Corporate Governance - June 12 Flashcards
What is a close or closely-held corporation? (Epstein)
A close corporation is a corporation which has few shareholders and the stock of which is not publicly traded. (183)
What is a publicly-held corporation? (Epstein)
A publicly-held corporation is a corporation for which there is a public market in the stock. (183)
When can shareholders be liable to creditors? (Epstein)
Shareholders can be liable to creditors when the shareholders agree to be personally responsible for credit. (184)
What is the rule from DeWitt Truck Brokers v. W. Ray Flemming Fruit Co.? (Epstein/Q)
When substantial ownership of a corporation’s stock lies in a single individual, and there are other factors in support, courts often apply the “alter ego” or “instrumentality” doctrine to pierce the corporate veil and make the individual stockholder liable. (187)
What does the term undercapitalize mean? (Q)
To create a business and operate it without sufficient funds to be able to pay bills or satisfy judgments.
What is a subsidiary? (Epstein/Q)
A corporate entity owned or controlled by some separate, higher corporate entity. (190)
What is the rule from In re Silicone Gel Breast Implants Products Liability Litigation (1995)? (Epstein/Q)
Where a parent corporation directly controls the functions of a subsidiary and markets the subsidiary’s products using its own name, it can be held liable both through the subsidiary and directly for injuries caused by that product. (196)
What is straight voting? (Epstein)
“Under straight voting, there is a separate election for each seat on the board. Each shareholder gets to cast her number of shares in any way she desires for each of these separate elections. Unless the articles provide otherwise, she gets one vote for each share she holds.” (341)
What is cumulative voting? (Epstein)
“With cumulative voting, however, directors are not elected seat-by-seat. There is one at-large election in which the shareholders cast votes and the top five finishers would be elected to the board (because Todos has five directors in this hypo). In voting, however, here the shareholders get to “cumulate.” This means that each gets to multiply the number of shares she owns times the number of directors to be elected.” (342)
When can cumulative voting apply? (Epstein)
Cumulative voting can only apply to shareholders’ election or removal of directors. (342)
What is the rule from Villar v. Kernan (1997)? (Epstein/Q)
An agreement between corporate shareholders that governs salary must be in writing to be enforceable. (361)
A shareholder acquired a significant majority of the outstanding voting shares in a corporation. Pursuant to the corporation’s bylaws, the corporation had a board of three directors elected by a majority vote of the shareholders. The bylaws also allowed for cumulative voting. At the annual meeting, the majority shareholder voted all his shares for only one director. This meant that only one director received enough votes for re-election under the corporation’s bylaws. The minority shareholders objected, arguing that the corporation could not act through only one director. The majority shareholder disagreed, arguing that the bylaws could be amended to allow only one director to manage the corporation. The corporation was governed by the laws of a jurisdiction that followed the Model Business Corporation Act.
May the bylaws be amended to allow a sole director to manage the corporation? (Q)
Yes, because the board may vote to change the number of directors required to manage the corporation. Historically, most states required that a corporate board have at least three directors. See, e.g., Ind. Code § 23-17-12-3. Today, both the Model Business Corporation Act and the Delaware statutes permit a sole director to be an entire corporate board. See Model Bus. Corp. Act § 8.03 (2016); Del. Code Ann. § 141(b). A corporation may also require a specific number of directors in either the certificate of incorporation or the bylaws. See Model. Bus. Corp. Act § 8.03(a). Raising or lowering the number of directors specified by a certificate of incorporation requires amending the certificate by shareholder vote. In contrast, changing the number of directors specified in the bylaws may be accomplished simply by a vote of the board of directors. See id. at § 8.03(b).
Here, because this corporation is governed by the Model Business Corporation Act, the law allows the corporation to have a board of directors with only one director. However, the corporation will need to amend its own rules to reduce the number of directors on its board from three seats to just one seat. This corporation set the number of director seats in its bylaws, not the certificate of incorporation. Therefore, the existing board of directors may vote to amend the corporation’s bylaws to allow only one director to manage the corporation.
Four shareholders owned all 100 outstanding voting shares of a corporation. One shareholder owned 55 shares, and the other three shareholders owned 15 shares each. The bylaws of the corporation required the shareholders to elect three directors.
For an election to select the corporation’s directors, which type of voting would best protect the three minority shareholders’ interests? (Q)
Cumulative. Corporations may implement cumulative voting to protect the rights of minority shareholders. See Model Bus. Corp. Act. § 7.28(c) (2016). In most states, the default rule for shareholder voting is a straight vote, in which each shareholder may cast one vote per share for each director seat. See id. at § 7.28(a)-(b). In cumulative voting, a shareholder receives one vote per share for each director seat, but the shareholder may cast any or all of his votes for a single seat. See id. at § 7.28(c). Cumulative voting for director seats best protects the minority shareholders’ interests because a minority shareholder has a better chance of electing at least one director of his or her choice (rather than being outvoted by a majority shareholder on all director seats in a straight vote). This is particularly true if the minority shareholders collectively hold more voting shares than the largest shareholder alone, and the minority shareholders band together. In some states, cumulative voting is the default rule unless the certificate of incorporation provides otherwise. See, e.g., Alaska Stat. § 10.06.420(d). In a very small minority of states, cumulative voting is mandatory. See, e.g., Ariz. Rev. Stat. § 10-728.
Here, if there are three director seats available, straight voting would give one shareholder the right to vote 55 votes for each of three possible directors. Each of the other three shareholders could vote only 15 votes for each of that shareholder’s top three choices. That means the minority shareholders cannot defeat the 55-vote shareholder’s choices, even if the minority shareholders band together and vote their combined 45 possible votes for the same three candidates. Therefore, the minority shareholders cannot override the majority shareholder’s choices using straight voting.
However, under cumulative voting, the minority shareholders may be able to elect one or more directors of their choice. For example, if the majority shareholder still spreads 55 votes across three candidates, any minority shareholder could place all 45 of that shareholder’s votes (15 votes per shareholder times three possible seats = 45 cumulative votes to cast) on one candidate. In that situation, if one of the other minority shareholders placed even 11 votes on that candidate, the minority shareholders could collectively defeat a candidate that had only the majority shareholder’s 55 votes, ensuring at least some minority-shareholder voice in the election. Alternatively, if the majority shareholder placed 110 or 165 votes on just one or two candidates, then at least one seat remains to be filled by the choice of one or more minority shareholders. Again, this would mean that the minority shareholders would have at least some voice in the final choices.
A corporation hired a chief executive officer (CEO) pursuant to a valid, two-year employment contract. Three months later, after quarterly reports showed significant losses, the board wanted to replace the new CEO. These events occurred in a jurisdiction that followed the Model Business Corporation Act.
May the board remove and replace the CEO midway through the employment contract without cause? (Q)
Yes, because a board of directors may remove a corporate officer at any time, with or without cause. Under the Model Business Corporation Act, a board of directors may remove a corporate officer at any time, with or without cause. Typically, corporate officers serve for the term selected by the board or the corporation’s bylaws. However, officers may resign or be removed at any time during that term. See Model Bus. Corp. Act. § 8.43-44 (2016). The right to remove corporate officers is vested in the board of directors, who may remove any officer at any time, even without cause (i.e., even if the officer did nothing wrong, like if the board just finds someone else that the board likes more). See id. Moreover, the board may remove an officer even if doing so would breach the corporation’s contract with the officer or otherwise create contractual liability for the corporation. See id. Therefore, here, the board has the right to remove the CEO midway through the CEO’s employment contract, with or without cause. This is true even if it means the corporation is breaching the CEO’s employment contract and owes the CEO money damages for the early removal.
The board of directors of a dry-cleaning chain was considering whether to open a new location. Not all of the directors on the board agreed on whether the business should expand to the new location. The controlling jurisdiction had adopted the Model Business Corporation Act (MBCA), and the dry-cleaning chain’s articles of incorporation and bylaws did not alter the MBCA’s default rules about meeting and voting.
Which of the following accurately states how the board decides whether to open the new location? (Q)
A majority of directors must meet and a majority of those present must vote in favor of the expansion. In general, a corporation’s board of directors may act by two methods: (1) by majority vote at a meeting, or (2) without a meeting, so long as all members agree. See, e.g., 8 Del. Code Ann. § 141(b), (f). In order for a board to act at a meeting, a quorum must be present. Model Business Corporation Act § 8.24 (2016). The MBCA defines a quorum as a majority of the directors. Corporations are free to define a quorum to require a greater or fewer number of directors; however, the MBCA prohibits corporations from defining a quorum to require fewer than one-third of directors. Id. If a quorum is present, then the board may act by a majority vote of those present, unless the articles of incorporation require more than a majority vote. Id.
Here, not all the directors agree on whether to open a new location. To act on the proposal, the board must therefore meet. A valid meeting must have at least a quorum of the directors present, which by default here is a majority of the directors. To open the new location, a majority of the directors present at the meeting must vote in favor. Therefore, to open a new location: (1) the board of directors must meet, (2) a quorum (here, a majority) of directors must be present at the meeting, and (3) a majority of directors present at the meeting must vote in favor of opening the new location.
