessary, or risk jeopardizing the validity of the submission, or potentially the good standing of the business with the state of maryland.

For many years, the attorneys at Miles & Stockbridge have held leadership positions on the Corporate Law Committee of the Business Law Section of the Maryland State Bar Association. That committee monitors legislation implementing Maryland’s General Corporation Law, as well as laws governing other Maryland business entities. If you have questions about the laws summarized above, or how they may affect your business, please contact our corporate, securities and tax practice group for further assistance.

The opinions and conclusions in this post are solely those of the author, unless otherwise stated. The information contained in this blog is general in nature and is not provided and cannot be considered legal advice for any particular situation. The author has provided the links mentioned above for informational purposes only and in doing so does not endorse or include the content. Any federal tax advice provided in this communication is not intended or written by the author to be used, and may not be used by the recipient, for the purpose of avoiding penalties that may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format that complies with IRS rules and can be relied upon to avoid penalties.

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