Chapter 35 Corporations

1
Chapter 35 CorporationsDirectors,Officers and
Shareholders
2
1 The Role of Directors

• Every corporation is governed by a board of
  directors.
• Individual directors are not agents of
  corporation, only the board itself can act as a
  super-agent and bind the corporation.
• A director can also be a shareholder, especially
  in closely-held corporations.

3
Election of Directors

• Subject to statutory limitations, the number of
  directors is set forth in the articles of
  incorporation
• Directors appointed at the first organizational
  meeting.
• In closely held companies, directors are
  generally the incorporators and/or the
  shareholders.
• Term of office is generally for one year.
• Director can be removed for cause (for failing
  to perform a required duty).

4
Directors Meetings

• Directors hold meetings pursuant to bylaws with
  recorded minutes.
• Special meetings may be called with sufficient
  notice.
• Meetings require QUORUM (minimum number of
  directors to conduct official corporate business,
  usually majority).
• Each director generally has one vote.

5
Rights of Directors

• Directors have the right to
• Participate in corporate decisions and inspect
  corporate books and records.
• Compensation (usually a nominal sum) and
  indemnification. If a director is sued for acts
  as director, the corporation should guarantee
  reimbursement (indemnification) or purchase
  liability insurance to protect the board from
  personal liability.

6
2 Role of Corporate Officers

• Officers serve at the pleasure of the Board of
  Directors but have fiduciary duties to company as
  well.
• Their employment relationships are generally
  governed by contract law and employment law.
• Officers may be terminated for cause.

7
3 Fiduciary Duties of Directors and Officers

• Directors and officers are fiduciaries of the
  corporation. They owe ethical and legal duties
  to the corporation and shareholders
• Duty of Care Directors/officers are expected to
  act in good faith and the best interests of the
  corporation. Failure to exercise due care may
  subject individual directors or officers
  personally liable.

8
Fiduciary Duties of Directors and Officers 2

• Duty of Care (contd)
• Make informed and reasonable decisions
• Rely on competent consultants and experts and
• Exercise reasonable supervision.
• A dissenting director is rarely held liable for
  mismanagement of corporation. Dissent must be
  registered with the corporate secretary and
  posted in the minutes of the meetings.

9
Fiduciary Duties of Directors and Officers 3

• Duty of Loyalty subordination of personal
  interests to the welfare of the corporation.
• No competition with Corporation.
• No corporate opportunity.
• No conflict of interests.
• No insider trading.
• No transaction that is detrimental to minority
  shareholders Case 35.1 Stokes v. Bruno (1998).

10
Fiduciary Duties of Directors and Officers 4

• No Conflicts of Interest full disclosure of any
  potential conflicts of interest and abstain from
  voting on any transaction that may benefit the
  director/officer personally.
• However, if transaction was fair and reasonable,
  it will not be voidable if approved by majority
  of disinterested directors.

11
4 Liability of Directors and Officers

• Directors and officers may be liable for
  negligent acts that breach the standard of due
  care
• Crimes and torts committed by individually and/or
  those committed by employees under their
  supervision.
• Shareholder derivative suits where shareholder(s)
  sue directors on behalf of corporation.

12
Business Judgment Rule

• Immunizes a director or officer from liability
  from consequences of a business decision that
  turned sour.
• Court will not require directors or officers to
  manage in hindsight.
• As long as decision was reasonable, informed,
  made in good faith and in the best interests of
  the corporation, BJR will apply.

13
5 Role of Shareholders

• Ownership of shares grants a shareholder an
  equitable ownership interest in a corporation.
• Shareholders generally have no right to manage
  the daily affairs of the corporation, but do so
  indirectly by electing directors.
• Shareholders are generally protected from
  personally liability by the corporate veil of
  limited liability.

14
Shareholder Powers

• Shareholder powers include approving all
  fundamental changes to the corporation
• Amending articles of incorporation or bylaws.
• Approval of mergers or acquisition.
• Sale of all corporate assets or dissolution.
• Shareholders also elect and remove the board of
  directors.

15
Shareholder Meetings 1

• Shareholders meetings must occur at least
  annually. Voting requirements and procedures
  are
• Quorum of shareholders owning more than 50 of
  shares must be present to conduct business
• Shareholders may appoint a proxy or enter into a
  voting trust agreement.

16
Shareholder Meetings 2

• For special shareholder meetings
• Notice and time of meetings must be sent in
  writing to each shareholder within a reasonable
  time ahead of the meeting.
• Notice mus state reason for meeting and only deal
  with this matter.

17
Shareholder Voting

• Common shareholder entitled to one vote per
  share.
• Articles and by-laws can exclude or limit voting
  rights of certain classes of stock.
• Quorum must be present -- shareholders
  representing more than 50 of outstanding shares
  must be present.

18
Shareholder Voting 2

• Shareholders may vote on resolutions.
• Need majority present for most resolutions.
• Need a super majority (e.g., 67) for
  important matters sale of assets, etc..
• Voting lists by corporate secretary contains
  record of stock ownership. Cut off date 70 days
  ahead of action (notice, dividends, etc..)

19
Shareholder Voting 3

• Methods of Increasing Minority Shareholder Power
  Within the Corporation
• Cumulative Voting allows minority shareholders to
  get a board member elected.
• x to be elected x shareholders of shares
  shareholder can cast them all for one board
  nominee.
• Shareholder Voting Agreements.
• Voting Trusts.

20
Shareholder Voting 4

• Proxies and Shareholder proposals under
  Securities and Exchange Commission Rule 14a-8
• Proxy solicitation must include proposals which
  will be discussed at the meeting.
• Shareholders who own 1,000 worth of stock may
  submit their own proxy solicitations.
• Company does not have to include shareholder
  proposals which relate to ordinary business
  operations.

21
6 Rights of Shareholders

• Shareholders have the right
• To vote.
• To have a stock certificate.
• To purchase newly issued stock.
• To dividends, when declared by board.
• To inspect corporate records.
• To transfer shares, with some exceptions.
• To a proportionate share of corporate assets on
  dissolution.
• To file suit on behalf of corporation.

22
Stock Certificates

• Certificate which evidences ownership in a
  certain number of shares in the corporation given
  to person of record (regardless of who has
  certificate) gets notices, dividends reports.
• Corporate ownership is intangible personal
  property.
• Some states allow uncertificated stock -- no
  tangible certificate.

23
Preemptive Rights

• Common law concept which is a preference to
  existing shareholders to purchase a pro-rated
  share of newly-issued stock within a certain
  period of time.
• Provided for in the articles of incorporation.
• Significant in a close corporation to prevent
  dilution and loss of control.

24
Stock Warrants or Rights

• Transferable options to purchase newly-issued
  stock at a stated price.
• Warrants are publicly traded.
• Called rights when option is for a short period
  of time.

25
Dividends

• Distribution of corporate profits or income.
• Only as ordered by the Board.
• Can be stock, cash, property, stock of other
  corporations.
• State laws control the sources of revenues for
  dividends, which may be paid from retained
  earnings, net profits and surplus.

26
Illegal Dividends

• If dividends paid from an unauthorized account
  shareholder must return if she knew they were
  illegal when received.
• Directors can be held personally liable for the
  amount of payment.
• Dividends paid when corporation is insolvent are
  automatically illegal.

27
Directors Failure to Declare Dividends

• When directors fail to declare a dividend,
  shareholders can sue.
• Directors do not have to declare if they have a
  rational basis for withholding a dividend (a bona
  fide purpose).
• Often, profits are retained for expansion,
  research or upgrades.

28
Inspection Rights

• Shareholders can inspect books for a proper
  purpose.
• But corporation can protect trade secrets, other
  confidential information.
• Shareholder must have held a minimum number of
  shares for a minimum amount of time.
• All shareholders can see list of other
  shareholders of record.

29
Transfer of Shares

• Shares are freely transferable unless restricted
  by articles and noted on the stock certificate.
• Closely held corporations may have right of
  first refusal or preemptive rights.
• Transfer accomplished by delivery or endorsement
  to corporate secretary.
• New shareholder must be recorded on corporate
  books.

30
Rights on Dissolution

• Shareholders have right to pro-rata share of
  assets upon liquidation.
• Shareholder may petition the court for
  dissolution of the corporation for following
  reasons
• Board mishandling corporate assets.
• Board deadlocked and irreparable injury will
  result.
• Acts of directors are illegal, oppressive, or
  fraudulent.
• Shareholders are deadlocked for two meetings and
  cant elect directors.

31
Shareholder Derivative Suit

• Shareholders can sue a 3rd party on behalf of the
  corporation if the Directors fail or refuse to
  correct the wrong or injury.
• Directors may refuse to take action because they
  might personally be liable.
• Any damages recovered go to corporations
  treasury.

32
7 Liability of Shareholders

• Shareholders are generally not liable for the
  contracts or torts of the corporation.
• If the corporation fails, shareholders cannot
  lose more than their investment, except when
• A shareholder hasnt paid for stock pursuant to
  the subscription agreement.
• Shareholder buys watered stock which is below
  the stocks par value.

33
8 Duties of Majority Shareholders

• Majority shareholders own enough shares to
  exercise de facto (actual) control over the
  corporation.
• Majority shareholders owe a fiduciary duty to
  corporation and the minority shareholders and
  creditors when they sell their shares because of
  the possibility of transfer of control.

34
Case 35.1 Stokes v. Bruno(Duty of Loyalty)

• FACTS
• Point Cotile Parks Association, Inc. (PCPA), is a
  nonstock, nonprofit corporation. Members are
  limited to owners of a lot or a building site
  within the subdivision.
• The directors, including Bruno and Wright,
  adopted resolutions granting Bruno and Wright the
  authority to sell certain common ground on
  PCPAs behalf. The board designated lots and set
  prices.
• Six years later, when some of the lots had not
  sold, Bruno and Wright sold to themselves, for
  lower prices, some of the common ground,
  including lots with timber that had not been
  previously offered for sale.

35
Case 35.1 Stokes v. Bruno(Duty of Loyalty)

• FACTS (contd)
• Craig Stokes and other PCPA members filed suit in
  a Louisiana state court against Bruno and Wright.
  The court declared the sale void. Bruno
  appealed.
• HELD AFFIRMED. FOR PCPA.
• Bruno and Wright had a duty to PCPA to maximize
  its return on the sale of the common ground.
• They should have offered the other PCPA members
  and the public the opportunity they gave to
  themselves.

36
Case 35.2 FDIC v. Castetter(Liability of
Directors)

• FACTS
• Peterson, with twenty-six years of banking
  experience, opened Balboa National Bank. Except
  for Peterson, none of the directors had any
  significant banking experience. Peterson focused
  the bank on lending money to auto buyers.
• Later, the federal Office of the Comptroller of
  the Currency (OCC) found many problems at the
  bank.
• The bank hired consultants to fix the problems
  but were unsuccessful.
• The FDIC sued the directors, contending that they
  were negligent and personally liable for the
  banks losses.

37
Case 35.2 FDIC v. Castetter(Liability of
Directors)

• HELD FOR DIRECTORS.
• Court applied the judgment rule in favor of the
  directors.
• Directors acted in good faith and relied on
  opinions of outside experts, and ultimately lost
  substantial sums of their own money.

38
Case 35.3 Hayes v. Olmstead(Duty of Majority
Shareholders)

• FACTS
• Olmsted Associates was a food brokerage in
  Oregon.
• Under OAs bylaws, the board of directors and
  the shareholders were to hold annual meetings at
  which the price of OA stock was to be set.
• The voting shareholders, including Arbanas,
  Olmsted, and Hayes, were also the firms officers
  and managers.
• During a corporate restructuring, an Executive
  Committee, consisting of Arbanas, Olmsted, and
  two nonshareholders, assumed the functions of the
  board.
• The board and the shareholders stopped meeting.

39
Case 35.3 Hayes v. Olmstead(Duty of Majority
Shareholders)

• FACTS (contd)
• The members of the Executive Committee secretly
  voted to pay themselves bonuses of more than
  100,000 each.
• Hayes asked about the bonuses, but was denied the
  information. When he complained, he was fired.
• OA offered to buy his stock for 67 per share.
  He rejected the offer and was removed from the
  board.
• He sued Olmsted, Arbanas, and OA, alleging,
  among other things, breach of fiduciary duty.

40
Case 35.3 Hayes v. Olmstead(Duty of Majority
Shareholders)

• HELD FOR HAYES.
• Minority shareholders were not given the formal
  and required opportunities to participate in or
  comment upon major changes in direction of OA.
• The court explained that Olmsted and Arbanas
  assumed control of OA by creating a de facto
  Executive Committee in violation of the bylaws.
• The Executive Committee did not observe corporate
  formalities and failed to hold regular meetings
  of the corporations Board of Directors and
  shareholders.