Chapter 35
Corporations, Directors, Officers, and Shareholders

WHAT THIS CHAPTER IS ABOUT

This chapter outlines the rights and responsibilities of all
participants-directors, officers, and shareholders-in a corporate
enterprise. Also noted are the ways in which conflicts among these
participants are resolved.

CHAPTER OUTLINE

I. ROLE OF DIRECTORS
The board of directors governs a corporation. Officers handle daily business.

A. ELECTION OF DIRECTORS

1. Number of Directors
Set in a corporation's articles or bylaws. Corporations with fewer than
fifty shareholders can eliminate the board of directors [RMBCA 8.01].

2. How Directors Are Chosen
The first board (appointed by the incorporators or named in the articles)
serves until the first shareholders' meeting. Subsequent directors are
elected by a majority vote of, the shareholders (see below).

3. Removal of Directors
A director can be removed for cause by shareholder action (or the board may
have, the power). In most states, a director cannot be removed without
cause, unless the shareholders have reserved the right.

B. BOARD OF DIRECTORS' MEETINGS

1. Formal Minutes and Notice
A board conducts business by holding formal meetings with recorded minutes.
The dates for regular meetings are usually set in the articles and bylaws or
by board resolution, and no other notice is required. Special meetings
require notice to all directors.

2. Quorum Requirements and Voting
Quorum requirements vary. If the firm specifies none, in most states a is a
majority of the number of directors authorized in the articles or bylaws.
Voting is done in person, one vote per director.

C. RIGHTS OF DIRECTORS

1. Participation and Inspection
A director has a right to participate in corporate business. A director must
have access to all corporate books and records to make decisions.

2. Compensation and Indemnification
Nominal sums may be paid to directors, and there is a trend to provide more.
Most states permit a corporation to indemnify a director for costs and fees
in defending against corporate-related lawsuits. Many firms buy insurance to
cover indemnification.

D. MANAGEMENT RESPONSIBILITIES

1. Areas of Responsibility
Major policy and financial decisions; appointment, supervision, pay, and
removal of officers and other managerial employees.

2. Executive Committee
Most states permit a board to elect an executive, committee from among the
directors to handle management between board meetings. The cornmittee is
limited to ordinary business matters.

II ROLE OF CORPORATE OFFICERS AND EXECUTIVES
Officers and other executive employees are hired by the board. Officers act
as agents of the corporation (see Chapters 31 and 32).

A. QUALIFICATIONS
At the discretion of the firm; included in the articles or bylaws. A person
can hold more than one office and also be a director.

B . RIGHTS AND DUTIES
The rights of corporate officers and other high-level managers are defined by
employment contracts. Officers normally can be removed by the board a t any
time (but the corporation could be liable for breach of contract). Officers'
duties are the same as those of directors.

III FIDUCIARY DUTIES OF DIRECTORS AND OFFICERS
Directors and officers are fiduciaries of the corporation.

A. DUTY OF CARE
Directors and officers must act in good faith, in what they consider to be
the best interests of the corporation, and with the care that an ordinarily
prudent person would exercise in similar circumstances.

1. Duty to Make Informed and Reasonable Decisions
Directors must be informed m corporate matters and act in accord with their
knowledge and training. A director can rely on information furnished by
competent officers, or others, without being accused of acting in bad faith
or failing to exercise due care (RMBCA 8.30)

2. Duty to Exercise Reasonable Supervision
Directors must exercise reasonable supervision when work is delegated.

3. Dissenting Directors
Directors must attend board meetings; ff not, he or she should register a
dissent to actions taken (to avoid liability for mismanagement).

B .DUTY OF LOYALTY

Directors and officers cannot use corporate funds or confidential information
for personal advantage. Specifically, they cannot-

1. Compete with the corporation.

2. Usurp a corporate opportunity.

3. Have an interest that conflicts with the interest of the corporation.

4. Engage in insider trading (see Chapter 37).

5. Authorize a corporate transaction that is detrimental to minority
shareholders.

6. Sell control over the corporation.

C. CONFLICTS OF INTEREST
Directors and officers must disclose fully any conflict of interest that
might occur in a deal involving the corporation. A contract may be upheld if
it was fair and reasonable to the firm when it was made, there was full
disclosure of the interest of the officers or directors involved, and it was
approved by a majority of disinterested directors or shareholders.

IV. LIABILITY OF DIRECTORS AND OFFICERS

A. THE BUSINESS JUDGMENT RULE
Honest mistakes of judgment and poor decisions do riot make directors and
officers liable to the firm for poor results, if the decision complies with
management's fiduciary duties, has a reasonable basis, and is within
managerial authority and the power of the corporation.

B. LIABILITY FOR TORTS AND CRIMES
Directors and officers are personally liable for their torts and crimes, and
may be liable for those of subordinates (under the 'responsible corporate
officer' doctrine or the 'pervasiveness of control" theory). The corporation
is liable for such acts when committed within the scope of employment.

V. ROLE OF SHAREHOLDERS

A. SHAREHOLDERS' POWERS
Shareholders own the corporation, approve fundamental corporate changes, and
elect and remove directors.

B . SHAREHOLDERS' MEETINGS
Regular meetings must occur annually; special meetings can be called to
handle urgent matters.

1. Notice of Meeting Must be in Writing in Advance
Notice of a special meeting must state the purpose.

2. Proxies
Rather than attend a meeting, shareholders normally authorize third parties
to vote their shares. A proxy may be revocable and may have a time limit.
When a firm sends proxy materials to its shareholders, i t must allow them to
vote on pending policy proposals.

C. SHAREHOLDER VOTING

1. Quorum Requirements
At the meeting, a quorum must be present. A majority vote of the shares
present is required to pass resolutions. Fundamental changes require a
higher percentage.

2. Voting Techniques
Each common shareholder has one vote per share. The articles can exclude or
limit voting rights.

a. Cumulative Voting
The number of members of the board to be elected is multiplied by
the total of voting shares. This is the number of votes a shareholder has
and can be cast for one or more nominees.

b. Shareholder Voting Agreements
A group of shareholders can agree to vote their shares together. A
shareholder can vote by proxy. Any person can soH dt proxies.

c. Voting Trust
Exists when legal title (recorded ownership on the corporate books) is
transferred to a trustee who is responsible for voting the shares. The
shareholder retains all other ownership rights.

VI. RIGHTS OF SHAREHOLDERS

A. STOCK CERTIFICATES
Notice of shareholder meetings, dividends, and corporate reports are
distributed to owners listed in the corporate books, not m the basis of
possession of stock certificates (which most states do not require).

B. PREEMPTIVE RIGHTS
Usually apply only to additional, newly issued stock sold for cash and be
exercised within a specified time (usually thirty days). When new shares are
issued, each shareholder is given stock warrants (transferable options to
acquire a certain number of shares at a stated price).

C. DIVIDENDS
Dividends can be paid in cash, property, or stock. Once declared, a cash
dividend is a corporate debt. Dividends are payable only ftmn (1) retained
earnings, (2) current net profits, or (3) any surplus.

1. Illegal Dividends
A dividend paid when a corporation is insolvent is illegal and must be
repaid. A dividend paid from an unauthorized account or causing a
corporation to become insolvent may have to be repaid. In any case, the
directors can be held personally liable.

2. If the Directors Fail to Declare a Dividend
Shareholders can ask a court to compel a declaration of a dividend, but to
succeed, the directors' conduct must be an abuse of discretion

D. INSPECTION RIGHTS
Shareholders (or their attorney, accountant, or agent) can inspect and copy
corporate books and records for a proper purpose, if the request is made in
advance [RMBCA 16.02]. This right can be denied to prevent harassment or to
protect confidential corporate information.

E. TRANSFER OF SHARES
Any restrictions m transferability must be noted an the face of a stock
certificate. Restrictions must be reasonable-for example, a right of first
refusal remains with the corporation or the shareholders 'for only a
specified time or a reasonable time.

F. RIGHTS ON DISSOLUTION
Shareholders can petition a court to dissolve a firm if [RMBCA 14.30]-

1. The directors are deadlocked, shareholders are unable to break the
deadlock, and there is or could be irreparable injury to the firm.

2. The acts of the directors or those in control of the corporation are
illegal, oppressive, or fraudulent.

3. Corporate assets are being misapplied or wasted.

4. The shareholders are deadlocked in voting power and have failed, for a
specified period (usually two annual meetings), to elect successors to
directors.

G SHAREHOLDER'S DERIVATIVE SUIT
If directors fail to sue in the corporate name to redress a wrong suffered by
the firm, shareholders can do so (after complaining to the board). Any
recovery normally goes into the corporate treasury.

VII. LIABILITY OF SHAREHOLDERS
In most cases, if a corporation fails, shareholders lose only their
investment. Exceptions include (see also Chapter 37)-

A. STOCK-SUBSCRIPTION AGREEMENTS
Once a subscription agreement is accepted, any refusal to pay is a breach,
resulting in personal liability.

B. WATERED STOCK
hi most cases, a shareholder who receives watered stock (stock sold by a
corporation for less than par value) must pay the difference to the
corporation. In some states, such shareholders may be liable to creditors of
the corporation for unpaid corporate debts.

VIII. DUTIES OF MAJORITY SHAREHOLDERS
A single shareholder (or a few acting together) who owns enough shares to
control the corporation owes a fiduciary duty to the minority shareholders
and creditors when they sell their shares.

TRUE-FALSE QUESTIONS

(Answers at the Back of the Book)

1. Both directors and officers may be immunized from liability for poor
business decisions under the business judgment rule.

2 . Because their positions involve similar decision making and control,
officers have the same duties as directors.

3. The rights of shareholders are established solely in the articles of
incorporation.

4. Dividends can be paid in cash or property.

5. Any damages recovered in a shareholder's derivative suit are normally
paid to the shareholder or shareholders who brought the suit.

6. As a general rule, shareholders are not personally responsible for the
debts of the corporation.

7. Officers, but not directors, owe a duty of loyalty to the corporation.

S. The business judgment rule makes a director liable for losses to the firm
that result from the director's authorized, good faith business decisions.

9. Shareholders may vote to elect directors and they may vote to remove
directors.

10. Par-value shares have a specific face value.

FILL-IN QUESTIONS
(Answers at the Back of the Book)

A stock certificate may be lost or destroyed,
(and ownership is/but ownership is not) destroyed with it. A
new certificate (can/cannot) be issued to replace
one that has been lost or destroyed.
Notice of meetings, dividends, and operational and financial reports are all
distributed according to the individual
(in possession of the certificate /recorded as
the owner in the corporation's books).

MULTIPLE-CHOICE QUESTIONS

(Answers at the Back of the Book)

1. Jill is a shareholder of United Manufacturing Company. As a shareholder,
Jill's rights include all of the following EXCEPT a right to
a one vote per share, subject to any limitation in the articles.
b. access to corporate books and records, subject to the firm's right to
protect it self from potential abuse.
c. transfer shares, subject to any valid restriction.
d. take title to and sell corporate property when directors are mishandling
corporate assets, subject to any limitation in the articles.

*notes provided by West Business Law