FACT PATTERN FOUR— SHAREHOLDERS Flashcards
1
Q
SHAREHOLDERS: MANAGEMENT
AND LIABILITY
7.1 DO SHAREHOLDERS GET TO MANAGE THE
CORPORATION?
A
- Power to manage corp generally is vested in board of directors.
- Generally, shareholders have no direct control in management of corp’s business.
- They may act in their own personal interests & generally have no fiduciary duty to corp/fellow
shareholders. - Shareholder liability is thus generally limited to liabilities for unpaid stock, a pierced corporate veil, or absence of a de facto corp
2
Q
Close Corporations
A
- Shareholders can run corp directly in a close corp.
- The characteristics of a close corporation are
that there are few shareholders, & the stock is not publicly traded. - In a close corporation, we can set up management
w/ a board of directors & run it like a regular corp. - Or we can set up management differently, such as by eliminating the board & having shareholders run the business/appointing a manager, and so on.
3
Q
Shareholder Management Agreements
A
- Shareholder management agreements set up alternative management for a close corporation.
- The MBCA allows shareholders to enter into agreements to dispense w/ board & vest management power in shareholders.
- If articles do not include such a special provision,
shareholders exercise only indirect control of corp
through their voting power, by which they elect & remove directors, adopt & modify bylaws, & approve
fundamental changes in the corporate structure - There are 2 ways to set up a shareholder management agreement:
(1) In the articles & approved by all shareholders OR
(2) By unanimous written shareholder agreement - Either way, the agreement should be conspicuously noted on the front and back of the stock certificates. (Failure to do so, though, does not affect validity.)
- If shareholders do this & set up management by shareholder or by a manager, who owes the duties of care and loyalty to the corporation?
- It’s whoever manages corp.
- Managing shareholders will thus have the liabilities that a director ordinarily would have with respect to that power.
4
Q
Tip
A
If examiners question you about the power of shareholders to run the day-to-day affairs of their corp, unless corp’s articles/shareholder agreement provides otherwise, you should respond that shareholders have no such power; that power is vested in the board of directors, & shareholders have power to elect the board.
5
Q
Special Fiduciary Duty in Close Corporations
A
- We just saw that whoever manages corp owes duties of care & loyalty to corp. In many states, cts impose a fiduciary duty on shareholders owed to other shareholders.
- Why? B/c a close corporation looks like a partnership (with few owners, who usually are employed by the business).
- B/c partners owe each other a fiduciary duty of UTMOST GOOD FAITH, these cts apply the same duty in the close corporation
6
Q
Duties of Controlling Shareholders to Minority
Shareholders
A
- Controlling shareholders cannot use their power
to benefit at expense of minority shareholders. - Controlling shareholder could be a corp.
- Ex: parent corporation should not use its domination of a subsidiary corporation to receive something to the detriment of subsidiary’s minority shareholders.
- Doing so would breach this duty.
- There is also a duty to disclose material info to minority shareholders.
7
Q
Oppression of Minority Shareholders
A
- If there is oppression of minority shareholders, they
can sue controlling shareholders who oppress
them for breach of this fiduciary duty. - Ex. controlling shareholders might deny minority any voice in corporate affairs, fire them from employment, refuse to declare dividends, & refuse to buy minority’s stock (sominority is getting no return on investment).
- Why do some cts let minority shareholder sue here? - B/c oppression thwarts their legit goals for investing & they have no way out.
8
Q
Professional Corporations
A
- Licensed professionals, including lawyers, medical professionals, & CPAs, may incorporate as a “professional corporation” or “professional association.”
- The name must include one of those phrases or “P.C.” or “P.A.”
- The articles must state the purpose is to practice in a particular profession.
- Generally, the rules governing regular corporations apply to the professional corporation.
9
Q
Employees
A
- Directors, officers, & shareholders usually must be
licensed professionals.
-Professional corporation employ non-professionals, but not to practice the profession.
10
Q
Liability
A
- Professionals are personally liable for their malpractice.
- However, shareholders are generally not liable for corporate obligations/other professionals’ malpractice.
11
Q
CAN SHAREHOLDERS BE HELD LIABLE FOR
CORPORATE DEBTS?
A
- Shareholders generally cannot be held liable for corporate debts.
- But a shareholder might be personally liable for what corp did if ct pierces corporate veil.
- This can happen in close corporations ONLY
12
Q
Piercing the Corporate Veil
A
- To pierce corporate veil & hold shareholders personally liable:
(1) Shareholders must have abused the privilege of incorporating; and
(2) Fairness must require holding them liable. - So cts may pierce corporate veil to avoid fraud/ unfairness by shareholders in a close corporation.
- But something like sloppy administration is not enough.
13
Q
Common Scenarios—Elements Justifying
Piercing
A
- There are 3 situations in which corporate veil is often pierced:
(1) Alter Ego (Identity of Interests) - If shareholders ignore corporate formalities such the corp may be considered the “alter ego” or a “mere
instrumentality” of the shareholders/another corp,
& some basic injustice results, a ct might pierce corporate veil. - These situations may arise where shareholders treat corporate assets as their own, commingle their money w/ corporate money, & so on.
14
Q
Undercapitalization
A
- Corporate veil may be pierced where corp is inadequately capitalized, so that at time of formation
there is not enough unencumbered capital to reasonably cover prospective liabilities.
15
Q
Fraud, Avoidance of Existing Obligations, or Evasion
of Statutory Provisions
A
- Corporate veil may be pierced where necessary to
prevent fraud/prevent an individual shareholder from
using entity to avoid his EXISTING personal obligations. - But 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 corporate veil.
