Have you incorporated your small- or mid-sized business by filing the Articles of Incorporation, but you now realize that the company never took other necessary steps to complete the incorporation? Or, has your corporation been operating for a while without properly reflecting decisions and actions in corporate minutes? Have you neglected to hold annual meetings of the shareholders and directors?
We see this all the time. However, most of these errors can be easily remedied. The California Legislature enacted the relatively new ratification/validation statute Corporations Code section 119 as a practical tool for businesses operating throughout California to address defective corporate actions that can arise in formation and early operations.
California corporations can use this procedure to correct otherwise lawful corporate actions not in compliance with the Corporations Code or corporate documents or agreements. This is usually accomplished by drafting omnibus minutes to shore up any inadvertent failures to properly authorize previous corporate actions. For incorporation-related errors that implicate filings with the Secretary of State or other agencies, section 119 requires the organization to file a “certificate of ratification” when the ratified action would have required a filing or would make an existing filing materially inaccurate or incomplete.
Section 119 provides that unless the resolutions or a court determination state otherwise, the ratification relates back to the date of the original corporate action. For employers, this relation-back concept can be critical when corporate status, authority or capitalization is questioned in connection with employment onboarding, benefit plan administration, equity compensation, banking or contracting.
If there is uncertainty about validity, shareholder disputes or heightened risk (e.g. where a third party might challenge the effectiveness of the corrective action), section 119 provides a pathway for a court to determine the validity and effectiveness of the corporate action.
Section 119 is commonly used for:
- Defective incorporator actions
- Failure to properly appoint initial directors
- Missing or defective minutes
- Other technical noncompliance with articles/bylaws
The statute requires ratifying resolutions to:
- Identify each corporate action to be ratified
- State the date of the original act
- Describe the noncompliance
- Approve the ratification
Why is this important?
There are risks to having defective corporate documents. There are many situations where third parties ask to inspect the corporate records. For example, if the organization wants financing, banks and lenders will want to see proper corporate records. If the organization is seeking to sell its business, any buyer will look carefully to make sure that there are no defects in the corporate documents. In litigation, the organization could lose its limited liability protection if it has not followed corporate formalities (referred to as “piercing the corporate veil”). That could lead to individual shareholders being liable for corporate debts. Finally, faulty corporate documents could cause or exacerbate disputes among the shareholders and directors of an organization.
We would be happy to help you shore up any defects in your corporate records and assist with periodic corporate maintenance. Please contact us.