2012 Ohio Corporate Law Update

Corporate Transactions & Securities Update

Date: August 09, 2012

Acknowledgments

This annual summary of selected developments in Ohio corporate law was prepared by the following members of Thompson Hine LLP's Corporate Transactions & Securities practice group: Frank D. Chaiken, Practice Group Leader; Philip J. Holroyd; J. Michael Herr; Thomas A. Aldrich; Jim Balthaser; and Todd M. Schild.

Introduction

In May, Ohio enacted a number of changes to its corporation and limited liability company statutes. This update provides an overview of the more significant changes, which include:

  1. A new limitation on a corporation's ability to rescind articles providing for the indemnification of employees, officers and directors.
  2. A reduction in the minimum number of corporate directors from three to one.
  3. A more structured process for voluntary corporate dissolution and winding up.
  4. New limitations on dissenters' rights in transactions involving publicly traded shares and a new dissent procedure.
  5. The institution of mandatory fiduciary duties for members of limited liability companies, including a broad duty not to compete with the company.


This update also summarizes two recent Ohio Supreme Court cases that address Ohio corporation law. The first, Acordia of Ohio, L.L.C. v. Fishel, No. 2012 Ohio 2297 (Ohio Jan. 2012), addressed the enforceability of employee noncompete agreements with a corporate employer in the event of a subsequent statutory merger. The second, Miller v. Miller, No. 2012 Ohio 2928 (Ohio July 2012), clarified the scope of a corporation's duty to advance the litigation expenses of directors who may be entitled to indemnification.

Statutory Changes
I. OHIO GENERAL CORPORATION LAW


House Bill 48 amended four substantive areas of the Corporation Law: the indemnification of directors, officers and employees; the number of corporate directors; voluntary dissolution and winding up; and dissenters' rights. These topics are addressed in order below.

II. THE LIMITED LIABILITY COMPANY LAW


House Bill 48 made a significant addition to the Limited Liability Company Law, in that it codified the fiduciary duties that members owe to the company and to other members.

III. STATUTE OF LIMITATIONS

 Effective September 28, 2012, Senate Bill 224 shortens Ohio's statute of limitations for actions on written contracts from 15 years to eight. The new eight-year window applies to all claims accruing after September 28, 2012, regardless of the contract's execution date. Claims accruing prior to September 28, 2012 are, on the other hand, subject to a different limitations period. Such claims must be brought by the earlier of September 28, 2020 (eight years after the law becomes effective) or the date 15 years after the claim accrued.

The shortened limitations period should factor into contract negotiations. The change will reduce litigation risk for contracting parties, which should encourage parties to select Ohio as the governing body of law. While the change does limit a party's ability to protect his or her contract rights, the limitation appears marginal, as Ohio's claim window remains relatively long - eight years, as opposed to the three years Delaware law provides for actions on written contracts.

Ohio's statutory changes arise out of House Bill 48, which became effective May 4, 2012. The bill contains a number of amendments to the Ohio General Corporation Law (Ohio Revised Code, Title XVII, Chapter 1701) (Corporation Law) and the Ohio Limited Liability Company Law (Ohio Revised Code, Title XVII, Chapter 1705) (Limited Liability Company Law).

On June 26, 2012, Ohio also shortened the statute of limitations for actions on written contracts, which is discussed in Section III.

Recent Case Law
A. Acordia of Ohio, L.L.C. v. Fishel

Acordia addresses a surviving entity's right to enforce employee noncompetition agreements following a merger. While the complete organizational history is complex, the salient transaction in Acordia was the 2001 merger of Acordia, Inc. with and into the plaintiff, Acordia of Ohio L.L.C. (Acordia L.L.C.). Acordia L.L.C. survived the merger and assumed a number of Acordia, Inc.'s employees who had noncompetition agreements with the predecessor corporation, Acordia, Inc. (and certain intermediate entities).

In August 2005, four of the assumed employees went to work for one of Acordia L.L.C.'s competitors. Believing that the merger gave it the right to enforce Acordia, Inc.'s noncompetition agreements, Acordia L.L.C. filed a breach of contract action against the four employees, seeking injunctive relief and damages.

The Ohio Supreme Court rejected Acordia L.L.C.'s claim in a 4-3 decision. Although Acordia L.L.C. "control[ed] the employees' contracts after the merger" pursuant to O.R.C. ? 1701.82, Acordia L.L.C. could "not enforce the noncompete agreements as if [it] had stepped into the shoes of the company that originally contracted with the employees." Id. at ? 11. The holding was dictated by the common law of contract. The agreements at issue prevented the employees from competing with Acordia, Inc. (or the intermediate entities), not Acordia L.L.C. The agreements also "did not state that they [could] be assigned or [that the noncompetition provisions would] carry over to successors." Id. at ? 12. According to the court, the agreements' plain language showed that the parties did not intend to prevent the employees from competing with successor entities.

Acordia follows the Sixth Circuit's affirmation of another limitation on the transfer of contract rights in a corporate merger under Ohio law. In Cincom Systems, Inc. v. Novelis Corp., the Sixth Circuit affirmed its holding in PPG Industries, Inc. v. Guardian Industries Corp., 597 F.2d 1090 (6th Cir. 1979), that (i) a merger pursuant to the Corporation Law effectuates a "transfer" of patent or copyright licenses from the merged entity to the surviving entity and (ii) federal common law prohibits the transfer of copyright or patent licenses in a merger without contractual provisions to the contrary.

Like Acordia, Cincom Systems arose out of a corporate reorganization that included a merger governed by the Corporation Law. Alcan Rolled Products Division (Alcan) licensed two computer programs from Cincom Systems. As part of the reorganization, Alcan merged into a Texas corporation and changed its name to Novelis. Novelis continued to use the two programs without Cincom Systems' consent. It must be noted that the reorganization did not result in an actual change of ownership or control of the business.

After it discovered the post-merger use, Cincom Systems sued Novelis for violating transfer restrictions in the two licenses, citing PPG Industries. The Sixth Circuit upheld a lower court ruling in favor of Cincom Systems. The court held that the merger effectuated a "transfer" of the two software licenses under PPG Industries, which federal law prohibits without the copyright holder's (i.e., Cincom Systems') consent.

Addressing Novelis' statutory argument, the court found that the PPG Industries merger-causes-transfer rule for intellectual property contracts survived a recent change to the controlling merger provision in the Corporation Law. Passed in 1955, the statute originally provided that "all property of a constituent corporation shall be 'deemed to be [t]ransferred to and vested in the surviving corporation without further act or deed." O.R.C. Ann. ? 1701.91(A)(4)(1955) (emphasis added). The 2009 version of the statute removed all reference to property transferring to the surviving entity. The statute now provides that the surviving entity "possesses all assets or property of every description ... all of which are vested in the surviving ... entity without further act or deed" (emphasis added). Novelis argued that the removal of the word "transferred" from the statute meant that contracts no longer "transferred" pursuant to the statute but, rather, automatically vested by operation of law in the surviving entity. The Sixth Circuit rejected Novelis' argument, holding that "in the context of a patent or copyright license, a transfer occurs any time an entity other than the one to which the license was expressly granted gains possession of the license," such as in a merger.

The Acordia and Cincom Systems cases highlight the need for careful due diligence in Ohio corporate mergers and for parties to take effective action to preserve valuable contract rights of the constituent entities. Such measures may include amendments as necessary to ensure that contracts continue to be binding on the corporate successors of the parties in the merger.

B. Miller v. Miller

Miller clarifies the scope of an Ohio corporation's obligation to advance litigation expenses to officers and directors in connection with the corporation's duty to indemnify them for claims arising out of their duties. Tasked with analyzing the interaction of the Corporation Law's advancement provision, Section 1701.13(E)(5), and the provisions allowing for director indemnification, Sections 1701.13(E)(1) and (2), the Ohio Supreme Court issued two important holdings.

First, it held that a corporation that agrees to indemnify a director pursuant to Sections 1701.13(E)(1) or (2) must advance the director's litigation expenses pursuant to Section 1701.13(E)(5) regardless of whether the director is ultimately entitled to indemnification. This means that a corporation must advance a director's litigation expenses even in cases where the director is accused of misconduct detrimental to the corporation, as happened in Miller. In other words, a corporation cannot "avoid its duty to advance expenses to a director under [Section] 1701.13(E)(5)(a) by claiming that the director's alleged misconduct, if proven, would amount to a violation of his or her fiduciary duties and would therefore foreclose indemnification." Id. at ? 39.

The second holding follows from the first. A corporation that receives an undertaking that complies with Section 1701.13(E)(5)(a) must "advance expenses to the director unless the corporation's articles or regulations specifically state that [Section] 1701.13(E) does not apply to the corporation" (emphasis added). The "undertaking" is a writing or other agreement whereby the director agrees to:

  1. [R]epay such amount if it is proved by clear and convincing evidence in a court of competent jurisdiction that [the director's] action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the corporation or undertaken with reckless disregard for the best interests of the corporation; and
  2. [R]easonably cooperate with the corporation concerning the action, suit or proceeding.


The Miller holding mirrors Delaware law on the advancement of litigation expenses to corporate directors. As the decision effectively mandates advancement if the corporation has agreed to indemnify, corporations can only avoid the potentially distasteful prospect of advancing monies for the defense of an unscrupulous director by jettisoning indemnification altogether. This may be an unrealistic proposition that could discourage qualified individuals from serving in those capacities.

Conclusion

The preceding highlights recent, notable changes to the Ohio law of corporations and limited liability companies. The new duties for members of limited liability companies is probably the most significant; it has certainly generated the most commentary in the corporate-law community. The new creditor notification and claim resolution procedure for voluntarily dissolved corporations is also significant. And, finally, although more narrow and technical, familiarity with the other changes to the Corporation Law, such as the reduction in the minimum number of directors and the limitation on retroactive removal of indemnification, is necessary to provide comprehensive counsel.

Footnotes

1Under Section 1701.87(G), newspaper publication is still required for corporations that voluntarily dissolve before May 4, 2017.