FACT PATTERN FOUR: Shareholders Flashcards
Close Corporations
A corporation where there are few shareholders, and the stock is not publicly traded.
Can set up management with a board of directors and run it like a regular corporation, or we can have shareholders run the business, or we can appoint a manager etc.
Shareholder’s Management Rights
Generally, the shareholders have no direct control in management of the corporation’s business.
They may act in their own personal interests and generally have no fiduciary duty to the corporation or their fellow shareholders.
Shareholder liability is thus generally limited to liabilities for unpaid stock, a pierced corporate veil, or the absence of a de facto corporation.
Shareholder Management Agreements
The MBCA allows shareholders to enter into agreements to dispense with the board and vest management power in the shareholders.
If the articles do not include such a special provision, shareholders exercise only indirect control of the corporation through their voting power (electing and removing directors, adopting and modifying bylaws, and approving fundamental changes in the corporate structure.)
There are two ways to set up a shareholder management agreement:
* In the articles or bylaws and approved by all shareholders
* By unanimous written shareholder agreement
Special Fiduciary Duty in Close Corporations
In many states, courts impose a fiduciary duty on shareholders owed to other shareholders:
- Controlling shareholders cannot use their power to benefit at the expense of minority shareholders.
- If there is oppression of minority shareholders, they can sue
the controlling shareholders who oppress them for breach of this fiduciary duty.
Professional Corporations
Most states prohibit professionals from forming corporations for the purpose of practicing their professions. This prevents professions from avoiding personal liability for their own malpractice by hiding behind the corporate veil. However, most states have also adopted special statutes permitting professionals to incorporate to take advantage of certain federal tax provisions that are available only to corporations.
REQUIREMENTS:
(1) Licensed professionals (e.g., lawyers, doctors, and accountants) may incorporate as a “professional corporation” or “professional association.” (“P.C.” or “P.A.” The articles must state that the purpose is to practice in a particular profession.
(2) Directors, officers, and shareholders usually must be licensed professionals, but non-professionals may also be employed. The non-professional employees must not practice the profession or to render professional services.
(3) The professionals are personally liable for their malpractice. However, shareholders are generally not liable for corporate obligations or for other professionals’ malpractice.
(4) Generally, the rules governing regular corporations apply to professional corporations.
Shareholder Liability for Corporate Debts
Shareholders generally cannot be held liable for corporate debts unless the “pierce the corporate veil.” This most frequently happens in closed corporations. Only shareholders who are active in the operation of
the business will be personally liable. They will be joint and severally liable.
To pierce the corporate veil and hold shareholders personally liable:
(1) The shareholders must have abused the privilege of incorporating, and
(2) Fairness must require holding them liable
Common Scenarios where the Corporate Veil is Pierced
- Shareholders ignore corporate formalities such that the corporation is a “mere instrumentality” of the shareholders (e.g., when the shareholders treat corporate assets as their own, commingle their money with corporate money)
- Undercapitalization: The corporate veil may be pierced where, at the time of formation, there is not enough unencumbered capital to reasonably cover prospective liabilities.
- The corporate veil may be pierced where necessary to prevent fraud or to prevent an individual shareholder from using the entity to avoid his EXISTING personal obligations.
Derivative Suits
In a derivative suit, a shareholder is suing to enforce the corporation’s claim against an officer or director(s), not their own personal claim.
REQUIREMENTS TO BRING A DERIVATIVE CLAIM:
(1) Standing (stock ownership at the time the claim arose, SH must adequately represent the corporation’s interests)
(2) SH must make a written demand on the corporation to take suitable action.
- In some states, SH cannot sue until 90 days after making the demand unless notified that the demand was rejected earlier or irreparable injury would result from waiting.
- In other states, shareholders are not required to make this demand if the demand would be futile.
(3) The corporation must be joined as a defendant.
- Parties can settle or dismiss a derivative suit only with court approval
- Dismissal must be based upon an independent investigation that concluded that the suit is not in the corporation’s best interest
Direct Actions Brough by a Shareholder Against a Corporation
A direct action may be brought for a breach of a fiduciary duty owed to the shareholder by an officer or director.
Outcome of Derivative Suits: What does SH/Corp get?
If the shareholder-plaintiff prevails in a derivative suit:
- The corporation who receives the judgement
- The shareholder-plaintiff may recover costs and attorneys’ fees
If the shareholder-plaintiff loses the derivative suit:
- They cannot recover costs and attorneys’ fees.
- If the court finds that the action was commenced or maintained without reasonable cause or for an improper purpose, it may order the plaintiff to pay reasonable expenses of the defendant.
Which Shareholders May Vote?
GENERAL RULE: The “record shareholder” of as of the “record date” may vote at the meeting.
The record shareholder is the person shown as the owner in the corporate records. The record date is a voter eligibility cut-off date, fixed by the board of directors (but may not be more than 70 days before the meeting.)
If directors don’t set a record date, the record date is deemed to be the day the notice of the meeting is mailed to the shareholders.
EXCEPTIONS:
Treasury Stock (reacquired stock before the record date) does not give anyone extra votes.
If a SH dies (but is the record SH on the record date), that SH’s executor can vote
A shareholder may vote their shares in person or by proxy executed in writing.
How can Minority Shareholders Increase their Influence?
Block Voting (voting alike)
- Voting trust, or
- Voting agreement.
A voting trust is a written agreement of shareholders where all of the shares owned by the parties to the agreement are transferred to a trustee, who votes the shares and distributes the dividends in accordance with the provisions of the voting trust agreement. Legal title of the shares must be transferred to the trustee, but the shareholders retain beneficial ownership.
A voting agreement provides for how the SHs will vote their shares. The requirements are that the agreement be in writing and signed.
Where do Shareholders Vote?
(1) Unanimous written consent signed by the holders of all voting shares (email is fine)
(2) At a meeting:
- Annual Meeting (required, typically to elect directors, max 15 months after the last meeting otherwise SH can petition the court to order one)
- Special Meeting
NOTICE REQUIRED
For either meeting, notice must be given at least 10 before the meeting but not more than 60 days before the meeting. notice must state the date, time, and place of the meeting
If proper notice is not given to all shareholders, whatever action was taken at the meeting is voidable (maybe void), unless those who were not sent notice waive the notice defect. Waiver can occur either by an express waiver in a signed writing, or by an implied waiver where the shareholders attend the meeting without objecting at the outset.
Quorum of SH Meetings
General Rule: A quorum is a majority of outstanding shares entitled to vote, unless the articles or bylaws require a greater number.
Note: A shareholder quorum will not be lost if people leave the meeting after it has begun
SH Voting When a Quorum is Present: How many votes are needed to approve a matter?
If a quorum is present, generally, shareholders will be deemed to have approved a matter if the votes cast in favor of the matter exceed the votes cast against the matter, unless the articles or bylaws require a greater proportion.
