Shareholders

Question 1

What is a closed corporation and what is required for it to have shareholder management?

Answer 1

A closed corporation has few shareholders and the stock is not publicly traded. If the closed corporation wants shareholder management, there needs to be a provision in the certificate restricting or transferring board power to shareholders (or others). You also need:

1) All incorporators or shareholders (voting and nonvoting) approve it;
2) It is conspicuously noted on frong and back of all shares;
3) All subsequent shareholders have notice and
4) Shares are not listed on an exchange or regularly quoted over the counter.

Question 2

In a closed corporation run by shareholders, who owes the duties of care and loyalty?

Answer 2

The managing shareholder

Question 3

Why do courts protect minority shareholders in a close corporation?

Answer 3

It’s to give them a remedy for behavior by majority or controlling shareholders that defeats their reasonable expectations for investing, which are employement, return on investment, and voice in management.

Question 4

What is a professional service corporation (P.C.) and how is it different from traditional corporations?

Answer 4

Members of a licensed profession, like doctors and lawyers, cannot practice the profession through a general business corporation, but they can form a professional service corporation (P.C.). The differences are:

a) Shareholders, officers, and directors must all be licensed professionals, but they can hire non-professionals as employees.
b) Professionals are liable for their own malpractice, but not of the others in the corporation (as in a partnership).
c) Professionals are not labile for contracts entered by the entity or for rent due on leases in the P.C.’s name, the entity is liable.
d) The certificate must include the use of P.C. in the corporation title, must indicate the profession to be practiced, and include the names and addresses of the original shareholders, directors, and officers.
e) There must also be certification that each shareholder, director, and officer is licensed to practice the profession. If a shareholder in a P.C. dies or is disqualified from the practice, the P.C. must buy his shares.

Question 5

When are shareholders liable for what the corporation does?

Answer 5

Generally, shareholders are not liable for what the corporation does (the corporation is liable), but a shareholder can be liable if the court pierces the corporate veil, which happens only in a close corporation.

Question 6

When will court’s pierce the corporate veil?

Answer 6

Shareholders must have (1) abused the privilege of incorporating and (2) fairness must require holding them liable. In NY, fairness might require piercing the corporate veil, if the shareholder exercises complete domination and control over the corporation to perpetrate fraud or injustice.

Question 7

What are the two classic fact patterns for piercing the corporate veil?

Answer 7

Alter-ego: where there is an identity of interests, agency or excessive domination - the corporation is a mere alter-ego of its controlling shareholder.

Undercapitalization: a corporation is undercapitalized when the shareholders have failed to invest enough to cover prospective liabilities. This is not enough in NY - still need complete domination and control.

Question 8

What is a derivative suit?

Answer 8

In a derivative suit, a shareholder is suing to enforce the corporaton’s claim, not her own personal claim. To differentiate between a direct and derivative suit, one should ask, could the corporation bring the claim, and if the answer is yes, then the shareholder is suing in the right of the corporation. Suits against the board for breaching duty of care and loyalty is always a derivative suit, because these duties are owed to the corporation.

Question 9

What happens if the shareholder wins the derivative suit? What does the shareholder receive?

Answer 9

The recovery for a judgment always goes to the corporation in a derivative suit. However, the shareholder can receive costs and attorney’s fees for suing on behalf of the corporation. The shareholder may recover damages if that money were to go to the liable directors.

Question 10

What are the requirements for bringing a shareholder derivative suit?

Answer 10

1) Stock ownership when claim arose, whroen the action is brought and through entry of judgment -
2) Plaintiff must adequately represent the interests of the corporation and the shareholders.
3) Shareholder may be required to post a bond for the defendant’s costs.
4) Shareholder must make a demand on directors that the corporation sue, but she doesn’t not need to make demand if it would be futile to do so.

Plaintiff must plead with particularity her efforts to get the board to sue or why demand was futile.

5) The corporation is joined in the litigation as a defendant.

Question 11

When might demand for a derivative suit be futile?

Answer 11

Demand would be futile if:

1) Majority of the board is interested or under the control of interested directors;
2) The board did not inform itself of the transaction to the extent reasonable under the circumstances;
3) The transaction is so egregious on its face that it could not be the result of sound business judgment.

Question 12

How can the corporation move to dismiss a derivative suit?

Answer 12

The motion is based on a finding by independent directors (or a committee of independent directors) called a “special litigation committee,” that the suit is not in the corporation’s best interests.

The courts look at the following factors in deciding whether to dismiss:

1. the independence of those making the investigation; and
2. the sufficiency of the investigation - did they do their homework?

Question 13

Which shareholders vote?

Answer 13

The general rule is that the record owner as of the record date has the right to vote. The record owner is the person shown as the owner in the corporate records. The record date is a vote eligibility cut-off, set no fewer than 10 and ano more than 60 days before the meeting.

Question 14

Can the corporation vote on treasury stock? Who votes in the event of a shareholder’s death?

Answer 14

The corporation does not get to vote on “treasury stock” - it’s not outstanding stock.

In the event of the death of a shareholder, the shareholder’s executor can vote the shares.

Question 15

Can shareholders have proxies? If so, what are the requirements and how long does it last? How can a proxy be revoked and when does it become irrevocable?

Answer 15

Yes. A proxy is a:

1. a writing
2. signed by record shareholder or authorized agent
3. directed to secretary of corporation
4. authorizing another to vote the shares.

The proxy is good for only 11 months unless the proxy says otherwise.

A proxy can be revoked in writing, by showing up to the meeting and voting or, if the shareholder dies, only when written notice of death is received by the secretary.

Generally, proxies can always be revoked unless it is a proxy coupled with an interest, which requires that:

1. the proxy says its irrevocable AND
2. the proxyholder has some interest in the stock other than voting.

You can also get irrevocable proxy when the proxy is given subject to a voting agreement and states that it is irrevocable.

Question 16

What are voting trusts and voting agreements? What are their requirements?

Answer 16

A voting trust is one method for block voting for a group of shareholders. It requires:

1. Written trust agreement controlling how the shares will be voted;
2. Copy to corporation;
3. Transfer legal title of shares to voting trustee; and
4. Original shareholders receive voting trust certificates and retain all shareholder rights except for voting.

The time limit on voting trusts are 10 years, but within 6 months of expiration, it can be extended for another term of up to 10 years.

A voting agreement, or “pooling” agreement, is another way that shareholders can block vote. It must be in writing and signed, but shareholders cannot get specific enforcement on them. However, a proxy given subject to a voting agreement is irrevocable if it says so.

Question 17

What are the two ways the shareholders can take a valid act?

Answer 17

1. Written consent of the holders of shares OR
2. A meeting

Question 18

Where do shareholders vote?

Answer 18

Shareholders vote at meetings. There are two types of meetings:

Annual: required by the certificate. At the annual meeting, the shareholder elects the directors

Special: for other specified purposes in the notice. Special meetings can be called by the board OR anyone provided in the certificate or bylaws.

Question 19

Is notice needed for annual or special meetings and if so, what is the required contents?

Answer 19

For both annual and special meetings, written notice is required, to every shareholder, entitled to vote, between 10 and 60 days before the meeting. Notice should always state the time and place of the meeting.

If the action proposed at the meeting is something on which shareholders have appraisal rights, the notice must say so, tell why, and include the statute about appraisal rights.

If it is a notice is for a special meeting, it must state who called it, and the purpose of the meeting. Shareholders cannot deal with anything else at the special meeting, other than what is in the statement of purpose.

Question 20

What happens if the corporation does not give notice to everyone entitled to vote? Can a defect in notice be waived?

Answer 20

Any action at the meeting is void, unless those not given notice waive the defect. They can waive either:

Expressly: in writing and signed anytime OR

Impliedly: if the shareholder attends the meeting without objection.

Question 21

How do shareholders vote?

Answer 21

There must be a quorum represented at the meeting, which is determined by the number of shares represented - a quorum requires a majority of outstanding shares. The certificate or bylaws can reduce the quorum to less than a majority but never fewer than 1/3 of the shares entitled to vote. Once shareholder quorum is met, it is never lost

If quorum is met, voting approval happens with a majority of the shares *actually voting *in favor or against the proposal (abstentions don’t count). For voting for directors, the highest vote-getter for each seat on the board wins, even if she did not get a majority of the votes. All the director needs is a plurality of the votes.

Question 22

Can a stockholder sell her shares for less than par?

Answer 22

Yes - par is only an issuance rule, and only applies when the corporation issues stock.

Question 23

Can a stock have transfer restrictions? Where are those restrictions set? When are are they valid?

Answer 23

Yes, stock can have transfer restrictions, especially in a close corporation. Those restrictions are set in the certificate, bylaws or by agreement. They are only valid if they are not an undue restraint on alienation. Even if they are valid, the restrictions cannot be invoked against the transferee unless it is either: 1) it is conspicuously noted on the stock certificate OR 2) the transferee had actual knowledge of the restriction.

Question 24

How does a stockholder exercise his right to examine or inspect the corporations records and books?

Answer 24

It depends on the record:

1. For minutes of shareholder proceedings or the record of shareholders, any shareholder can access these on 5 days written demand;
   a. The corporation can demand that the shareholder given an affidavit that his purpose is not other than in the interest of the corporation and he has not within 5 years tried to sell any list of shareholders.
2. For list of the current directors and officers, any shareholder can demand that on 2 days written demand.
3. For the annual balance sheet, profit and loss statement and interim statements distributed to shareholders or public, any shareholder can make a written request, and the corporation must provide the documents and can do so by mail.
4. All shareholders have a common law right to inspect records at a reasonable time and proper place. The inspection must be for a proper purpose.

Question 25

What are distributions and when are they made? Which funds may be used for any distribution? When can a corporation NOT make distributions?

Answer 25

Distributions are payments by the corporation to shareholders. There are three types:

1. dividend or
2. payment to repurchase shares or
3. to redeem shares [forced sale to corporation at price set in certificates].

Distributions are declared in Board’s discretion.

Distrubtions may be paid out of surplus only, which is computed by taking assets - liabilities - stated capital.

Stated Capital: is the amount of (i) consideration received for par value, in aggregate, of par shares, (ii) consideration received, in aggregate, for no par shares; and (iii) amounts transfered by the board (all or part of surplus) to stated capital.

Corporations cannot make distributions if it is insolvent or if the distrubution would render it insolvent. Directors are personally liable for unlawful distributions.