Any experienced Washington corporate attorney will tell you that, despite popular belief, you can incorporate your business in Washington state. We are proud to point out the number of publicly traded companies that have eschewed the pull of Delaware and kept their roots local, such as Microsoft, Starbucks and Costco.
Historically, companies have needed to consider including a few provisions in their articles of incorporation that are not needed in Delaware because of some peculiar quirks of Washington corporate law. If you had the misfortune of forming a Washington corporation without the help of a skilled practitioner, you could quickly create a corporate mess that may take significant time and legal fees to fix.
Thanks to Senate Bill 5003, which was recently signed by Gov. Jay Inslee and goes into effect Jan. 1, 2020, those Washington quirks may soon become the stuff of corporate legend. The Washington State Bar Association (WSBA) sponsored the bill, which addresses many of the pitfalls that Washington corporate law created for unwary corporations.
Shareholder Preemptive Rights
For corporations formed in Washington prior to Jan. 1, 2020, all shareholders had preemptive rights to stock issuances, unless otherwise specified by a company’s articles of incorporation (RCW §§ 23B.02.020(l); 23B.06.300). This means that unless certain language was included in the articles to disclaim such preemptive right, every time a corporation issued shares, the existing shareholders had a “fair and reasonable opportunity” to “acquire proportional amounts of the corporation’s unissued shares upon the decision of the board of directors to issue them” (RCW § 23B.06.300(1)). As noted in the bill report, this right is not afforded to shareholders under the Model Business Corporations Act or the business corporation laws of over 40 states (Final Bill Report of SB 5003).
The new law provides that a shareholder of a corporation formed on or after January 1, 2020 “has no preemptive right to acquire the corporation’s unissued shares …” Thus, beginning January 1, 2020, no special language is required in the articles to protect corporations from having to seek shareholder preemption waivers for every stock issuance approved by their boards of directors. If a corporation wants to retain a shareholder preemptive right, it can opt in by expressly including such right in its articles of incorporation.
Cumulative Director Voting
Current Washington law sets the following default procedure for board of director elections: Shareholders may multiply the number of votes they are entitled to cast by the number of directors for whom they are entitled to vote. In other words, if there are three board vacancies, a shareholder could vote three times his or her number of shares in favor of one director to fill one vacancy. This approach to voting is known as “cumulative voting” and conceivably makes it easier for minority shareholders to elect directors.
Prior to SB 5003, to avoid cumulative voting, a corporation’s articles of incorporation had to specifically opt out. See RCW § 23B.02.020(w). Once SB 5003 takes effect, this will no longer be the default provision in Washington. Instead, beginning on January 1, 2020, a corporation will have to opt in to cumulative voting.
Sale of “Substantially All” of a Company’s Assets
Like other states, Washington requires that shareholders approve a transaction whereby a corporation sells “all, or substantially all, of its property and assets” (RCW § 23B.12.020[1]). How much of a company’s properties and assets constitutes “substantially all”? This provision ensures that shareholders are protected when a company executes a change of control transaction through the sale of its assets rather than the sale of its stock or a merger.
The challenge with the current law is that it can be difficult to determine what constitutes “substantially all” of a business’s assets, particularly when a corporation is selling only a portion or subsidiary of its business enterprise. The new law clarifies that shareholder approval is required when “the disposition would leave the corporation without a significant continuing business activity.” SB 5003 further defines a continuing business activity to mean an activity that represents at least 25 percent of the business’s total assets from the previous fiscal year and 25 percent of either its revenue or income for the previous fiscal year. Finally, the new law requires that assets of a subsidiary are treated as assets of its parent corporation for purposes of the determination. This brighter line provides clarity for when shareholder approval is required in Washington.
Remaining Pitfalls
While the Washington State Bar Association, Washington Legislature and Gov. Inslee are to be commended for taking action to ensure Washington’s corporate law remains competitive, there are still a few oddities that remain. For example, shareholder approval of major corporate transactions requires approval by two-thirds of the shareholders entitled to vote, unless otherwise specified in the corporation’s articles of incorporation. The same holds true for amendments to a corporation’s articles of incorporation. Additionally, shareholder approval for corporate action must be obtained through a formal meeting or by unanimous written consent — an inefficient and cumbersome process — unless the articles of incorporation allow for a lower threshold.
Entrepreneurs, founders, investors and venture capitalists should work with knowledgeable Washington corporate attorneys to ensure these corporate traps are avoided. Thanks to the SB 5003 and careful planning, Washington remains a great place to do business.
Special thanks to Mark Worthington for his help with this article.
About the Author
Laura Harper's practice focuses on corporate and securities law. She represents companies in all stages, including startup, in a broad range of business-related matters including supporting ongoing operations, financing through private offerings or venture capital, strategic alliances and corporate restructuring. She also has extensive experience assisting clients with both sell- and buy-side mergers and acquisitions.
Prior to joining Summit Law Group, Laura was a corporate attorney in Alabama, both in-house at a biotechnology nonprofit company and in private practice.
Laura enjoys spending time with her family, including hiking and camping, and volunteering with her daughters’ Girl Scout troops.
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