I. DO SHAREHOLDERS GET TO MANAGE THE CORPORATION?
general rule?
exception?
C. How do we change the management structure in a close corporation?
what actions does not affect its validity?
Once the corporation starts operating under the shareholders’ agreement, it may?
no, the board manages
But in a close corporation (it has few shareholders, and its stock is not publicly traded), management can be set up differently from that in an “ordinary” corporation. A close corporation can have a board of directors. BUT there need not be a board of directors! Instead, shareholders can take over management, or management can be vested in a single manager, and the company can be run very informally.
C. You need a shareholders’ agreement authorizing the change (e.g., abolishing the board, making management much less formal than an ordinary corporation).
enter agreement:
1, in the certificate or bylaws, and approved by all shareholders, or
2, written agreement of all sharesholders
– Stock certificates should note close corporation status and that shareholders are to manage; The corporation should deliver to each shareholder a copy of the agreement, but failure to do so does not affect its validity.
– Once the corporation starts operating under the shareholders’ agreement, it may deliver a Statement of Operation to the Secretary of State for filing. It makes the manner of operation a matter of public record.
– Once the Statement of Operation is filed, the agreement is binding on all shareholders and transferees. Is this true even if a transferee does not have knowledge of the agreement?
yes; filing is notice to all
ARE SHAREHOLDERS LIABLE FOR THE ACTS OF THE CORPORATION?
exception
no; because Corp. is liable
in close corp only: But a court might pierce the corporate veil (PCV) and hold shareholders personally liable if (1) they have abused the privilege of incorporating and (2) limited liability would be unfair.
a court might PCV to prevent fraud or to achieve equity
*PCV is never automatic. Make the argument.
PCV answer template
– X and Y are the only shareholders of Corp. X commingles personal and corporate funds, uses the corporate car as his own, and uses the corporate credit card to pay for personal purchases. In the meantime, corporate creditors are not being paid. Can Creditor (unable to collect its claim from the corporation) collect from X or Y?
Classic fact pattern: Alter ego theory (not available for mere failure to observe corporate formalities, such as failure to select officers and hold meetings).
– Start with general rule (shareholders not liable for acts or debts of corporation). Then PCV standard. Make the argument for PCV (never sure how a court will rule, though).
1. Did a shareholder abuse the corporation?
yes; treated corp assets like his own
2. Would limited liability for X be unfair?
arguably yes, because creditors are not being paid
If PCV, only X would be liable. Y did nothing wrong.
D. Whenever the shareholders manage the close corporation, who owes the duties of care and loyalty to the corporation?
E. What about duties of shareholders to each other?
the managing shareholders
In a Texas close corporation, shareholders do not owe each other fiduciary duties as a matter of law. But a court may find a fiduciary duty depending on the facts of a given case.
make an argument of breach of fiduciary duty
PCV answer template
– S is a shareholder of Glowco, Inc., a corporation that hauls and disposes of nuclear waste. Glowco does not carry insurance. Glowco has an initial capitalization of $1,000. V is injured when one of Glowco’s trucks melts down. Can V sue S?
Another classic fact pattern: Undercapitalization theory.
- Start with general rule (shareholders are not liable for what the corporation does), then PCV standard. Here a court MIGHT PCV because the corporation is undercapitalized. Shareholders failed to invest enough to cover prospective liabilities.
argue: this is a dangerous business, there is no insuance, and they only invested 1k
- Start with general rule (shareholders are not liable for what the corporation does), then PCV standard. Here a court MIGHT PCV because the corporation is undercapitalized. Shareholders failed to invest enough to cover prospective liabilities.
D. In what kinds of cases is PCV most likely?
fraud?
a parent corporation forms a subsidiary to avoid its obligations.
more likely in tort than in contract (can see the corp. book)
– So we cannot PCV for a contract claim based on fraud unless the shareholder made the corporation commit fraud for his own personal benefit.
– Remember, PCV allows imposition of liability on a shareholder. That shareholder might be another corporation.
The court might pierce through the sub and hold the parent liable just as it would if the shareholder were a human.
III. SHAREHOLDER DERIVATIVE SUITS (SHAREHOLDER AS PLAINTIFF)
A. definition
S sues the board of directors of C Corp. for breaching the duty of care or the duty of loyalty.
S sues board of directors of C Corp. for issuing new stock without honoring her preemptive rights.
B. If the shareholder plaintiff (S) wins the derivative suit, what happens?
Who gets the money from the judgment?
What does S receive?
A. In a derivative suit, a shareholder is suing to enforce the corporation’s claim, not her personal claim.
always ask: could the corp have brought this suit, if yes then it is derivative
yes; they r derivative, because the duties r owed to corp.
no; this is a direct suit, to vindicate S’s personal claim.
the corp
recover cost and attorney’s fees from the corp (After all, S conferred a benefit on the corporation by suing and winning.)
C. If the shareholder plaintiff (S) loses in derivative, what happens?
- Can S still recover her costs and attorney fees?
- Is S liable to the defendant he sued for the defendant’s attorney fees?
- Can other shareholders later sue that defendant on the same transaction?
no
Yes, if the court finds that S sued without reasonable cause or for an improper purpose.
no; already asserted
D. What are the requirements for bringing a shareholder derivative suit?
- Stock ownership.
To bring a derivative suit, one must have owned stock when the claim arose or have gotten it by “operation of law” (inheritance and divorce decree) from someone who did. - Must also fairly and adequately represent the corporation’s interests. This may mean, among other things, that she own stock throughout the litigation.
- Must also make a written demand on directors that the corporation bring suit.
Shareholder cannot file a derivative suit until 90 days after demand unless demand is rejected before that or waiting 90 days would cause irreparable damage to the corporation.
must demand can’t be excused even if it’d be futile
The demand must set forth the nature of the claim with particularity. - Corporation must be joined as a defendant (even though we are asserting the corporation’s claim) because it did not sue on its own.
Can the parties settle or dismiss a derivative suit?
- Corporation may move to dismiss based upon?
In ruling on the motion to dismiss, what is the standard?
when might the court treat a derivative suit as a direct action
only with court approval
If the proposed settlement or dismissal may substantially affect shareholders, the court may require notice to those shareholders.
- Corporation may move to dismiss based upon determination by independent and disinterested directors (or a committee of two or more such directors). the basis of the motion to dismiss: that suit is not in the corp’s best interest
the court must dismiss if it finds the determination was made in good faith by independent and disinterested directors
- In a close corporation of 35 or fewer shareholders, the court might treat a derivative suit as a direct action so the various requirements don’t have to be met. Treating it as a direct suit means the recovery would go to the plaintiff, not the corporation.
SHAREHOLDER VOTING
A. Who votes?
C Corp. sets its annual meeting for July 7 and record date for June 8. S sells B her C Corp. stock on June 25. Who is entitled to vote the shares at the meeting, S or B?
General rule: you vote if you are the record shareholder as of the record date.
1. The record shareholder is the person shown as the owner in the corporate records. The record date is a voter eligibility cut-off set no more than 60 days before the meeting.
S, because she owned it on the record day
Exceptions to the general rule that record owner on record date votes.
a. Corporation reacquires stock from shareholders before the record date. So the corporation is the record owner of this “treasury” stock. Does it vote the treasury stock?
no; not outstanding
b. Death of shareholder: S’s executor vote the shares
c. Proxies.
A proxy is a (i) writing (fax and e-mail are OK), (ii) signed by record shareholder (fax and e-mail are OK), (iii) directed to secretary of corporation, (iv) authorizing another to vote the shares.
agency
SHAREHOLDER VOTING
A. Who votes?
proxies
– On March 2, 2015, S sends a signed letter to secretary of C Corp. authorizing Joe to vote her shares. Can Joe vote S’s shares at the 2015 annual meeting in July?
– Can Joe vote S’s shares at the 2016 annual meeting in July 2016?
– What if, before the 2015 meeting, S writes to the secretary of C Corp. that she now wants Courtney to vote her shares at the 2015 meeting?
– Can S revoke her proxy even though it states that it is irrevocable?
***Can we ever have an irrevocable proxy?
c. Proxies.
A proxy is a (i) writing (fax and e-mail are OK), (ii) signed by record shareholder (fax and e-mail are OK), (iii) directed to secretary of corporation, (iv) authorizing another to vote the shares.
agency
yes
no; good for 11 months unless says otherwise
ok; revoke and change
yes!!!!!!!!!!
Yes if it is a “proxy coupled with an interest.” This requires: (1) the proxy says irrevocable and (2) the proxyholder has some interest in the shares other than voting.
Example: S gives B an option (interest in the stock) to buy her stock. Then S gives B a proxy to vote her shares at the upcoming annual meeting. The proxy says it’s irrevocable.
SHAREHOLDER VOTING
X, Y, and Z own relatively few shares of C Corp. They ask for your advice on how they can pool their voting power.
Is it OK for shareholders to agree to vote shares to elect each other as directors?
shareholders agree on what they will do once they become directors. Is that OK?
You tell them about two things:
A. Requirements for voting trust (no time limit imposed by corporate law)
1) written trust agreement controlling how the shares will be voted;
2) file a copy with the corporation;
3) transfer legal title of shares to voting trustee;
4) original shareholders receive trust certificates and retain all shareholder rights other than voting.
B. Requirements for voting (pooling) agreement (no time limit imposed by corporate law)
in writing and copy to the corp
Are voting agreements specifically enforceable against transferees? Yes if the affected stock certificates conspicuously note the agreement.
Voting trusts and agreements must be for a proper shareholder purpose. It is OK for shareholders to agree to vote shares to elect each other as directors.
no; voting agreement for directors action is void
B. Where do shareholders vote?
- There are two ways shareholders can take a valid corporate act:
- There are two kinds of shareholder meetings.
– Suppose ten percent of the shares call a special meeting for the purpose of removing an officer. Is this OK?
What if the purpose of the meeting was to remove a director. Would that be OK?
- There are two ways shareholders can take a valid corporate act: (1) unanimous consent in writing and signed or by electronic transmission of holders of all voting shares, or (2) a meeting that satisfies quorum and voting rules.
- There are two kinds of shareholder meetings. They can be held anywhere.
a. Annual meeting (elect directors) must be held. If none is held within 13 months, a shareholder may petition the court to order one.
b. Special meeting can be called by (1) the Board, (2) the president, (3) the holders of at least 10 percent of the shares entitled to vote, or (4) anyone else permitted in certificate.
no, shareholders cant remove officers
yes
B. Where do shareholders vote?
3. Notice requirement
Why does the stated purpose of the meeting matter?
Consequence of failure to give proper notice to all shareholders entitled to vote:
meetings notice requirement
- Notice requirement—must give written notice to every shareholder entitled to vote, for every meeting (annual or special) between 10 and 60 days before the meeting (21 to 60 days if the meeting is to consider a fundamental change).
a. Notice is given personally or by mail or, if the shareholder consents, by e- mail.
b. Contents of the notice: must always state (1) when, (2) where, and (3) why (the purpose of the meeting).
because they can’t do anything else
Consequence of failure to give proper notice to all shareholders entitled to vote: any action taken at the meeting is void unless those not sent notice (or those who got defective notice) waive the notice defect. How does waiver occur?
- Express: in writing anytime; or
- Implied: attend meeting without objection.
How do shareholders vote? for what?
X Corp. has 120,000 shares outstanding. X Corp. has 700 shareholders. What or who constitutes a quorum?
– Once a shareholder quorum is established, can it be lost if people leave the meeting?
– If the quorum requirement is met, the shareholders vote. What vote is required?
D. Cumulative voting.
not important
Shareholders generally get to vote on these things: (1) to elect directors (2) to remove directors and (3) on fundamental corporate changes. They may also vote on other things if the board asks for a shareholder vote on those things.
– Every time the shareholders vote, we must have a quorum represented at the meeting. Determination of a quorum focuses on the number of shares represented, not the number of shareholders.
General rule: a quorum requires a majority of outstanding shares.
majority of shares, 60k+1 shares
no; different from directors
(1) To elect a director: plurality (the person who gets more votes for that seat on the board than anyone else).
(2) To remove a director: majority of the shares entitled to vote.
(3) To approve a fundamental corporate change: ??? later
(4) Other matters: majority of the shares that actually vote on the issue.
- Cumulative voting is only available in electing directors. It is a device to give small shareholders a better chance of electing someone to the board.
- Multiply number of shares times the number of directors to be elected.
Instead of three separate elections, in which you would have 1,000 votes each, with cumulative voting there is one at-large election, with the top three finishers would be elected. u can’t do 3000 on 1 director - If the certificate says nothing about cumulative voting, it doesn’t exist
- When cumulative voting exists, at least one shareholder must give written notice to the corporate secretary of her intent to cumulate. If one shareholder gives such notice no later than the day before the meeting, all shareholders can vote cumulatively.
V. STOCK TRANSFER RESTRICTIONS (or limit on how much stock someone can own)
stock is subject to a stock transfer restriction that requires her to offer it first to the corporation (a right of first refusal (RFR)). S sells the stock to Federline in violation of the agreement.
A. Stock transfer restrictions are OK if:
B. Enforceable against transferee?
One of the great things about a corporation is transferability of the ownership interest. Sometimes in close corporations, shareholders want to impose restrictions on that freedom, usually to keep outsiders out. Where can such restrictions be set up?
certificate or bylaws or by agreement
A. ok if not an undue restriction on alienation
The RFR is OK, assuming the corporation offers a reasonable price.
B. Enforceable against transferee? Look for transferee’s knowledge or notice.
Even if the restriction is valid, it cannot be invoked against the transferee unless either (a) it is conspicuously noted on the stock certificate or (b) the transferee had actual knowledge of the restriction.
VI. RIGHT OF SHAREHOLDER (PERSONALLY OR BY AGENT) TO INSPECT AND COPY THE BOOKS AND RECORDS OF THE CORPORATION
A. What shareholders are eligible?
Can other shareholders ever inspect the books and records?
B. Procedure: written demand stating a proper purpose. What is a proper purpose?
C. If the corporation does not allow inspection, the shareholder can?
D. Note that all of this was for a shareholder to inspect. Do directors have to make a similar showing to get to inspect books and records?
A. What shareholders are eligible? Any shareholder who has (1) owned stock for at least six months OR (2) owns at least 5 percent of the outstanding shares.
only with a court order
it is related to your interest as a shareholder
C. If the corporation does not allow inspection, the shareholder can get a court order and recover expenses and attorney’s fees. If there is litigation, the corporation has the burden of showing that the shareholder’s purpose was improper.
D. no, they r managers and have access
VII. DISTRIBUTIONS (Payments by the corporation to shareholders. Can be (1) a dividend, or (2) to repurchase shares, or (3) to redeem shares (forced sale to corporation at price set in certificate).)
A. Distributions are declared in the board’s discretion. When do shareholders have a right to a distribution?
—rarely tested
B. Which shareholders get dividends?
Suppose the board of directors declares dividends totaling $400,000. Who receives dividends if the outstanding stock is:
1. 100,000 shares of common stock.
2. 100,000 shares of common and 20,000 shares of preferred with $2 dividend preference.
3. 100,000 shares of common and 20,000 shares of $2 preferred that is cumulative (and no dividends have been paid in the three prior years).
when the board declares it
So a suit by shareholders to force the declaration of a distribution requires a strong showing of abuse of discretion. An example is if the corporation consistently makes profits and the Board refuses to declare a dividend while paying itself a bonus.
B.
1, $4 per share
2, Preferred means pay first. 20,000 preferred shares multiplied by $2 preference equals a total preference of $40,000. That is paid first. That leaves $360,000, which goes to the common shares. Because there are 100,000 of those, each common share gets $3.60.
3, Cumulative means add them up. For the years in which no dividend was paid, the cumulative holders’ dividend is adding up. So the corporation owes them for three prior years plus this year (when the dividend is declared). Four years multiplied by the $2 preference equals $8 per share. So the corporation owes $8 to each cumulative preferred share. There are 20,000 such shares. leaves 240k
C. Which funds can be used for any distribution (dividend, repurchase, redemption)?
C Corp. has issued 10,000 shares of $2 par stock for $50,000. How is that $50,000 allocated? Of the $50,000, $20,000 goes to stated capital and $30,000 goes to surplus. Why?
D. A corporation cannot make any distribution if the company is insolvent or if the distribution would render it insolvent or if distribution would exceed surplus. What does insolvent mean?
- Surplus = assets - liability - stated capital, can be used
- Stated capital can never be distributed
stated capital is the par value of the issuance
– On a no-par issuance, within 60 days of the issuance, the board can allocate any part, but not all, to surplus.
unable to pay its debt as they come due
**
E. Directors are jointly and severally liable to the corporation for an unlawful distribution to the extent it was impermissible. Can a director held liable for an unlawful distribution seek contribution from others?
yes from other directors who approved it,
and from shareholders who knew it was improper when they got it
Whenever a director is in trouble for an unlawful distribution, think about director defense of good faith reliance. Directors may be able to claim that they relied in good faith on what the financial people told them.
