Chapter 40: Corporate Directors, Officers, and Shareholders
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
Liability of Shareholders
-Shareholders are generally not liable for the contracts or torts of the corporation
Shareholder's 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 corporation's treasury
Three Rights of Directors
1) Right to Participation 2) Right of Inspection 3) Right to Indemnification
Shareholders Voting
1) Straight Voting 2) Cumulative Voting 3) Block Voting
Directors and Officers are immune from personal liability as long as:
1) The directors and officers: a) took responsible steps to become informed about the matter b) had a rational basis for his or her decision c) did NOT have a conflict of interest between his or her personal interest and that of the corporation AND 2) The actions taken were within: a) the corporation's power to act b) the directors' and officers' authority
Shareholders Rights
1) to vote 2) to have a stock certificate 3) to dividends, when declared by board 4) to inspect corp records 5) to transfer shares (w/ some exceptions) 6) to an accurate/proportional share of corporate assets on dissolution 7) to file suit on behalf of corporation
Stock Warrant
A certificate granting the owner the option to buy a certain number of shares of stock, at a stated price, usually within a set time period
Stock Certificate
A certificate issued by a corporation evidencing the ownership of a specified number of shares in the corporation and all rights attached thereto
Business Judgement Rule
A corporate director or officer will not be liable to the corporation or to its shareholders for honest mistakes of judgment and bad business decisions as long as the decision was reasonable, informed, and made in good faith and in the best interest of the corporation
Removal of Directors
A director can be removed for cause, or failing to perform a required duty specified in the articles or bylaws by shareholders or by board of directors (subject to shareholder review)
Outside Director
A director who does not hold a management position (officer)
Inside Director
A director who is also an officer of the corporation
Independent Director
A director with no business or family relationships with the corporation or its officers
Block Voting
A group of shareholders may, by voting agreement or by entering into a voting trust, vote their shares together, increasing their influence on the outcome
Quorum of Directors
A minimum number of directors, usually the majority, must be present for board meetings to be valid
Shareholders' Separating Ownership and Management
A shareholder (other than one who is also a director or officer) has no responsibility for the corporation's day-to-day affairs. Nor do the officers and directors owe a duty to any individual shareholder that is distinct from the duty they owe all shareholders as owners of the corporation
Majority Shareholder's Liability
A shareholder who holds more than 50 percent of a corporation's outstanding stock may owe fiduciary duties to the corporation and to minority shareholders - particularly when the majority shareholder sells his shares, thereby effecting a change in corporate control
Watered Stock Liability
A shareholder who, usually in return for in-kind services or for property, is issued shares for less than their assessed value, is personally liable to the corporation (or the corporation's creditors) for the difference between the price paid and the value of the stock
Shareholder Derivative Suit
A suit by one or more shareholders: 1) suing the corporation's directors or others, 2) on the corporation's behalf, 3) for injury to the corporation
Business Judgement Rule Applies
As long as the director or officer: 1) took reasonable steps to become informed 2) had a rational basis for their decision 3) did not have a conflict of interest between their personal and the corporation's interest
Committees of the Board of Directors
Board of large, publicly held corporations create committees of directors and delegate certain tasks to these committees, increase efficiency of board
Audit Committee
Committee responsible for the selection, compensation, and oversight of the independent public accountants that audit the firm's financial records. Required of all publicly held corporations by the Sarbanes-Oxley Act
Executive Committee
Committee that handles interim management decisions between board meetings and is limited to dealing with ordinary business matters; does not have the power to declare dividends, amend bylaws, authorize issuance of stock
Duty of Care of Directors and Officers
Directors and Officers are expected to: 1) act in good faith (honestly) 2) exercise the care that an ordinarily prudent (careful) person would exercise in similar circumstances 3) act in the best interest of the corporation
Duty of Loyalty of Directors and Officers
Directors and Officers must place the corporation's best interest ahead of their personal interests. Directors and Officers may not: 1) compete with the corporation 2) have an interest that conflicts with the corporation's 3) engage in insider trading 4) authorize corporate transactions detrimental to minority shareholders without their approval 5) use corporate funds or confidential information for their personal gain 6) engage in self-dealing 7) sell control of the corporation without shareholder approval
Duty to Make Informed Decisions
Directors and officers are expected to be informed on corporate matters and to conduct a reasonable investigation of the situation before making a decision by: attend meetings and presentations, ask for information from those who have it, read reports, and review other written materials
Conflicts of Interest
Directors and officers must fully disclose any potential conflict of interest regarding a particular transaction and must abstain from voting on the proposed transaction
Director's Right to Participation
Directors are entitled to participate in all board of directors' meetings and have a right to be notified of these meetings. Dates of regular board meetings are specified in bylaws; thus, no notice is required. Special meetings require notice
Directors Rights
Directors are entitled to: 1) reasonable notice of, and to participate in, all board meetings 2) exercise their voting rights on corporate matters 3) inspect all corporate books and records 4) have the corporation indemnify them for any judgement entered against them, and for an legal fees and expenses incurred defending claims made, for acts taken in their directorial capacity
Duty to Exercise Reasonable Supervision
Directors are expected to exercise a reasonable amount of supervision when they delegate work to corporate officers and employees
Compensation of Directors
Directors are often paid at least nominal sums and may receive more substantial compensation in large corporations
Director's Responsibilities
Directors are responsible for: 1) declaring and paying corporate dividends 2) authorizing major corporate decisions 3) hiring, promoting, supervising, and removing corporate officers and managerial employees 4) deciding whether to issue stock or bonds
Board of Directors' Meetings
Directors hold meetings, established in the articles or bylaws, with recorded minutes. Meetings require quorum (minimum number of directors to conduct official corporate business, majority) and each director has one vote. Special meetings may be called with sufficient notice
Failure to Exercise Duty of Care
Directors or officers can be held liable for negligence
Director's Right of Inspection
Each director can access the corporation's books and records, facilities, and premises to make informed decisions and to exercise the necessary supervision over officers. Cannot be restricted
Straight Voting
Each shareholder may vote the number of her shares for each open seat on the board
Cumulative Voting
Each shareholder may vote the number of her shares times the number of open seats on the board, and may distribute her votes as she chooses
Board of Directors
Elected by shareholders and are responsible for all policy-making decisions necessary to the management of all corporate affairs
Types of Board Committees
Executive committee and Audit committee
Shareholders Quorum
For votes to be effective at a shareholders meeting, there must be enough shareholders or others holding proxies present to represent at least 50 percent of the corporation's voting stock
Officers and Executives
Hired by the board of directors to act as agents of the corporation and are responsible for managing the day-to-day operations of the corporation
Election of Directors
Incorporators appoint the first board of directors; subsequent directors are elected by majority vote of shareholders. Directors usually serve for one year term; common practice is to elect one-third of the board members for a three-year term, greater management continuity
Liability of Directors and Officers
May be liable for negligent acts that breach the standard of due care: 1) Crimes and torts committed individually and/or those committed by employees under their supervision 2) Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation
Right of First Refusal
May require that any shares be offered to the holder of the right (the corporation or some or all of its shareholders) before they may be sold to the public
Shareholders Meetings
Must occur at least once annually. In order for votes recorded to be effective, there must be a quorum present (enough shareholders and others holding proxies present to represent at least 50 percent of the corporation's voting stock)
Voting of Directors
Once quorum is met, directors present each have one vote. Matters generally require a majority vote
Shareholders
Owners of the corporation in proportion to the percentage of outstanding corporate stock they own
Shareholders' Agency
Shareholders are NOT authorized agents of the corporation simply by virtue of being shareholders
Shareholders' Compensation
Shareholders are entitled to a share of the corporation's profits and net assets upon its dissolution. In addition, shareholders may be entitled (depending on the share agreement) to receive dividends periodically or when declared by the board of directors
Inspection Rights of Shareholders
Shareholders are entitled, both as a matter of common law and of statute, to inspect the corporation's books and records: 1) for a proper purpose 2) in person or through an agent, attorney, accountant, or other authorized assistant 3) provided that the request is made in advance
Shareholders' Limited Liability
Shareholders are generally NOT personally liable for the obligations of the corporation. Therefore, their liability is limited to the amount they paid for the corporation's shares
Corporate Dissolution
Shareholders may petition a court to dissolve the corporation and appoint a receiver if: 1) the board of directors is deadlocked, or corporate affairs are being mismanaged, such that irreparable injury to the corporation is occurring or threatened 2) the directors or those in control are acting illegally, fraudulently or oppressively 3) corporate assets are being misapplied or wasted 4) the shareholders, after a specified number of ballots over a specified period of time, are unable to agree to a slate of directors
Shareholder Approval and Powers
Shareholders must approve, before the board can implement any fundamental corporate change such as: •Amending the articles of incorporation or by-laws •Merging or dissolving the corporation •Increasing the number of shares of stock the corporation is authorized to issue •Selling all or substantially all, of the corporation's assets
Transfer of Shares
Stock certificates are negotiable and are freely transferable by indorsement
Preemptive Rights
The right of an existing shareholder to purchase newly-issued shares in proportion to their percentage of ownership of the corporation prior to the issue of the new shares, before the newly-issued shares are offer for sale to the general public. An existing shareholder may avoid having her interest in the corporation diluted by newly-issued shares
Vacancies on the Board
Vacancies occur on the board if a director dies or resigns or when a new position is created through amendment of the articles or bylaws; Shareholders or the board can fill the vacant position
Director's Right to Indemnification
When a director becomes involved in litigation, the director may have the right to be reimbursed for the legal costs, fees, and damages incurred
Dissenting Directors
When an individual director disagrees with the majority's vote and mismanagement results from the majority's vote decision, the dissenting director is rarely held liable for the mismanagement. Absent directors register a dissent, posted in the minutes of the meeting
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
If the corporation fails, shareholders cannot lose more than their investment, except when:
•A shareholder hasn't paid for stock pursuant to the subscription agreement •Shareholder buys "watered stock" which is below the stock's par value
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 can't elect directors