SHAREHOLDERS: STOCK TRANSFER RESTRICTIONS, RIGHTS TO INSPECT, DISTRIBUTIONS

Question 1

STOCK TRANSFER RESTRICTIONS

Answer 1

• One great thing about corporations is transferability of the ownership interest.
• A shareholder can sell/give her stock away.
• Sometimes people want to restrict transferability,
  especially in a close corporation (so they can keep outsiders out).
• For example, S is a shareholder of Corporation, Inc. Her stock is subject to a stock transfer restriction that requires her to offer it first to the corporation (this is a “right of first refusal” (“RFR”)). S sells the stock to X, 3rd party, in breach of the agreement. Was she allowed to do so?
• To figure this out, we need to know a few rules regarding stock transfer restrictions

Question 2

Enforcing Restriction Against Transferee

Answer 2

• If restriction is valid, can it be enforced against transferee, a 3rd-party purchaser (X, in our example)? - Yes, if (1) restriction is conspicuously noted on the stock certificate (or contained in info statement required for uncertificated shares) or (2) transferee had actual knowledge of restriction at time of purchase.

Question 3

.

Answer 3

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Question 4

SHAREHOLDERS’ INSPECTION RIGHTS

Answer 4

• Shareholder has right, personally/by agent, to inspect (& copy) the books & records of corp.

Question 5

Standing

Answer 5

Any shareholder can demand access

Question 6

Procedure

Answer 6

• MBCA: procedure followed depends on material sought.
• Generally, for non-controversial things, shareholders have an unqualified right of access; for more controversial things, their right of access is qualified

Question 7

Unqualified Right for Certain Records

Answer 7

• Any shareholder may inspect the following records regardless of purpose:
  (1) corp’s articles & bylaws,
  (2) board resolutions regarding classification of shares,
  (3) minutes of shareholders’ meetings from past 3 years,
  (4) communications sent by corp to shareholders
  over past 3 years,
  (5) a list of names & business addresses of corp’s current directors & officers, and
  (6) a copy of corp’s most recent annual report.
• The shareholder must make a written demand at least 5 business days in advance.

Question 8

Qualified Right

Answer 8

• For more controversial things, such as
  (1) excerpts of the minutes of board (in contrast to shareholder, referenced above) meetings,
  (2) corp’s books, papers, & accounting records, and
  (3) shareholder records, shareholder must state a proper purpose for the demand.
• What’s a proper purpose? It’s one that’s reasonably related to person’s interest as a shareholder.
• The shareholder also must provide 5 business days’ advance written notice.
• The shareholder need not personally conduct the inspection; they may send an attorney, accountant, or other agent.

Question 9

Failure to Allow Proper Inspection

Answer 9

• If corp fails to allow proper inspection, shareholder
  can seek a ct order.
• If they win, they can recover their costs & attorney’s fees incurred in making the motion.

Question 10

Compare—Directors’ Inspection Rights

Answer 10

• Recall that directors need not go through this procedure to get access to corporate books & records.
• Directors have unfettered access to such materials.

Question 11

DISTRIBUTIONS

Answer 11

Distributions are payments by the corporation to shareholders

Question 12

Types of Distributions

Answer 12

• Distributions can take form of dividends, redemptions (meaning, a forced sale to the corp at a price set in articles) of shares, repurchases of shares, distribution of assets upon liquidation, & so on.

Question 13

Rights to Distributions
.

Answer 13

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

Question 14

Declaration Generally Solely Within Board’s
Discretion

Answer 14

• Even if articles authorize distributions, decision
  whether to declare distributions generally is solely w/in directors’ discretion, subject to solvency limitations (below) & any provisions to the contrary in a shareholders’ agreement/articles.
• A shareholder has a “right” to a dividend/other distribution only when board declares it.

Question 15

Compelling Distributions

Answer 15

• Shareholders have no general right to compel a distribution.
• Because decision about distributions is board’s,
  it is difficult to win a case to force declaration of a distribution.
• To win, P must make a very strong showing
  of abuse of discretion.
• Ex. maybe corp consistently makes profits & board refuses to declare a dividend while paying themselves a bonus.

Question 16

Contractual Rights in Regard to Distributions
z Limitations and Preferences

Answer 16

• Shares may be divided into classes w/ varying rights
  (ex. some classes may be redeemable, others
  not; some may have no right to receive distributions,
  others could have preferences; etc.)

Question 17

Terminology

Answer 17

• Preferred stock is paid before common stock is paid.
• Right to preferred dividend may/may not
  accumulate if unpaid in a particular year (“cumulative” vs. “noncumulative” preferred shares), or may accumulate only if there are sufficient current
  earnings (“cumulative if earned” preferred shares).
• Preferred shares have no right to a share of distributions made on common shares unless preferred shares provide that they are “participating.”

Question 18

Rights After Declaration—Same as a General Creditor

Answer 18

• Once a distribution is lawfully declared, shareholders generally are treated as creditors of the corp & their claim for distribution is equal in priority to claims of other unsecured creditors.
• However, a distribution can be enjoined/revoked if it was declared in violation of the solvency limitations, articles, or a superior preference right.

Question 19

Limitations
z Restrictions in the Articles

Answer 19

• Articles may restrict board’s right to declare dividends (ex. creditor might insist that corp include in its articles a provision prohibiting payment of any distributions unless corp earns a certain amount of profits).

Question 20

Share Dividends

Answer 20

• Distributions of a corp’s own shares (“share dividends” or “stock dividends”) to its shareholders are excluded from definition of “distribution.”
• Therefore, the above restrictions are inapplicable.
• However, shares of one class/series may not be
  issued as a share dividend in respect of shares of
  another class/series unless one of the following
  occurs:
  (1) the articles so authorize;
  (2) a majority of votes entitled to be cast by the class/series to be issued approves the issue; or
  (3) there are no outstanding shares of the class/series to be issued.

Question 21

Which Shareholders Get Dividends?

Answer 21

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

Question 22

Which Funds Can Be Used?

Answer 22

• The modern view doesn’t look at funds that can be used for distributions.
• Under the modern view, a corp cannot make a distribution if it’s insolvent/if 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 become due in the usual course of business (corp is insolvent in the bankruptcy sense); or
  (2) Corp’s total assets would be less than sum of its total liabilities plus (unless articles permit
  otherwise) the amount that would be needed, if corp were to be dissolved attime of the distribution, to satisfy the preferential rights on dissolution of
  shareholders whose preferential rights are superior to those receiving the distribution (corp is insolvent in the balance sheet sense).

Question 23

Liability for Unlawful Distributions
a. Director Liability

Answer 23

• Directors are jointly & severally liable for improper distributions.
• Director who votes for/assents to a distribution that
  violates above rules is personally liable to corp for the amount of the distribution that exceeds what could
  have been properly distributed.
• But remember, directors have a good faith reliance defense:
• Director is not liable for distributions approved in good faith:
  (1) based on financial statements prepared according to reasonable accounting practices, or on a fair valuation/other method that is reasonable under the circumstances; or
  (2) by relying on info from officers, employees, legal counsel, accountants, etc., or a committee of the board of which the director is not a member.
• A director who is held liable for an unlawful
  distribution is entitled to contribution from
  (1) every other director who could be held liable for the distribution, that is, those who voted in favor of the distribution) and
  (2) each shareholder, for amount she accepted while knowing that distribution was improper.

Question 24

Shareholder Liability

Answer 24

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