Shareholders

Question 1

Shareholders: Management and Liability

Closely Held Corporations

Answer 1

Small # of shareholders
Stock not publicly traded
Shareholders can manage directly

Question 2

Shareholders: Management and Liability

Closely Held Corps: Shareholder Management Agreements

Answer 2

SHH management agreeements set up alterantive management for a close corporation. Two ways to set up a SHH management agreement:
1. in the articles and approved by all shareholders, OR
2. by unanimous written shh agreement.

If the shareholders do this and setup management by shareholder or by a manager, who owes the duties of care and loyalty to the corporation? Whoever manages corp owes the fiduciary duties.

Question 3

Shareholders: Management and Liability

Special Fiduciary Duties in Closed Corps

Answer 3

In closed corps, SHHs owe fiduciary duteis to other shareholders because it looks a lot like a partnership.
* i.e., owe fiduciary duty of utmost good faith

Question 4

Shareholders: Management and Liability

Closed Corp: Duties of Controlling Shareholders to Minority Shareholders

Answer 4

Controlling SHHs can’t exploit their pwoer to benefit at the expense of minority SHHs.

If Minority SHH is oppressed, the minority SHH can sue teh Majority for that oppression because of fiduciary duties –> this is because there is no public market to sell stock if the minority shareholder is unhappy.

Question 5

Shareholders: Management and Liability

Professional Corporations

Answer 5

Licensed professionals, including lawyers, medical professionals, and CPAs, may incorporate as “professional corp”

Employees: Directors, Officers, and Shareholders usually must be licensed professionals.

Liability: The professionals are personally liable for their malpractice, however, SHHs are generally not liable for corporate obligations or for other professional’s malpractice.

Question 6

Shareholders: Management and Liability

Can Shareholders be held liable for Corporate Debt?

Answer 6

SHHs generally cannot be held liable for corporate debt.

BUT a shareholder might be personally liable for what the corp did if the court pierces the corp veil. This can happen ONLY in close corporations

Question 7

Shareholders: Management and Liability

Piercing the Corporate Veil

Answer 7

ONLY IN CLOSE CORPORATIONS
Allows SHHs to be sued for debts of corporation

Fairness must require holding them (SHHs) liable.

So courts may peirce the corp veil to avoid fraud or unfairness by shareholders in a close corp. But something like sloppy administration is not enough.

Two Part Test:
1. Did a Shareholder abuse the corporation?
2. Would it be unfair for ‘x’ to have limited liability?

Question 8

Shareholders: Management and Liability

Piercing Corp Veil: Common Fact Patterns

Answer 8

1. Alter Ego (Identity of Interests) - SHHs ignore corporate formalities such that the corp may be considered the “alter ego” or a mere instrumentality of the SHHs or another corp
2. Undercapitalization - corp veil may be peirced where the corp is inadequately capitalized, so that at the time of formation there is not enough unencumbered capital to reaosnably cover prospective liabilities
3. Fraud, Avoidance of Existing Oblications, or Evasion of Statutory Provisions.

Question 9

Shareholders: Management and Liability

Who is Liable?

Answer 9

Liability is Joint and Several

Generally, only SHHs who are active int eh operation of the business will be personally liable.

Peircing the corp veil allows imposition of liability on a shareholder. That shareholder be be another corporation.

Question 10

Shareholders: Management and Liability

Types of Liability

Answer 10

The corporate veil is easily peirced in tort cases, but not in contract cases since parties who contracted with the corp had an opportunity to investigate its stability.

Where the corp is insolvent, claims of shareholder-creditors may be subordinated to outside creditors’ claims if equity so requires.

Question 11

Shareholders: Management and Liability

Who may Pierce the Veil?

Answer 11

Generally, creditors may be allowed to pierce the corp veil. Courts almost never pierce the veil at the request of shareholders.

Question 12

Shareholder Derivative Suits

SHH as Plaintiff and Recovery

Answer 12

If you see SHH as plaintiff, ask: could corp have brought this suit? If yes, it is derivative.

If a SHH 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 suti to enforce teh corp’s rights.

Question 13

Shareholder Derivative Suits

Direct Action

Answer 13

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 v. shareholder, ask:

1. who suffers teh most immediate and direct damage, the corp or the shareholder?
2. to whome did the defendant’s duty run, the corp or the shareholder?

Question 14

Shareholder Derivative Suits

Recovery of Derivative Suit

Answer 14

If a SHH-P wins a derivative suti, who gets the money from the judgment? the corporation.

Court may order payment of expenses - the SHH-P may recover costs and atty’s fees.

If SHH-P loses, SHH-P is liable for D’s fees if sued without reasonable cause.

Other SHH’s barred from suing on same transactin again after P SHH loses.

Question 15

Shareholder Derivative Suits

Requirements for Derivative Suits

Answer 15

1. Standing - (a) stock owernship at time of wrong, and (b) adequate representation
2. Demand Requirements
3. Corporation Joined as Defendant

Question 16

Shareholder Derivative Suits

Stock Ownership at Time of Wrong

Answer 16

A SHH must have been a shareholder at the time the claim arose or must have become a shareholder through transfer by operation of law from someone who did won stock at the time the claim arose.

Question 17

Shareholder Derivative Suits

Adequate Representation

Answer 17

The SHH must also fairly and adequately represent the corp’s interests.

Question 18

Shareholder Derivative Suits

Demand Requirements

Answer 18

The SHH must make a written demand on the corp to take suitable action.

Question 19

Shareholder Derivative Suits

Corp Joined as Defendant

Answer 19

The corp must be joined as a defendant. Even though the suit asserts the corp’s claim, since the corp did not do so.

Question 20

Shareholder Derivative Suits

Dismissal or Settlement Requires Court Approval

Answer 20

The parties can settle or dismiss a deriviative suit only with court approval. The court may give notice to shareholders and get their input on whether to settle or dismiss.

After the derivative suit is filed, the corp may move to dismiss:
* Dismissed if found not in corp’s best interests
* investigation by independent directors or panel
* court determination

Burden of Proof: In most cases, the burden of proof is on the SHH bringing the suit to prove to the court that the decision was not made in good faith after reasonable inquiry. However, if a majority of the directors had a personal interest in teh controversy, the corporation will have the burden of showing that hte decision was mad ein good faith after reasonable inquiry.

Question 21

Shareholders: Voting

Who Votes: Outstanding Stock and Record Shareholders

Answer 21

Authorized stock is the number of shares the corp may issue. Issued stock is the number of shares the corp has sold. Outstanding stock is the shares the company issued, but has not reacquired.

Record SHH’s and Record Date: SHHs of record on the record date may vote at the meeting. The record date is fixed by teh BOD but may nto be more than 70 days before the meeting.

Question 22

Shareholders: Voting

Who Votes: Treasury Stock

Answer 22

Suppose the corp reaquires stsock before the record date, so the corp is the owner of this treasury stock as of the record date. No one votes the stock, because it was nto outstanding on the record date.

Question 23

Shareholders: Voting

Voting by Proxy

Answer 23

A SHH may vote her shares in person or by proxy executed in writing.

A proxy is:
1. a writing,
2. signed by the record shareholder,
3. directed to the secretary of the corp,
4. authorizing another to vote the shares.

Question 24

Shareholders: Voting

Revocation of Proxy

Answer 24

A proxy is generally revocable by the SHH and may be revoked byt eh SHH attending the meeting to vote themselves, in writing to the corp secretary, or by subsequent appointment of another proxy.

Question 25

Shareholders: Voting

Irrevocable Proxies

Answer 25

A proxy will be irrevocable only if it states that it is irrevocable and is coupeld with an interest or given as security.

This requires:
1. the proxy says it’s irrevocable and
2. the proxy holder has some interest in teh shares other than voting.

Question 26

Shareholders: Voting

Requirements: Shareholder Voting Trusts and Voting Agreements

Answer 26

Requirements for Voting Trusts:
1. Written trust agreement, controlling how the shares will be voted;
2. copy of the agreement is gvien to the corporation;
3. legal title to the shares is transferred to the voting trustee; and
4. the original shareholders receive trust certificates and retain all shareholder rights except for voting.

Requirements for Voting Agreement
The agreement must be:
1. In writing, and
2. signed

Question 27

Shareholders: Voting

Where do Shareholders vote?

Answer 27

At metting, or by unanimous written consent.

Meeting can be held anywhere.

Two types of meeting:
1. Annual - primarily elect directors at this meeting; can be petitioned/called for by SHH if it is not held withint he earlier of six months after teh end of the corp’s fiscal year or 15months after its last anual meeting.
2. Special - may be called by (1) BOD, (2) President, (3) the hodlers of at least 10% of the outstanding shares, or (4) anyone else authorized to do so in the articles or bylaws.

Question 28

Shareholders: Voting

Meetings: Annual and Special - Notice

Answer 28

Written notice delivered 10-60 days before meeting

Special Meeting - state purpose of meeting because that is all that can be discussed at the special meeting.

Failure to give notice:
1. Whatever action taken at meeting is voidable
2. Notice defect can be wiaved - expressly or impliedly

Question 29

Shareholders: Voting

How Do SHHs Vote?

Answer 29

SHHs can vote on:
1. elect directors
2. remove directors
3. fundamental corporate changes

Quorum
* Every time SHHs vote, we must have a quorum represented at the meeting.
* Look at # of shares represented at meeting - quorum is majority of outstanding shares entitled to vote, unless the articles or bylaws call for a greater number.
* SHH quorum not lost if people leave.

Question 30

Shareholders: Voting

Voting in General

Answer 30

If a quorum is present, shareholders will be deemed ot have approved a matter if the votes cast in favor of the matter exceed the votes cast against the matter.

• Elect director: Plurality
• Approve Fundamental Change: majority of shares entitled to vote - increasingly treated as other matters
• Remove a Director: Majority of shares entitled to vote - increasingly treated as other matters
• Other Matters: Majority of shares that actually vote on the issue.

Question 31

Shareholders: Voting

Cumulative Voting Optional

Answer 31

Cumulative voting - usually comes up in close corporations. Gives smaller SHHs a better chance of electing someone to the BOD.

Only available when shareholders elect directors. If the articles are silent about cumulative voitng, it does not exist.

Question 32

Shareholders: Voting

Straight Voting

Answer 32

Separate election for each seat on the BOD being elected. Each outstanding share gets one vote for each seat.

Question 33

Shareholders: Voting

Mechanics of Cumulative Voting

Answer 33

To determine your voting power when cumulative voting exists, mulitply teh shareholder’s number of voting shares by the the number of directors to be elected. The total number may be divided among the candidates in any manner that hte shareholder desires, including casting all for the same candidate.

NO CUMULATIVE VOTING IF ARTICLES ARE SILENT

Question 34

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Stock Transfer Restictions

Answer 34

A SHH can sell or give her stock away.

Restrictions are Fine if Reasonable: restrictions are valid if they are nto an undue restraint on alienation.

Question 35

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Enforcing Restriction against transferree

Answer 35

If the restrictin is valid, can it be enforced against the transferee, a 3P purchaser?

Yes, if:
1. the restriction is conspicuously noted on teh stock certificate, or
2. the transferee had actual knowledge of the restriction at the time of the purchase.

Question 36

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

SHH Inspection Rights

Answer 36

SHH has the right, personally or by an agent, to inspect the books and records of the corporation.

Standing - Any SHH can demand access

Procedure - for non-controversial things, SHHs have an unqualified right of acces; for more controversial things, their right of access is qualified.
* Unqualified - may inspect the following records regardless of purpose: Articles or Bylaws, BOD resolutions regarding classification of shares, minutes of SHHs meetings, communications sent by teh corp to shhs, list of the names and business addresses of the corp’s current directors and officers, and a copy of the corps most recent annual report. SHH must make a written demand at leasst five business days in advance
* Qualified - Controversial things such as: excerpts of teh minutes of BOD meetings, teh corp’s books, papers, and accoutning records, and shareholder records, SHH must state a proper purpose for the demand. Must be reasonably related to the person’s interest as a shareholder

NOTE: DIRECTOR’S HAVE UNFETTERED INSPECTION RIGHTS

Question 37

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

SHH Inspection Rights: Failure to Allow Proper Inspection

Answer 37

The SHH can seek a court order. If they win, they can recover their costs and atty’s fees incurred in making the motion.

Question 38

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Distributions

Answer 38

Payments by the corp to shareholders

Types of Distributions:
1. divedends,
2. redemptions of shares,
3. repurchases of shares,
4. distribution of assets upon liquidation, and so on.

Rights to Distribution
* At least one class of stock must have a right to receive the corp’s net assets on dissolution. Beyond this, distributions generally are discretionary.

Declaration Generally Solely within BOD’s Discretion

Question 39

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Compelling Distributions

Answer 39

Generally - distributions are within the BOD’s discretion

To win and compel distributions, the P must make a very strong showing of abuse of discretion.

Question 40

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Which Shareholders get Distribution?

Answer 40

The record SHH of the stock as of the record date will receive the dividend.

Question 41

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Which Funds can be Used? (Dividends)

Answer 41

Under the modern view, a corp cannot make a distribution if it’s insolvent or if teh distribution would render it insolvent. What that means is that a distribution is not permitted if, after giving it effect, either:
1. Corp would not be able to pay its debts as they became due, or
2. The Corps total assets would be less than the sum of the total liabilities plus the amount needed if the corp were to be dissolved at the time of distribution to satisfy the preferential rights on dissolution of SHHs whose preferential rights are superior to those receiving the distribution.

Question 42

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

Director Liability

Answer 42

Directors are Jointly and Severally liable for improper distributions, but remember they have good faith reliance defense -

A director is not liable if, in good faith,:
1. based on financial statemetns prepared according ot reasonable accounting practices, or on a fair valuation or other method that is reasonable under the circumstances; or
2. by relying on info from officers, employees, legal counsel, accoutnants, etc., or a committe of the BOD of which the director is not a memeber.

Question 43

SHHs: Stock Tansfer Restrictins, Right to Inspect, Distributions

SHH Liability

Answer 43

SHH are personally liable only if they knew the distribution was improper when they received it.