Why Maryland is the Favored Jurisdiction for Forming REITs

Annie: Hello, everyone. And welcome to today's webinar, "Maryland's Continued Dominance in Forming REITs." My name is Annie Triboletti, and I will be your moderator. Joining us today, our guest speakers, Jim Hanks and Sharon Kroupa from Venable LLP. And with that, let's welcome Jim and Sharon.

Jim: Thanks, Annie. To get into the beginning of the history of REITs, we have to go back to the Sixteenth Amendment to the U.S. Constitution in 1913 when Congress for the first time amended the Constitution with the approval of the states to provide for an income tax. There had been an earlier effort at imposing an income tax that failed on constitutional grounds. But this time, the Constitution itself was amended to permit an income tax. So immediately, of course, people began to think of ways to avoid paying the income tax.

And within 20 years or so, the Supreme Court took a case involving a trust, a Massachusetts trust, that was set up for the purpose of holding real estate. And the Massachusetts trust claimed that it did not have to pay any income tax because it was not a separate person, it was simply a trust. Obviously, it was not an individual, and they claimed it was not a corporation because nowhere in its formation documents did it say anything about being a corporation.

So it said we're not taxable on our income. The case brought by the Internal Revenue Service went all the way to the Supreme Court. And the Supreme Court basically held, and I gave you the quote there, but it can be boiled down to, if it looks like a corporation, if it smells like a corporation, if it feels like a corporation, it's a corporation and it's going to be taxed as a corporation.

That was a big setback, of course, for people who wanted to hold real estate or any other property for that matter in trust form. And a few years later, as we all know, World War Two came along and everybody was occupied with other things. And then after the war, people were focused in other directions.

Finally, in the late '50s, a movement began to address this legislatively by the Congress. And Senator John Kennedy sponsored a bill that permitted the formation of real estate investment trusts and made them essentially tax-free. We'll talk about that in a moment. It happened to be the last bill signed by his predecessor President Eisenhower. And the purpose of the bill was to provide for public ownership, widely dispersed public ownership of real estate in the United States.

At that time, the sense was that real estate, particularly high-value commercial real estate, was largely owned by wealthy people or wealthy families and a lot of money was made that was not available to the general public. So the trade-off for creating what was essentially a tax-free vehicle was, "Okay, but you're going to have to allow general public ownership in the entity."

And so in the bill, there were provisions that the entity have at least 100 owners and that no more than 50% of the value of the equity of the entity could be owned by five or fewer individuals. This is known as the 5/50 Test. And it is a very important test for REITs that has many state law aspects to it as well, and we'll be talking about them later.

It was also required, as you might expect for a real estate investment trust, that 75% of its assets be real estate assets. Over the years, there's been some litigation over this, some legislation, some rule-making over this, and what are "real estate" assets have evolved with a great deal of complexity.

So now we have not only hard ground and improvements, but things like real-estate related assets. There are REITs today that are invested in forms of real estate that I don't think were ever contemplated in 1960 like cell towers. There are billboard REITs that the real estate is the billboard. There are data service center REITs. Certainly, no one was thinking of data service centers in 1960. So the concept of what is a real estate asset has expanded significantly.

This is not a tax webinar, but we should note that there are more and more REITs forming in more and more areas that may not previously have been thought of as hardcore real estate.

The bill passed in 1960 and signed by President Eisenhower also limited the entity that could hold these assets to an unincorporated trust or association under state law. And presumably, I don't know this but I'm just guessing, this was because this bill sought to reverse the Morrisey case. And the entity in the Morrissey case was a trust. So this bill provided that trusts that met these tests we've been talking about could have certain tax benefits.

And to get to the principal tax benefit that makes this entity essentially equivalent to a non-taxable entity, even though it isn't specifically, it's a deduction that the entity can take for distributions of its REIT taxable income to its shareholders.

Now the original statute required that 95% of that REIT taxable income had to be distributed to the shareholders in order to maintain REIT status. Congress has now reduced that requirement to only 90%, but still assuming the REIT distributes at least 90% of its income, of its REIT taxable income to its shareholders, then it meets that test. Many REITs distribute 100% of their REIT taxable income.

So if the REIT distributes 100% of its REIT taxable income, then it's not going to have any REIT taxable income any longer to be taxed on. And that's what gives it its essentially tax-free quality. It's, as I've said before, not literally a tax-free entity, but it can be and, in fact, must be to the extent of at least 90% of its REIT taxable income assuming that the REIT makes the distributions to its shareholders.

Well, the 1960 statute containing these REIT provisions in the Internal Revenue Code was followed just three years later by the Maryland legislature enacting a statute providing for a separate, free-standing vehicle at state law, known as a real estate investment trust, to take advantages of the new REIT provisions of the Internal Revenue Code. And because the Internal Revenue Code was focused on, at that time, the trust form, the Maryland legislature followed suit.

It recognized that under the federal tax amendments in 1960, there was a need for a state law vehicle and Maryland provided it in the form of what is now Title 8 of the Corporations & Associations Article of the Annotated Code of Maryland. So if you want to look it up, that's where you go. The Annotated Code of Maryland, the Corporations and Associations Article, look at Title 8.

The statutory short title for this is the Maryland REIT Law by which the statute isn't known and also known as Title 8. It's, as I characterized it here, a junior varsity entity statute. It's just not as fully-fleshed out as a Maryland General Corporation law, the Maryland General Corporation law has three successive titles one, two, and three, it goes on. I don't know, it probably has close to 100 or more sections.

And the legislature was just not going to repeat all that for one form of entity. So it provides for certain basics, the Declaration of Trust, which is the correlative to Articles of Incorporation, bylaws are provided for as well. Instead of directors, the Title 8 provides for trustees, officers, and other basic essentials of forming an entity.

Well, the final stage in the federal state legislation of REITs took place in 1976 when Congress looked at what it had done 16 years earlier with REITs and said, "Hey, this is working pretty well. People seem to be complying with the statute, and we're achieving the results that we hoped for from a policy point of view diversification of ownership of real estate." And more and more people are saying to us, "Well, if you can do this for a trust, why couldn't you, why shouldn't you be able to do it for a corporation?"

So Congress amended the Internal Revenue Code, the REIT sections of the Internal Revenue Code, beginning at Section 856, and provided that a federally tax-qualified REIT can now be either a trust or a corporation and they're treated exactly the same. So why then has Maryland continued to dominate as the preferred jurisdiction of choice for the formation of REITs? And I think they're really two answers and Sharon's going to expand on them.

First, the Maryland legislature has done a very good job of staying current with general corporate practice, adopting good provisions of the . . . in the corporation statute bringing them into the REIT statute as well, Title 8. And our courts understand the importance of REITs under Maryland law. And the courts have rendered good decisions, good judgments on REITs. And so for those reasons, people have continued to form REITs in Maryland. Sharon.

Sharon: Thank you, Jim. As a result of the historical landscape that Jim just described, more REITs are formed in Maryland than in all other states combined. So approximately 69 to 70—it actually got updated—70% of all publicly-registered REITs are formed in Maryland. So this includes both publicly-traded REITs as well as publicly-registered non-traded REITs.

Additionally, approximately 67% of REITs listed on a national exchange, or OTC, are formed in Maryland and approximately 66% of REITs included in the Russell 3000 are formed in Maryland. The two primary entity choices for publicly-registered REITs in Maryland are, as Jim mentioned, the corporation and the Title 8 REIT. We see that many of the older legacy REITs were formed as trust REITs for the reasons that Jim described.

Both are separate legal entities with limited liability and both are accepted in the public marketplace. As Jim noted, the primary difference is a more robust statutory framework for a corporation and the ability to free write in a Title 8 organizational documents. We generally will look to the MGCL by analogy in instances where we don't have statutory guidance, but again that's not a statutory mandate.

We often see that the market understands a share of stock a little better than it understands a share of beneficial interest. That terminology I think is more accepted in the public marketplace. But there are advantages to using a Title 8 REIT as well to the extent that it was beneficial that the trustee, the governing body of the REIT be an entity. Title 8 does permit entities to serve as trustees. Whereas, under the MGCL, anyone serving as a director must be a natural individual.

Additionally, there may be tax advantages in certain states to own properties in trust. Although we have seen that to be less the case as time has gone on. Initially, I think, there were more states that accorded favorable tax treatment to trust-holding entities, but I think that definitely has diminished.

There's a number of private REITs as well that are formed in Maryland, typically formed as statutory trusts under Title 12. There's no way to really quantify the number of private REITs, but Maryland statutory trusts which are very similar to Delaware statutory trusts are often used in fund structures, as REIT subsidiaries, or to facilitate foreign investments. We've recently seen an uptick actually in private reformations and conversions by existing real estate funds or companies take advantage of the new Internal Revenue Code Section 199A, which provides a 20% pass-through for qualified REIT dividends. And that has been very appealing to property holders in the marketplace.

Jim: Continuing on with the advantages of Maryland law for REITs, I should say at the outset that many of these advantages are of general applicability to Maryland corporations. In fact, Maryland is among the top four or five states in the country in terms of New York Stock Exchange listed companies. So many non-REIT companies, well-known non-REIT companies like Lockheed, NCR Corp, Black & Decker until it was acquired, McCormick Spice Company, Sara Lee also recently acquired, have found it advantageous to form under Maryland law. Legg Mason is another.

So in thinking about starting up a company, whether it's a REIT or not, Maryland offers a lot of advantages. And we've had some good startup companies here. One of the biggest advantages, particularly for a startup company, is that Maryland has no franchise tax. In Delaware, the calculation of the franchise tax once you get beyond small mom-and-pop corporations can easily ramp up to as high as $250,000 every year. Maryland has none of that. There's one $300 personal property tax return filing fee that has to be paid and that's it. So there's that advantage right away.

Second, for REITs in particular, Maryland has validated the REIT share ownership and transfer limitations that appear in just about every REIT charter. These limitations lead back or are the result of what I mentioned earlier, the 5/50 Test. The requirement of the Internal Revenue Code that not more than 50% of the value of the equity of a REIT may be owned by five or fewer people. So dividing 50 by 5 yields, of course, 10%. So it's very typical for a REIT, in fact, just about every REIT will have in its charter a provision that limits any holder from owning more than typically 9.8% of the value of the equity of the REIT.

Why 9.8% instead of 9.9%? I asked this question many years ago when I first started working with REITs. And was told by one of the actual drafters of the 1960 REIT tax provisions, "Well, we just wanted a little bit of extra room when we formed our REITs." So there you go. Could it be 9.9%? Sure. Are there some REITs that actually say 9.9%? Yes.

And in fact, there are a number of REITs that provide for significantly lower than that because on formation, they want the historic or legacy owners of the real estate to own more than 9.8%. They want them to be able to own 15%, or 20%, or 25%. Well, if one individual is going to own 20% or 25% leaving just 30% or another 25% to be owned by others, then you're going to have to drop that percentage down to something like 5%, or 4.9%, or something like that.

So it's something that you have to play with. But that's what drives the very typical provisions that you see in REIT charters limiting share ownership and transfer. I say these are nearly unique to Maryland. There are other states who have attempted to provide for these types of provisions or to authorize them. And, of course, the concern is the common law rule against restrictions on transferability.

So there other states that have tried to legislate in this area to provide this protection. But the key feature of the Maryland validation of REIT share ownership and transfer limitations is that in both the Maryland General Corporation law and in Title 8, it specifically says that these provisions may be used to protect the tax status of the vehicle and for other purposes like protection against takeovers. And as we know, there are two ways to take over control a company, hostile tender offer and hostile proxy contest. The share ownership and transfer limitations help with both. And we can talk more about each of those two ways of taking over control of a company more later.

Also, the Maryland law authorizes REITs to issue up to 100 shares for no consideration. This is unique to Maryland as well, but it's probably not very important any longer because the tax lawyers generally insist that there be some at least nominal value to a share of a REIT and that it not be received just for no consideration.

Our statute also permits the board and the board alone to amend the charter to increase or decrease the authorized stock. This is true not just for REITs, but for all Maryland corporations. This is unique to Maryland. The statute provides that the board of directors may amend the charter directly to increase or decrease the number of authorized shares of stock.

Of course, it can't do anything to affect already issued shares of stock, but it can increase the number of authorized shares to increase the ceiling, if you will, or decrease the ceiling of authorized shares that the corporation may issue. Some people have told us they're a little bit startled by this provision. They've never seen it anywhere else. It's certainly not in Delaware.

We view it very positively. This is something that we participated in the drafting of and getting it passed by the legislature. And we made the point which we think is the right point that this is just a matter of financing. There's plenty of financing that gets them at the debt level typically most corporations including most REITs have several times the amount of debt financing that they have of equity financing. The equity financing comes below the debt, so why shouldn't the board which already has authority over debt financing be able to exercise its authority over equity financing as well?

The board also in Maryland has the power to reverse split the stock. Again, this is unique in our experience. Most Maryland REITs in the past 20 years have adopted this provision. There is a limitation on it—you can't combine more than 10 shares into one in any 12-month period. But this is an extremely helpful statute particularly for a REIT or other company whose stock goes down, say, into single digits where institutional investors may be prohibited from buying it so they can combine. They can do a reverse stock split, increase the share price back to a level where a lot of major holders can buy the stock again.

We forget quickly but during the financial crisis, there were many REITs along with many other companies whose stock was down in single digits. These are REITs that today are selling in the high two figures, low three figures, but their stock was actually down in single digits, and this was helpful to many of them.

Also particularly helpful for REITs is our statute which provides that charter amendments are binding on all shareholders. This is particularly useful for REITs because of the share ownership and transfer provisions. If you want to amend your charter or your declaration of trust, if you're a Title 8 REIT, to alter the 5/50 Test, so you want to amend your charter to enhance compliance with the 5/50 Test, then it will be binding on all shareholders of the REIT, whether they vote for it, against it, or abstain.

As long as it gets the requisite vote, it will be binding on all the shareholders. Unlike Delaware, which provides that charter amendments related to share ownership and transfer provisions, including the REIT protective provisions we've been talking about, are effective only against shareholders who have consented. That in effect, of course, means that you're never going to get a charter amendment of the Delaware corporation passed, so you're very unlikely to get it passed if it's not going to be binding on all the holders.

Another advantage of Maryland law of general applicability not just for REITs, and this applies to both the corporate REITs and Title 8 REITs, is we have a very stable statute on duties of directors. It's a very simple three-part standard of conduct, good faith, reasonable belief, an ordinary care. Good faith, of course, means an absence of any personal interest. Reasonable belief, we think is a low bar. There has to be some rational basis for the director's decision, which we don't think it is hard to meet.

And ordinary care for us means principally information, information, information, but it also includes deliberation, avoidance of hast, and all the things that you would normally associate with someone making an important business decision about assets over which he or she was responsible like being a director or a trustee. In this regard, we should say it's important to keep good minutes and reflect the availability of information, the amount of deliberation, the fact that the board proceeded in a reasonable sort of way including getting advice when it needs to.

This three-part standard of conduct was first enacted in 1976 based upon the Model Business Corporation Act importantly. Importantly, the official comment to the Model Business Corporation at that time specifically disclaimed the fiduciary label for director's duties. So we regard these duties not as fiduciary duties, although the courts often refer to them that way, but as what they are, statutory duties that apply not, by the way, collectively to the board, but individually director by director.

We have an exculpation statute in Maryland that is much broader than Delaware's. Our exculpation statute permits both directors and officers to be exculpated for any liability for money damages in suits by or on behalf of the corporation or by stockholders with only two very narrow exceptions—actual receipt of an improper personal benefit in the form of money property or services and active and deliberate dishonesty established by a final judgment of a court of capital jurisdiction.

Delaware, by contrast, has six somewhat very fuzzy exceptions, breach of the duty of loyalty, whatever that is. The duty of loyalty appears nowhere in the Delaware statute. It's strictly case-based and has a shifting configuration from case to case. Acts not in good faith, whatever that means, that was litigated for over 10 years in the Disney case. Intentional misconduct, knowing violation of law, unlawful distributions, and improper personal benefits.

So there are a lot of ways around the exculpation statute in Delaware. We also have a broader indemnification statute in Maryland, but for one thing permits the indemnification for derivative suit settlements, which are not infrequent, and the Delaware does not do that.

We also in Maryland, unlike Delaware, allow the board to have exclusive control over the bylaws. Delaware permits, in fact, states that both the board and the stockholders amend the bylaws. But many Delaware corporations get around that by simply providing for a high vote requirement by shareholders to amend the bylaws which seems to, at least based on observation and experience, have deterred a lot of shareholders from seeking bylaw amendments in Delaware.

Maryland's exclusive control of the bylaws has become controversial with Institutional Shareholder Services. Recently, they adopted a new voting policy in 2016 saying that they would recommend against the election of members of nominating and governance committees of boards of companies that provided for exclusive board control of the bylaws.

ISS has been 100% unsuccessful in this policy over the past two proxy seasons. Approximately 220 members of nominating the governance committees have been recommended against by ISS and not a single one of them has failed of re-election because of the bylaw issue. Major shareholders just seem not to care about whether a director is a member of a nominating and governance committee of the board of a company with exclusive board control of the bylaws.

They seem to care less about the things they should care about: how is the company doing, what is its strategy, what's the quality of management and vote on that basis rather than who can amend the bylaws. So most Maryland corporations with exclusive board control over the [bylaws 00:35:56] have retained it. Board also has the power to change the name of the corporation or the par value of its stock without getting any approval by the shareholders.

We also have something that Delaware does not have and some other states do not as well. And that's a unitary standard for distributions of all kinds, whether by dividends, share buybacks, share redemption, partial liquidation, or otherwise. Only two tests, the equity solvency test, meaning the ability of the company to pay its debts in the usual course of business, and the balance sheet solvency test, meaning do the assets these equal or exceed the liabilities of the company.

These two tests were amplified during the financial crisis by the addition of some net earnings provisions. Because some companies during the financial crisis were finding that because of the financial crisis that they did not meet either the equity solvency test and/or the balance sheet solvency test, particularly taking into account liabilities for unfunded pensions. And so we amended the statute to permit dividends to be paid from the net earnings of the company over up to the prior two years.

Also a very useful in our statute again based on the Model Business Corporation Act is a provision that the board may determine compliance with either or both of these to solvency tests based on reasonable accounting practices and principles which could be GAAP, but might not be. And certainly, in the REIT world, there is non-GAAP accounting known as funds from operation and adjusted funds from operation.

Or the board may face its determination that one or both of the two solvency tests are met on a fair valuation or other reasonable method. This is particularly useful for REITs because they own real estate. And real estate often historically at least increases in value above what its value is shown as on the balance sheet. So fair value determinations for purposes of making dividends distributions or other distributions is very important to REITs. One thing we are cautious about though is cherry-picking and fair valuing assets of increased in value but not assets of decreased in value.

There's also the issue of, "Well, if we can fair value assets can we or should we also have to fair value liabilities as well?" And these issues are generally very circumstance-specific. We have a nice little statute that is a presumption of the validity of GAAP-based financial statements, which is very handy.

We have more favorable abandoned property statutes than Delaware. Delaware at least recently has decided to go after a lot of additional revenue based on abandoned property statutes. They're not satisfied with the fact that 28% or 29% of their state budget is funded by the franchise tax. And in second place, so I am told on reliable authority, are the tolls that you pay on I-95 as you're going through Delaware. So Delaware's gotten very good at sustaining itself on other people's money. Our abandoned property statutes are much more favorable.

Finally, we specifically provide in our Maryland Corporation Law that a corporation can disclaim appraisal rights altogether. And most of our REIT clients that we've represented in the past 20 years have eagerly embraced this provision. And you will find in the charters of most of them a disclaimer of appraisal rights. That doesn't mean, of course, that appraisal rights can't be granted in a particular case, but it leaves it up to the board's determination in a particular transaction. Sharon, back to you.

Sharon: Great. In this portion of the program, I'm going to be focusing in more detail on the specific takeover advantages under Maryland law. Jim touched on the single standard of judicial review but it bears repeating in the takeover context. In response to a case that created some confusion, the Maryland legislature acted in 2016 to clarify that the three-part statutory standard of conduct for directors that Jim described is the sole source of director duties to the corporation or its stockholders, whether or not a decision has been made to enter into an acquisition or any other transaction.

All acts of directors are presumed to satisfy that statutory standard of conduct. So essentially, Maryland has a statutory codification of the business judgment rule. And that presumption is available in interested director transactions as well, so long as the transaction is approved by disinterested directors or disinterested stockholders.

And perhaps most importantly, there is no higher duty or greater scrutiny that is applied to director actions in change of control transactions. So the enhanced scrutiny and entire fairness standards derived from the Delaware cases, Unocal and Weinberger, are not applicable in Maryland.

As Jim started to discuss, when discussing takeover defenses, you can separate them into two buckets. There's defenses against an accumulation of shares, such as a tender offer, and defenses against a hostile proxy contest such as an effort to gain board control.

So the next several takeover protections, we're going to discuss how to prevent against the accumulation of shares without first coming to negotiate with board. Jim touched on this as well in his discussion, but again, most REIT charters do include a transfer restriction to 9.8%, 9.9%, but provides the board the [power to 00:43:56] grant exceptions to those ownership limits if the board satisfies that the ownership will not cause the corporation to fail to continue to qualify as a REIT.

And as Jim noted, the Maryland statute goes further by specifically validating these transferring ownership restrictions for any purpose. And we do have a case in Maryland, the Realty Acquisition case, 1989 REIT takeover case, where the U.S. District Court in Maryland upheld the target board's refusal to exempt a bidder from the ownership limits and thereby facilitate their takeover attempt. And this means that the board can refuse to grant a waiver even if proposed ownership would not have REIT implications if the board deems that action to be in the best interest of the company.

Under the Maryland Business Combination Act, business combinations with an interested stockholder, which is defined generally to be a holder of more than 10% of the outstanding voting stock or its affiliates, are prohibited for five years and thereafter any combination would have to be approved by the board and by stockholders, by two separate supermajority votes—80% of the votes entitled to be cast and two-thirds of the votes entitled to be cast by disinterested stockholders.

By contrast under Delaware law business combinations with a 15% interested stockholder are prohibited for three years and then subject to a two-thirds vote of disinterested stockholders. So the Business Combination Act operates to delay substantially a second-step freeze out merger following a successful tender offer. And dissenters must be paid in accordance with a fair price formula rather than fair market value.

So the difficulty in achieving the supermajority votes and the economic unattractiveness of paying fair price to avoid the supermajority votes is generally believed to discourage bidders from taking that first step. And the board can opt out of a five-year moratorium and supermajority votes before a person becomes an interested stockholder, and can control transactions that will be subject to the Business Combination Act again encouraging bidders to first negotiate with the board.

The stockholder rights plans, often referred to as poison pills, are probably not as common as they once were. But the Maryland statute specifically authorizes a board to establish a stockholder rights plan including flip-over and flip-in provisions. The former allows stockholders in a squeeze-out transaction to purchase the acquiring person's shares at a significant discount. And the latter allows stockholders other than the acquirer to purchase additional shares in the company at significant discounts.

Further, the Maryland statute validates continuing director or slow-hand provisions of up to 180 days. This type of provision operates to limit the power of future directors to vote for the redemption, modification, or termination of the rights. By contrast under Delaware law, 180-day slow-hand provisions has been struck down.

In addition to the defenses discussed, Maryland law supports the board's power to protect the company against unsolicited takeovers. And provides that the duties of directors do not require them to accept, recommend, or respond to any proposal by an acquiring person or to act or fail to act solely because of the impact of the potential acquisition or the amount of consideration offered. The board can just say no.

The Maryland statute also makes it clear that the duties of directors do not require them to take a refrain from taking actions in order to facilitate a takeover such as redeeming rights under a rights plan, or exempting a transaction or acquirer under the Business Combination Act.

The next few defenses that we're going to discuss are intended to assist a corporation in the face of a hostile proxy contest. Under the Maryland Control Share Acquisition Act, holders of control shares acquired in a control share acquisition have no voting rights except to the extent that the voting rights are approved by two-thirds of the votes entitled to be cast excluding shares held by the acquiring persons, or by officers, or employee directors of the company.

Control shares are shares of voting stock which entitle an acquiring person to exercise voting power in electing directors within three increasing ranges of voting power. One-tenth or more but less than a third, one-third or more, but less than a majority, or a majority or more. The Control Share Act does not apply voting rights of shares that have been if the acquisition is approved generally or specifically beforehand.

The Control Share Act is widely viewed as having a significant disadvantage in that it does permit the calling of a special meeting before a potential acquirer has even purchased a single share, thus allowing a bidder a forum to make a case for its proposed bid without ever having made an investment. That being said, if a board is concerned about disruption and cost of a hostile proxy battle, it may conclude that the benefits of the Control Share Acquisition Act outweigh its detriments. To be noted that Delaware has no similar corollary statute.

Subtitle 8 of Title 3 of the MGCL was enacted by the Maryland legislature in 1999 to empower the boards of public Maryland corporations and REITs to defend against unsolicited takeovers. Delaware has no similar statute. In order to take advantage of Subtitle 8, a company must have a class of equity securities registered under the Exchange Act and at least three independent directors. Maryland corporations and Title 8 REITs can implement Subtitle 8 through a provision in charter or bylaws or by resolutions of its board of directors or trustees without stockholder approval and notwithstanding any contrary provision in its charter or bylaws.

A Maryland corporation or REIT may elect to be subject to all or any of five different provisions regardless of what is included in its governing documents. The first provision is a classified board. This is probably the most important provision afforded under Subtitle 8. Classified boards were once a mainstay in corporate governance, but are now disfavored by the governing scorekeepers and have been the subject of aggressive stockholder proposals. Nonetheless, they remain the best protection against a hostile proxy contest.

Second provision would be to increase the vote to remove a director from a majority to two-thirds. It'll also opt into a provision that would require that the number of directors be fixed only by the board. Or a requirement that a board vacancy be filled only by the affirmative vote of a majority of the remaining directors and for the full term in which the vacancy occurred. This would prevent stockholders who may have removed a director from simultaneously electing his or her successor.

And lastly, you could opt into a provision that requires a majority of stockholder votes entitled to be cast in order to call a special meeting of stockholders. The default standard for calling a special meeting under Maryland law was 25% and government scorekeepers these days are in favor of 10%. Based on our data for 2018, approximately 20% of eligible REITs have opted out of 3803, which is the classified board provision of Subtitle 8. If we exclude publicly-registered non-traded REITs, that number jumps to 31%.

Opt-outs conditioned on a stockholder vote to opt in are largely the result of stockholder proposals, particularly in the lodging sector and campaigns by ISS and Greenstreet to render these defenses inapplicable the corporations and REITs.

Advance notice bylaw provisions help to prevent last-minute surprise nominations or business proposals by stockholders, thereby allowing the board and other stockholders the opportunity to thoughtfully consider nominees and proposals.

The Maryland statute specifically validates advance notice bylaw provisions. We find a typical bylaw provision for our publicly-held Maryland corporations provides for 120 to 150-day advance notice of director nominations and new business proposals. These provisions often require enhanced disclosure regarding proponents nominees for director as well as information including economic interest in the corporation of the proponent and those acting in concert with the proponent. So Delaware has no comparable statutory validation provision, although the Court of Chancery has upheld advance notice provisions.

And with all of the takeover defenses or protections that we've been discussing, it's important to keep in mind that the Maryland statute provides flexibility and a menu of protections that a corporation can opt in to or out of providing the company hasn't taken steps to render one or more defenses unavailable. A board can implement one or more protections as needed or exempt transactions or persons for specific purposes and specific time periods.

There's no one-size-all model for what is an appropriate takeover defense profile. Directors in the exercise of their duties should regularly review a company's takeover defense posture and consider whether additional protections may be warranted from time to time.

Jim: We're now going to finish up with the discussion of some recent cases in Maryland largely involving REITs. Because of the time, I think I'm going to skip over the Shenker case which both Sharon and I have referred to and which has largely been mooted now by later cases and by the legislature in 2016.

In the Nationwide Health Properties case, that was a case in our business and technology case management program which was started about 15 years ago in which either litigant or the court sua sponte can move a case into the business and technology case management program.

It's a small set of judges in a few major jurisdictions in Maryland. They got special business training, and it seems to have worked out fairly well. This case was a stock-for-stock merger decided by Judge Berger who distinguished it from the Shenker case by saying that Shenker applies only where the target shareholders are left with no continuing interest in the combined company. In Shenker was a cash-out merger, so the shareholders of Laureate had no interest in the continuing entity.

Judge Berger distinguished it on that ground and the case was followed in two other stock-for-stock cases, the Starwood case and the [Aviv 00:57:51] case. Likewise, in the Terra Industries case, which was not a REIT case, Judge Cannon made the very apt observation which we found very helpful in many cases to quote that, directors duties are not to act flawlessly but to act reasonably. And our experience has been that most of our REIT client boards do act reasonably. So her observation was very apt.

In Frederick versus Corcoran, this was a cash-out merger case like the Shenker case. But judge, in that case, held that no Maryland Court has held that there is a need to have a pre-market check or auction which the plaintiffs were saying the board had failed to do. And this emphasizes an important point that Sharon and I make all the time really to our clients which is that there is no single blueprint to the right process for selling a company.

If the company has a very, very fulsome process aimed at value maximization before the deal is announced, then there's less that it will have to do on the back end by way of a fiduciary out, or a go-shop, or something like that. On the other hand, and this is the case in Frederick versus Corcoran, if there's very little done on the front end, then more is required on the back end in terms perhaps of a go-shop or an extended period of time before closing. And this issue sometimes comes up when people say, "Well, now that the SEC as of several years ago has re-blessed or re-permitted tender offers followed by second-step mergers, how come more deals are not getting done that way?"

Because, you know, you can do them very, very quickly, maybe it's few as 20 days. And our view is that one reason why people are continuing to do mergers in the traditional way is that it does take longer and leaves open the possibility of a competing or interloping bid. That obviously will vary highly from case to case.

Finally, the Oliveira versus Sugarman case was an important case because of what it had to say about the duties of directors in refusing a demand. There had been an earlier case a few years earlier the Boland versus Boland case, a private family company case in which there was a minority shareholder demand made on the board, which claimed that the board had entered into a deal that was favorable to members of the board to the disadvantage of other stockholders, members of the same family, the Boland family. And the minority shareholders made a demand on the board which the board appointed the special litigation committee to investigate.

The special litigation committee came back saying that the transaction was fine. And the minority shareholders challenged that. It went all the way to the Court of Appeals of Maryland, our highest state court. And the court held that where the board is composed of a majority of directors who are interested in the transaction, then it cannot enjoy the business judgment rule protection of a decision to turn down to refuse demand.

And, in fact, it cannot even rely on the decision of a special litigation committee of supposedly independent directors if a majority of the board who appointed the special litigation committee were interested, unless the board goes through a very deep searching analysis of the independent and the disinterest of the special litigation committee members and the reasonableness of their procedures.

That was a very startling case to many of us. And fortunately, we were not involved in that case. But fortunately, a case came along a couple of years later, the Oliveira versus Sugarman case, in which we were involved. It went all the way to the Court of Appeals of Maryland. And the same judge, Judge Adkins who wrote the Boland case wrote the Oliveira case and said, without disclaiming Boland at all, she said that there is an exception where the board consists of a majority of independent directors who make the decision or who will appoint a special litigation committee that makes the decision, then that's okay.

And she went on to say in fact that the plaintiffs were attempting to expand the Boland decision to all demand-refused cases, and she was not going to agree with that. And, of course, she was writing for the majority. So that has turned out to be a very, very good opinion and we're back on track with demand requirements in Maryland.