COM LAW Chap 34

Stock Certificate:

A certificate issued by a corporation evidencing the ownership of a specified number of shares in the corporation.

Outside Director:

A person on the board of directors who does not hold a management position at the corporation.

Inside Director:

A person on the board of directors who is also an officer of the corporation.

Business Judgment Rule:

A rule under which courts will not hold corporate officers and directors liable for honest mistakes of judgement and bad business decisions that were made in good faith.

Shareholder's Derivate Suit:

A suit brought by a shareholder to enforce a corporate cause of action against a third person.

Guth v. Loft, Inc.

Background info:Guth ran Loft. Loft made and sold candies, syrups, beverages and food . Coca-Cola supplied Loft with it's coke syrup. Guth didn't like how expensive it was, so he acquired the trademark and formula for Pepsi-Cola. He didn't have the money to support the venture, so he used Loft's resources (capital, credit, facilities and employees) without the consent of Loft's board. Issue: Duty of Loyalty Rule: by embracing the opportunity, the self-interest of the office or director will be brought into conflict with that of his corporation, the law will permit him to seize the opportunity for himself. Analysis: the state supreme court was "convinced that the opportunity to acquire the pepsi-cola trademark and formula goodwill and business belongs to Loft, and that Guth, as its President, had no right to appropriate the opportunity to himself." Conclusion: the lower courts ruling against the defendant was upheld.

Case v Sink & Rise Inc

Background: Eighty four shares of c/s voting. Appellee owned 20 shares he and spouse owned another 16 shares and 3 other people owned 16 shares each. During a shareholders meeting of sink and rise inc. James Caleb Case was the only shareholder present, another was present by proxy. He concluded that a minimum number of members must be present. He elected himself and another shareholders to be directors replacing his wife as the corproation's secretary. His wife filed a complaint in district court against sink and rise and Case set aside the action. The court concluded that the resoltuions were passed with authority and did not set them aside. Shirley appealed to the Supreme Court arguing that the shares she held jointly with Case couldn't be counted. Decision: The court affirmed the lower court's judgment, holding that the shares of stock co-owned were entitled to vote. Because the shares were represented in person at the shareholders' meeting, they could be counted for quorum purposes. The resolutions of the meeting were passed with authority.

34-1: Voting Techniques. Algonquin Corp. has issued and has outstanding 100,000 shares of common stock. Four stockholders own 60,000 of these shares, and for the past six years thy have nominated a slate of candidates for membership on the board, all of whom have been elected. Sergio and twenty other shareholders, owning 20,000 shares, are dissatisfied with corporate management and want a representative on the board who shares their views. Explain under what circumstances Sergio and the twenty other shareholders can elect their representative to the board.

Cumulative voting allows Sergio to be entitled to have the same number of votes as the number of voting shares he owns multiplied by the number of board members to be elected. Therefore, by following this method of voting, Sergio and the other twenty minority shareholders can all vote to elect their representative to the board. Together, the number of votes that will go towards their representative will (1 representative to be elected *20,000 shares) equal 20,000 votes. The majority shareholders have 60,000 votes, but their shares will have to be distributed among the other representatives.

What are the duties of corporate directors and officers?

Duties and liabilities include: Duty of care (to main informed & reasonable decisions, Duty to exercise reasonable supervision, Dissenting directors) Duty of Loyalty (competing, usurping, conflict of interest, insider trading, detrimental transaction, selling control over corporation) Conflicts of interest (must make full disclosure of any potential conflicts in corporate transaction).

34-6: Duty of Loyalty. Kids International Corp. produced children's wear for Walmart and other retailers. Gila Dweck was a Kids director and its chief executive officer. Because she felt that she was not paid enough for the company's success, she started another firm, Success Apparel, to compete with Kids. Success operated out of Kids' premises, used its employees, borrowed on its credit, took advantage of its business opportunities, and capitalized on its customer relationships. As an "administrative fee," Dweck paid Kids 1 percent of Success's total sales. Did Dweck breach any fiduciary duties? Explain.

Dweck breached the duty of loyalty in this situation. The duty of loyalty requires directors and officers to subordinate their personal interests to the welfare of the corporation. Directors cannot use corporate funds or confidential corporate information for personal advantage and must refrain from self-dealing. Dweck should not have done all of the things she was doing to advance her own personal business. She took business away from Kids because she did not think she was getting paid enough. It does not matter that she paid 1% of Kids of her sales for administrative fees, it still breaches the duty of loyalty.

34-3: Rights of Shareholders. Lucia has acquired one share of common stock of a multimillion-dollar corporation with more than 500,000 shareholders. Lucia's ownership is so small that she is wondering what her rights are as a shareholder. For example, she wants to know whether owning this one share entitles her to (a) attend and vote at shareholders' meetings, (b) inspect the corporate books, and (c) receive yearly dividends. Discuss Lucia's rights in these three matters.

Lucia would have the right to attend and vote at shareholders' meetings because all shareholders are entitled to one vote per share. Lucia would have the right to inspect the books provided that she has a proper purpose to and the request is made in advance. Finally, Lucia has a right to receive yearly dividends that would be proportionate to the number of shares she has in the corporation

34-2: Liability of Directors. Starboard, Inc., has a board of directors consisting of three members (Ellsworth, Green, and Morino) and approximately five hundred shareholders. At a regular meeting of the board, the board selects Tyson as president of the corporation by a two-to-one vote, with Ellsworth dissenting. The minutes of the meeting do not register Ellsworth's dissenting vote. Later, during an audit, it is discovered that Tyson is a former convict and has openly embezzled $500,000 from Starboard. This loss is not covered by insurance. The corporation wants to hold directors Ellsworth, Green, and Morino liable. Ellsworth claims no liability. Discuss the personal liability of the directors to the corporation.

Officers and directors can be held liable for their own torts and crimes. They can also be held liable when shareholders believe that they are not acting in the best interest of the company as well as for the torts and crimes committed by corporate employees under their management. In this case, Ellsworth, Green, and Morino will be held liable for Tyson's crimes because it can be argued by shareholders that the directors did not act in the best interest of the company by ensuring there were background checks in place before anyone is hired. It should be noted that the only way Ellsworth could avoid personal liability is if his dissenting vote was properly recorded.

34-7: Duties of Majority Shareholders. Bill McCann was the president and chief executive officer of McCann Ranch & livestock Co. He and his brother Ron each owned 36.7 percent of the stock, but Ron had been removed from the board of directors on their father's death and was not authorized to work for the firm. Their mother, Gertrude, owned the rest of the stock, which was to pass to Bill on her death. The corporation paid Gertrude's personal expenses in an amount that represented about 75 percent of the net corporate income. Bill received regular salary increases. The corporation did not issue a dividend. Was Ron the victim of a freeze-out? Discuss.

Ron was a victim of a freeze-out in this situation. The other two shareholders are significantly benefiting from being a shareholder while Ron has nothing. Ron has been removed from the board and now he can no longer vote on matters, while the other two control the business. Ron is not authorized to work for the firm either. Meanwhile, Bill is receiving regular salary increases and the company is paying personal expenses for Gertrude. There is a fiduciary duty to Ron as a minority shareholder and Bill and Gertrude as majority shareholders are not upholding.

Watered Stock:

Shares of stock issued by a corporation for which the corporation receives, as payment, less than the stated value of the shares.

From what sources may dividends be paid legally? In what circumstances is a dividend illegal? What happens if a dividend is illegally paid?

State laws differ, but most are paid from the following: 1- Retained earnings (undistributed net profits) 2-Net profits - without regard to deficits in prior years 3- Surplus- any kind. Dividends can be illegal if they are improperly paid from an unauthorized account, or if payment causes the corporation to become insolvent. If a dividend is illegally paid, the Board could be held personally liable.

Directors are expected to use their best judgement in managing the corporation. What must directors do to avoid liability for honest mistakes of judgment and poor business decisions?

The business judgment rule immunizes corporate management from liability for actions that result in corporate losses or damages if the actions are undertaken in good faith and within the power of the corporation and the authority of management to make. Directors must exercise due care in performing their duties. The rule will apply as long as the director did all of the following: 1) Took reasonable steps to become informed on corporate matters 2) Act in accord with personal knowledge and training 3) Had a rational basis for his or her decision 4) Exercise a reasonable amount of supervision when they delegate work to others 5) Attend board of director's meetings 6) Didn't have a conflict of interest between his or her personal interest and that of the corporation

Quorum:

The number of members of a decision-making body that must be present before business may be transacted.

34-4: Duties of Directors and Officers. First Niles Financial, Inc., is a company whose sole business is to own and operate a bank, Home Federal Savings and Loan Association of Niles, Ohio. First Niles' directors include bank officers William Stephens, Daniel Csontos, and Lawerence Safarek; James Kramer, president of an air-conditioning company that services the bank; and Ralph Zuzolo, whose law firm serves the bank and whose title company participates in most of its real estate deals. First Niles' board put the bank up for sale. There were three bids. Farmers National Bank Corp. stated that it would not retain the board. Cortland Bancorp indicated that it would terminate the directors but consider them for future service. First Financial Corp. said nothing about the directors. The board did not pursue Farmers' offer, failed to respond timely to Cortland's request, and rejected First Financial's bid. Leonard Gantler and other First Niles shareholders filed a suit in a Delaware state court against Stephens and the others. What duties do directors and officers owe to a corporation and its shareholders? How might those duties have been breached here? Discuss.

The officers and directors owe several duties to the corporation and its shareholders. They owe the duty of care and must exercise due care in performing their duties. Officers and directors owe the duty to make informed and reasonable decisions. Directors have a duty to exercise reasonable supervision when they delegate work to corporate officers and employees. Directors have duty to use their best judgment in guiding corporate management by using the business judgment rule. The business judgment rule states that the director will not be liable to the corporations or to its shareholders for honest mistakes in judgment so long as they: took reasonable steps to become informed, had a rational basis for their decisions, and did not have a conflict of interest. They also owe the duty of loyalty. The duties were breached here because First Niles failed to inform the directors and the board failed to respond timely to Cortland's request. The duty of making informed and reasonable decisions was breached by the directors and the business judgment rule was violated because the directors failed to make reasonable steps to become informed.

Preemptive Rights:

The right of a shareholder in a corporation to have the first opportunity to purchase a new issue of that corporation's stock in proportion to the amount of stock already owned by the shareholder.

If a group of shareholders perceives that the corporation has suffered a wrong and the directors refuse to take action, can the shareholders compel the directors to act? If so, how?

They can file a "shareholders derivative suit" 90 days after written demand to the corporation has been made and the director refuses to take appropriate action. This is to act as guardians of the corporate entity.

34-8: Business Judgment Rule. Country Contractors, Inc., contracted to provide excavation services for A Westside Storage of Indianapolis, Inc., but did not complete the job and later filed for bankruptcy. Stephen Songer and Jahn Songer were Country's sole shareholders. The Songers had not misused the corporate form to engage in fraud, the firm had not been undercapitalized, personal and corporate funds had not been commingled, and Country had kept accounting records and minutes of its annual board meetings. Are the Songers personally liable for Country's failure to complete its contract? Explain.

Under the business judgement rule the Songers are not personally liable for Country's failure to complete its contract. The business judgement rule states that a corporate officer or director will not be liable to the corporation or to its shareholders honest mistakes of judgement or bad business decisions. In this situation, we can see that the Songers were not trying to commit fraud or under capitalize their firm. They had no personal funds integrated with the company. Lastly, they had accounting records and minutes of annual board meetings. There was no indication in the facts above that the Songers were acting intentional or dishonestly.

Proxy:

When a shareholder formally authorizes another to serve as his or her agent and vote his or her shares in a certain manner.

34-5: Rights of Shareholders. Stanka Woods is the sole member of Hair Ventures, LLC. Hair Ventures owns 3 million shares of stock in Biolustre, Inc. For several years, Woods and other Biolustre shareholders did not receive notice of shareholders' meetings or financial reports. When Woods learned that Biolustre planned to issue more stock, Woods, through Hair Ventures, demanded to see Biolustre's books and records. Biolustre asserted that the request was not for a proper purpose. Does Woods have a right to inspect Biolustre's books and records? If so, what are the limits? Do any of those limits apply in this case? Explain.

Yes, Stanka Woods has a right to inspect Biolustre's books and records. Every shareholder is entitled to examine corporate records. A shareholder can inspect the books in person or through an agent. The inspection is limited to the inspection and copying of corporate books and records for a proper purpose. Stanka Woods has a proper purpose for inspecting Biolustre's books because the shareholders did not receive notice of shareholders meeting or financial reports.

What is a voting proxy?

voting proxy is when a stockholder authorizes the other party to vote the stockholders shares in a certain manner. Cumulative voting is designed to allow minority shareholders to be represented on the board of directors. number of board members elected multiplied by number of voting shares owned.