Johnson Testifies Before Vermont Legislature on Virtual Company Bill

April 4, 2007

Testimony of David R. Johnson Regarding H-458
Before the House Commerce Committee
Of the Vermont Legislature

Thank you very much for providing me with the opportunity to testify in support of H-458. By way of introduction, I serve as a Visiting Professor at New York Law School, having previously practiced law with Wilmer, Cutler and Pickering in Washington, D.C. for many years. I have worked with teams of students at NYLS for several years to find ways to enhance the global economy by enabling companies to form and operate entirely online. I believe that H-458 constitutes an important step in this direction and will bring many benefits to the State of Vermont.

As you know, the Internet has already substantially affected global commerce and culture. But, up to now, it has produced mainly new marketplaces in which individuals and established companies engage in transient transactions. More recently, groups of people have come together to collaborate on a more sustained basis, to create encyclopedias and software and other valuable things. In most cases, however, these collaborations are undertaken for purely altruistic reasons. I believe there is a major gap in this picture – we need to make it easier for people to come together to form companies (firms, rather than just markets) that can provide economic incentives for sustained work by dispersed individuals, that can collectively own the jointly produced work product (whether that is a valuable piece of intellectual property or a new branded service created by the participants), that can enjoy limited liability (thereby avoiding being re-characterized as partnerships) and that can open a bank account, distribute net proceeds to the participants who have contributed value, and enter into contracts with third parties.

Requirements

Enabling this new online mode of economic production requires some minor changes in existing law. It is not surprising that our current laws governing corporations and limited liability companies do not fully recognize the capabilities of the Internet. Now that we can communicate and collaborate electronically from anywhere, it is time to eliminate artificial requirements of paper-based filings, of physical, face-to-face real-time meetings, and of physical company headquarters (while preserving, of course, the requirement of an agent for service of process).

•    Permitting the Secretary of State to prescribe document formats and methods for electronic filing allows for a company formation process that can adapt to the needs of online companies and to the ever-changing array of online communication tools. Electronic filings have the additional advantage to the Secretary of State of streamlining the filing process, enabling a more efficient and accurate record system.
•    Holding meetings in an entirely online forum is only a small departure from current practice, which regularly involves the use of telephonic communication. Asynchronous online communication tools, however, allow for greater participation by company members, providing the flexibility necessary to accommodate a truly global membership base.
•    The traditional requirement that a business entity retain a physical place of business is a vestige of a different time and way of thinking. The act of filing in Vermont is sufficient to confer jurisdiction and online companies should not be required to have more of a local presence than an agent for service of process.

Now that we have tools that allow groups to make decisions online, to communicate asynchronously so as to accommodate differences in global time zones, and to embody various rules regarding corporate authorizations into software algorithms that can help to assure compliance, the law should be adapted to allow these new forms of corporate activity.

Benefits

If Vermont takes a leadership role in creating a legal environment that is hospitable to the formation and operation of online companies, it will achieve many important benefits.

I. Revenue

I recommend that the Secretary of State initially impose a nominal filing fee for accepting the filings necessary for establishing an online company. Limiting transaction costs attendant on company formation will encourage the rapid utilization of the online company form. Because many of the early adopters are likely to be small departures from existing wiki-like group efforts, which have traditionally operated with no revenues at all and are unlikely to have access to substantial start-up capital, initial transaction costs have a disproportionately large impact on online company formation when compared to more traditional forms. By applying appropriate fees to the most successful of such companies, however, the state could build a new franchise fee revenue base – much as it did some years ago by creating a legal environment receptive to the “captive insurance” industry.

II. Job Creation

This legislation is not radical in character, but it does present radical opportunities for the creation of new kinds of jobs. The day-to-day operation of online companies will require special support services, including the provision of a technical infrastructure to enable novel forms of communication, collaboration, and decision making. In addition to providing such support, service companies could become repositories of operating agreement templates and the operational company records of a variety of online companies. Individuals looking for a company to join might browse a database of available companies, comparing features and business models before ultimately choosing one (or several) to contribute to. In this scenario, the service company resembles an auction house where companies compete for employees, an E-Bay for online businesses. By allowing online companies to adopt innovative operating agreements, and by enabling local financial institutions to provide services that help online companies keep their books, pay their taxes, comply with law, resolve disputes and distribute net proceeds, Vermont will encourage the creation of high-skilled, environmentally low-impact jobs.

III. Leadership

This Bill offers still another way in which Vermont can become the leading eState. Some other states already allow electronic filing or online company meetings. But no state of which I am aware has established a comprehensive legal regime specifically designed to encourage and enable groups of self-selecting individuals to come together to create valuable products and services, to govern their own company affairs, and to achieve full recognition of the legal personhood of the resulting online company. No state has taken the initiative to allow innovative company operating agreements, such as those that might make use of online dispute resolution and software-based mechanisms for enabling company decision-making and enforcing limitations on authority to bind the company. By allowing innovation by the private sector, including the members of the Vermont Bar who will assist such companies, this Bill may make it easier for people all over the world to find a job (online) and to create valuable products and services (a portion of the revenues from which will rightly become payable to Vermont in the form of fees -- in exchange for the provision of an electronic company headquarters).

By being the first state to expressly enable a flexible online company structure, Vermont will generate a critical mass of such companies, with the result that new business activity will increasingly be drawn to Vermont to take advantage of its progressive legal system and experienced support industry. The advantages that densely populated urban centers have enjoyed with respect to business activity are being eroded by the power of Internet-based communication and collaboration tools. Accordingly, physical restraints on the proliferation of business activity are being subordinated to legal restraints. In effect, the playing filed is now level and no state or region of the country is in a better position than any other with respect to promoting these new forms of economic activity. Vermont can seize this opportunity to influence the norms that will come to define new business models, thereby shaping the face of business in the information economy of the 21st century.

Passage of this Bill is a necessary but just a first step along the path towards making Vermont into the “Delaware of the Net”. With its authority, the Secretary of State will be able to create flexible regulations, local financial institutions and the Bar will be able to provide innovative services, and the executive branch will be able to promote the use of these services on a global basis. I am eager to provide assistance to any such activities and will be happy to try to answer any questions you may have.

Thank you.

David R. Johnson
Visiting Professor
New York Law School