CLA Sections Have Successful 2022 With Their Sponsored Legislation
By Saul Bercovitch
CLA’s Sections were hard at work in 2022 pursuing their legislative proposals, with eight out of eight section-sponsored bills being enacted. The changes made by these bills, discussed in detail in this article, become effective on January 1, 2023.
II. BUSINESS LAW SECTION
a. Corporations Committee
SB 49 conforms the conversion provisions applicable to California corporations with the conversion provisions applicable to California partnerships and limited liability companies (as well as corporations organized under the laws of most other states) by permitting a California corporation to convert into a business entity organized under the laws of another state in a single-step process.
Under the law in effect before SB 49, a California corporation that desired to convert into a business entity organized in another state needed to (a) create a new entity in the other state and then merge the two entities together, with the foreign entity surviving the merger and the California corporation ceasing to exist, or (b) convert into another type of California business entity (e.g., a partnership or limited liability company), and then convert that entity into a business entity organized in the other state.
Such multi-step conversions are significantly more cumbersome, time-consuming, and expensive than the single-step processes available to other types of California business entities and to corporations in other states.
Business owners often desire to change the form of organization of their business, or the state in which their business is formed—e.g., to respond to changing economic conditions, changes in the business they conduct, or changes in their shareholders’ priorities. While the Corporations Code provides flexibility in this regard for California partnerships and limited liability companies (LLCs), it did not provide the same flexibility to California corporations. The Corporations Code permits California partnerships and LLCs to convert in a single step from one type of entity to any other type of entity, whether the resulting entity is organized in this state or in another state. However, the Corporations Code discriminated against California corporations by allowing single-step conversions into different types of California entities, but not into entities formed in another state.
SB 49 remedies the problem described above by offering California corporations the same single-step conversion process available to California partnerships and limited liability companies, and the same flexibility available to corporations in other states.
SB 218 creates a statutory mechanism that allows California corporations to ratify or petition the superior court to validate noncompliant but otherwise lawful corporate actions, bringing California in line with several other states that have established a framework to ratify or validate such actions.
It is not unusual for small, privately held corporations (often family-owned at the start) to be managed with less formality than seasoned corporations. Such businesses often try to conserve resources by, among other things, handling board and shareholder matters on their own rather than seeking the advice of legal experts. As the individuals who form California corporations often hope, these businesses can develop to a stage where the formality of board and shareholder actions becomes more important. That often happens when developing businesses reach the point of undertaking significant corporate transactions, such as seeking outside funding, acquiring other businesses, selling a line of business (or the entire corporation), or undertaking an initial public offering. When corporations reach that point, management often learns that certain prior corporate actions were not properly undertaken and that corrective action is necessary to proceed with the transaction.
Although common law ratification may be used to “clean up” such matters, there is uncertainty as to whether such ratification can cure prior defects in authorization as the law is silent as to whether those efforts actually have the intended effect. Common law ratification also does not enable ratification as of the time the defective action was initially taken, which means subsequent actions taken in good faith but which are defective are not cured. That uncertainty can serve as the basis to inhibit the ability of a closely-held, relatively informally managed young corporation from carrying out its objectives—to create a new business that would grow and create economic benefits for the individuals who took the risk to start it and the employees it was able to recruit into that effort.
SB 218 is limited to ratification or validation of “otherwise lawful corporate actions.” To further safeguard against the possibility of corporate malfeasance, the bill explicitly identifies certain corporate actions that cannot be ratified or validated under the statutory scheme. Thus, corporations cannot ratify or validate actions that do not comply with these delineated provisions: Corporations Code section 309(a) (establishing the fiduciary duties of a director); Corporations Code section 310(a) and (b) (setting forth requirements for disclosure and voting on contracts or transactions that potentially present a conflict of interest for a director); Corporations Code section 315 (setting forth procedures to ensure the propriety of loans and loan guarantees to directors and officers); Corporations Code section 500 (a) (establishing what a corporate board must determine in good faith in order to make a distribution to shareholders); and Corporations Code section 501 (forbidding corporations and their subsidiaries from making such a distribution if doing so would render the corporation unable or unlikely to meet its liabilities). SB 218 also may not be used by corporations that have previously dissolved or foreign corporations.
Any action that would have required the consent of the board of directors or shareholders of the corporation must receive the vote of the required members of the board of directors or shareholders, as the case may be, to be ratified.
SB 218 requires the corporation to provide timely notice to shareholders of any potential ratification or validation. SB 218 also avoids ratification or validation of past corporate actions in order to render moot a pending lawsuit challenging the validity of those actions. The bill requires a petition for validation filed in the superior court to identify every pending legal proceeding of which the petitioner is aware in which (1) the validity of the corporate action is being directly challenged, or (2) the validation of the corporate action would result in the dismissal of the proceeding. If the corporation is a party to a pending legal proceeding in which the validity of a corporate action sought to be ratified or validated is at issue or the ratification or validation would result in the dismissal of the proceeding, the corporation must also notify the judge, arbitrator, or other person presiding over that other proceeding.
Finally, as with other provisions of the California corporation code, corporations using Corporations Code section 119 to ratify or validate defective acts are required to retain records of a ratification or validation.
b. Partnerships and Limited Liability Companies Committee
AB 1802 improves the provisions of the Revised Uniform Limited Liability Company Act (“RULLCA”), clarifies and eliminates a potential ambiguity or conflict of terms, and conforms to the practices in place for other California business entities. Specifically, the bill clarifies who may act on behalf of a dissolved (canceled) limited liability company (“LLC”) that has filed a Certificate of Cancellation with the Secretary of State and how the otherwise dissolved LLC may distribute or transfer any omitted or retained assets and discharge any remaining liabilities. The bill also corrects certain cross-references with regard to related sections of the dissolution and winding up provisions of RULLCA. Specifically, the bill clarifies and correct the provisions concerning the effect of the filing of a Certificate of Cancellation and authorizes the appropriate representatives of an LLC to pay over to creditors and then distribute any excess assets in the canceled LLC. The bill will also avoid unnecessary legal actions that may otherwise be required to address the right to transfer of property retained in a canceled LLC.
The statutory changes in the bill clarify that any assets inadvertently or otherwise omitted from the initial winding up process continue in the LLC for the benefit of the persons entitled to those assets upon dissolution and cancellation and that the assets must be used to discharge unsatisfied liabilities, if any, known to the company, with any excess distributed to the members. In addition, the bill expressly provides that an exception to the language of Corporations Code section 17707.08 that states that the LLC has no powers is the express right in Corporations Code section 17707 to apply omitted assets to discharge liabilities and distribute the balance to the members. Finally, since Corporations Code sections 17707.04 and 17705 address the winding up and dissolution of assets, the bill corrects the cross-reference in Corporations Code section 17707.08(b)(1) to reference Corporations Code sections 17707.04 and 17705 and both the winding up of the LLC’s affairs and distribution of its assets pursuant to Corporations Code sections 17707.04 and 17707.05.
AB 2431 (Committee on Banking and Finance)
AB 2431 addresses an inconsistency in the treatment of limited liability companies from that of corporations. Specifically, under Corporations Code section 17702.09, every limited liability company and every foreign limited liability company registered to transact intrastate business in California is required to deliver to the Secretary of State for filing within 90 days after the filing of its original articles of organization or registering to transact intrastate business, and biennially thereafter during the applicable filing period, a statement of information as specified in the statute.
Under the statutory language, the statement of a corporation applies only to the officers or directors of the corporation, thereby applying the provisions to those who manage and direct the affairs of the business entity. It does not, for example, apply to a corporation’s shareholders. In contrast, under the statutory language in effect before AB 2431, the statement of a limited liability company applied to “any member” even if the member was not an agent of the limited liability company for the purpose of its business and affairs.
AB 2431 ensures that the disclosure requirement for a limited liability company is consistent with that of a corporation by limiting that requirement to managers and those members who are agents of the limited liability company for the purpose of its business and affairs.
III. TRUSTS AND ESTATES SECTION
AB 1745 clarifies the 120-day limitation period for contesting a trust. Under Probate Code section 16061.7, a trustee is required to serve a statutory notification on all persons interested in the trust within 60 days of the following events:
- when a revocable trust or a portion of a trust becomes irrevocable because of the death of a settlor;
- whenever there is a change of trustee of an irrevocable trust; and
- whenever a power of appointment retained by a settlor over an otherwise irrevocable trust lapses upon death.
Under Probate Code section 16061.8, a person upon whom this notification is served shall not bring an action to contest the trust more than 120 days from the date the notification is served, or 60 days from the date on which a copy of the terms of the trust is delivered, whichever is later.
The statutory notification promotes the efficient administration of a trust after the death of a settlor because it alerts all interested parties to the short 120-day limitation period available to contest the trust instrument. The trustee serves the notification, commonly with a copy of the relevant terms of the trust, on all interested parties. If the applicable limitation period expires with no action by the interested parties, the trustee can confidently administer the trust according to its terms and without fear of a pending contest. If one or more interested parties file a contest within the 120-day period, the trustee can bring all contests to a head and settle them with finality.
More than one event may occur during a trust administration that triggers notification under Probate Code section 16061.7. For example, (1) death of the settlor in year 1 would trigger notification; and (2) change of the trustee in year 3 would trigger a second notification. Under the law in effect before AB 1745, it was not clear if the beneficiaries had a new 120-day period to contest the trust following the second notification sent in year 3. Yet there would be no reason to allow trust contests following change of the trustee and to do so would be contrary to the goal of finality, established following the initial statutory notification that is provided after death of the settlor.
AB 1745 clarifies that the 120-day limitation period for contesting a trust, after the trustee notification required under Probate Code section 16061.7, applies only when the notification is required by reason of the death of a settlor. This clarification is consistent with the language in Probate Code section 16061.7(h). Under Probate Code section 16061.7(h), the trustee notification must include a statutory warning about the 120-day period to contest the trust, but only when the notification is required by reason of the death of a settlor.
Irrevocable grantor trusts are a commonly used tool in estate planning. AB 1866 modernizes existing trust law and will incentivize people to continue to have their trust governed by California law, while not diminishing the rights of creditors. Specifically, the bill clarifies that if the settlor’s sole beneficial interest in a trust is a discretionary right to be reimbursed for income taxes payable by the settlor on the income or principal of the trust then that interest, alone, will not subject the assets of the trust to claims of the settlor’s creditors.
An irrevocable grantor trust is characterized by its conflicting treatment under income tax law and transfer tax (i.e., gift, estate and generation-skipping transfer tax) law. Under federal transfer tax law, a gift to an irrevocable grantor trust can be removed from the grantor’s taxable estate as a completed gift; but, due to certain powers retained by the settlor, the trust assets, and the corresponding income and principal, are deemed owned by the settlor under income tax law, so the settlor will be subject to income tax on the trust’s income.
Because the settlor of an irrevocable grantor trust is responsible for paying income tax on trust income that the settlor never receives, many settlors would like to include a provision granting the trustee a discretionary power to pay (or reimburse the settlor for) some or all of the increased tax liability imposed on the settlor attributable to the assets of the trust. California trust and estate practitioners, however, are generally cautioned under best practice principles to avoid including such “discretionary tax reimbursement powers” in irrevocable grantor trusts out of concern that inclusion of such a power could cause all or a portion of the trust assets to be includible in the settlor’s estate for federal estate tax purposes.
Accordingly, a Californian seeking to establish an irrevocable grantor trust would often be encouraged to form the trust in another state that allows for discretionary tax reimbursement powers, thereby potentially prejudicing California beneficiaries who may need to travel to that state or hire local counsel to enforce their interests in the trust. Settlors of existing irrevocable grantor trusts who no longer wish to bear the burden of the trust’s income taxes often have no choice but to “turn off” grantor trust status (by relinquishing the rights causing such status). This is often accompanied by transferring the situs of the trust to a low or no income tax state, thereby potentially depriving California of the tax revenue formerly paid by the settlor.
AB 1866 amends the spendthrift provisions under Chapter 2, Part 2 of the Trust Law to effectively allow the trustee of a California irrevocable grantor trust to reimburse the settlor, on a discretionary basis, for income taxes payable by the settlor on income or principal of the trust by clarifying that such a discretionary reimbursement right does not cause the assets of the trust to be subject to claims of the settlor’s creditors (and, thereby, potentially includable in the settlor’s gross estate for estate tax purposes). This modification does not allow a settlor to create a “self-settled asset protection trust” that is otherwise prohibited under existing California law.
AB 1866 will incentivize settlors to establish irrevocable trusts with California trustees and subject to California law, when they might otherwise look to a different jurisdiction to enjoy this benefit. This will put California creditors and beneficiaries in a better position to exercise their rights with regard to the settlor and the trust; increase California tax revenue by encouraging California taxpayer settlors to set up grantor trusts when they might otherwise use non-grantor trusts outside of California to avoid having non-reimbursable tax liability for trust income; and benefit California fiduciary business due to an increased number of California irrevocable grantor trusts.
Under existing law, the court may authorize a conservator to sell a conservatee’s present or former personal residence only if the court finds by clear and convincing evidence that the conservator demonstrated a compelling need to sell the residence for the benefit of the conservatee, subject to other statutory requirements. Under the law in effect before SB 1005, these requirements did not apply to the partition of a conservatee’s personal residence, which often results in a sale (or division) of that residence.
Under Probate Code section 2541, a guardian or conservator may sell real or personal property of the estate in any of the following cases: (a) if the income of the estate is insufficient for the comfortable and suitable support, maintenance, and education of the ward or conservatee or those legally entitled to support, maintenance, or education from the ward or conservatee; (b) if the sale is necessary to pay certain debts; or (c) if the sale is for the advantage, benefit, and best interest of the ward or conservatee, the estate, or the ward or conservatee and those legally entitled to support, maintenance, or education from the ward or conservatee. Notwithstanding Probate Code section 2541, under Probate Code section 2541.5, the court may authorize a conservator to sell a conservatee’s present or former personal residence only if the court finds by clear and convincing evidence that the conservator demonstrated a compelling need to sell the residence for the benefit of the conservatee. Further, under Probate Code section 2540, subdivision (b), in seeking to sell the conservatee’s present or former personal residence, the conservator must notify the court that the residence is proposed to be sold and that the conservator has discussed the sale with the conservatee. The conservator must inform the court whether the conservatee supports or opposes the sale, describe the circumstances that require the sale, and report whether the conservatee has the ability to live in the personal residence and why other alternatives, including in-home care services, are not available. (Prob. Code, § 2540, subd. (b).)
Under Probate Code section 2463, a guardian or conservator may bring an action against the other cotenants for partition of any property in which the ward or conservatee has an undivided interest if the court has first made an order authorizing the guardian or conservator to do so.
Under the law in effect before SB 1005, Probate Code section 2463 did not discuss the showing necessary to bring a partition action of the conservatee’s personal residence, nor did the Probate Code impose on a partition the requirements set forth in Probate Code sections 2352.5, 2540, 2541, and 2541.5 that are imposed on a sale. SB 1005 fixes this problem by extending to a partition the requirements governing the sale of a conservatee’s residence.
SB 1279 strengthens and codifies several aspects of guardian ad litem appointments, which often occur informally or without clear guidance for litigants and their lawyers, and resolves ambiguities in the statutes as to when appointment of a guardian ad litem is appropriate. The changes made by SB 1279 are:
- The bill clarifies language specifying those for whom the court may appoint a guardian ad litem.
- The bill adds requirements if an application is made for the appointment of a guardian ad litem for a person who already has a guardian or conservator of the estate. The application may be granted only if:
- The applicant gives notice and a copy of the application to the guardian or conservator of the estate upon filing the application.
- The application discloses the existence of a guardian or conservator of the estate.
- The application sets forth the reasons why the guardian or conservator of the estate is inadequate to represent the interests of the proposed ward in the action.
The guardian or conservator of the estate will then have five court days from receiving notice of the application to file any opposition to the application.
- The bill requires a proposed guardian ad litem, before their appointment in a civil or probate proceeding, to disclose both of the following to the court and all parties to the action or proceeding:
- Any known actual or potential conflicts of interest that would or might arise from the appointment.
- Any familial or affiliate relationship the proposed guardian ad litem has with any of the parties.
If a guardian ad litem becomes aware that a potential conflict of interest has become an actual conflict of interest or that a new potential or actual conflict of interest exists, the guardian ad litem must promptly disclose the conflict of interest to the court. These provisions will ensure that the court and the parties are aware of any conflicts, allow the court to make a decision as to the appointment, and protect the interests of the ward (the person whose interests are being represented by the guardian ad litem).
Saul Bercovitch is CLA’s Associate Executive Director of Governmental Affairs.