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