Corporations - Shareholders: Management, Liability, and Derivative Suits Flashcards
Shareholder Power
The power to manage the corp is vested in the board.
Shareholders have no direct control in management of the corp’s business.
Shareholder liability is thus generally limited to liabilities for unpaid stock, a pierced corp veil, or the absence of a de facto corp.
Close Corporations
Shareholders can run the corp directly in a close corp. The characteristics of a close corp are few shareholders and the stock is not publicly traded.
Eliminating the board and having shareholders run the business, or appointing a manager, and so on, are also viable options for close corps.
Shareholder Liability for Corporate Debts - In General
Shareholders generally cannot be held liable for corporate debts. Because the corporation is liable for what it does and shareholders have limited liability. A shareholder might be personally liable for what the corporation did if the court pierces the corporate veil. This most commonly happens in close corps.
Shareholders Liability for Corporate Debts - Piercing the Corporate Veil
The general standard is that courts may pierce the corporate veil to avoid fraud or unfairness. To pierce the corporate veil and hold shareholders personally liable:
- the shareholders must have abused the privilege of incorporating AND
- fairness must require holding them liable
Elements Justifying PCV:
- Alter ego: the corporation is considered an “alter ego” or a “mere instrumentality” of the shareholders or another corp, AND some basic injustice results, a court may pierce the corp veil. These situations may arise where shareholders treat corp assets as their own, commingle their money with corporate money, and so on.
- Undercapitalization: the corp veil may be pierced where the corp is inadequately capitalized, so that at the time of formation there is not enough unencumbered capital to reasonably cover prospective liabilities.
- Fraud, avoidance of existing obligations, or evasion of statutory provisions: the corp veil may be pierced where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his existing personal obligations. The mere fact that an individual chooses to adopt the corporate form of business to avoid future personal liability is not itself a reason to pierce the corp veil.
Who is liable when a corp has its veil pierced?
Normally, only shareholders who are active in the operation of the business will be personally liable. Liability is joint and several.
PCV allows imposition of liability on shareholders for what should be a corp debt.
Shareholder as Plaintiff and Recovery - Derivative Suit Context
In a derivative suit, a shareholder is suing to enforce the corporation’s claim, not their personal claim. If a shareholder believes the corp has been wronged but the directors have not done anything to enforce its rights with respect to the wrong, the shareholder may be able to bring a shareholder derivative suit to enforce the corp’s rights.
Could the corp have brought this suit? If so, it’s probably a derivative suit.
Compare - Direct Actions by Shareholders vs. Derivative Suits
A direct action may be brought for a breach of a fiduciary duty owed to the shareholder by an officer or director.
To distinguish breaches of duty owed to the corp and duties owed to the shareholder, ask: 1) who suffers the most immediate and direct damage, the corp or the shareholder; and 2) to whom did D’s duty run, the corp or the shareholder? In a shareholder direct action, any recovery is for the benefit of the individual shareholder.
Recovery to Corporation
In a derivative action, the shareholder is asserting the corp’s rights rather than her own rights. So if a shareholder-plaintiff wins a derivative suit, who gets the money from the judgment? The corp.
Requirements for Derivative Suits
Standing - a shareholder needs stock ownership at time of wrong and throughout the suit. Or they could become a shareholder through transfer by operation of law from someone who did own stock at the time the claim arose. This shareholder must also fairly and adequately represent the corporation’s interest.
Demand - Under the MBCA, the shareholder must make a written demand on the corp to take suitable action. In some states, shareholder must always do this and can’t sue until 90 days after making the demand. In other states, no need for shareholders to make the demand if it would be futile.
Procedural Matters for Derivative Suits
For procedural reasons, the corporation must be joined to the suit as a defendant. So even though the suit asserts a claim on behalf of the corp, it is technically joined as D.
Dismissal or settlement requires court approval. It will be dismissed if not in corp’s best interests based on an independent investigation by independent directors or panel and the court believes them.
The burden of proof to avoid dismissal is on the shareholder bringing the suit to prove the decision was not made in good faith after reasonable inquiry.
–» BUT If a majority had a personal interest in the controversy, the corp will have the burden of showing that the decision was made in good faith after reasonable inquiry.
