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New Statute Provides Remedy for Overissuance of Stock

By Kristen M. Cox on January 29, 2016

    Often, shareholders of small and midsized corporations who also serve as the governing persons of those corporations must devote so much of their time and energy to business operations that corporate formalities may be overlooked and actions taken without proper approval. An example of such a situation is the issuance by a corporation of stock in excess of the number of authorized shares included in the corporation’s Certificate of Formation, which happens more often than you would expect. Fortunately, a new amendment to the Texas Business Organizations Code (“TBOC”) provides a relatively simple remedy for the overissuance of shares by Texas corporations.

    During its most recent session, the Texas legislature passed S.B. 860, which added a new Subchapter R to Chapter 21 of the TBOC effective as of September 1, 2015. Under Subchapter R, an overissuance of shares will not be void or voidable if the shares are ratified by the directors and shareholders of the corporation in accordance with Subchapter R.

    First, the corporation’s directors must adopt a resolution that: (i) describes the overissuance to be ratified, including the number and type of shares that were part of the overissuance and the date(s) on which the corporation purportedly issued putative shares, (ii) explains the failure of authorization related to the issuance of the shares, and (iii) approves the ratification of the overissuance.

    Second, the corporation’s shareholders must also adopt the resolution adopted by the board of directors to ratify the overissuance.

    Finally, a Certificate of Validation must be filed with the Texas Secretary of State. The certificate must include a copy of the resolution adopted by the directors and shareholders as well as the dates of adoption and a statement that the resolution was adopted in accordance with Subchapter R. The Certificate of Validation must also include any provisions that would have been required by the TBOC for a filing with the Texas Secretary of State in connection with the issuance of the putative shares if the issuance had been proper and not an overissuance—in this case the provisions that would have been required in a Certificate of Amendment to increase the number of the corporation’s authorized shares.  

    Notably, no form Certificate of Validation is available on the Texas Secretary of State’s website. The Secretary of State is unlikely to promulgate such a form as the provisions required to be included in the Certificate of Validation are very fact-specific to the corporation and to the act being ratified. Accordingly, one must pay very close attention to Subchapter R to make sure that all required provisions are included in a Certificate of Validation to be filed with the Texas Secretary of State.           

    Significantly, Section 21.913 of the TBOC provides that the procedures outlined in Subchapter R are not the exclusive remedy for overissuances and other defective corporate acts. Nevertheless, following the steps outlined in Subchapter R seems to be the best practice for remedying an overissuance. Further, while this blog entry discusses the procedures outlined in Subchapter R only as they apply to ratifying an overissuance of stock, it is important to note that Subchapter R also may be utilized to ratify other types of corporate actions that are either void or voidable for a failure of authorization.