Shareholder Duties and Liability

Question 1

Limited liability

Answer 1

Shareholders of corporations generally are not liable for debts the business entity incurs, which means a plaintiff who sues an insolvent corporation may prevail in the lawsuit but be unable to recover financially because the entity has no assets and the owners are not personally liable

Question 2

Piercing the corporate veil

Answer 2

Plaintiffs may sue the company’s owners personally for the company’s
debts in two situations:

1. Corporation is owner’s alter ego
2. Corporation is used for fraud, wrong, or unjust act

Question 3

When is a corporation the owner’s alter ego?

Answer 3

1. Domination: The business entity’s owner dominates it to the degree that it reflects only the owner’s personal will
2. Failure to observe corporate formalities: The entity does not hold the regular directors’ and shareholders’ meetings as required by state corporation statutes
3. Commingling of funds: The business entity’s owner routinely uses business funds to make personal purchases, or the entity routinely pays for business expenses out of its owner’s personal bank account
4. Inadequate capitalization: The corporation possesses so little capital that it cannot adequately compensate injured parties for risks likely to arise in the industry in which it operates

Question 4

When is a corporation used for fraud, wrong, or unjust act?

Answer 4

Courts may pierce the corporate
veil if the entity has done something wrong or incurred a liability it cannot pay; what constitutes a wrong varies (e.g., breach of contract, reckless behavior), but it is usually fraud or misuse

Question 5

Shareholders’ fiduciary duties

Answer 5

Shareholders do not owe fiduciary duties to directors, officers, the
corporation, or other shareholders unless the shareholder is a controlling majority shareholder, in which case a duty is owed to minority shareholders

Question 6

Controlling shareholders

Answer 6

Include shareholders who own more than 50% of the corporation’s shares or otherwise have the power to elect the board or exert control over the corporation

Question 7

Breach/Oppression

Answer 7

A majority shareholder may wield control in the majority shareholder’s
own broad strategic and financial interest, but may not systematically disfavor the interests of minority shareholders

Question 8

Reasonable expectations test

Answer 8

Examines whether the majority shareholder’s actions toward
the minority shareholder were inconsistent with the latter’s reasonable expectations when
initially deciding to invest in the corporation

Question 9

Burdensome, harsh, or wrongful conduct test

Answer 9

Where the minority shareholder was not an original shareholder, the court will look to whether the majority shareholder’s conduct toward the minority shareholder was burdensome, harsh, or wrongful

Question 10

Remedy for majority shareholder’s breach or oppression

Answer 10

A minority shareholder may bring a cause of action to dissolve the corporation; the court may require the majority shareholder to take action to improve the minority shareholder’s
position or to buy out the minority shareholder’s stake in the corporation