When extending credit to a Professional Service Corporation (herein, “PSC”) in Kentucky, lenders should take note of important statutory distinctions between a PSC and other entity borrowers. KRS Chapter 274 sets forth specific requirements related to a “Qualified Person” that must be taken into account when making a loan to a PSC and when taking collateral as security for repayment of the loan.
Capabilities and the respective authorities of owners and managers of any entity are important factors in lending decisions, even to the extent that loan documents often include a material change in ownership or management as an “event of default.” Generally, an entity’s governing body may name anyone it chooses to hold various officer positions or to serve on the board of the entity. However, if the entity happens to be a PSC, all shareholders, all officers other than secretary and treasurer, and not less than one-half (1/2) of the directors must meet the definition of “Qualified Person” as set forth in statutes applicable to the PSC.
In Kentucky, in addition to statutes (e.g., KRS Chapters 14A and 271B) that relate to the creation and operation of corporations generally, a PSC is also subject to its own chapter, namely KRS 274.
KRS 274.005(2) broadly defines “Professional Service” as “…any type of personal service to the public which requires as a condition precedent to the rendering of such service the obtaining of a license or other legal authorization and which, prior to the passage of this chapter and by reason of law or a professional code of ethics, could not be performed by a corporation. The personal services which come within the provisions of this chapter are the personal services rendered by but not limited to certified public accountants, public accountants, chiropractors, osteopaths, physicians and surgeons, doctors of medicine, doctors of dentistry, podiatrists, chiropodists, architects, veterinarians, optometrists and attorneys-at-law.”
KRS 274.005 (4) defines “Qualified Person” as “a natural person, partnership, limited liability company, or professional service corporation which is eligible under this chapter to own shares issued by a professional service corporation.”
KRS 274.017 describes the persons and entities to whom a PSC may issue shares, and to whom the shareholders thereof may transfer or pledge shares, fractional shares, and rights and options to purchase shares. The statute also provides that any issuance, pledge or transfer in violation of this section (other than by operation of law or court decree) is void. This is important to the lender who may be considering taking a pledge of PSC shares as collateral because, under this section, the pledge may not be enforceable.
KRS 274.015, with reference to KRS Chapter 271B, establishes the criteria for the formation of a PSC and what must be included in the articles of incorporation: “(1) One (1) or more individuals, each of whom is licensed to render the same professional service or who are licensed to render related professional services such that applicable licensing laws and regulations would not prohibit the practice of such multiple professional services through a single business partnership, may incorporate and form a professional service corporation by filing articles of incorporation in the office of the Secretary of State. Such articles of incorporation shall meet the requirements of KRS Chapter 271B, and in addition to the information required by KRS 271B.2-020, such articles shall contain the following: …(c) A statement by the incorporator or incorporators that each of the incorporators, shareholders, not less than one-half (1/2) of the directors, and each of the officers other than secretary and treasurer is a qualified person [emphasis added] within the meaning of this chapter.”
Similarly, KRS 274.105 requires each PSC to file an annual report as provided in KRS 14A.6-010, which states that “…[e]ach entity and foreign entity authorized to transact business in this Commonwealth shall deliver to the Secretary of State for filing an annual report that sets forth…with respect to each… Professional service corporation, domestic or foreign, a statement that each of the shareholders, not less than one-half (1/2) of the directors, and each of the officers other than secretary and treasurer is a qualified person.”
Finally, KRS 274.027 provides that “not less than one-half (1/2) of the directors of a professional service corporation and all the officers other than the secretary and treasurer shall be qualified persons with respect to the corporation.”
These statutes demonstrate that the concept of “Qualified Person” is determinative of who can hold specific positions within the PSC and as to transferability of shares in the PSC. This all becomes very real when the lender learns that the person listed in the official corporate records, or the person who signed loan documents as an officer other than secretary or treasurer, either never was or has lost her/his status as a “qualified person,” or when the sole shareholder of a PSC has died.
Some of the issues that may arise include whether the loan documents are valid; whether the PSC can continue to operate; and what steps can be taken at the beginning of the lending relationship or in the middle of it when such questions arise. Is an opinion of counsel sufficient protection? Maybe, but that opinion may contain reference to counsel making an assumption but having no actual knowledge to the contrary, that natural persons involved on behalf of the client have sufficient legal capacity to enter into the transaction or carry out their role in it. Should the lender request that the borrower provide more specific verification that a PSC’s officers are “Qualified Persons” under the statute? Can a lender rely on the certification as to the qualified status of officers required to be filed with the Secretary of State as part of the annual report?
As answers to these and other questions may vary depending upon specific factual circumstances, it is recommended that lenders have discussions about the same with counsel.
Thomas W. Volk focuses his legal practice on banking and finance law, loan workouts, commercial litigation, foreclosure and collections. He has extensive in-house counsel experience having worked for two banks for a combined 24 years, giving him insight and sensitivity to issues faced by lenders including management of legal budgets. Tom is a member in M&P’s Louisville office.
