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Wednesday, July 9, 2003

305,274 Shares of SCO Stock to be Sold

SCO has filed, on July 8, a Registration Statement on Form S-3, relating to "the public offering or distribution by selling stockholders of up to 305,274 shares of common stock, par value $0.001 per share, of The SCO Group, Inc." The shares will be sold by Vultus, Inc., The Canopy Group, Inc., Angel Partners Inc., Michael Meservy, Bruce K. Grant Jr., Ty D. Mattingly and R. Kevin Bean. Only Canopy Group, in this list, will retain any SCO stock. SCO "will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders. ... On July 3, 2003, the last price for our common stock, as reported by the Nasdaq National Market, was $10.71."

Because I am simply speechless, I will just let the document speak for itself, with some relevants snips:

"This offering may have an adverse impact on the market value of our stock.

"This prospectus relates to the sale or distribution of up to 305,274 shares of Common Stock by the selling stockholders. We will not receive any proceeds from these sales and have prepared this prospectus in order to meet our contractual obligations to the selling stockholders. The shares subject to this prospectus represent over two percent of our currently issued and outstanding common stock. The sale of such a significant block of stock, or even the possibility of its sale, may adversely affect the trading market for our common stock and reduce the price available in that market. . . .

"No due diligence review of our company has been done in connection with this offering.

"No securities broker-dealer or other person has been engaged to perform any due diligence or similar review of this offering or our company on behalf of the selling stockholders, persons who may purchase common stock in this offering, or any other person. Consequently, individual investors cannot rely on such a due diligence review having been performed in making a decision to invest in our common stock.

"Risks associated with the potential exercise of our options outstanding.

"As of July1, 2003, we have issued and outstanding options to purchase up to 4,011,975 shares of common stock with exercise prices ranging from $0.66 to $59.00 per share. The existence of such rights to acquire Common Stock at fixed prices may prove a hindrance to our future equity and debt financing and the exercise of such rights will dilute the percentage ownership interest of our stockholders and may dilute the value of their ownership. The possible future sale of shares issuable on the exercise of outstanding options could adversely affect the prevailing market price for our common stock. Further, the holders of the outstanding rights may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us.

"Potential for the issuance of additional common stock.

"We have an authorized capital of 45,000,000 shares of Common Stock, par value $0.001 per share, and 5,000,000 shares of Preferred Stock, par value $0.001 per share. As of July 1, 2003, we have 13,334,886 shares of common stock and no shares of preferred stock issued and outstanding. Our board of directors has authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares. Any such issuance will dilute the percentage ownership of shareholders and may dilute the book value of our common stock. . . .

"We will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders. We anticipate that we will incur costs of approximately $20,000 in connection with the transactions described in this prospectus, including filing fees, transfer agent costs, printing costs, listing fees, and legal and accounting fees."

So, now we know why they filed the May 2001 Amendment, listing the indemnification of their directors. This July 8th document also addresses the issue of indemnification, in case anybody was thinking about suing anybody:


"Our articles of incorporation provide for the indemnification of our officers and directors to the full extent permitted by Delaware corporate law. Such indemnification includes the advancement of costs and expenses and extends to all matters, except those in which there has been intentional misconduct, fraud, a knowing violation of law, or the payment of dividends in violation of the Delaware General Corporation Law and could include indemnification for liabilities under the provisions of the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been informed that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.

"In the event that a claim for indemnification against such liabilities (other than the payment by our company of expenses incurred or paid by one of our directors, officers, or controlling persons in the successful defense of any action, suit, or proceeding) is asserted by such director, officer, or controlling person in connection with the securities subject to this offering, we will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by our company is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue."

Speaking of fraud, there is another way that owners of a corporation can be sued, despite indemnification. It's called "piercing the corporate veil", and I wrote an article just prior to finding out about the massive stock sale, so it's lacking a measure of emotion. Still, some of you might find it interesting to read how it works.

Piercing the Corporate Veil

The first thing you need to know about corporate law is that it is complex. You've got to like details. If you do, then it's powerfully interesting, because corporations have pretty much all the real money, so they are almost the only entities that can afford to litigate all the way. As a result, all kinds of corporate minutia gets decided by the courts, which in turn adds to the "On the other hand..." complexity of corporate law. So bear in mind that what I am writing here is a simplification and an overview.

Why form a corporation in the first place, instead of just a bunch of guys shaking hands and getting to work? Because if someone slips on your factory floor and breaks his neck, he's going to sue you and your business. This is America. And if he wins, and you're just a bunch of guys, you have to pay him, even selling your homes to pay the debt if necessary. A chief purpose of setting up in the corporate form, then, is to protect you from personal liability. All you risk are corporate assets, not your house. This advantage stems from the law's recognizing a corporation as a separate legal "person", so its debts are personal to it, just as yours are to you.

That's a legitimate purpose, and the courts recognize it as such. Here's what one court said pointblank on this point:

"The law permits the incorporation of a business for the very purpose of enabling its proprietors to escape liability."

But that protection isn't total. Here's what Findlaw says about "piercing the corporate veil":

"Sometimes, courts will allow plaintiffs to receive compensation from corporate officers or directors for damages rather than limiting recovery to corporate resources. This procedure avoids the usual corporate immunity for organizational wrongdoing, and may be imposed in a variety of situations..."

What kinds of situations? Well, people being people, it does on occasion happen that corporations get formed just to perpetuate a scam and leave creditors holding the bag. When that happens, the court may allow the creditors to "pierce the corporate veil" so that the corporation's liability, when the corp can't pay it, attaches to the owners of the corporation.

Here's what one NY court said on this subject, in IN THE MATTER OF JOSEPH MORRIS, APPELLANT, v. NEW YORK STATE DEPARTMENT OF TAXATION AND FINANCE ET AL., RESPONDENTS, 82 N.Y.2d 135, 623 N.E.2d 1157, 603 N.Y.S.2d 807 (1993):

"In Walkovsky v Carlton (18 NY 414), we stated the general rule that: 'Broadly speaking, the courts will disregard the corporate form, or, to use accepted terminology, 'pierce the corporate veil', whenever necessary to 'prevent fraud or to achieve equity' ( International Aircraft Trading Co. v Manufacturers Trust Co. , 297 NY 285, 292). (id., at 417).'"

Equity just means fairness. Fairness is what the court system is supposed to be about. If a plaintiff can prove that the corporation it is suing abused the privilege of doing business as a corporation to perpetuate a wrong against the plaintiff, a court can intervene by piercing the veil.

What kinds of things make it sometimes possible to pierce the corporate veil? It varies from state to state, because each state has its own laws and point of view, and the piercing concept doesn't come from the laws of the states or federal government anyway. It's a judicial creation. It's what is called "common law," meaning judges build a history of cases that rule on the matter, and over time as more and more cases accumulate on the same topic, you get to see how that state feels about the issue. Judges pay attention to rulings from everywhere to a point, especially if there aren't many local cases, but they are bound by their own state's body of case law when it exists.

You could say that piercing the corporate veil is something judges do when it would just be too cussedly unfair not to. What are some of the other things that a corporation can do wrong, so that creditors get to pierce the veil? Here and here you'll find a list of things, which I will summarize:

-- If a business is indistinguishable from its owners or principal shareholders, especially when they act in their own interests and not those of the business. This would be kind of rare in a public corporation, or at least it used to be rare, but can come up with closely held or family corps, where one common bank account is used by the business and the sole shareholder, for example. This company has a dominant shareholder. Even after the sale, Canopy will have 39.something% of all shares. The other dominant player is also a Canopy guy. There is a case, In re Silicone Breast Implant Litigation, MDL No. 926 (N.D. Ala.), where Bristol-Meyers was the sole shareholder of another company, MEC, which manufactured and distributed silicone breast implants. Bristol Meyers provided common board members, financing, and services to MEC and controlled it, but without carefully maintaining corporate formalities. In addition, MEC was underfunded and unable to satisfy risks of responding to and defending against the numerous and predictable potential claims against it. The corporate veil was pierced in that case. The court in essence found that when one shareholder so dominates a corporation's decision-making, that corporation loses its separate legal "person" status, and with it goes the limited liability. I'm not saying SCO is the equivalent of Bristol-Meyers; just pointing out that it does have dominant shareholders. And Canopy has loaned money to Caldera, which granted Canopy a security interest in all of Caldera's assets, including its IP. Yup. Here's the Security Agreement. It lists these items: "business records, deposit accounts, inventions, intellectual property, designs, patents, patent applications, trademarks, trademark applications, trademark registrations, service marks, service mark applications, service mark registrations, trade names, goodwill, technology, knowhow, confidential information, trade secrets, customer lists, supplier lists, copyrights, copyright applications, copyright registrations, licenses, permits, franchises..."

-- If it's established that the business was set up only to bypass the law. An example might be a man sets up a corporation so as to make it seem like he has no income to pay alimony.

-- If the corporation wasn't set up properly to begin with but does business anyway.

-- If the corporation's executives sign contracts without a line stating that they were acting in their corporate capacity. Example: a contract is signed "Joe Doe" instead of "Joe Doe, President, XYZ Corp., Inc.

-- If corporate debt is knowingly and deliberately incurred by an already insolvent corporation; in other words, when they knew there was no hope of paying the creditors back. It's kind of like a man asking for bankruptcy relief but the court sees that after he was way over his head and lost his job, he went out and bought diamonds for his girlfriend on credit. That's a no-no, and he isn't likely to get relief of that debt. It's kind of the same for a corporation, and in such a case a judge may say the owners can't hide behind the corporate protection.

-- If the corporation is undercapitalized. You're supposed to have enough money on hand to pay your legitimate debts and cover foreseeable risks. If shareholders raid the kitty, endangering the fiscal soundness of the business, piercing the veil may be the consequence.

-- If a corporation does not follow proper corporate procedures, such as doing the proper paperwork. For example, corporations are supposed to follow state laws affecting corporations. In the state I am in, for example, corporations have to keep a corporate kit, and in the kit must be kept all the paperwork for the corporation. If the business leases space, it's supposed to have a meeting of the directors and then they have the shareholders vote to approve or not whatever they decide. Anything that goes beyond day-to-day business and that could affect shareholders' interests has to follow that process. Minutes of all the meetings, verifying that the directors and shareholders voted to approve leasing that space go in the kit. Every year, there is supposed to be a shareholders' meeting, and annually a directors' meeting too, and there are notice requirements and the minutes of all that also must be kept in the kit, detailing who was voted in as officers of the corporation, and any other business that was handled at the meeting, etc., or in the alternative, if the bylaws allow, shareholders can decide matters by written consent procedures instead of actually meeting. But the documentation is a requirement.

The annual meetings are supposed to actually happen, too. Shares of stock must actually be issued and kept track of. There are also SEC requirements for public corporations, and certain kinds of paperwork are supposed to be filed with that agency. One of the drawbacks of incorporating is that it's annoying to keep up all the paperwork, which is why privately owned businesses often choose to be LLCs instead.

When corporations fail to keep up, they risk, in the course of a lawsuit, being asked by the judge to present its corporate kit in half an hour in court. If it doesn't look like the corporation has been acting like a corporation, by which they mean doing all the paperwork and following all the formalities, a tort plaintiff may succeed in getting a new home from the corporation's owners. When the formalities aren't followed, the corp may be deemed to be nothing but an alter ego of the owners. One missing piece of paper isn't enough, but a strong pattern is a big problem.

Normally, contracts make it harder to pierce, because you were supposed to protect yourself in the contract, not by asking a court to make up new protections for you. And passive shareholders aren't in any danger. It's the CEO who is also the principal shareholder that needs to worry.

It's typical for a corporation to indemnify its officers, so they don't need to worry about personal liability in case of lawsuits, because without such a clause, no one would want to be the president of any company. This is America, and companies know they are going to get sued eventually in the normal course of business.

Piercing the corporate veil is only a worry if you are being sued, not when you are suing someone else, and only when the business doesn't have enough money to pay for any liabilities. It's typical to carry insurance, of course, for such times. But even without it, if the business has sufficient assets to pay all claims, there is no need to pierce the veil and go after the owners.

So when a client comes in and he is the defendant being sued, the first thing you are hoping for is that they kept up their corporate kit. And if you are the party suing, you definitely want to look at that kit if the business assets look thin but the shareholders have deep pockets.

Delaware is a corporate-friendly state, and there are fairly simple requirements, compared to CA or NY, but even in Delaware, you are required to file an annual report. A lot of corporations are formed in Delaware, even if they really do business somewhere else, and generally the state where they really are will impose additional requirements on what they view as a "foreign" corporation. SCO, for example, is a Delaware corporation, but it is really doing business in Utah, so presumably they have to file and meet certain requirements in Utah as a foreign corporation as well as meeting filing requirements in Delaware.

And where do you sue (and under what state's law) a corporation that's a Delaware corporation doing business in Utah that damaged you in, say, California is another issue. Example, the VP of the corp drives a company car from Utah to California on business, and in California he hits someone with the car and that person sues him in California courts. Which state's law applies? As I said, it's complex, but if you're interested in such things, here is an article on just such a case, "The Approach of California in Applying Its Law to Foreign Corporations, and Whether a Contractual 'Choice-of-Law' Provision Can Overcome This". It's interesting. No, really. At least it is if you're the person that got hit by the Utah car in California, so to speak. And here's a pierce-the-veil case involving both Utah and NY law.

All of this is what was flooding my mind when I saw that SCO had just filed with the SEC an "Amended and Restated Certificate of Incorporation of Caldera International, Inc." from 2001. My first thought was, Why are they filing this now? It's not unusual to clean up your corporate kit when you expect to be sued. Were they expecting something? After seeing the notice of sale of the stock, I understand. And though the Amended and Restated Certificate of Incorporation specifically and strongly indemnifies the directors, you know by now that no corporation can totally indemnify its execs and shareholders, because of the possibilities of piercing the veil.

So... here's my worst case scenario, and my best fantasy. Worst is that SCO goes down in financial flames (that's not the bad part) and Canopy ends up owning UNIX. And my dream scenario? That Linus and all the other kernel coders sue SCO for defamation and get the UNIX rights as damages, and then set it free, once and for all. I know. I know. But I can dream, can't I?
comment [] 5:51:37 AM    

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