1. © 2007 West Legal Studies in Business, A Division of Thomson Learning Chapter 26 Corporate Directors, Officers, and Shareholders

2. © 2007 West Legal Studies in Business, A Division of Thomson Learning 2 What are the duties of corporate directors and officers? Directors are expected to use their best judgment in managing the corporation. What must directors do to avoid liability for honest mistakes of judgment and poor business decisions? What is a voting proxy? What is cumulative voting? If a group of shareholders perceives that the corporation has suffered a wrong and the directors refuse to take action, can the shareholders compel the directors to act? If so, how? From what sources can dividends be paid legally? What happens if a dividend is illegally paid? Learning Objectives

3. © 2007 West Legal Studies in Business, A Division of Thomson Learning 3 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.

4. © 2007 West Legal Studies in Business, A Division of Thomson Learning 4 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). –CASE 26.1 MM Companies, Inc. v. Liquid Audio, Inc. (2003).

5. © 2007 West Legal Studies in Business, A Division of Thomson Learning 5 Board of 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.

6. © 2007 West Legal Studies in Business, A Division of Thomson Learning 6 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.

7. © 2007 West Legal Studies in Business, A Division of Thomson Learning 7 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. Role of Corporate Officers and Executives

8. © 2007 West Legal Studies in Business, A Division of Thomson Learning 8 Duties and Liabilities 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.

9. © 2007 West Legal Studies in Business, A Division of Thomson Learning 9 Duty of Care (cont’d): –Make informed and reasonable decisions; –Rely on competent consultants and experts; and –Exercise reasonable supervision. Duties and Liabilities of Directors and Officers

10. © 2007 West Legal Studies in Business, A Division of Thomson Learning 10 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. –CASE 26.2 In re Cumberland Farms, Inc. (2002). Duties and Liabilities of Directors and Officers

11. © 2007 West Legal Studies in Business, A Division of Thomson Learning 11 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. Duties and Liabilities of Directors and Officers

12. © 2007 West Legal Studies in Business, A Division of Thomson Learning 12 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.

13. © 2007 West Legal Studies in Business, A Division of Thomson Learning 13 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].

14. © 2007 West Legal Studies in Business, A Division of Thomson Learning 14 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.

15. © 2007 West Legal Studies in Business, A Division of Thomson Learning 15 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.

16. © 2007 West Legal Studies in Business, A Division of Thomson Learning 16 Shareholders’ 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.

17. © 2007 West Legal Studies in Business, A Division of Thomson Learning 17 Shareholders’ Meetings 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.

18. © 2007 West Legal Studies in Business, A Division of Thomson Learning 18 Shareholders’ Meetings 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 must state reason for meeting and only deal with this matter.

19. © 2007 West Legal Studies in Business, A Division of Thomson Learning 19 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.

20. © 2007 West Legal Studies in Business, A Division of Thomson Learning 20 Shareholder Voting 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..)]

21. © 2007 West Legal Studies in Business, A Division of Thomson Learning 21 Shareholder Voting Methods of Increasing Minority Share-holder 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.

22. © 2007 West Legal Studies in Business, A Division of Thomson Learning 22 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.” Shareholder Voting

23. © 2007 West Legal Studies in Business, A Division of Thomson Learning 23 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. Rights of Shareholders

24. © 2007 West Legal Studies in Business, A Division of Thomson Learning 24 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. Stock Certificates

25. © 2007 West Legal Studies in Business, A Division of Thomson Learning 25 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.

26. © 2007 West Legal Studies in Business, A Division of Thomson Learning 26 Stock Warrants 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.

27. © 2007 West Legal Studies in Business, A Division of Thomson Learning 27 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.

28. © 2007 West Legal Studies in Business, A Division of Thomson Learning 28 Directors’ Failure to Declare a Dividend 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.

29. © 2007 West Legal Studies in Business, A Division of Thomson Learning 29 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.

30. © 2007 West Legal Studies in Business, A Division of Thomson Learning 30 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.

31. © 2007 West Legal Studies in Business, A Division of Thomson Learning 31 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.

32. © 2007 West Legal Studies in Business, A Division of Thomson Learning 32 Shareholder’s 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.

33. © 2007 West Legal Studies in Business, A Division of Thomson Learning 33 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 stock subscription agreement. –Shareholder buys “watered stock” which is below the stock’s par value.

34. © 2007 West Legal Studies in Business, A Division of Thomson Learning 34 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. CASE 26.3 Robbins v. Sanders (2004).