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Corporate Alert: New Jersey Corporate Business Tax Imposed on Out-of-State Company, Grasso Retirement Package Ruled Breach of Fiduciary Duty, SEC Broadens Category of "Eligible Portfolio Companies" that BDCs May Invest In, Dissention Not Enough for Judicial Dissolution of Partnership
November 2006
Authors: Edward B. Stevenson, Irwin A. Kishner

New Jersey Corporate Business Tax Imposed on Out-of-State Company

On October 12, 2006, the New Jersey Supreme Court rendered a decision which rejected a widely used corporate tax avoidance strategy. In Lanco, Inc. v. Director, Division of Taxation, 379 N.J. Super 562 (App. Div. 2005), the Supreme Court held that the New Jersey Division of Taxation may impose its Corporate Business Tax ("CBT") on out-of-state businesses that do not maintain a physical presence within New Jersey. Lanco, Inc. does not have any physical presence in New Jersey, however, it does derive income from a New Jersey source through licensing intellectual property to a related entity which conducts business in New Jersey. The Court deemed this relationship to be sufficient for purposes of being subject to the CBT.

The Court in Lanco found that the physical presence requirement applied by the U.S. Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) applies only to sales and use tax, not the CBT. By eliminating the physical presence requirement with respect to the imposition of the CBT, the Court effectively concluded that corporations may no longer avoid the higher corporate taxes imposed by some states, such as New Jersey, by using out-of-state subsidiaries to hold intangible property (such as intellectual property).

The Court's broad language in Lanco could be read to mean that all out-of-state companies which derive income from sources within the State of New Jersey might be subject to the CBT regardless of whether such companies have any physical presence in the State of New Jersey.

Grasso Retirement Package Ruled Breach of Fiduciary Duty to NYSE

In what some analysts consider a surprising win by New York Attorney General Eliot Spitzer, New York Supreme Court Judge Charles Ramos held last month that former New York Stock Exchange Chairman Richard Grasso violated his fiduciary duties to NYSE by not fully informing the board of directors about the compensation he had accrued over the years under pension and supplemental executive savings plans and two loans extended to him. Grasso claimed that he believed the NYSE board was fully aware of all the elements of his compensation; after all, they increased it annually. In his decision, Judge Ramos said this defense "shocked" him.

Judge Ramos ruled that Grasso must return a bulk of the undisclosed compensation and ordered an accounting based on Grasso's contracts and other NYSE documents. Spitzer, charged by Judge Ramos with calculating the repayment amount, has since alleged that Grasso should return $112.2 million to the board. Judge Ramos is expected to rule on the amount shortly. Grasso has filed an appeal with New York's Appellate Division.

If Judge Ramos' ruling stands, it could have major effects on executive compensation decisions and the corporate directors who are charged with guarding against excessive executive pay.

SEC Broadens Category of "Eligible Portfolio Companies" that BDCs May Invest In

The Securities and Exchange Commission adopted new rules under the Investment Company Act of 1940 to broaden the types of companies in which business development companies (BDCs) may invest. BDCs are typically closed-end investment companies that make capital available to small, developing or financially troubled companies. A BDC is required, pursuant to the Investment Company Act of 1940, to have at least 70% of its portfolio invested in securities of "eligible portfolio companies" at the time it makes any new investments. "Eligible portfolio companies" is currently defined as companies that, among other things, do not have any class of securities that is marginable, which includes—by Federal Reserve Board definition—all publicly traded equity securities and most debt securities.

The definition of "eligible portfolio company" as of November 30, 2006 will be changed to include "all private companies and companies whose securities are not listed on a national securities exchange." As a consequence, companies quoted on the over-the-counter bulletin board or through pink sheets will be "eligible portfolio companies." In addition, many debt securities will also be available for BDC investments. As a result of the new rules, BDCs should become more attractive investment vehicles.

Dissention Not Enough for Judicial Dissolution of Partnership

The Supreme Court of New York for New York County recently interpreted Section 17-802 of the Delaware Limited Partnership Act ("DLPA") which allows for judicial dissolution of a limited partnership if "it is not reasonably practicable to carry on the business in conformity with the partnership agreement." The Court held in Trump v. Cheng, 2006 LEXIS 2465 (NY Supr. Ct., NY Cty), that the dissolution of a profitable, viable ongoing limited partnership will not be allowed because of dissension among the partners.

The plaintiff in Trump v. Chang sued Hudson Waterfront LP, a Delaware limited partnership and a real estate investment entity, the general partners and the limited partners for various causes of action, including dissolution of the partnership pursuant to Section 17-802 of DLPA. In order for judicial dissolution to be authorized, the plaintiff must show that the business is no longer reasonably practicable to continue. The Court found that the plaintiff did not point to specific facts alleging deadlock that would prevent the partnership from functioning.

In ruling on the issue of dissolution of the partnership, the Court relied on Delaware decisions interpreting Section 18-802 of the Delaware Limited Liability Company Act ("DLLCA"), which is analogous to Section 17-802 of DLPA. Similar to DLPA, the DLLCA does not include provisions similar to those of Section 273 of the Delaware General Corporation Law, which allow for judicial dissolution upon a deadlock between shareholders where there are only two shareholders and each owns a 50% interest in the corporation. No Delaware decision interprets Section 17-802 of DLPA and Section 18-802 of DLLCA as providing for the judicial dissolution of a profitable, viable ongoing limited partnership or limited liability company merely due to dissension or alleged deadlock. Partners should be aware that mere dissension or deadlock among partners will not constitute adequate grounds to obtain a judicial dissolution of a partnership.

For more information on these issues or other corporate matters, please contact:

Irwin Kishner at 212.592.1435 or ikishner@herrick.com
Edward Stevenson at 973.274.2025 or estevenson@herrick.com

Copyright © 2006 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.