Many Still Unaware of 2017 Changes to Law Involving Corporate Disputes

Any lawyer who advises clients on disputes involving corporations, LLCs, or limited partnerships needs to be aware of the significant changes that were enacted in Pennsylvania’s Act 170 on Feb. 21, 2017. Lawyers who are not aware of these changes will not only be operating at a disadvantage, they could be exposed to legal malpractice claims. This article summarizes changes in Act 170 that will have the most significant impact on commercial litigation in Pennsylvania. (The new statutory changes can be found at 15 PA.C.S. Section 101 et seq.)

Importantly, the changes in Act 170 apply retroactively to all LLCs, LLPs, corporations and GPs. I have been surprised by the number of lawyers who are unaware of these changes, and as a result, I have listed the highlights from a commercial litigator’s perspective.

Minority Owner’s Rights Expanded

If you represent a minority owner in a dispute involving a pre-2017 shareholders agreement that does not specify that a majority vote is sufficient for all corporate actions, these changes are good news. The new act requires “unanimous consent” of all owners to make any decisions that are deemed “outside the regular course of business.” This includes amending operating agreements or selling any ownership interest in the company. On the other hand, when representing a majority owner you will now need unanimous consent from even a 1 percent owner if you are going to make any significant decisions that are “outside the ordinary course of business.” I used to tell my clients once you get 51 percent control you are the “king,” but that is no longer the case unless the company had an existing operating agreement that specifically called out the ability of a majority vote to make such decisions.

Operating and Shareholder Agreements Rules Have Changed

There are huge changes in this area of the law, and you cannot get around Act 170 by attempting to amend the shareholders agreements now—without unanimous consent—unless your client’s existing shareholders agreement already specified that owners can amend the operating agreement with only a majority vote. This would even prevent the majority owners from selling a company without unanimous consent unless the shareholders agreement authorized a sale by majority vote before these 2017 changes. In my opinion, this will lead to many more legal disputes among owners who may incorrectly presume that the traditional majority vote would carry the day.

The changes to Act 170 also offer the benefit of “filling in the blanks” in any existing operating agreements that may have been poorly drafted and have no specific provisions covering the topics involved in your clients current dispute. The new act will also control situations where your clients have no operating agreement. In those instances, you will simply apply the statutory language in the act.

In my view, this gives minority shareholders greatly enhanced rights to pursue shareholder oppression clams against majority owners if they feel they are being treated unfairly by not getting a unanimous vote on important business issues That being said, the majority owners were also dealt some favorable changes with regard to certain procedural defenses that can be raised in response to a lawsuit-by minority shareholders as discussed below.

Defense Tools

Let’s say your client receives a threat of a lawsuit from a minority owner.  In that instance, the new Act allows them to potentially avoid litigation altogether by simply forming what is known as a special litigation committee (SLC) to review the allegations of the disgruntled shareholder. The majority owners can select the members of the SLC from the local business community—including individuals who are friendly with the majority owners.

The members on the SLC committee do not have to be shareholders or members of the company. If the SLC makes a determination that the minority owners complaints do not have merit, the court has the authority to dismiss any lawsuit based on the minority shareholders allegations. Further, the act anticipates that the SLC will do its own investigation. (See 15 PA.C.S. Section 8694) (b) (1).)

In fact, as long as the court finds that the members of the SLC committee were “disinterested” and acted in “good faith” the court is required to enforce the SLC’s determination of dismissal! This is potentially a very useful tool to avoid litigation from disgruntled minority owners, as it would result in a case being dismissed even before any discovery takes place.

Formal Written Notice Required

 The old rule permitted a shareholder to allege that sending notice and demand for action as a prerequisite to filing suit would have been “futile.” Under the new act, your case will be dismissed unless you provide a detailed written notice to any entity you plan on suing. The purpose of the notice is to give the entity the opportunity to resolve this issue before litigation is required. The notice must be sufficiently detailed and my practice is to include the draft complaint as a notice to avoid any dispute over the sufficiency of the notice. If no action is taken by the corporation then we file suit after a 14-day waiting period.

The notice requirement is a good defensive tool that can stop a lawsuit in its tracks. In cases where notice was actually given and you are defending the company, you can now ask the court to require the minority shareholder to post a bond to cover legal fees and demand damages to comply if the suit fails. While the court has the discretion to set the amount or to waive it, you do get a hearing on this issue and it is yet another tool to impede minority suits.

Agency Authority

A member will not be deemed an agent of an LLC solely because they are member regardless of whether the LLC is member managed.

Not only that, even a manager is not deemed to be an agent of an LLC unless the original certificate of organization filed with the state says so.

It remains to be seen whether these changes will lead to more or less litigation. Regardless, it is important to know that the rules of the game have changed significantly.