Chapter 37

Audit Committee

A committee of the board of directors that is composed of outside directors that are responsible for the oversight and the outside and internal audits of the corporation. (More information on page 626)

Notice of a Shareholders' Meeting

A corporation is required to give the shareholders written notice of the place, day, and time of annual and special meetings. For a special meeting, the purpose of the meeting must also be stated. Only matters stated can be considered at the meeting. The notice, which must be given no less than 10 days or more than 50 days before the date of the meeting, may be given in person or by mail. If the required notice is not given or is defective, any action taken at the meeting is void.

Cumulative Voting

A corporation's articles of incorporation may provide for or corporate law may require this type of voting. A system in which a shareholder can accumulate all of his or her votes and vote them all for one candidate or split them among several. Gives a minority shareholder a better opportunity to elect someone to the board of directors.

Record Date

A date specified in corporate bylaws that determines whether a shareholder can vote at a shareholders' meeting. Only shareholders who own stock on the record date can vote. May not be more than 70 days before the shareholders' meeting.

Terms of Office of the Board of Directors

A director's term of office expires at the next annual shareholders; meeting following his or her election, unless terms are staggered. The RMBCA allows boards of directors that consist of nine or more members to be divided into two or three nearly equal or equal classes that are elected to serve staggered terms of two or three years, respectively. The specifics must be outlined in the articles of incorporation. Only one class of directors of the board would come up for election each year. Vacancies on a board of directors can occur because of death, illness, the resignation of a director, or an increase in the number of positions on the board. Such vacancies can be filled by the shareholders or the remaining directors.

Dividend

A distribution of profits of the corporaiton to shareholders. Paid at the discretion of the board of directors. The directors are respnsible for determining when, where, how, and how much will be paid in dividends. The directors may opt to retain the profits in the corporation to be used for corporate purposes instead of as dividends. This authority cannot be delegated to a committee of the board of directors or to officers of the corporation. When a corporation declares a divident, it sets a date, usually a few weeks prior to the actual payment, that is called the record date. Persons who are shareholders on that date are entitled to receive the dividend, even if they sell their shares before the payment date. Once declared, a cash or property divident cannot be revoked. Shareholders can sue to recover declared but unpaid dividends.

Piercing the Corporate Veil (Alter Ego Doctrine)

A doctrine that says if a shareholder dominates a corporation and uses it for improper purposes, a court of equity can disregard the corporate entity and hold the shareholder personably liable for the corporation's debts and obligations. This is often resorted to by unpaid creditors who are trying to collect from shareholders a debt owed by the corporation. Also called alter ego doctrine because the corporation becomes the alter ego of the shareholder or shareholders. Courts will pierce the corporate veil if (1) the corporation has been formed without sufficient capital (thin capitalization) or (2) separateness has not been maintained between the corporation and its shareholders (commingling of personal and corporate assets, failure to hold required shareholders' meetings, failure to maintain corporate records and books). The courts examine this doctrine on a case-by-case basis.

Duty of Care

A duty of corporate directors and officers to use care and diligence when acting on behalf of the corporation. The directors and officers must discharge their duties (1) in good faith, (2) with the care that an ordinary prudent person in a like position would use under similar circumstances, and (3) in a manner they reasonably believe to be in the best interest of the corporation. A director or an officer who breaches the duty of care is personally liable to the corporation and its shareholders for any damages caused by the breach. Such breaches, which are normally caused by negligence, often involve a director's or officer's failure to (1) make a reasonable investigation of a corporate matter, (2) attend board meetings on a regular basis, (3) properly supervise a subordinate who causes a loss to the corporation through embezzlement, or (4) keep adequately informed about corporate affairs. The courts examine breaches on a case-by-case basis.

Duty of Loyalty

A duty that directors and officers have not to act adversely to the interests of the corporation and to subordinate their personal interests to those of the corporation and its shareholders. Fiduciary duty to act honestly. If a director or officer breaches his or her duty of loyalty, and makes profit or gain on a transaction, the corporation can sure the director or officer to recover the profit or gain.

Duty of Obediance

A duty that directors and officers of a corporation have to act within the authority conferred on them by the state corporation codes, the articles of incorporation, the bylaws, and the resolutions adopted by the board of directors. Directors and officers who intentionally or negligently engage in conduct beyond their authority are personally liable for any resultant damages caused to the corporation or its shareholders.

Derivative Lawsuit (Derivative Action)

A lawsuit a shareholder brings against an offending party on behalf of a corporation when the corporation fails to bring the lawsuit. A shareholder can bring derivative action if he or she (1) was a shareholder at the time of the act complained of, (2) fairly and adequately represents the interests of the corporation, and (3) made a written demand on the corporation to take suitable actions and either the corporation rejected the demand or 90 days have expired since the date of the demand. Often, the third party who has damaged the corporation is one or more of the directors or officers. For example, board member or officer may have committed fraud or otherwise stolen property from or misused property of the corporation. In this case, the written demand will be excused. A derivative lawsuit will be dismissed by the court if either a majority of independent directors or a panel of independent persons appointed by the court determines that the lawsuit is not in the best interests of the corporation. This decision must be reached in good faith and only after conducting a reasonable inquiry. If a shareholder's derivative action is successful, any award goes into the corporate treasury. The plaintiff-shareholder is entitled to recover payment for reasonable expenses, including attorney fees, incurred in bringing and maintaining the derivative action. Any settlement of a derivative action requires court approval.

Annual Shareholders' Meeting

A meeting of the shareholders of a corporation that must be held by the corporation to elect directors, choose an independent auditor, and take other actions. Must be held at times fixed in the bylaws. If a meeting is not held within either 15 months of the last annual meeting or 6 month's after the end of the fiscal year, whichever is earlier, a shareholder may petition the court to order the meeting held. Any act that can be taken at the shareholders' meeting can be taken without a meeting if all the corporate shareholders sign a written consent approving the action.

Inside Director

A member of the board of directors who is also an officer of the corporation. Ex: President of corporation

Outside Director

A member of the board of directors who not an officer of the corporation. Often officers and directors of other corporations, bankers, lawyers, professors, and are often selected for their business knowledge and expertise.

Board of Directors

A panel of decision makers who are elected by the shareholders. Responsible for formulating policy decisions that affect the management, supervision, control, and operation of the corporation. Such policy decisions include deciding the business or businesses in which the corporation should be engaged, selecting and removing the top officers of the corporation, and determining the capital structure of the corporation. Originally it was considered an honor to serve as a director and no payment was involved. Today, directors are often paid in annual retainer and an attendance fee for each meeting attended. Unless otherwise provided in the articles of incorporation, the directors are permitted to fix their own compensation. There are no special qualifications. A director need not be a resident of the state of incorporation or a shareholder. However, the articles of incorporation or bylaws may prescribe qualification for directors. Can consist of one or more individuals. The number of initial directors is fixed by the articles of incorporation. This number can be amended in the articles of incorporation or the bylaws. The articles of incorporation or bylaws can establish a variable range for the size of the board of directors. The exact number within the range may be changed by the board of directors or shareholders.

Business Judgement Rule

A rule that says that directors and officers are not liable to the corporation or its shareholders for honest mistakes of judgement. The determination of whether a corporate director or officer has met his or her duty of care is measured as of the time the decision is made; the benefit of hindsight is not a factor. Were it not for the protection of this rule, many high-risk but socially desirable endeavors might not be undertaken.

Proxy

A shareholder's authorizing of another person (the proxy) to vote the shares at the shareholders' meetings in the event of the shareholder's absence. The proxy may be directed exactly how to vote the shares or may be authorized to vote the shares at his or her discretion. Proxies may be in writing or posted online. The written document itself is called the proxy. Unless otherwise stated, a proxy is valid for 11 months.

Straight Voting (Noncumulative Voting)

A system in which each shareholder votes the number of shares he or she owns on candidates for each of the positions opened. A majority shareholder can elect an entire board of directors.

Resolution

A vote taken by the board of directors of a corporation at a directors' meeting that authorizes certain actions to be taken on behalf of the corporation. The resolution is put forward by a member of the board, usually seconded by another board member, and then put to a vote of the entire board of directors. Resolutions usually pass. Corporate resolutions are recorded in the written minutes of the board of directors' meetings and specify the action taken by the board of directors. Resolutions can be adopted for many subjects that affect the corporation like authorizing the corporation to enter into contracts and leases, employing an accountant or other professionals, appointing a new officer, declaring a dividend, authorizing entering into a banking relationship, and issuing stock. The board may initiate certain actions that require shareholders' approval. These actions are initiated when the board of directors adopts a resolution that approves a transaction and recommends that is be submitted to the shareholders for a vote. Ex: Mergers, sale of substantially all of the assets outside the course of ordinary business operations, amending the articles of incorporation, and voluntary dissolution. Corporate directors are required to have access to the corporation's books and records, facilities, and premises, as well as any other information that affects the operation of the corporation. This right of inspection is absolute. It cannot be limited by the articles of incorporation, the bylaws, or board of resolution.

Stock Dividend

Additional shares of stock distributed as a dividend. Not a distribution of corporate assets. They are distributed in proportion to the existing ownership interests of shareholders, so they do not increase a shareholder's proportionate ownership interest.

Shareholder Voting Agreement

An agreement between two or more shareholders that stipulates how they will vote their shares for the election of directors or other matters. They are not limited to duration and do not have to be filed with the corporation. Specifically enforceable. Shareholder voting agreements can be either revocable or irrevocable.

Right of First Refusal

An agreement that requires a selling shareholder to offer his or her shares for sale to the other parties to the agreement before selling them to anyone else. If the shareholders do not exercise this right, the selling shareholder is free to sell his or her shares to another party. May be granted to the corporation as well.

Buy and Sell Agreement

An agreement that requires selling shareholders to sell their shares to the other shareholders or to the corporation at the price specified in the agreement. The price of the shares is normally determined by a formula that considers the profitability of the corporation. The purchase of shares of a diseased shareholder pursuant to buy-and-sell agreement is often funded by proceeds from life insurance.

Voting Trust

An arrangement in which the shareholders transfer their stock certificates to a trustee who is empowered to vote the shares. Legal title to these shares is held in the name of the trustee. In exchange, voting trust certificates are issued to the shareholders. The trust may either specify how the trustee is to vote the shares or authorize the trustee to vote the shares at his or her discretion. The members of the trust retain all other incidents of ownership of the stock. A voting trust agreement must be in writing and cannot exceed 10 years. It must be filed with the corporation and is open to inspection by the shareholders.

Self-Dealing

Contracts of a corporation to purchase property from, sell property to, or make loans to corporate directors or officers where the directors or officers have not disclosed their interest in the transaction are often voided. In the alternative, the corporation can affirm the contract and recover profits from the self-dealing employee. Contracts or transactions with corporate directors or officers are enforceable if their interest in the transaction has been disclosed to the corporation, and the disinterested directors or the shareholders have approved the transaction.

Competing with the Corporation

Directors and officers cannot engage in activities that compete with the corporation unless full disclosure is made and a majority of the disinterested directors or shareholders approve the activity. The corporation can recover any profits made by non-approved competition and any other damages caused to the corporation.

Usurping a Corporate Opportunity

Directors and officers may not usurp (steal) a corporate opportunity for themselves. This constitutes a violation of the duty of loyalty. If usurping is proven, the corporation can (1) acquire the opportunity form the director or officer and (2) recover any profits made. The following elements must be shown: 1. The opportunity was presented to the director or officer in his or her corporate capacity 2. The opportunity is related to or connected with the corporation's current or proposed business 3. The corporation has the financial ability to take advantage of the opportunity 4. The corporate officer or director took the corporate opportunity for him or herself. However, the director or officer is personally free to take advantage of a corporate opportunity if it was full disclosed and presented tot he corporation and the corporation rejected it.

Meetings of the Board of Directors

Directors can act only as a board. Cannot act individually on the corporation's behalf. Every director has the right to participate in any meeting. Each director has one vote. Directors cannot vote by proxy. Regular meeting os a board of directors are held at the times and places established in the bylaws. Such meetings can be held without notice. The board can call special meetings of the board of directors as provided in the bylaws. Usually convened for purposes such as issuing new shares, considering proposals to merge with other corporations, and adopting maneuvers to defend against hostile takeover attempts. The board of directors may act without a meeting if all the directors sign written consents that set forth the actions taken. The RMBCA permits meetings of the board to be held via conference calls.

Corporate Officers

Employees of a corporation who are appointed by the board of directors at such time and by such manner as prescribed in the bylaws to manage the day-to-day operations of the corporation. The directors can delegate certain management authority to the officers of the corporation. Most corporations have a president, one or more vice presidents, a secretary, and a treasurer. The bylaws or the board of directors can authorize duly appointed officers the power to appoint assistant officers. The same individual may simultaneously hold more than one office in the corporation. The duties of each officer are specified in the bylaws. An officer of a corporation may be removed by the board of directors. The board only has to determine that the best interests of the corporation will be served by such removal. Officers who are removed in violation of an employment contract can sure the corporation for damages.

Sarbanes-Oxeley Act of 2002 (SOX)

Established rules to improve corporate governance, prevent fraud, and add transparency to corporate operations. The goals are to improve corporate governance rules, eliminate conflicts of interest, and instill confidence in investors and the public that management will run public companies in the best interests of all constituents. (more on page 632)

Negligence

Failure of a corporate director or officer to exercise the duty of care while conducting the corporation's business.

Making a Secret Profit

If a director or officer breaches his or her duty of loyalty and makes a secret profit on a transaction (bribe or kickback to purchase from a certain company) the corporation can sue the director or officer to recover the profit.

Special Shareholders' Meetings

Meetings of shareholders that may be called by the board of directors, the holders of at least 10 percent of the voting shares of the corporation, or any other person authorized to do so in the articles of incorporation or bylaws (president) to consider and vote on important or emergency issues, such as a proposed mergers, consolidations, the removal of directors, amending the articles of incorporation, or dissolution.

Corporate Electronic Communications

Modern method by which corporations communicate with shareholders, among directors, with regulatory agencies, and others. (Examples in book)

Agency Authority of Officers

Officers and agents of a corporation have such authority as may be provided in the bylaws and as determined by resolution of the board of directors. Because they are agents, officers have the express authority granted to them, as well as implied authority and apparent authority, to bind a corporation to contracts. A corporation can ratify an unauthorized act of an officer or agent. Officers are liable on an unauthorized contract if the corporation does not ratify it.

Shareholders

Owners of a corporation who elect the board of directors and vote on fundamental changes in the corporation. They are not agents of the corporation and cannot bind the corporation to contracts.

Preemptive Rights

The articles of incorporation can grant these rights. Rights that give existing shareholders the option of subscribing to new shares being issued in proportion to their current ownership interests. This can prevent a shareholder's interest in the corporation from being diluted. Shareholders are given a reasonable period of time (30 days) to exercise these rights. If a shareholder does not exercise these rights during this time, shares can then be sold to anyone.

SUpramajority Voting Requirement (Supermajority Voting Requirement)

The articles of incorporation or the bylaws can require this method of voting. A requirement that a greater than majority of shares constitutes a quorum of the vote of the shareholders. Such votes are often required to approve mergers, consolidation, and the sale of substantially all the assets. To add a supramajority requirement, the amendment must be adopted by the number of shares of the proposed increase. For example, increasing a majority voting requirement to an 80 percent supramajority would require an 80 percent affirmative vote.

Shareholders' List

The corporation must prepare this list that contains the names and addresses of the shareholders as of the record date and the class and number of shares owned by each shareholder. This list must be available for inspection at the corporation's main office.

Fiduciary Duties

The duties of obedience, care, and loyalty owed by directors and officers to their corporation and its shareholders when making decisions and taking action on behalf of the corporation.

Quorum of the Board of Directors

The number of directors necessary to hold a board meeting or transact business of the board. A simple majority of the number of directors established in the articles of incorporation or bylaws usually constitute a quorum for transacting business. However, the articles of incorporation and the bylaws may increase this number. If a quorum is present, the approval or disapproval of a majority of the quorum binds the entire board. The articles of incorporation or the bylaws can require a greater than majority of directors to constitute a quorum of the vote of the board.

Quorum to Hold a Meeting of the Shareholders

The required number of shares that must be represented in person or by proxy to hold a shareholders' meeting. The RMBCA establishes a majority of outstanding shares as a quorum. Once a quorum is present, the withdrawal of shares does not affect the quorum of the meeting. The affirmative vote of the majority of the voting shares represented at a shareholders' meeting constitutes an act of the shareholders for actions other than for the election of directors.