Corporations: Shareholder Duties Flashcards
Direct Suit
Suit alleging a direct loss to shareholder
Derivative Suit
A suit alleging a loss to the shareholder caused by a loss to the corporation.
Two suits in one:
- Corporation against the directors for their failure to carry out fiduciary duties
- Suit by the plaintiff arguing that he or she should substitute for the directors in managing this particular aspect of the corporation’s business
Basis for Direct v. Derivative Claims
Basis for Direct Claims:
○ Force payment of promised dividend
○ Enjoin activities that are ultra vires
○ Claims of securities fraud
○ Protect participatory rights for shareholders
Basis for Derivative Suits:
○ Breach of Duty of Care
○ Breach of Duty of Loyalty
Remedy in Derivative Suit
○ Remedy from principal suit goes to corporation;
○ Corporation is required to pay shareholder attorney’s fees if suit is successful or settles
Duties, Liabilities, and Roles of Corporate Actors
Board of Directors
Duties: Fiduciary Duties of Care and Loyalty
Liabilities: Breach of Fiduciary Duty
Roles: Manage Business
Shareholders
Duties: None, unless controlling (Controlling shareholders owe fiduciary duties to the minority )
Liabilities: Only if pierce corporate veil
Roles:
- Sue (Direct or Derivative)
- Vote
- Sell
Procedural Hurdles of a Derivative Suit
1) Bonding Requirements (A derivative claimant with “low stakes” must post security for corporation’s legal expenses [deters frivolous lawsuits])
2) Demand Requirement
3) Special Litigation Committees
Demand Requirement
Most states require shareholders to approach Directors and demand they pursue legal action (unless the shareholder can claim a valid excuse)
Letter from SH to directors includes:
- Request that the board bring suit on the alleged cause of action
- Specific facts to apprise the board of the nature of the alleged cause of action and to evaluate its merits
Court of Chancery Rule 23.1: The complaint shall allege “the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors … and the reasons for the plaintiff’s failure to obtain the action OR for not making the effort”
What to ACTUALLY do in Deleware
A rational plaintiff will file derivative suit before making demand
- Consequences of not making demand trivial (if required, slight delay while you make demand)
- Preserves right to litigate
How to Excuse Demand
Post-Aaronson:
Demand excused if it is shown that demand is futile. Do this by showing there was a reasonable doubt that:
(a) Majority of directors are disinterested, or
(b) The challenged transaction was product of valid exercise of business judgment.
NEW TEST under Zuckerberg
To excuse demand, a complaint must allege that at least ½ of the members of the board:
(1) received a material personal benefit from the misconduct
(2) face a substantial likelihood of liability, or
(3) lack independence from someone who received a material personal benefit from the alleged misconduct
Derivative Suit Decision Tree
Direct Suit:
- Plaintiff sues
Derivative Suit:
- “Demand” Decision
- If Demand excused, then Plaintiff sues (may still face Special Litigation Committee)
- If Demand required, Demand Made
Special Litigation Committees
NEW YORK: Aurebach v. Bennett
Substantive decision by the SLC fall squarely within the business judgment doctrine. However, judicial inquiry is permitted with respect to:
- Disinterested independence of SLC members
- Adequacy of SLC’s investigation
- Burden of proof on plaintiff
DELAWARE: Zapata v. Maldonado
STEP 1:
■ Inquiry into the independence and good faith of the committee
■ Inquire into the bases supporting the committee’s recommendations
STEP 2
■ Court applies its own business judgment as to whether the case should be dismissed
Shareholder Voting: Default Rule
Default Rule is one share = one vote, unless Articles of Incorporation provide otherwise
When do Shareholders Vote
Shareholder Meetings
○ Annual meetings (MBCA § 7.01)
■ Time set in bylaws
○ Special meetings (MBCA § 7.02)
■ By request of Board of Directors, or
■ At written request of at least 10% of shares
If there is unanimous written consent, shareholders may take action without a meeting, unless CoI provides otherwise
How Many Votes do You Need
MBCA: Majority of shares present at a meeting at which there is a quorum. (e.g., if 100 shares outstanding and 60 shares present, only need 31 votes)
Delaware: Default is a majority of shares entitled to vote. Certificate or bylaws can opt out of default, but never less than ⅓ of the shares. (e.g., if 100 shares outstanding and 60 shares present, need 51 votes)
Who Nominates Directors: Default
Default: Incumbent Board nominates a slate of directors
- Company sends out official proxy solicitation materials
- A competing slate can be offered in separate proxy materials
- Dodd-Frank / SEC allows direct nomination if shareholder owns >3% of shares for 3 years
Straight v. Cumulative Voting
Straight voting (DE): when a shareholder votes, the number of votes the shareholder has is accorded to each slot that is up for election/being voted upon
Cumulative voting (CA): each shareholder’s # of votes is multiplied by the number of director positions up for election and the shareholder can split their votes any way they like
Plurality Voting v. Majority Voting
Plurality: whoever gets the most votes for the seat wins in plurality
Majority: must get majority of votes to receive seat
Voting for directors v. filling vacancies
Delaware: SHs may act by written consent to elect. directors in lieu of an annual meeting only if:
(i) action is by unanimous written consent or
(ii) action by non-unanimous consent is exclusively to fill director vacancies
Froessel Rule
incumbent board proxy costs paid regardless of outcome; insurgent costs may be reimbursed if insurgents win
SH Voting to Amend AoI and Bylaws
MODIFYING ARTICLES OF INCORPORATION
MBCA:
● (a) Amendment must be adopted by the board of directors, and
● (e) approved by a majority of the votes of the SHs present (as long as a quorum)
DGCL:
● The directors shall adopt a resolution and holders of a majority of the outstanding stock must vote in favor of the amendment.
MODIFYING BYLAWS
MBCA:
● (a) Shareholders may amend or repeal, and
● (b) Directors may amend or repeal, unless pertaining to director election or bylaws prohibit
DGCL:
■ The power to adopt, amend, or repeal bylaws shall be in the stockholders entitled to vote (plus, directors may also have this power if so provided in the articles of incorporation)
Shareholder Voting on Fundamental Transactions
YES (e.g., Merger)
Shareholder Voting on Precatory Measures + Corporation’s Response
Qualifying shareholders can put a proposal before their fellow shareholders (company pays expenses)
This SH must have owned at least 1% or $2,000 (whichever is less) of the issuer’s securities for at least one year prior to the date the proposal is submitted
Corp Response:
(1) The Corp is required to include the proposal UNLESS it can prove to the SEC that it may be excluded under Rule 14a-8 (e.g., law would be violated, involves special interest, not relevant to firm’s operations)
(2) Corp can include the proposal with opposing statement
(3) Corp can negotiate with proponent
Shareholder Duties: Selling (Two Main Laws)
Securities Fraud Lawsuits (both gov and private Ps)
Insider Trading Prohibition (enforced by SEC and DoJ)
Requirements for Private Securities Fraud Suit
(1) Material misrepresentation or omission
● Substantial likelihood that a reasonable shareholder would consider the fact important”
(2) Scienter
● Requires pleading with “particularity facts giving rise to a strong inference that the defendant acted with the intent to deceive, manipulate, or defraud
(3) Reliance
■ “Fraud on the market” theory: Rebuttable presumption that investor relied on integrity of public trading market price when making investment decision, so investor need not have seen misrepresentation (i.e., If you lied and the stock went up because of the lie, then we’re going to assume they relied on this)
(4) Causation
● Fraud caused the plaintiff’s loss (Change in stock prices when truth revealed)
