Shareholders: Stock Transfer Restrictions, Rights to Inspect, Distributions

Question 1

Stock Transfer Restrictions - General Concept

Answer 1

• measures that restrict transferability of stock
• valid if not an undue restraint on alienation

Question 2

Right of First Refusal

Answer 2

• a valid stock transfer restriction
• requires that if SH wants to sell a share, they have to first offer it to the corp

Question 3

Enforcing Restriction Against Transferee

Answer 3

Can enforce a valid restriction against the transferee (i.e. third-party purchaser) IF:
1) the 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 T of purchase

Question 4

Shareholder Inspection Right

Answer 4

• any SH has right, personally or by an agent, to inspect (and copy) the books + records of the corporation

Question 5

Shareholder Inspection Rights - Procedure

Answer 5

• depends on material sought
• generally, for non-controversial things, SHs have unqualified right of access
  -> qualified for more controversial things

Question 6

Unqualified Right for Certain Records

Answer 6

SH may inspect following records REGARDLESS of purpose:
1) corp’s articles + bylaws
2) board resolutions re classification of shares
3) minutes of SHs meetings from past 3 yrs
4) communications sent by corp to SHs over past 3 yrs
5) list of names + business addresses of corp’s current dirs + officers AND
6) copy of corp’s most recent annual report

• SH must make a written demand at least 5 business days in advance

Question 7

Shareholder Inspection Rights - Qualified Right

Answer 7

• need to state proper purpose for demand for more controversial things
  -> proper if reasonably related to person’s interest as a SH
• also need 5 business days’ advance written notice
• need not personally conduct the inspection, may send attorney, accountant, or other agent

Question 8

Controversial Things for Which Qualified Right Applies

Answer 8

• excerpts of minutes of board (instead of SH) meetings
• corp’s books, papers, + accounting records
• SH records

Question 9

Failure to Allow Proper Inspection

Answer 9

• if corp fails to allow proper inspection, SH can seek ct order
• if they win, can recover their costs + attorney’s fees in making the motion

Question 10

Directors’ Inspection Rights

Answer 10

• directors need not go through the SH procedure to get access to corp books + records -> have unfettered access to such materials

Question 11

Distributions

Answer 11

• payments by corp to SHs

Question 12

Types of Distributions

Answer 12

Include:
- dividends
- redemptions (forced sale to corp at a price set in the articles) of shares
- repurchases of shares
- distribution of assets upon liquidation

Question 13

Rights to Distributions

Answer 13

• at least one class of stock must have a right to receive the corp’s assets on dissolution
• beyond this rule, distributions are generally discretionary

Question 14

General Rule Re Declaring Distributions

Answer 14

• even if distributions authorized by the articles, the decision whether to declare them is solely w/in directors’ discretion
  -> subject to solvency limitations
  -> also subject to any provisions to the contrary in an SH agreement or the articles
• SH has a “right” to a dividend or other distribution only when board declares it

Question 15

Compelling Distributions

Answer 15

• generally difficult to compel distribution
• to win, pl must make very strong showing of abuse of discretion
  -> ex: corp consistently makes profits but board refuses to declare dividend while paying themselves a bonus

Question 16

Distributions - Limitations + Preferences

Answer 16

• shares may be divided into classes w/ varying rights

Question 17

Preferred Stock

Answer 17

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

Question 18

Rights After Distribution Declared

Answer 18

• once lawfully declared, SHs generally treated as creditors of corp
  -> their claim for distribution is equal in priority to claims of other unsecured creditors
• BUT distribution can be enjoined or revoked if declared in violation of solvency limitations, articles or a superior preference right

Question 19

Restrictions in Articles Re Distributions

Answer 19

• articles may restrict board’s right to declare dividends

Question 20

Share Dividends

Answer 20

• distributions of a corp’s own shares to SHs are excluded from definition of “distribution” -> certain restrictions are inapplicable
• shares of one class or series may not be issued as a share dividend in respect of shares of another class or series unless one of following occurs:
  1) articles so authorize
  2) majority of votes entitled to be cast by class or series to be issued approves the issue OR
  3) there are no outstanding shares of the class or series to be issued

Question 21

Which SHs Get Dividends?

Answer 21

• the record SH of the stock as of the record date will receive the dividend

Question 22

Which Funds Can Be Used?

Answer 22

• under modern view, corp can’t make distribution if it’s insolvent or if the distribution would render it insolvent

Question 23

When Is a Distribution NOT Permitted

Answer 23

If, after giving it effect, either:
- corp wouldn’t be able to pay its debts as they become due in the usual course of business (i.e. corp insolvent in the bankruptcy sense)
- corp’s total assets would be less than the sum of its total liabilities plus (unless articles permit otherwise) the amount that would be needed, if the corp were to be dissolved at t of distribution, to satisfy preferential rights on dissolution of SHs whose preferential rights are superior to those receiving the distribution (i.e. insolvent in the balance sheet sense)

Question 24

Director Liability for Unlawful Distributions

Answer 24

• directors = jointly + severally liable for improper distributions
• dir who votes for or assents to distribution that violates the above rules is personally liable to corp for amount of distribution that exceeds what could’ve been properly distribution
• BUT good faith reliance defense

Question 25

Director Good Faith Defense Re Unlawful Distributions

Answer 25

• director is NOT liable for distributions approved in good faith:
  1) based on financial statements prepared according to reasonable accounting practices, or on fair valuation or other method that is reasonable under the circs OR
  2) by relying on info from officers, employees, legal counsel, accountants, etc or a committee of board of which dir is not a member

Question 26

Directors - Contribution Re Unlawful Distribution

Answer 26

• a dir held liable for unlawful distribution is entitled to contribution from:
  1) ever other dir who could be held liable for distribution (i.e. those who voted in favor of the distribution) AND
  2) each SH, for the amount she accepted while knowing the distribution was improper

Question 27

Shareholder Liability for Unlawful Distributions

Answer 27

• SHs personally liable ONLY if they knew the distribution was improper when they received it