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Filing Articles of Incorporation Online in California is a Good Bet for Loan Out Corporations Despite Being Unable to Include Optional Provisions

May 6, 2020

A single shareholder/officer/director corporation’s inability to include optional liability-limiting and indemnification provisions in its articles of incorporation should not deter online filing in California.

The California Secretary of State recently launched the ability to file Articles of Incorporation online. The online service offers a major advantage over paper filings for new corporations in that online filings take only about five days to be returned, while paper filings are currently running as long as five weeks.  Further, expedited filings have been temporarily halted.

The catch is that the new online filing system is the electronic version of California’s fill-in-the-blank preprinted Form ARTS-GS. The pre-printed form does not include various optional provisions that must be included in the articles of incorporation in order to be effective, most notably provisions concerning (1) limitation of liability for directors, and (2) excess indemnification of the corporation’s agents.[1]

We researched whether it’s worth waiting an extra five weeks for a single shareholder/officer/director corporation to file custom articles of incorporation to gain the benefit of including those two optional provisions? We don’t think so.

Limitation on Personal Liability of Directors.  The first optional provision we considered permits the new corporation to include in its articles of incorporation a provision “eliminating or limiting the personal liability of a director for monetary damages in an action brought by or in the right of the corporation for breach of a director’s duties to the corporation and its shareholders,” subject to a host of exceptions, including a director’s acts or omissions involving intentional misconduct or that the director believes to be contrary to the best interests of the corporation.[2] Such a limitation of liability only applies, however, in an “action brought by or in the right of the corporation,” that is, a shareholder derivative action.[3] In a single shareholder/director corporation, the lone shareholder is not going to be bringing any shareholder derivative actions against herself for breaching her duties as the lone director of the same corporation. Therefore, the optional provision limiting the liability of directors is of no meaningful benefit in a such a corporation.

Indemnification of Agents.  The second optional provision we looked at permits the corporation to include in its articles of incorporation a provision authorizing, by bylaw, agreement, or otherwise, the indemnification of the corporation’s agents in “excess” of that already permitted by California law for those agents for breaching a duty owed to the corporation and its stockholders, with the same exceptions noted above as to the corporation’s ability to limit a director’s liability in a shareholder derivative action (e.g., intentional misconduct).[4]

Even without the optional provision, California law authorizes a corporation to indemnify its agents who are party to, or threatened to be made party to, any proceeding (other than a shareholder derivative action) by reason of the fact that the person is or was an agent of the corporation against expenses, judgments, fines, settlements, and other amounts actually and reasonably incurred in connection with the proceeding if the agent acted in good faith and in a manner she reasonably believed to be in the corporation’s best interests.[5] The “agents” who may be so indemnified expansively include “any person who is or was a director, officer, employee or other agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another foreign or domestic corporation, partnership, joint venture, trust or other enterprise, or was a director, officer, employee or agent of a foreign or domestic corporation which was a predecessor corporation of the corporation or of another enterprise at the request of the predecessor corporation.”[6] This provision was made so broad in response to increasing litigation against corporate officers and directors, including outside directors, to the point where it was becoming difficult to even get qualified outsiders to serve on boards of directors.[7] But that is not a concern in a single shareholder/officer/director corporation. Moreover, even without the optional provision permitting “excess” indemnification, the corporation can still indemnify its sole officer/director against third-party actions under the circumstances prescribed in the California Corporations Law. Therefore, unless the single shareholder/officer/director corporation is hiring other “agents” who would balk at working for the corporation without the promise of excess indemnification, which is very unlikely, having to omit the optional indemnification provision when filing the State’s online form should not present an issue for such a corporation.

In sum, because we don’t think that either optional provision is terribly important in the context of a single shareholder/officer/director corporation, if expedited filing of articles of incorporation is desired, there is little reason not to use the Secretary of State’s form and file online.  In our firm, we are offering hesitant clients who prefer the speedy filing option to amend the Articles after the initial filing is returned to add the optional provisions.

[1] See Cal. Corps. Code §§ 204(a)(10), (11). There is an exception for a statutory “close corporation,” which permits the optional provisions to be included in a shareholders’ agreement rather than in the corporation’s articles of incorporation. Id. § 204(a). However, the Secretary of State’s pre-printed form does not include the language required to select close corporation status, so the same problem remains. See id. § 158(a).

[2] See id. § 204(a)(10). All that is required to limit directors’ liability in accordance with this provision is a statement in the articles that  ”[t]he liability of the directors of the corporation for monetary damages shall be eliminated to the fullest extent permissible under California law.” Id. § 204.5.

[3] See id. § 800.

[4] See id. § 204(a)(11).

[5] Id. § 317(b).

[6] Id. § 317(a).

[7] See Harold Marsh, Jr., et al., Marsh’s California Corporation Law § 11.22 (4th ed. 2020-1 supp.).

Our attorneys are admitted to practice law in California, New York, and Texas.
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