How Section 322 Allows Creditors to Elect Directors
Explore the legal process under California's Section 322, a governance tool allowing creditors to elect directors by amending a company's articles of incorporation.
Under California law, a corporation can provide a mechanism for its creditors to elect directors. This is accomplished by including a provision in the company’s articles of incorporation that grants specific creditors, or all creditors, the right to elect a certain number of the members of the board of directors. It is a strategic tool that can be employed to facilitate a corporate turnaround or to attract investment. By placing knowledgeable creditors in positions of governance, a company can leverage their expertise and vested interest in its success, which helps align the interests of the company with those of its financiers.
Granting Director Election Rights to Creditors
The ability for creditors to elect directors is not a right that arises automatically or is limited to times of financial distress. Instead, it is a flexible option that a corporation can grant at any time. This power can be included when the company is first formed or added later through an amendment to the articles of incorporation.
The decision to grant these rights begins with the board of directors, which must approve the proposed provision. Following the board’s approval, the amendment must be submitted to the shareholders for their consent, which often necessitates a majority vote of the outstanding shares.
Information for the Certificate of Amendment
To formally grant creditors the right to elect directors, a corporation must file a Certificate of Amendment to the Articles of Incorporation. The certificate must contain precise information to be accepted by the Secretary of State. The primary element is the exact text of the new provision being added to the articles. This text must clearly state that one or more specified creditors, or creditors generally, are entitled to elect a specified number of directors.
The document must also include the corporation’s exact legal name and its corporate file number. A statement of approval is a required component of the certificate. This section must affirm that the amendment has been approved by the board of directors and include a statement confirming that required shareholder approval has been obtained. This shareholder approval statement needs to specify the class and number of shares that voted in favor.
The text of the amendment should be drafted with legal counsel to ensure it accurately reflects the agreement with creditors, as ambiguity can lead to rejection or future legal disputes.
The Filing and Approval Process
Once the Certificate of Amendment is completed and executed by a corporate officer, it must be filed with the Secretary of State. Corporations can submit the document by mail or in-person delivery. A standard filing fee of $30 must be paid at the time of submission. For in-person delivery, a $15 special handling fee also applies, and other options for expedited processing are available for additional fees.
Upon receipt, the Secretary of State’s office reviews the Certificate of Amendment for compliance with legal requirements. This review ensures all required information is present and the document is properly signed. Standard processing times can range from several business days to a few weeks, though expedited services are available for an additional fee.
After the review is complete, the Secretary of State will officially file the amendment, and the change becomes effective on the date of filing. The corporation will receive a certified copy of the filed amendment for its records.
Terminating Creditor Control
The rights granted to creditors to elect directors are not permanent and are linked to the underlying debt. The termination of these rights is governed by the specific terms written into the provision within the articles of incorporation. While the practical right to vote would cease once the debt is paid or discharged, the provision itself remains in the articles until it is formally removed.
To reflect this change, the company must file another Certificate of Amendment to remove the now-obsolete provision. The process for this filing mirrors the initial one, requiring approval from the board of directors and shareholders. The certificate must state the text of the provision being deleted.
Filing this second amendment formally restores the exclusive right to elect all directors to the shareholders, aligning the articles of incorporation with the company’s current financial health.