a)Entity Status--a corporation is a legal entity
created under the authority of legislature
b)Limited Liability--as a legal entity, a corp
is responsible for its own debts; its sh’s liability is limited to their
c)Free Transferability of Interest--shares,
representing ownership interests, are freely transferable;
d)Centralized Management and Control--a corp’s
management is centralized in a board of dirs and officers. Shs have no direct
control over the board’s activities;
e)Duration--Continuity of Existence--a corp is
capable of perpetual existence;
f)Taxation--a corp, as an entity, pays taxes on
its own income; shs are taxed only on dividends;
g)Remember Attributes of the Corporation--CLIFF:
1)Centralization of management;
3)Forever (perpetual duration);
4)Freely alienable (shares can be sold).
B.CORPORATIONS DISTINGUISHED FROM OTHER FORMS OF
1.GENERAL PARTNERSHIPS--in most states, p’ships
are governed by the Uniform Partnership Act (UPA). However, the Revised UPA
(RUPA) has been adopted by a few states
a)Aggregate Status--a p’ship is an aggregation
of two or more persons who are engaged in business as co-owners. Although not a
legal entity, a p’ship is treated as one for certain purposes, e.g., ownership
and transfer of property. RUPA confers entity status on p’ships;
b)Unlimited Liability--every partner is subject
to unlimited personal liability on p’ship debts;
c)Transferability of Interests--a partner cannot
make a transferee a member of the p’ship. She can, however, assign his interest
in the p’ship, thus permitting the assignee to receive distributions of
profits. Because the assignee does not become a member of the p’ship, he is not
entitled to participate in p’ship business or management.
d)Duration and Dissolution--a p’ship cannot have
perpetual existence. It is terminable at will unless a definite term is
expressed or implied, and is also dissolved by death, incapacity, or withdrawal
of any partner.
1)Wrongful dissolution--p’ships can also be dissolved in
contravention of the p’ship agreement, by the express will of any partner, by a
court or by a partner’s conduct. Upon wrongful dissolution, nonbreaching
partners may seek damages for breach and, if they choose to do so, may continue
the p’ship upon payment to the breaching partner of the value of his interest.
1)Compare--dissociation under RUPA--termination
results in either the winding up of the p’ship or buyout of the dissociating
partner, depending on the event triggering the termination. A buyout may be
reduced by damages if dissociation was wrongful.
e)Management and Control--absent a contrary
agreement, every partner has a right to participate equally in the partnership
f)Autority--each partner, as an agent of the
firm, may bind the p’ship by acts done for the carrying on, in the usual way,
the business of the p’ship.
1)RUPA--a p’ship is bound by a partner’s act for
carrying on in the usual way either the actual p’ship business or a business of
the kind carried on by the p’ship.
g)Ownership of Property--title may be held in
the name of the p’ship, but property is owned by the individual partners as
tenants in p’ship. There is no tenancy in p’ship under RUPA, which provides
that property acquired by p’ship is owned by p’ship, not individual partners.
h)Capacity to Sue and be Sued--under the UPA, a
lawsuit may be brought by or against individual partners, rather than p’ship.
Partners are jointly and severally liable for wrongful acts and breaches of
trust; they are only jointly liable for debts and obligations of the p’ship.
1)Statutory reforms--many state statutes
specifically allow a p’ship to be sued in its own name. Other states make all
p’ship liabilities joint and several. Other reforms provide that not all joint
obligors need to be joined in a suit.
2)RUPA--a p’ship may sue and be sued in its own
name, and partners are jointly and severally liable for all p’ship obligations.
A claim against the p’ship cannot be satisfied from a partner’s personal assets
unless p’ship assets have been exhausted.
2.JOINT VENTURE--a p’ship formed for some
limited investment or operation, as opposed to a continued business enterprise.
Joint ventures are governed by the rules applicable to p’ships
3.LIMITED PARTNERSHIP--this is a p’ship
consisting of two classes of partners: general partners (with rights and
obligations as in an ordinary p’ship) and limited partners (with no control and
4.LIMITED LIABILITY PARTNERSHIPS--in a LLP, a
general partner is NOT personally liable for all p’ship obligations arising
from negligence, wrongful acts, and misconduct absent his involvement in the
misconduct. There is no exclusion for liability for contractual obligations.
5.LIMITED LIABILITY COMPANIES--LLC is a
non-corporate business entity whose owners (members) have limited liability and
can participate actively in its management. An LLC may be either for a term or
at will. It can be managed either by its members or nonmember managers.
Depending on the statute, distributions are made either equally to each member
or in proportion to each member’s contribution.
a)Withdrawal and Dissolution--some statutes provide that any event
that terminates a member’s membership (death, resignation) causes dissolution.
Other statutes distinguish between fault events(member misconduct...) and
non-fault events (death, bankruptcy), and some provide that dissolution can be
avoided by paying the withdrawing member fair value for his interest.
b)Advantages of LLCs--An LLC for a business
association, not publicly held, has strong advantages: partnership taxation,
virtually no restrictions in structuring ownership interests and management,
limited liability for owners and managers, and no limitations on the number or
nature of owners.
C.DISREGARD OF CORPORATE ENTITY--since a corp is
a distinct legal entity, shs are normally shielded from corporate obligations.
In certain instances, however, the corporate entity will be disregarded.
1.PIERCING THE CORPORATE VEIL--(Suits by
corporate creditors against shs)--it’s more common in contract claims than in
tort claims. The most important elements considered by the courts:
a)Commingling of Assets--commingling of corp
assets and personal assets of shs (e.g., paying private debts with corp funds)
may lead to piercing of the corporate veil;
b)Lack of Corporate Formalities--whether basic
corp formalities (e.g., regular meetings, corporate records maintained,
issuance of stock) were followed is also relevant. Statutory close corps are
permitted more flexibility regarding corp formalities;
c)Undercapitalization--if the corp was organized
without sufficient capital or liability insurance to meet obligations
reasonably expected to arise, the corp veil may be pierced;
d)Domination and Control By Shareholder--the
corp veil is often pierced when an individual or other corp owns most or all of
the stock, so that it completely dominates policy or business decisions.
e)”Alter Ego,” “Instrumentality,” “Unity of
Interest”--when no separate entity exists and the corp is merely the alter ego
or instrumentality of its shs (could be a corporate shareholder), or when there
is a unity of interest between the corp and its shs, the corp veil is often
pierced. These terms are usually applied only if other grounds are present;
f)Fraud, Wrong, Dishonesty, or
Injustice--generally, the veil will be pierced only if one of these elements is
available, e.g., no piercing of veil if there is a lack of corp formalities
without resultant injustice. Piercing the veil usually involves corps with a
small number of shs.
2.PIERCING HAPPENS MOST OFTEN WHEN:
1)The number of shs is small--the chance of one
sh dominating the corp is greater;
2)Deception--There is some kind of deception;
3)Agency--individual is a “principal” and corp
is his “agent”
4)Estoppel--outsider was led to believe that he
was dealing with an individual, while in fact he was dealing with the
5)Direct tort--individual and corp acted
together and should be jointly/severally liable
6)Instrumentality requirement is satisfied:
I)control of a subsidiary by parent
iii)to cause loss or injury.
3.PIERCING THE WALL BETWEEN AFFILIATED
CORPORATIONS--this occurs when a P with a claim against one corp attempts to
satisfy the claim against the assets of an affiliated corp under common
ownership. This type of aggregation is permitted only when each affiliated corp
is NOT a free-standing enterprise but merely a fragment of an entity composed
of affiliated corps.
4.USE OF CORPORATE FORM TO EVADE STATUTORY OR
CONTRACT OBLIGATIONS--the corp form may be ignored when it is used to evade a
statutory or contractual obligation. The issue is whether the contract or
statute was intended to apply to the shs as well as the corporation. Only third
parties, not the corp or its shs, are generally allowed to disregard the corp
5.TWO EXTREMES TO AVOID IN PIERCING THE
a)Old model--Superman (sh) used corp as his
b)New Model--Superman (sh) and corp are
inseparable (alter ego)
D.SUBORDINATION OF SHAREHOLDER DEBTS--”DEEP
ROCK” DOCTRINE--if a corp goes into bankruptcy, debts to its controlling shs
may be subordinated to claims of other creditors. When subordination occurs,
shareholder loans are treated as if they were invested capital (stock). Major
factors in determining whether to subordinate include fraud, mismanagement,
undercapitalization, commingling, excessive control, etc.
II.ORGANIZING THE CORPORATION--generally, corps
are created under and according to statutory provisions of the state in which
formation is sought.
A.FORMALITIES IN ORGANIZING CORPORATION:
1.CERTIFICATE OR ARTICLES OF
INCORPORATION--state law governs the content of the articles, which are filed
with the secretary of the state. Usually, the articles must specify the corp
name, number of shares and classes of stock authorized, address of the corp’s
initial registered office, name of initial registered agent, and the name and
address of each incorporator.
a)Purpose Clause--under most statutes, no
elaborate purpose clause is needed. It is sufficient to state that the purpose
of the corp is to engage in any lawful business activity.
b)State of Incorporation--incorporators need to
consider how flexible the state’s corporate law is versus the costs associating
with incorporating in that state
2.ORGANIZATIONAL MEETING--filling the articles in proper form
creates the corporation, after which an organizational meeting is held by
either the incorporators or dirs named in the articles. Matters determined at
1)Incorporators elect directors, if no dirs are
named in the articles;
5)Directors adopt by-laws (if necessary),
corporate seal and stock certificate
B.DEFECTS IN FORMATION PROCESS--”DE JURE” AND
“DE FACTO” CORPS--when there is a defect or irregularity in formation, the
question is whether the corp exists “de jure,” “de facto,” “by estoppel,” or
not at all. This issue usually arises when a third party seeks to impose
personal liability on would-be shs. Another method of challenging corporate
status, used only by the state, is a quo warranto proceeding. Note: where there
has not been compliance with the statute, we apply principles of de facto, de
jure and corp by estoppel. Where there has been compliance with the statute, we
apply principles of disregard of corporate fiction, a/k/a “piercing the
corporate veil,” which is an exception, rather than a rule.
1.DE JURE CORPORATION--this exists when the corp
is organized in compliance with the statute. Its status cannot be attacked by
anyone--not even the state. Most courts require only “substantial compliance”;
others require exact compliance with the mandatory requirements.
2.DE FACTO CORPORATION (substantially
abolished)--this exists when there is insufficient compliance as to the state
(i.e., state can attack in quo warranto proceeding), but the steps taken are
sufficient to treat the enterprise as a corp with respect to its dealings with
third parties. Requirements:
1)Colorable or apparent attempt;
3)Some use of corporate franchise; Then ct will
recognize status as to all but state
3.CORPORATION BY ESTOPPEL
a)Definition--estoppel is an equitable
evidentiary rule which prevents a party from denying the existence of a fact
notwithstanding that he fact is not true. Thus, certain parties are estopped
from asserting defective incorporation when they have dealt with the corp as though
b)Example--shs who claimed corp status in an
earlier transaction are estopped to deny that status in a suit brought against
the corp. The estoppel theory normally does NOT apply to bar suits against
would-be shs by tort claimants or other involuntary creditors.
c)Overlap With De Facto--many of the facts which
we would point to support a claim of de facto status are the same ones we point
for estoppel. However, substantial abolition of de facto concept doesn’t
necessarily abolish estoppel.
d)De Facto is For All; Estoppel is For
One--estoppel depends on relationship between party and corp.
MAY BE HELD LIABLE--when a would-be corp is not a de jure or de facto or a corp
by estoppel, the modern trend imposes personal liability against only those
owners who actively participated in management of the enterprise.
5.EFFECT OF STATUTES:
a)On De Facto Doctrine--states following the
prior version of the Model Act have abolished the de facto doctrine, thus
making all purported “shs” jointly and severally liable for all liabilities
incurred as a result of the purported “incorporation.” However, statutes based
on Revised Model Business Corporation Act require a person acting on behalf of
the enterprise to know that there was no incorporation before liability
b)On Estoppel Doctrine--the effect of both acts
is an unsettled issue.
c)On Liability--under the prior Model Act,
liability extends to investors who also exercise control or actively
participate in policy and operational decisions. It is expected that the
Revised Model Act will be interpreted in the same manner.
III.LIABILITIES FOR TRANSACTIONS BEFORE
A.PROMOTERS--a promoter participates in the
formation of the corp, usually arranging compliance with the legal requirements
of formation, securing initial capital, and entering into necessary contracts
on behalf of the corp during the time it’s being formed.
a)Fiduciary Duties to Each Other--Full
disclosure and fair dealing are required between the promoters and the corp and
among promoters themselves.
B.CONTRACTS MADE BY PROMOTERS ON CORP’S BEHALF
1.RIGHTS AND LIABILITIES OF CORPORATION:
a)English Rule--the corp is not directly liable
on pre-incorporation contracts even if later ratified. Rationale: the corp was
not yet in existence at the time the promoter was acting.
b)American Rule--the corp is liable if it later
ratifies or adopts pre-incorporation K.
c)Corporation’s Right to Enforce Contract--under
either rule, the corp may enforce the contract against the party with whom the
promoter contracted, if it chooses to do so.
2.RIGHTS AND LIABILITIES OF PROMOTERS.
a)Liability on Pre-incorporation
Contract--generally, promoters are liable if the corp rejects the
pre-incorporation contract, fails to incorporate, or adopts a contract but
fails to perform, unless the contracting party clearly intended to contract
with the corporation only and not with the promoters individually.
b)Right to Enforce Against the Other Party--if a
corp is not formed, the promoter may still enforce the contract.
C.OBLIGATIONS OF PREDECESSOR BUSINESS--a
corporation that acquires all of the assets of a predecessor business does not
ordinarily succeed to its liabilities, with exceptions:
a)Exceptions--the successor corp may be liable for its predecessor
1)the new corp expressly or impliedly assumes
the predecessor obligations (the creditors of the old corp may hold the new
corp liable as third-party beneficiaries);
2)the sale was an attempted fraud on the
3)the predecessor is merged into or absorbed by
IV.POWERS OF THE CORPORATION.
A.CORPORATE POWERS--generally, corporate
purposes and powers are those expressly set forth in the corporation’s
articles, those conferred by the statute, and the implied powers necessary to
carry out the express powers. Transactions beyond the purposes and powers of
the corporation are ultra vires.
1.TRADITIONAL PROBLEM AREAS--the following three
powers are particularly significant express powers, since older statutes did not
specifically confer them:
a)Guarantees--modern statutes confer the power
to guarantee the debts of others if it is in furtherance of the corporate
b)Participation in a Partnership--present-day
statutes explicitly allow the corp to participate with others in any corp,
partnership, or other association;
c)Donations--because the general rule is that
the objective of a business corporation is to conduct business activity with a
view to profit, early cases held that charitable contributions were ultra
vires; the modern view permits reasonable donations without showing the
probability of a direct benefit to the corp.
1.DEFINITION--agency is the fiduciary relation
which results from the manifestation of consent by one person to another that
the other shall act on his behalf and subject to his control, and consent by
the other to so act." Rest2dAg
a)Parties to an agency relationship--Principal
& Agent. Thus, three essential elements of an agency relationship:
1)Manifestation by principal that agent shall
act for him in some undertaking;
2)Acceptance by the agent; and
3)Understanding that the principal is in control
of the undertaking.
I)Note that these are factual issues; if they
are satisfied, then the relationship is one of agency, regardless of what the
parties themselves call it (but the parties' labels may provide evidence of
2.CATEGORIES OF AGENCY
a)Actual Express Authority--authority is the
power of the agent to affect the legal relations of the principal by acts done
in accordance with the principal's manifestations of consent to him." Rest
§7. Operative word is "manifestation" . If he says, do something,
it's express -- but the manifestation may include implied assent to
other things as well, which is--b)Actual Implied Authority--unless otherwise
agreed, authority to conduct a transaction includes authority to do acts which
are incidental to it, usually accompany it, or are reasonably necessary to
accomplish it." Rest § 35
c)Apparent Authority -- a.k.a.
"ostensible authority"--apparent authority is the power to affect the
legal relationships of another person by transactions with third persons,
professedly as agent for the other, arising from and in accordance with the
other's manifestations to such third persons." Rest §8. But note that the
manifestation includes allowing the agent to represent accurately his own
d)Inherent Authority--this is the authority that
inheres in an office. General agent (agent authorized to conduct a series of
transactions involving continuity of service): P is bound if A is acting in the
interests of P and A does an act usual or necessary with respect to the
authorized transactions ;
1)Unusual activities--depositing corporate
checks on a personal account is an unusual activity, and the bank should make
inquiry if the person is authorized to do that; otherwise, the bank is liable
to the principal for lost money (Mohr)
e)Ratification--ratification is the affirmance
by a person of a prior act which did not bind him but which was done or
professedly done on his account, whereby the act, as to some or all persons, is
given effect as if originally authorized by him." Rest § 82. The principal
can affirm by words, or by deeds. This includes the failure to repudiate the
subject matter when presented, suing to enforce the obligation, retaining the
benefits of the transaction. Note several things:
1)Ratification assumes that the principal was
not previously bound. If the principal had been previously bound, then the
liability would be based on another agency theory.
2)It doesn't matter to whom the affirmance is
made. It could be to the agent, to the third party, or anyone else or nobody at
all. Why? Because what was lacking in the original contract was merely his
expression of assent to the relationship of agency. The terms are fixed, the
third party believes he has an agreement, all that's missing is the opposite
party. So the President of the firm's note to himself that the affirms may be
sufficient. If there are some formalities required to authorize an act --e.g.,
sealed instruments, deeds -- then there might be additional
formality required for affirmance.
f)Estoppel--purported principal either (a)
intentionally or carelessly causes the belief that a purported agent is acting
on his behalf, or (b) sits silently knowing that such belief exists without
taking reasonable steps, and the third party relies detrimentally.
C.ULTRA VIRES TRANSACTIONS--those beyond the
purposes and powers, express and implied, of the corporation. Under common law,
shareholder ratification of an ultra vires transaction nullified the use of an
ultra vires defense by the corporation.
1.TORT ACTIONS--ultra vires is NO defense to
2.CRIMINAL ACTIONS--claims that a corporate act
was beyond the corp’s authorized powers are NO defense to criminal liability.
3.CONTRACT ACTIONS--at common law, a purely executory ultra vires
contracts were NOT enforceable against either party; fully performed contracts
could NOT be rescinded by either party; and, under the majority rule, partially
performed contracts were generally enforceable by the performing party, since
the nonperforming party was estopped to assert an ultra vires defense.
4.STATUTES--most states now have statutes that
preclude the use of ultra vires as a defense in a suit between the contracting
parties, but permit ultra vires to be raised in certain other contexts:
a)Suits Against Officers or Directors--if
performance of an ultra vires contract results in a loss to the corp, it can
sue the officers or dirs for damages for exceeding their authority.
b)Suit By State--these limiting statutes do NOT
bar the state from suing to enjoin a corp from transacting unauthorized
c)Broad Certificate Provisions--when the
certificate of incorporation states that the purpose is to engage in any lawful
activity for which corp may be organized, ultra vires is unlikely to arise.
V.MANAGEMENT AND CONTROL
A.ALLOCATION OF POWERS BETWEEN DIRECTORS AND
1.MANAGEMENT OF CORPORATION’S BUSINESS--corporate
statutes vest the power to manage in the board of directors, except as provided
by valid agreement in a close corp. He board’s power is limited to proper
2.SHAREHOLDER APPROVAL OF FUNDAMENTAL
CHANGES--shs must approve certain fundamental changes in the corp, e.g.,
amendment of articles, merger, sale of substantially all assets, and
3.POWER TO ELECT DIRECTORS--shs have the power
to elect dirs and to remove them for cause, absent provisions for removal
without cause in the certificate, bylaws, or in statutes. Some statutes also
permit the board or the courts to remove a dir for certain specific reasons
(e.g., felony conviction).
4.POWER TO RATIFY MANAGEMENT TRANSACTIONS--shs
have the power to ratify certain management transactions and insulate the
transactions against a claim that managers lacked authority, or shift the
burden on the issue of self-interest.
5.POWER TO ADOPT PRECATORY RESOLUTIONS--shs may
also adopt advisory but nonbinding (precatory) resolutions on proper subjects
of their concern.
6.BYLAWS--shs usually have the power to adopt
and amend bylaws, although some statutes give the board of dirs the concurrent
power to do this.
CORPORATION--this is a corp owned by a small number of shs who may actively
manage; it has no general market for its stock, and it has some limitations
regarding transferability of stock.
8.STATUTORY CLOSE CORPORATION STATUS--the basic
requirements to qualify for special treatment under the statutes are that, in
its cert of incorp’n, a statutory close corp must identify itself as such, and
must include certain limitations as to the number of shs, transferability of
shares, or both.
a)Functioning As a Close Corporation--there may
be sh agreements relating to any phase of the corp affairs.
1.APPOINTMENT OF DIRECTORS--initial dirs are
either designated in the articles of incorporation or elected at a meeting of
incorporators. Subsequent elections are by shs at their annual meetings. The
number of dirs is usually set by the articles or bylaws.
a)Qualifications--absent a contrary provision in
the articles or bylaws, dirs need not be shs of the corp or residents of the
state of incorporation.
b)Vacancies--statutes vary, but under Model Act,
a vacancy may be filled by either the shs or dirs.
1)Compare--removal: some statutes require that
vacancies created by removal of a dir be filled by the shs unless the articles
or bylaws provide otherwise.
2.TENURE OF OFFICE
a)Term of Appointment--under most statutes, office
is held until the next meeting, although on a classified board, dirs may serve
staggered multi year terms.
b)Power to Bind Corporation Beyond Term--unless
limited by the articles, the board has the power to make contracts biding the
corp beyond the dirs’ term of office.
c)Removal of Director During Term--at common
law, shs can remove a dir for cause (e.g., fraud, incompetence, dishonesty)
unless an article or bylaw provision permits removal without cause. a dir being
removed for cause is entitled to a hearing by shs before a vote to remove. a
number of statutes permit removal without cause.
1)Removal by Board--board can NEVER remove a dir
unless authorized by statute;
2)Removal by Court--there is a split authority
as to whether a court can remove a dir for cause.
I)Statutes--some statutes permit courts to
remove a dir for specified reasons. Usually, a petition for removal can be
brought only by a certain percentage of shs or the attorney general.
3.FUNCTIONING OF BOARD
a)Meetings--absent a statute, dirs can act only
at a duly convened meeting consisting of a quorum. In most jurisdictions, a
meeting can be conducted by telephone or other means whereby participants can
hear each other simultaneously. Most statutes also allow board action by
unanimous written consent without a meeting.
1)Notice--although formal notice is unnecessary for a regular
meeting, special meetings require notice to every dir of date, time, and place.
Usually, notice can be waived in writing before or after a meeting. Attendance
waives notice unless the dir attends only to protest the meeting.
2)Quorum--a majority of the authorized number of
dirs constitutes a quorum. Many statutes permit the articles or bylaws to
require more than simple majority or less than that.
3)Voting--absent a contrary provision, an
affirmative vote of a majority of those present, not a majority of those
voting, is required for board action.
b)Effect of Noncompliance With
Formalities--today, most courts hold that informal but unanimous approval of a
transaction is effective, as is a matter receiving the explicit approval by a
majority of dirs without a meeting, plus acquiescence by the remaining dirs.
c)Delegation of Authority--the board has the
power to appoint committees of its own members to act for it either in
particular matters or to handle day-to-day management between board meetings.
Typically, these committees cannot amend the articles or bylaws, adopt or
recommend major corporate changes (e.g., merger), recommend dissolution,
declare a dividend, or authorize issuance of stock unless permitted by the
articles or bylaws. Note that while the board may delegate operation of the
business to an officer or management company, the ultimate control must be
retained by the board.
d)Provisional Directors--some statutes allow
them to be appointed by court if the board is deadlocked and corporate business
is endangered. a provisional dir serves until the deadlock is broken or until
removed by a court order or by majority of shs.
e)Voting Agreements--an agreement in advance
among dirs as to how they will vote is void as contrary to public policy. There
are certain exceptions for statutory close corps.
4.COMPENSATION--dirs are NOT entitled to
compensation unless they render extraordinary services or such compensation is
otherwise provided for. Officers are entitled to reasonable compensation for
5.DIRECTORS’ RIGHTS, DUTIES, AND LIABILITIES
a)Right to Inspect Corporate Records--if done in
good faith for purposes germane to his position as dir, this right is absolute.
b)Duty of Care--dirs must exercise the care of
an ordinarily prudent and diligent person in a like position, under similar
circumstances. There is no liability (absent a conflict of interest, bad faith,
illegality, or gross negligence) for errors of judgment (business judgment
rule--the rebuttable presumption that action was taken on an informed basis, in
good faith and exercising reasonable care), but the dir must have been
reasonably diligent before the rule can be invoked (Shlensky)
1)The duty of care requires:
I)Education--a dir should acquire at least a
rudimentary understanding of the business of the corporation;
ii)Information--a dir is under a continuing
obligation to keep informed about the activities of the corp;
iii)Participation--dirs must “generally monitor”
corporate affairs, but need NOT involve themselves in the day-to-day
operations; (i.e. they should attend board of dirs meetings with reasonable
iiii)Inquiry--a dir has a duty to inquire when
circumstances would alert a reasonable person for the need of inquiry.
iiiii)Action--where wrongdoing is revealed, a dir should object,
correct, or resign. Object to the course of conduct, steer toward correction,
and resign if it isn’t corrected.
2)Extent of liability--dirs are personally
liable for corporate losses directly resulting from their breach of duty or
negligence in falling to discover wrongdoing. a director may seek to avoid
being held personally liable for acts of the board by recording his dissent.
I)Many statutes permit the articles to abolish
or limit dir’s liability for breach of the duty of care absent bad faith,
intentional misconduct, or knowing violation of law.
3)Defenses to liability--these include good
faith reliance on management or expert’s reports. Disabilities may be
considered in determining whether the dir has met the standard of care.
c)Duty of Loyalty--a catch-all duty designed to
prevent unfairness--the duty to act in good faith (BJR applies). Application:
(1)early absolute prohibition against
self-dealing renders transactions void or voidable;
(2)permissive self-dealing: dirs and officers
may contract with the corp if (a)done in “strictest good faith.”; (b)with full
disclosure; and (c)consent of “all concerned.”
--burden of proof is on the dir to establish
good faith, honesty & fairness;
--courts weigh self-dealing transactions with
(3)self-dealing prohibition also applies to
intercorporate transactions where dirs are common.
(1)quasi-safe harbor approach (Iowa
statute)--transaction is not void or voidable because of dirs’ interest, if
--interest is disclosed and approval is made
without counting the vote of the interested dir.
--interest is disclosed to shs and shs
--transaction is fair and reasonable
(2)Note--dir must still establish that he acted
in good faith, honesty, and fairness
2)Domination of subsidiary by parent--courts
look at the transaction to see if self-dealing has occurred. Example (Sinclair
I)declaration of dividends shared pro rata was
NOT self-dealing; BJR applies
ii)contract between parent and sub was
self-dealing; apply intrinsic fairness test
I)Ordinary corporations--conflicts are
inevitable but all firms need to set compensation. The burden of proof is
placed on challengers as a matter of convenience.
ii)Close corporations--the income generated by
the firm may be diverted to salaries, so there is an option for self-dealing by
the parties in control to take tax-advantaged compensation in the form of
salaries (taxed once) as opposed to dividends (taxed twice).
d)Statutory Duties and Liabilities--in addition
to general duty of care, federal and state laws also impose certain duties and
liabilities, e.g., registration requirements under the Securities Act of 1933,
liability for rule 10b-5 violations, liability for illegal dividends. Some
statutes also impose criminal liability on corporate managers for unlawful
1.ELECTION--officers are usually elected by the
board of dirs. Some statutes permit election of officers by shs.
2.AUTHORITY OF CORPORATE OFFICERS (liability of
corp to outsiders)--only authorized officers can bind the corp. Authority may
be: actual (expressed in bylaws or by valid board resolution), apparent (corp
gives third parties reason to believe authority exists), or power of position
(inherent to position). If ratified by the board, even unauthorized acts can
bind the corp.
a)Authority of President--the majority rule is
that the president has the power to bind the corp in transactions arising in
regular course of business.
3.DUTIES OF CORPORATE OFFICERS--the duty of care
owed by a officer is similar to that owed by dirs ( and sometimes higher).
D.CONFLICTS OF INTEREST IN CORPORATE
1.DUTY OF LOYALTY--because of their fiduciary
relationship with the corp, officers and dirs have the duty to promote the
interests of the corp without regard for personal gain.
2.BUSINESS DEALINGS WITH THE
CORPORATION--conflict of interest issues arise when a corp transacts business
with one of its officers or dirs, or with a company in which an officer or dir
is financially interested.
a)Effect of Self-Interest on Right to
Participate in Meeting--most statutes permit an “interested” dir to be counted
toward quorum, and interested dir’s transactions are NOT automatically voidable
by the corp because the interested dir’s vote was necessary for approval.
b)Voidability Because of Director’s
Self-Interest--today, such transactions are voidable only if unfair to the
corporation. The burden of establishing fairness is on the interested director.
Note that a dir’s failure to fully disclose material facts may be per se
1)Unanimous shareholder ratification--if, after
full disclosure, shareholder ratification is unanimous, the corp will be
estopped from challenging the transaction with the interested dir (except at to
I)Less-than-unanimous ratification--courts then
will look at whether the majority shares were owned or controlled by the
interested director. Courts are more likely to uphold ratification by a
disinterested majority so as to preclude the transaction from being attacked by
the corp or by a sh in a derivative suit.
2)Statutes--most statutes provide that such
transactions are NOT voidable if: (1)approved, after full disclosure, by a
disinterested board majority or by majority of shs, or (2)the transaction is
fair to the corp notwithstanding disclosure.
I)”Interested”--an “interested” dir or officer is one who has a
business, financial, or familial relationship with a party to the transaction
that would reasonably affect the person’s judgment so as to adversely affect
c)Remedies--the corp may rescind, or affirm and
sue for damages.
transactions between corps with common dirs are subject to the same rules of
interested director transactions. There is no conflict of interest if one corp
is the wholly owned subsidiary of the other. However, a question of fairness
arises where the parent owns only a majority of the subsidiary’s shares.
4.CORPORATE OPPORTUNITY DOCTRINE (Also see duty
a)Definition--COD bars dirs from taking any
business opportunity belonging to the corp without first offering it to the
corp.. If the corp is unwilling to pursue an opportunity (after an independent
board is fully informed of the opportunity), then the dir may pursue it.
b)Defenses (available in most, but not all
1)Inability--If the corp is legally or
financially unable to take the opportunity, then the dir generally may take
advantage of it. (But the question of who caused the financial inability is
quite relevant. Example: Irving Trust Co--the defense of inability was
2)Rejection, abandonment, or approval--then the
fiduciary has a valid defense.
c)Remedies--constructive trust or damages--the
fiduciary must account to the firm for all the profits he has made as a result
d)Definition of a Corporate Opportunity:
1)Line of business test--does the firm have
fundamental knowledge, practical experience, and ability to pursue the
opportunity? If yes, then it is within the firm’s line of business. It should
be a natural fit, and not a mere desire by a firm to pursue the opportunity.
e)Application--Guth Rule and Corollary:
1)Guth rule (offered in corporate capacity)--if
there is presented to O/D a business opportunity which the corp is
(1)financially able to undertake, which is from its nature (2a) in the line of
business and is of practical advantage to it OR (2b)is one in which the corp
has an interest or reasonable expectancy (under an established corporate policy
or plan), and, (3)by embracing the opportunity the self-interest of the dir
will be brought into conflict with that of his corp, then officer or dir may
NOT take the opportunity.
2)Guth corollary (a safe harbor; satisfy all
provisions and dir can take)--if a business opportunity (1)comes to O/D in his
individual capacity and (2) is not essential to the corp and is (3)one in which
corp has no interest or expectancy, then the O/D can treat it as his own, IF he
has not taken corporate resources to pursue the opportunity.
I)”Essential”--indispensably necessary to the
continued viability of the firm;
ii)Individual or corporate? Look at O/D capacity
to determine how offer was made
5.COMPETING WITH CORPORATION--such competition
by a dir or officer may be a breach of fiduciary duty even when the competing
business is not a corporate opportunity
6.COMPENSATION FOR SERVICES TO THE
CORPORATION--the compensation plan must be duly authorized by the board, and
its terms must be reasonable. Good faith and the BJR ordinarily protect
disinterested dirs from liability to the corp for approving compensation.
a)Publicly Held Corporations--The SEC has authorized shs to make
proposals about executive pay in management’s proxy statements. Further, the
tax code now limits expense deductions for executive pay over $1mln, unless it
is tied to the corp’s performance.
b)Past and Future Services--compensation for
past services is generally invalid. Compensation for future services is proper
if there is reasonable assurance that the corp will receive the benefit of the
VI.INSIDER TRADING--purchase or sale of
securities by someone with access to material
nonpublic information. It may be illegal. It
affects corps with more than $1 mln in total assets and with at least 500/750
a)Who may be hurt by insider trading:
1)Target shareholders--they sell too early;
2)Other arbitrageurs--they lose a portion of the
gain that they make from honest effort
3)Other issuers--they lose confidence in the
4)The acquiring company--insider trading drives
up their cost of acquisition, since the target may adopt defensive measures
otherwise not in place.
b)Possible Sources of Liability:
3)10b-5 misappropriation theory (O’Hagan);
4)Mail or wire fraud;
6)Statutory liability under 16(b)--insiders are
forced to give their profits to the corp, if the y buy and sell securities
within a 6-month period regardless of whether they are using insider info.
(Need to know 2, 3, 6)
c)O’Hagan--insider trading violation where a
partner in law firm took info rom his firm regarding the firm’s client’s plans
for acquisition of Pillsbury and used that info to buy shares in Pillsbury
d)Penalties For Insider Trading--ITSA (Insider
Trading Sanctions Act)--3 measures:
1)Out-of-pocket measure--if a sh buys a share
for $10, while in fact it costs $9, his out-of-pocket expense is $1.
2)Causation-in-fact--because an insider engaged
in insider trading, it caused a loss
3)Disgorgement--we look at D’s profit. ITSA
measures the damage to sh by the amount of profit that D received from the
2)SEC civil penalties--treble damages; SEC may
seek penalty capped by three times profit gained or loss avoided.
A.COMMON LAW--under the majority rule, there was
no duty to disclose to the shs inside info affecting the value of shares.
Therefore, the protection of investors was very weak.
a)For lability to exist there should be:
1)At least fraud or deceit upon purchasers;
2)May also be a device or scheme;
3)May also be an implied misrepresentation.
b)Two Elements (relationship and unfairness):
1)Relationship--existence of a relationship giving access,
directly or indirectly, to information intended to be available for a corporate
purpose and no other.
I)Insiders include at least officers, dirs,
controlling shs (In re Cady Roberts)
ii)Persons charged with confidentiality by
contractual or fiduciary relationship
2)Unfairness--inherent unfairness that results
when a party takes advantage of such information knowing it is unavailable to
person with whom he is dealing.
B.SECURITIES EXCHANGE ACT OF 1934--IN GENERAL--the
act superseded common law. Section 12 of the Act requires registration of any
security traded on a national exchange, or any equity security (held by 500 or
more persons) of a corp with assets exceeding $5 million.
C.SECTION 10(B) AND RULE 10B-5--section 10(b)
prohibits any manipulation or deception in the purchase or sale of any
security, whether or not it’s registered. Rule 10b-5 prohibits the use of the
mails or other instrumentality of interstate commerce to defraud, misrepresent,
or omit a material fact in connection with a purchase or sale of any security.
1.COVERED CONDUCT--rule 10b-5 applies to
nondisclosure by dirs or officers, as well as to misrepresentations. It applies
not only to insider trading but also to any person who makes a misrepresentation
in connection with a purchase or sale of stock.
2.COVERED SECURITIES--rule 10b-5 applies to the
purchase or sale of any security, registered or unregistered. a jurisdictional
limitation requires that the violation must involve the use of some instrumentality
of interstate commerce.
3.WHO CAN BRING SUIT UNDER 10B-5--private
plaintiffs and the SEC. Private plaintiffs must be either purchasers or sellers
4.MATERIALITY--for rule 10b-5 to apply, the
information misrepresented or omitted must be material (i.e., a reasonable sh
would consider it important in deciding whether to buy or to sell).
5.FAULT REQUIRED (SCIENTER)--a defendant is not
liable under rule 10b-5 if he was without fault or merely negligent. The
scienter requirement is satisfied by recklessness or an intent to deceive,
mislead, or convey a false impression. Scienter is also required for injunctive
1)D knew the hazard and proceeded nonetheless
2)D proceeded despite what a reasonable person
would perceive (objective test);
b)Recklessness Under PSLRA:
1)Knowing conduct-- yields jointly and severally
2)Non-knowing conduct (e.g.,
recklessness)--yields fair share (proportionate liability), found in accordance
with special interrogatories.
6.CAUSATION AND RELIANCE--a plaintiff must prove that violation
caused a loss (i.e., he must establish reliance on the wrongful statement or
omission). However, in omission cases, there is a rebuttable presumption of
reliance once materiality is established.
a)Fraud On The Market--where securities are
traded on a well-developed market (rather than in a face-to-face transaction),
reliance on a misrepresentation may be shown by alleging reliance on the
integrity of the market.
b)Face-to-Face Misrepresentations--a plaintiff
can show actual reliance in these cases by showing that the misrepresentation
was material, testifying that he relied upon it, and showing that he traded
soon after misrepresentation.
7.WHEN NONDISCLOSURE CONSTITUTES a VIOLATION
a)Mere Possession of Material
Information--generally, nondisclosure of material, nonpublic information
violates rule 10b-5 only when there is a duty to disclose independent of rule
b)Insider Trading--insiders (dirs, officers,
controlling shs and corporate employees) violate rule 10b-5 by trading on the
basis of material, nonpublic info obtained through their positions. They have a
duty to disclose before trading.
c)Misappropriation--the liability of noninsiders
who wrongfully acquire (misappropriate) material nonpublic info has not been
ruled upon by the US Supreme Court, although some lower level federal courts
have imposed criminal liability.
1)Duty to Employer--using the misappropriation
theory, criminal liability under rule 10b-5 has been imposed where an employee
trades on info used in violation of the employee’s fiduciary duty to his
employer. An employee’s duty to “abstain or disclose” with respect to his ER
does NOT extend to the general public. However, the Insider Trading and
Securities Fraud Enforcement Act of 1988 makes any person who violates rule
10b-5 by trading while in possession of material, nonpublic info liable to any
person who, contemporaneously to the transaction, purchased or sold securities
of the same class. Liability is limited to the defendant’s profit or avoided
2)Mail and wire fraud--the application of the
federal mail and wire fraud statute to this situation lessens the importance of
the misappropriation theory in imposing criminal liability under rule 10b-5.
3)Special rule for tender offers--once
substantial steps toward making a tender offer have begun, it is a fraudulent,
deceptive, or manipulative act for a person possessing material information about
the tender offer to purchase or sell any of the target’s stock, if that person
knows that the info is nonpublic and has been acquired from the bidder, the
target, or someone acting on the bidder’s or the target’s behalf.
d)”Disclose or Abstain”--nondisclosure by a
person with a duty to disclose violates rule 10b-5 only if he trades (Cady
8.LIABILITY OF NONTRADING PERSONS FOR
MISREPRESENTATION--a nontrading corp or person who makes a misrepresentation
that could cause reasonable investors to rely thereon in the purchase or sale
of securities is liable under rule 10b-5, provided the scienter requirement is
9.LIABILITY OF NONTRADING CORPORATION FOR NONDISCLOSURE--the basic
principle is “disclose or abstain.” Thus, a nontrading corp is generally not
liable under rule 10b-5 for nondisclosure of material facts.
a)Exceptions--a corp has a duty to:
1)Correct misleading statements (even if
2)Update statements that have become materially
misleading by subsequent events; 3)Correct material errors in statements by
others (e.g, analyst’s report) about the corp, but only if the corp was
involved in the preparation of the statements; and
4)Correct inaccurate rumors resulting from leaks
by the corp or its agents.
10.TIPPEE AND TIPPER LIABILITY--a person, not an
insider, who trades on info received from an insider is a tippee and may be
liable under rule 10b-5 if he received info through an insider who breached
fiduciary duty in giving the info, AND the tippee knew or should have known of the
a)Breach of Insider’s Fiduciary Duty--whether an
insider’s fiduciary duty was breached depends largely on whether the insider
communicated the info to realize the gain or advantage. Accordingly, tips to
friends or relatives and tips that are a quid pro quo for a past or future
benefit from the tippee result in fiduciary breach. Note that if a tippee is
liable, so is the tipper.
11.”TEMPORARY INSIDERS”--corporate info
legitimately revealed to a professional or consultant (e.g., accountant)
working for the corp may make this person a fiduciary of corp
12.AIDERS AND ABETTORS--liability cannot be
imposed solely because a person aided and abetted the violation of the rule.
13.APPLICATION OF RULE 10B-5 TO BREACH OF
FIDUCIARY DUTY BY DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS.
a)Ordinary Mismanagement--a breach of fiduciary
duty not involving misrepresentation, nondisclosure, or manipulation does NOT
violate rule 10b-5;
b)Misrepresentation or Nondisclosure--if this is
the basis of a purchase from or sale to the corp by a dir or officer, the corp
can sue the fiduciary under rule 10b-5 and also for breach of fiduciary duty.
If the corp doesn’t sue, a minority sh can maintain a derivative suit on the
c)Purchase or Sale By Controlling
Shareholder--when a corp purchases stock from or sells stock to a controlling
sh at an unfair price, and material facts aren’t disclosed to minority shs, a
derivative action may lie if the nondisclosure caused a loss to the minority
shs. The plaintiffs must establish causation by showing that an effective state
remedy (e.g., injunction) was foregone because of nondisclosure.
14.BLUE CHIP RULE--PRIVATE PLAINTIFF--a
plaintiff can bring a private cause of action only if he actually purchased or
sold the relevant securities. “Sale” includes an exchange of stock for assets,
mergers and liquidations, contracts to sell stock, and pledges. The SEC can
bring action under rule 10b-5 even though it has neither purchased or sold
Diligence--if a plaintiff’s reliance on a misrepresentation or omitted fact
could have been prevented by his exercise of due diligence, recovery may be
barred. Mere negligence does NOT constitute a lack of due diligence, although a
plaintiff’s intentional misconduct and his own recklessness (if D was merely
reckless) will bar recovery.
b)In pari delicto--a private suit for damages
under rule 10b-5 will be barred if:
1)The plaintiff bears substantially equal
responsibility for the violations, AND
2)Preclusion of the suit would not significantly
interfere with the enforcement of securities law.
a)Out-of-pocket Damages--this is the difference
between the price paid for stock and its actual value.
are measured by the value of the stock as it really is and the value it would
have had if a misrepresentation had been true.
2)Standard measure of conventional
damages--out-of-pocket damages is the standard measure in private actions under
rule 10b-5; benefit-of-the-bargain damages are usually not granted.
b)Restitutionary Relief--this may be sought
instead of conventional damages:
1)Rescission--returns the parties to their
status quo before the transaction
2)Rescissionary or Restitutionary damages--money
equivalent of rescission
3)Difference between conventional damages and
Restitutionary relief--out-of-pocket damages are based on the P’s loss, while
Restitutionary relief is based on the D’s wrongful gain. Rescission or
Rescissionary damages may be attractive remedies when the value of the stock
changed radically after the transaction. However, Restitutionary relief is
usually unavailable in cases involving publicly held stock.
c)Remedies Available to the Government--although
the SEC cannot sue for damages, it can pursue several remedies including
special monetary remedies:
1)Injunctive Relief--the SEC often seeks
injunctive relief accompanied with a request for disgorgement of profits or
other payments that can be subject to criminal sanctions (fines and jail
sentences) and civil penalties (up to three times the profit gained or loss
17.JURISDICTION, VENUE, AND SERVICE OF
PROCESS--suits under 10b-5 are based on the 1934 Act, and exclusive
jurisdiction is in the federal district courts. State claims arising out of the
same transactions may be joined with the federal claim under the supplemental
jurisdiction doctrine. Venue can be wherever any act or transaction
constituting a violation occurred, or where the D is found or transacts
business. Process can be served where the D can be found or where he lives.
18.STATUTE OF LIMITATIONS--the 1934 Act contains
no SOL; however, the SCt has held that private actions must be brought within
one year after discovery of the relevant facts and within three years following
accrual of the cause of action. The tolling doctrine is inapplicable.
a)Exceptions--the time limitations don’t apply to all rule 10b-5
private actions, e.g., SEC limitations period of five years for private suits
by contemporaneous traders against purchasers or sellers who violate rules
regarding trades while in possession of material, nonpublic information.
Further, the SEC is not subject to any limitations period in civil enforcement
D.SECTION 16 OF THE 1934 ACT--Section 16
concerns purchases followed by sales, or sales followed by purchases, by
certain insiders, within a six-month period.
1.FIRMS AND SECURITIES AFFECTED UNDER SECTION
16--Section 16 applies to those firms and securities that must be registered
under section 12 of the 1934 act.
a)Reason--16(a) references registered securities
under S12; S12(a) and 12(g) create the registration requirement for securities;
S12(g)creates an asset ($1 mln total) and distribution (500 to 700 depending on
timing); 16(b) references “such” officers, etc., which refers to sub(a)
b)Note--trading in all of a corp’s equity
securities is subject to section 16 if any class of its securities is
registered under section 12.
2.DISCLOSURE REQUIREMENT--Section 16(a) requires
every beneficial owner of more than 10% of the registered stock and directors
and officers of the issuing corp to file periodic reports with the SEC showing
their holdings and any changes in their holdings.
a)Who is an Officer (16a-1f)--issuer’s
president, principal financial director, principal accounting officer, any
vice-president of the issuer in charge of a principal business unit, any other
officer who performs similar policy-making functions for the issuer.
3.LIABILITY--to prevent the unfair use of
information, section 16(b) allows a corp to recover profits made by an officer,
dir, or more-than-10% beneficial owner on the purchase and sale or sale and
purchase of its securities within a six-month period.
a)Coverage--Section 16(b) does NOT cover all
insider trading and is NOT limited to trades based on inside info. The critical
element is short-swing trading by officers, dirs, and more-than-10% beneficial
1)Note--beneficial owner must own 10% or more
BOTH at he time of sale and purchase to be liable under 16(b).
b)Calculation of short-swing profit--the profit
recoverable is the difference between the price of the stock sold and the price
of the stock purchased within six month before or after the sale.
1)Multiple transactions--if there is more than
one purchase or sale transaction within the six-month period, the transactions
are paired by matching the highest sale price with the lowest purchase price,
the next highest price with the next lowest price, etc. a court can look six
month forward or backward from any sale to find a purchase, or from any
purchase to find a sale
c)Who May Recover--the profit belongs to the
corp alone. Although not a typical derivative action, if the corp fails to sue
after a demand by a sh, the sh may sue on the corp’s behalf. The cause of
action is federal, so there is no posting of security requirement, and no
contemporaneous sh requirement. Remedy:
1)All sales and purchases within 6 months are
2)Damages calculated as to maximize the gain to
highest sale price against lowest purchase price within relevant period;
continue until you can go no further.
d)Insiders--insiders are officers (named
officers and those persons functioning as officers), dirs (actually serving or
who authorized deputization of another), and beneficial owners of more than 10%
of the shares. Insider status for officers and dirs is determined at the time
they made a purchase or sale. Transactions made before taking office is NOT
within section 16(b), but those made after leaving office are subject to the
statute if they can be matched with a transaction made while in office.
Liability is imposed on a beneficial owner only if he owned more than 10% of
the shares at the time of both the purchase and sale.
e)”Purchase or Sale”--this includes any purchase
of stock. Unorthodox transactions that result in the acquisition or deposition
of stock (e.g., merger for stock, redemption of stock) are also purchases and
E.SECTION 16(B) COMPARED TO RULE 10B-5:
a)Covered Securities--Section 16(b) applies to
securities registered under the 1934 act; rule 10b-5 applies to all securities.
b)Inside Information--Section 16(b) allows
recovery for short-swing profits regardless of whether they are attributable to
misrepresentations or inside info; rule 10b-5 recovery is available only where
there was a misrepresentation or a trade based on inside info.
c)Plaintiff--recovery under section 16(b)
belongs to the corp, while rule 10b-5 recovery belongs to the injured purchaser
d)Overlapping Liability--it is possible that
insiders who make short-swing profits by use of inside info could be liable
under both section 16(b) and rule 10b-5.
F.COMMON LAW LIABILITY FOR INSIDER
TRADING--insider trading constitutes breach of fiduciary duties owed to the
corp, so the corp can recover profits made from insider trading
a)Common Law Liability Compared To Section 16(b)
Liability--both common law and section 16(b) liability run against insiders and
in favor of the corp. However, unlike section 16(b), the common law theory
applies to all corps (not just those with registered securities), recovery can
be had against any corporate insider, the purchase and sale is NOT limited by a
six-month period, and the transaction must be based on the inside info.
b)Common Law Liability Compared to Rule 10b-5
Liability--the theories of recovery are similar except that under the common
law recovery runs to the corp (not to the injured purchaser or seller), there
is no purchaser or seller requirement, and noninsiders (tippees) have not yet
been held liable.
VII.RIGHTS OF SHAREHOLDERS
TO VOTE IN GENERAL--shs may generally vote for the election and removal of
dirs, to amend the articles or bylaws, and on major corporate action or fundamental
a)Who May Vote--the right to vote is held by shs
of record as of the record date;
b)Restrictions on Right--shares may be either
voting or nonvoting, or have multiple votes per share.
2.SHAREHOLDER MEETINGS--generally, shs can act
only at meetings duly called and noticed at which a quorum is present.
a)Compare--informal action--statutes permit sh
action without a meeting if there is unanimous written consent of all shs
entitled to vote.
a)Straight Voting--this system of voting allows
one vote for each share held and applies to all matters other than director
elections, which may be subject to cumulative voting. Certain fundamental
changes (e.g., merger) frequently require higher shareholder approval.
b)Cumulative Voting For Director--this system
allows each share one vote for each director to be elected, and the votes may
be cast all for one candidate or divided among candidates as the sh chooses,
thereby helping minority shs to elect a dir. Cumulative voting may be mandatory
4.VOTING BY PROXY--a proxy authorizes another
person to vote a shareholder’s shares. The proxy usually must be in writing,
and its effective period is statutorily limited unless it is validly
a)Revocability--a proxy is normally revocable by
the sh at any time, although it may be made irrevocable if expressly stated and
coupled with an interest in the shares themselves. Absent written notice to the
corp, the death or incapacity of a sh does NOT revoke a proxy. a sh may revoke
a proxy by notifying the proxy holder, giving a new proxy to someone else, or
by personally attending the meeting and voting.
b)Proxy Solicitation--almost all shs of publicly
held corps vote by proxy. Solicitations of proxies are regulated by the
Securities Exchanges Act of 1934 Section 14a, federal proxy rules and, in some
cases, state law. Federal proxy rules apply to the solicitation of all proxies
of registered securities, but NOT to nonmanagement solicitation of 10 or fewer
shs. The term “solicitation” is broadly interpreted by the SEC to include any
part of a plan leading to a formal solicitation, e.g., inspection of
1)1992 amendments--the SEC revised the proxy
rules to make it easier for shs to communicate with each other. Significant
changes include: a safe harbor for communications that don’t involve
solicitation of voting authority, relaxation of requirements involving
broadcast of published communications, relaxed preliminary filing requirements
for solicitations, and removing communications between shs concerning proxy
voting from definition of “solicitation.”
2)Requirement of Full Disclosure--the proxy
rules require full and accurate disclosure of all pertinent facts and the
identities of all proxy participants, disclosure of compensation paid to
certain officers and dirs, and disclosure of conflict-of-interest transactions
involving more than $60, 000.
3)Inclusion of Shareholder Proposal--shareholder proposals must be
included in corporate proxy materials if the proponent is a record owner or
beneficial owner of at least 1% or $1000 worth of securities entitled to vote
on the matter. The proposal must not exceed 500 words.
I)Exceptions--a proposal need NOT be included if
it: is not a proper subject for shareholder action, would be illegal, is false
or misleading, seeks redress of a personal claim, relates to operations
accounting to less than 5% of the corp’s total assets and is not otherwise
related to the corp’s business, concerns a matter beyond the corp’s power to
effectuate, relates to ordinary business operations, relates to an election to
office, is counter to a proposal submitted by the corp at the same meeting, is
moot or duplicate, deals with the same subject matter as a very unsuccessful
prior proposal, or relates to specific amounts of cash or stock dividends.
ii)Private right of action--a private right of
action is available to a sh whose proposal was rejected by the corp on the
ground that it fails within one of the exceptions.
iii)Providing shareholder lists--a sh has a
right to obtain a list of shs or to have his communication included with the
corporate proxy materials.
4)Remedies for violation of proxy rules--these
include suit by the SEC to enjoin violations or to set aside an election and
individual suits, class actions, or derivative suits by the shs (In a private
suit, the P must show materiality and causation, but causation is normally
presumed from materiality. Fairness to the corp is NOT a defense to a violation
of proxy rules ). The court may rescind corporate action resulting from a
misleading proxy solicitation or award damages.
c)Expenses Incurred In Proxy Contests--corporate
funds may be used by management with respect to reasonable proxy solicitation
expenses incurred in order to obtain a quorum for the annual meeting or
regarding controversy over corporate policy (as opposed to a personnel
controversy). The corp may, with sh approval, voluntarily pay the reasonable
expenses to insurgents who win a proxy contest involving policy.
5.OTHER METHODS TO COMBINE VOTES FOR CONTROL
(CLOSE CORPORATIONS)--other methods include shareholder voting agreements which
may be enforced by specific performance, agreements regarding greater-than-majority
approval, shareholder agreements binding the discretion of dirs, and voting
B.RESTRICTIONS ON TRANSFER OF SHARES--although
most frequently used in close corps, stock transfer restrictions may also be
imposed by larger corps (e.g., to restrict ownership to employees). The two
most common types of restriction are a right of first refusal and a mandatory
sell-buy provision. Restrictions must be reasonable and will be strictly
a)Notice Requirements--a lawful stock transfer
restriction is of no effect unless noted conspicuously on the stock
certificate. If there is no such notice, an innocent transferee is entitled ti
have the shares transferred to him.
C.SHAREHOLDERS’ INFORMATIONAL RIGHTS:
OF BOOKS AND RECORDS--these include shareholder lists, minutes, financial
records, and business documents.
2.COMMON LAW--at CL, a sh has a right to inspect
records for proper purpose.
3.STATUTES--statutes govern these rights in most
states. Many statutes apply only to certain shs but are usually interpreted to
supplement the common law. Most statutes preserve the proper purpose test, but
place the burden on the corp to prove improper purpose.
4.PROPER VERSUS IMPROPER PURPOSES--the test is
whether the sh is seeking to protect the sh interest. Multiple purposes that
include a proper one usually will not preclude inspection. Generally, a sh can
inspect the sh list because it is often necessary to the exercise of other
rights like proxy fights, sh litigation, etc. Inspection of a sh list for proxy
contest is a proper purpose. However, it has been held that corporate records
cannot be examined solely for the purpose of advancing political and social
views or to aid a sh as a litigant on a personal, non-shareholder claim.
5.COMPARE--MANDATORY DISCLOSURE OF
INFORMATION--a sh’s inspection right is separate and distinct from the
statutory requirements governing the affirmative disclosure of certain
information by corps (e.g., Section 12 of Securities Exchange Act of 1934,
proxy rules, state statutes).
D.FIDUCIARY OBLIGATIONS OF CONTROLLING
SHAREHOLDERS--a controlling sh owes a fiduciary duty in his business dealings
with the corp, in taking advantage of corp opportunities (rules more lenient
than those applied to dirs and officers), and in causing fundamental changes.
1.ACTIONS ENTIRELY IN SHAREHOLDER CAPACITY--a
controlling sh must NOT act to benefit himself at the expense of the minority
shs; i.e., in a transaction where control of the corp is material, he must act
with good faith and inherent fairness toward the minority.
2.OBLIGATIONS OF SHAREHOLDERS IN CLOSE
CORPORATIONS--both majority and minority shs owe each other an even stricter
duty (utmost good faith and loyalty) than is owed by controlling shs in
publicly held corps. This duty has been interpreted to mean that there must be
equal treatment of all shs, i.e., they must be afforded equal opportunities.
3.DISCLOSURE--a controlling sh must make full
disclosure when dealing with minority shs.
4.SALE OF CONTROL--in most jurisdictions, a controlling
sh is permitted to sell his stock at a premium, i.e, a price not available to
other shs. Exceptions to these rule include a bare sale of office (invalid),
the corporate action theory, sales involving fraud or nondisclosure, and
knowing sales to transferees who plan to loot or deal unfairly with the corp.
1.DIRECT (INDIVIDUAL) SUITS--a direct suit may
be brought by a sh on his own behalf for injuries to sh interests. If the
injury affects a number of shs, the suit may be brought as a class action.
2.DERIVATIVE SUITS--if a duty owed to the corp
has been abridged, suit may be brought by a sh on behalf of the corp.
a)Distinguish Direct From Derivative Suits--the
test is whether the injury was suffered by the corp directly or by the sh, and
to whom the D’s duty was owed
1)Close corporations--in some cases, minority
shs have been allowed to bring a direct action against controlling shs for
breach of fiduciary duty
b)Prerequisite to Suit--Exhaustion of Corporate
Remedies--the P-sh must specifically plead and prove that he exhausted his
remedies within the corporate structure
1)Demand on directors--the P-sh must make a
demand on the dirs to remedy the wrong, unless such demand would have been
futile. Note that in the absence of negligence, self-interest, or bias, the
fact that a majority of dirs approved the transaction does NOT itself excuse
I)Model statutes--under both model statutes,
demand should be excused only if it is shown that irreparable injury to the
corp would result;
ii)Effect of rejection of demand--if the matter
complained of does not involve wrongdoing by the dirs, the board’s good faith
refusal to sue bars the action, unless the P-sh can raise a reasonable doubt
that the board exercised reasonable business judgment in declining to sue. If
the suit alleges wrongdoing by a majority of dirs, the board’s decision not to
sue will NOT prevent the derivative suit.
2)Demand on shareholders--in most states, the
p-sh must also make a demand on shs unless excused (e.g., the alleged
wrongdoing is beyond the power of the shs to ratify). Where demand on shs is
required, a good faith refusal to sue by the majority of disinterested shs will
preclude the suit.
c)Qualifications of Plaintiff--a few states
require the P to be a registered sh; most states also allow a beneficial owner
of shares to bring suit. Also, a sh of a parent corp can bring a derivative
suit on a subsidiary’s cause of action. Shs cannot complain of wrongs committed
before they purchased their shares except:
1)where the P acquires shares by operation of
2)in section 16(b) violations;
3)where serious injustice will result;
4)where the wrong is continuing in nature.
The P must fairly and adequately represent the
interests of all shs
d)Securities For Expenses--in a number of
states, the P, under certain circumstances, must post a bond to indemnify the
corp against certain of its litigation expenses, including attorney’s fees, in
the event the P loses the suit. a p-sh who loses may also be liable for the
court costs incurred by the parties.
e)Defenses--defenses to derivative suit include
the SOL and equitable defenses (laches, unclean hands, etc);
f)Settlement And Recovery--any settlement or judgment belongs to
the corp, absent special circumstances. Settlement or dismissal of the suit is
generally subject to court approval after notice to all shs.
g)Reimbursement to Plaintiff--a victorious
plaintiff may be entitled to reimbursement from the corp for litigation
h)Indemnification of Officers And
Directors--indemnification issues arise when officers and dirs are sued for
conduct undertaken in their official capacity. If the officer or dir wins on
the merits, he may be indemnified. Most statutes also authorize the corp to
advance (not pay) expenses in defending against the claim. Statutes vary where
the officer or dir settles or loses; they are most liberal concerning
indemnification in a third-party suit as opposed to a derivative suit.
I)Liability Insurance--in most states, a corp
can obtain liability insurance for its indemnification costs and for any
liability incurred by its officers in serving the corporation.