Chapter 35 Corporations—Directors, Officers and Shareholders

2 § 1: The Role of Directors Every corporation is governed by a board of directors. Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation. A director can also be a shareholder, especially in closely-held corporations.

3 Election of Directors Subject to statutory limitations, the number of directors is set forth in the articles of incorporation: Directors appointed at the first organizational meeting. In closely held companies, directors are generally the incorporators and/or the shareholders. Term of office is generally for one year. Director can be removed for cause (for failing to perform a required duty).

4 Directors’ Meetings Directors hold meetings pursuant to bylaws with recorded minutes. Special meetings may be called with sufficient notice. Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority). Each director generally has one vote.

5 Rights of Directors Directors have the right to: Participate in corporate decisions and inspect corporate books and records. Compensation (usually a nominal sum) and indemnification. If a director is sued for acts as director, the corporation should guarantee reimbursement (indemnification) or purchase liability insurance to protect the board from personal liability.

6 §2: Role of Corporate Officers Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well. Their employment relationships are generally governed by contract law and employment law. Officers may be terminated for cause.

7 § 3: Fiduciary Duties of Directors and Officers Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders: Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable.

8 Fiduciary Duties of Directors and Officers [2] Duty of Care (cont’d): Make informed and reasonable decisions; Rely on competent consultants and experts; and Exercise reasonable supervision. A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.

9 Fiduciary Duties of Directors and Officers [3] Duty of Loyalty: subordination of personal interests to the welfare of the corporation. No competition with Corporation. No “corporate opportunity.” No conflict of interests. No insider trading. No transaction that is detrimental to minority shareholders Case 35.1: Stokes v. Bruno (1998).

10 Fiduciary Duties of Directors and Officers [4] No Conflicts of Interest: full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally. However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors.

11 § 4: Liability of Directors and Officers Directors and officers may be liable for negligent acts that breach the standard of due care: Crimes and torts committed by individually and/or those committed by employees under their supervision. Shareholder derivative suits where shareholder(s) sue directors on behalf of corporation].

12 Business Judgment Rule Immunizes a director or officer from liability from consequences of a business decision that turned sour. Court will not require directors or officers to manage “in hindsight.” As long as decision was reasonable, informed, made in good faith and in the best interests of the corporation, BJR will apply.

13 § 5: Role of Shareholders Ownership of shares grants a shareholder an equitable ownership interest in a corporation. Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors. Shareholders are generally protected from personally liability by the corporate veil of limited liability.

14 Shareholder Powers Shareholder powers include approving all fundamental changes to the corporation: Amending articles of incorporation or bylaws. Approval of mergers or acquisition. Sale of all corporate assets or dissolution. Shareholders also elect and remove the board of directors.

15 Shareholder Meetings [1] Shareholders’ meetings must occur at least annually. Voting requirements and procedures are: Quorum of shareholders owning more than 50% of shares must be present to conduct business; Shareholders may appoint a proxy or enter into a voting trust agreement.

16 Shareholder Meetings [2] For special shareholder meetings: Notice and time of meetings must be sent in writing to each shareholder within a reasonable time ahead of the meeting. Notice mus state reason for meeting and only deal with this matter.

17 Shareholder Voting Common shareholder entitled to one vote per share. Articles and by-laws can exclude or limit voting rights of certain classes of stock. Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present.

18 Shareholder Voting [2] Shareholders may vote on resolutions. Need majority present for most resolutions. Need a “super majority” (e.g., 67%) for important matters: sale of assets, etc.. Voting lists by corporate secretary contains record of stock ownership. [Cut off date 70 days ahead of action (notice, dividends, etc..)]

19 Shareholder Voting [3] Methods of Increasing Minority Shareholder Power Within the Corporation: Cumulative Voting allows minority shareholders to get a board member elected. x # to be elected x shareholders # of shares = shareholder can cast them all for one board nominee. Shareholder Voting Agreements. Voting Trusts.

20 Shareholder Voting [4] Proxies and Shareholder proposals under Securities and Exchange Commission Rule 14a- 8: Proxy solicitation must include proposals which will be discussed at the meeting. Shareholders who own $1,000 worth of stock may submit their own proxy solicitations. Company does not have to include shareholder proposals which relate to “ordinary business operations.”

21 § 6: Rights of Shareholders Shareholders have the right: To vote. To have a stock certificate. To purchase newly issued stock. To dividends, when declared by board. To inspect corporate records. To transfer shares, with some exceptions. To a proportionate share of corporate assets on dissolution. To file suit on behalf of corporation.

22 Stock Certificates Certificate which evidences ownership in a certain number of shares in the corporation given to person of record (regardless of who has certificate) gets notices, dividends & reports. Corporate ownership is intangible personal property. Some states allow uncertificated stock -- no tangible certificate.

23 Preemptive Rights Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time. Provided for in the articles of incorporation. Significant in a close corporation to prevent dilution and loss of control.

24 Stock Warrants or Rights Transferable options to purchase newly- issued stock at a stated price. Warrants are publicly traded. Called “rights” when option is for a short period of time.

25 Dividends Distribution of corporate profits or income. Only as ordered by the Board. Can be stock, cash, property, stock of other corporations. State laws control the sources of revenues for dividends, which may be paid from retained earnings, net profits and surplus.

26 Illegal Dividends If dividends paid from an unauthorized account shareholder must return if she knew they were illegal when received. Directors can be held personally liable for the amount of payment. Dividends paid when corporation is insolvent are automatically illegal.

27 Directors’ Failure to Declare Dividends When directors fail to declare a dividend, shareholders can sue. Directors do not have to declare if they have a rational basis for withholding a dividend (a bona fide purpose). Often, profits are retained for expansion, research or upgrades.

28 Inspection Rights Shareholders can inspect books for a proper purpose. But corporation can protect trade secrets, other confidential information. Shareholder must have held a minimum number of shares for a minimum amount of time. All shareholders can see list of other shareholders of record.

29 Transfer of Shares Shares are freely transferable unless restricted by articles and noted on the stock certificate. Closely held corporations may have “right of first refusal” or preemptive rights. Transfer accomplished by delivery or endorsement to corporate secretary. New shareholder must be recorded on corporate books.

30 Rights on Dissolution Shareholders have right to pro-rata share of assets upon liquidation. Shareholder may petition the court for dissolution of the corporation for following reasons: Board mishandling corporate assets. Board deadlocked and irreparable injury will result. Acts of directors are illegal, oppressive, or fraudulent. Shareholders are deadlocked for two meetings and can’t elect directors.

31 Shareholder Derivative Suit Shareholders can sue a 3 rd party on behalf of the corporation if the Directors fail or refuse to correct the wrong or injury. Directors may refuse to take action because they might personally be liable. Any damages recovered go to corporation’s treasury.

32 § 7: Liability of Shareholders Shareholders are generally not liable for the contracts or torts of the corporation. If the corporation fails, shareholders cannot lose more than their investment, except when: A shareholder hasn’t paid for stock pursuant to the subscription agreement. Shareholder buys “watered stock” which is below the stock’s par value.

33 § 8: Duties of Majority Shareholders Majority shareholders own enough shares to exercise de facto (actual) control over the corporation. Majority shareholders owe a fiduciary duty to corporation and the minority shareholders and creditors when they sell their shares because of the possibility of transfer of control.

34 Case 35.1: Stokes v. Bruno (Duty of Loyalty) FACTS: Point Cotile Parks Association, Inc. (PCPA), is a nonstock, nonprofit corporation. Members are limited to owners of a lot or a building site within the subdivision. The directors, including Bruno and Wright, adopted resolutions granting Bruno and Wright the authority to sell certain “common ground” on PCPA’s behalf. The board designated lots and set prices. Six years later, when some of the lots had not sold, Bruno and Wright sold to themselves, for lower prices, some of the “common ground,” including lots with timber that had not been previously offered for sale.

35 FACTS (cont’d) Craig Stokes and other PCPA members filed suit in a Louisiana state court against Bruno and Wright. The court declared the sale void. Bruno appealed. HELD: AFFIRMED. FOR PCPA. Bruno and Wright had a duty to PCPA to maximize its return on the sale of the “common ground.” They should have offered the other PCPA members and the public the opportunity they gave to themselves. Case 35.1: Stokes v. Bruno (Duty of Loyalty)

36 Case 35.2: FDIC v. Castetter (Liability of Directors) FACTS: Peterson, with twenty ‑ six years of banking experience, opened Balboa National Bank. Except for Peterson, none of the directors had any significant banking experience. Peterson focused the bank on lending money to auto buyers. Later, the federal Office of the Comptroller of the Currency (OCC) found many problems at the bank. The bank hired consultants to fix the problems but were unsuccessful. The FDIC sued the directors, contending that they were negligent and personally liable for the bank’s losses.

37 HELD: FOR DIRECTORS. Court applied the judgment rule in favor of the directors. Directors acted in good faith and relied on opinions of outside experts, and ultimately lost substantial sums of their own money. Case 35.2: FDIC v. Castetter (Liability of Directors)

38 Case 35.3: Hayes v. Olmstead (Duty of Majority Shareholders) FACTS: Olmsted & Associates was a food brokerage in Oregon. Under O&A’s bylaws, the board of directors and the shareholders were to hold annual meetings at which the price of O&A stock was to be set. The voting shareholders, including Arbanas, Olmsted, and Hayes, were also the firm’s officers and managers. During a corporate restructuring, an “Executive Committee,” consisting of Arbanas, Olmsted, and two nonshareholders, assumed the functions of the board. The board and the shareholders stopped meeting.

39 FACTS (cont’d) The members of the Executive Committee secretly voted to pay themselves bonuses of more than $100,000 each. Hayes asked about the bonuses, but was denied the information. When he complained, he was fired. O&A offered to buy his stock for $67 per share. He rejected the offer and was removed from the board. He sued Olmsted, Arbanas, and O&A, alleging, among other things, breach of fiduciary duty. Case 35.3: Hayes v. Olmstead (Duty of Majority Shareholders)

40 HELD: FOR HAYES. “Minority shareholders were not given the formal and required opportunities to participate in or comment upon major changes in direction of O&A.” The court explained that “Olmsted and Arbanas assumed control of O&A by creating a de facto Executive Committee in violation of the bylaws. The Executive Committee did not observe corporate formalities and failed to hold regular meetings of the corporation’s Board of Directors and shareholders. Case 35.3: Hayes v. Olmstead (Duty of Majority Shareholders)