©2001 West Legal Studies in Business. All Rights Reserved. Chapter 35: Corporations-Directors, Officers and Shareholders

©2001 West Legal Studies in Business. All Rights Reserved.

Chapter 35: Chapter 35: Corporations-Directors, Corporations-Directors,

Officers and ShareholdersOfficers and Shareholders

Chapter 35: Chapter 35: Corporations-Directors, Corporations-Directors,

Officers and ShareholdersOfficers and Shareholders


§ 1: The Role of Directors§ 1: The Role of Directors§ 1: The Role of Directors§ 1: The Role of Directors

• Every corporation is governed by a board of directors. See the Board of Directors of Time Warner, Inc.

• Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation.

• A director can also be a shareholder, especially in closely-held corporations.


Election of DirectorsElection of DirectorsElection of DirectorsElection of Directors• Subject to statutory limitations, the number

of directors is set forth in the articles of incorporation:– Directors appointed at the first organizational

meeting.– In closely held companies, directors are generally

the incorporators and/or the shareholders.– Term of office is generally for one year.– Director can be removed for cause (for failing to

perform a required duty).


Directors’ MeetingsDirectors’ MeetingsDirectors’ MeetingsDirectors’ Meetings

• Directors hold meetings pursuant to bylaws with recorded minutes.

• Special meetings may be called with sufficient notice.

• Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority).

• Each director generally has one vote.


Rights of DirectorsRights of DirectorsRights of DirectorsRights of Directors

• Directors have the right to:– Participate in corporate decisions and inspect

corporate books and records.– Compensation (usually a nominal sum) and

indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability.


§2: Rights of Officers§2: Rights of Officers§2: Rights of Officers§2: Rights of Officers

• Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well.

• Their employment relationships are generally governed by contract law and employment law.

• Officers may be terminated for cause.


§ 3: Fiduciary Duties of § 3: Fiduciary Duties of Directors and OfficersDirectors and Officers

§ 3: Fiduciary Duties of § 3: Fiduciary Duties of Directors and OfficersDirectors and Officers

• Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders:

• Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable.


Fiduciary Duties of Fiduciary Duties of Directors and Officers Directors and Officers [2][2]


• Duty of Care (cont’d):– Make informed and reasonable decisions; – Rely on competent consultants and experts; and– Exercise reasonable supervision.

• A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.




• Duty of Loyalty: subordination of personal interests to the welfare of the corporation.– No competition with Corporation.– No “corporate opportunity.”– No conflict of interests.– No insider trading.– No transaction that is detrimental to minority

shareholders Case 35.1: Stokes v. Bruno (1998).




• No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally.

• However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors.


§ 4: Liability of § 4: Liability of Directors and OfficersDirectors and Officers

§ 4: Liability of § 4: Liability of Directors and OfficersDirectors and Officers

• Directors and officers may be liable for negligent acts that breach the standard of due care:– Crimes and torts committed by individually

and/or those committed by employees under their supervision.

– Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation].


Business Judgment RuleBusiness Judgment RuleBusiness Judgment RuleBusiness Judgment Rule• Immunizes a director or officer from

liability from consequences of a business decision that turned sour.

• Court will not require directors or officers to manage “in hindsight.”

• As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply.– Case 35.2 FDIC v. Castetter (1999).


§ 5: Shareholders§ 5: Shareholders§ 5: Shareholders§ 5: Shareholders

• Ownership of shares grants a shareholder an equitable ownership interest in a corporation.

• Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors.

• Shareholders are generally protected from personally liability by the corporate veil of limited liability.


Shareholder PowersShareholder PowersShareholder PowersShareholder Powers

• Shareholder powers include approving all fundamental changes to the corporation:– Amending articles of incorporation or bylaws.– Approval of mergers or acquisition.– Sale of all corporate assets or dissolution.

• Shareholders also elect and remove the board of directors.


Shareholder Meetings Shareholder Meetings [1][1]Shareholder Meetings Shareholder Meetings [1][1]

• Shareholders’ meetings must occur at least annually. Voting requirements and procedures are:– Quorum of shareholders owning more than

50% of shares must be present to conduct business;

– Shareholders may appoint a proxy or enter into a voting trust agreement.


Shareholder MeetingsShareholder Meetings [2][2]Shareholder MeetingsShareholder Meetings [2][2]

• For special shareholder meetings:– Notice and time of meetings must be sent in

writing to each shareholder within a reasonable time ahead of the meeting.

– Notice mus state reason for meeting and only deal with this matter.


Shareholder VotingShareholder VotingShareholder VotingShareholder Voting

• Common shareholder entitled to one vote per share.

• Articles and by-laws can exclude or limit voting rights of certain classes of stock.

• Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present.


Shareholder VotingShareholder Voting [2][2]Shareholder VotingShareholder Voting [2][2]

• Shareholders may vote on resolutions.– Need majority present for most resolutions.– Need a “super majority” (e.g., 67%) for

important matters: sale of assets, etc..

• Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)]


Shareholder VotingShareholder Voting [3][3]Shareholder VotingShareholder Voting [3][3]

• Methods of Increasing Minority Shareholder Power Within the Corporation:– Cumulative Voting allows minority

shareholders to get a board member elected.• x # to be elected x shareholders # of shares =

shareholder can cast them all for one board nominee.

– Shareholder Voting Agreements.– Voting Trusts.


Shareholder VotingShareholder Voting [4][4]

• Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a-8:– Proxy solicitation must include proposals which

will be discussed at the meeting.– Shareholders who own $1,000 worth of stock

may submit their own proxy solicitations.– Company does not have to include shareholder

proposals which relate to “ordinary business operations.”


§§ 6: Rights of Shareholders 6: Rights of Shareholders§§ 6: Rights of Shareholders 6: Rights of Shareholders• Shareholders have the right:

– To vote.– To have a stock certificate.– To purchase newly issued stock.– To dividends, when declared by board.– To inspect corporate records.– To transfer shares, with some exceptions.– To a proportionate share of corporate assets on

dissolution.– To file suit on behalf of corporation.


Stock CertificatesStock CertificatesStock CertificatesStock Certificates

• Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports.

• Corporate ownership is intangible personal property.

• Some states allow uncertificated stock -- no tangible certificate.


Preemptive RightsPreemptive RightsPreemptive RightsPreemptive Rights

• Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time.

• Provided for in the articles of incorporation.

• Significant in a close corporation to prevent dilution and loss of control.


Stock Warrants or RightsStock Warrants or RightsStock Warrants or RightsStock Warrants or Rights

• Transferable options to purchase newly-issued stock at a stated price.

• Warrants are publicly traded.

• Called “rights” when option is for a short period of time.


DividendsDividendsDividendsDividends

• Distribution of corporate profits or income.

• Only as ordered by the Board.

• Can be stock, cash, property, stock of other corporations.

• State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus.


Illegal DividendsIllegal DividendsIllegal DividendsIllegal Dividends

• If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received.

• Directors can be held personally liable for the amount of payment.

• Dividends paid when corporation is insolvent are automatically illegal.


Directors’ Failure Directors’ Failure to Declare Dividendsto Declare DividendsDirectors’ Failure Directors’ Failure

to Declare Dividendsto Declare Dividends

• When directors fail to declare a dividend, shareholders can sue.

• Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose).

• Often, profits are retained for expansion, research or upgrades.


Inspection RightsInspection RightsInspection RightsInspection Rights

• Shareholders can inspect books for a proper purpose.– But corporation can protect trade secrets, other

confidential information.– Shareholder must have held a minimum number

of shares for a minimum amount of time.

• All shareholders can see list of other shareholders of record.


Transfer of SharesTransfer of SharesTransfer of SharesTransfer of Shares

• Shares are freely transferable unless restricted by articles and noted on the stock certificate.

• Closely held corporations may have “right of first refusal” or preemptive rights.

• Transfer accomplished by delivery or endorsement to corporate secretary.

• New shareholder must be recorded on corporate books.


Rights on DissolutionRights on DissolutionRights on DissolutionRights on Dissolution• Shareholders have right to pro-rata share of

assets upon liquidation.• Shareholder may petition the court for

dissolution of the corporation for following reasons:– Board mishandling corporate assets.– Board deadlocked and irreparable injury will result.– Acts of directors are illegal, oppressive, or fraudulent.– Shareholders are deadlocked for two meetings and can’t elect

directors.– Case 35.3: Black v. Graham (1996).


Shareholder Derivative SuitShareholder Derivative SuitShareholder Derivative SuitShareholder Derivative Suit

• Shareholders can sue a 3rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury.

• Directors may refuse to take action because they might personally be liable.

• Any damages recovered go to corporation’s treasury.


§§ 7: Liability of Shareholders 7: Liability of Shareholders§§ 7: Liability of Shareholders 7: Liability of Shareholders

• Shareholders are generally not liable for the contracts or torts of the corporation.

• If the corporation fails, shareholders cannot lose more than their investment, except when: – A shareholder hasn’t paid for stock pursuant to the

subscription agreement.– Shareholder buys “watered stock” which is below

the stock’s par value.


§§ 8: Duties of Majority 8: Duties of Majority ShareholdersShareholders

§§ 8: Duties of Majority 8: Duties of Majority ShareholdersShareholders

• Majority shareholders own enough shares to exercise de facto (actual) control over the corporation.

• Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control.


Law on the WebLaw on the WebLaw on the WebLaw on the Web

• Retention Policies for E-Documents– Corporation must have policy to retain legal

documents, contracts, emails, faxes in the event of a lawsuit and discovery by opposing parties.

– If a company refuses to comply with legitimate discovery requests, company may be sanctioned and/or fined.

– Today’s document retention policy must include archival of emails, databases and websites.


E-Discovery: E-Discovery: The New Tech ThreatThe New Tech Threat

E-Discovery: E-Discovery: The New Tech ThreatThe New Tech Threat

A survey of members of the ABA's Litigation Section shows corporate America may be leaving itself vulnerable in another technological arena -- the courtroom. While vast amounts of corporate data are stored electronically, 83 percent of the lawyers surveyed said their clients are unable to produce such data for civil discovery. Read full text ©2000 http://www.law.com/ May 25, 2000.