Shareholders

Question 1

Close Corporation

Answer 1

A close corporation is a corporation that has few shareholders and that is not publicly traded.

⇒ Close corporations are often S Corporations: (1) Fewer than 100 shareholder; (2) all shareholders are U.S. citizens or residents; (3) not publicly traded.

Question 2

Shareholder Management Agreement

Answer 2

In general, shareholders do not manage the corporation; the board does. However, shareholders in a close corporation may enter into a shareholder management agreement to set up an alternative management scheme. There are two ways to do this:

1. The shareholder management agreement is contained in the articles of incorporation and unanimously approved by shareholders;
2. By a unanimous written shareholder agreement.

Question 3

If a shareholder agreement applies to a close corporation, who owes fiduciary duties?

Answer 3

Whoever manages the corporation owes duties.

Question 4

Do shareholders owe each other fiduciary duties?

Answer 4

In general, shareholders don’t owe each other fiduciary duties. However, some states impose fiduciary duties on shareholders in a close corporation. In this case, a shareholder may sue other shareholders for oppression.

⇒ Notice that this is only available in a close corporation because shares are not publicly traded. Thus, oppressed shareholders can’t simply sell to free themselves of the situation.

Question 5

Are shareholders liable for corporate obligations?

Answer 5

In general, shareholders are not liable for corporate obligations. They may be liable if the corporation is a close corporation and the plaintiff succeeds in piercing the corporate veil.

Question 6

Piercing the Corporate Veil

Answer 6

A plaintiff may pierce the corporate veil and hold the shareholders of a close corporation liable for corporate obligations if:

1. The shareholders abused the privilege of incorporation; and
2. Fairness requires holding the shareholders liable.

Courts are more likely to pierce the corporate veil in favor of a tort victim than to enforce a contract.

⇒ Courts may pierce the corporate veil when the corporation is an alter ego for the shareholders or when the shareholder undercapitalize the corporation when formed.

Question 7

Derivative Suit

Answer 7

A derivative suit is a suit brought by a shareholder to enforce a corporate claim.

• If the shareholder wins, the corporation takes the money from the judgment, although the shareholder takes reasonable litigation costs.
• If the shareholder loses, the shareholder is not entitled to reimbursement by the corporation for litigation expenses.

Question 8

Requirements for Shareholder Derivative Suit

Answer 8

In order to bring a shareholder derivative suit:

1. The shareholder must have owned stock when the claim arose;
2. The shareholder must adequately represent the corporation’s interests;
3. The shareholder must make written demand on the corporation, unless demand would be futile, such as when the derivative suit is against the directors;
4. The corporation is joined as a defendant​.

Question 9

How may a corporation respond to a derivative suit?

Answer 9

If a shareholder files a derivative suit, independent directors may conduct an independent investigation to determine whether the suit is in the corporations best interests.

If the “special litigation committee” concludes that the suit isn’t in the corporation’s best interest, they may dismiss the suit. The court will approve if (1) those recommending are truly independent and (2) they made a reasonable investigation.

Question 10

Which shareholders are entitled to vote?

Answer 10

A shareholder is entitled to vote if they own outstanding stock on the record date.

Question 11

Requirements for a Valid Proxy

Answer 11

To be valid, a proxy must be:

1. In writing;
2. Signed by the record shareholder (note that an email is sufficient);
3. Directed to the secretary of the corporation;
4. Authorize another person to vote the shares.

Question 12

How long is a proxy valid for?

Answer 12

11 months.

Question 13

How may a proxy be revoked?

Answer 13

A proxy may be revoked:

1. In writing to the corporation’s secretary;
2. By attending the shareholder meeting and voting.

Question 14

How can a shareholder create an irrevocable proxy?

Answer 14

A shareholder may create an irrevocable proxy by:

1. Satisfying the requirements for a valid proxy;
2. Specifying that the proxy is irrevocable;
3. Ensuring that the proxy-holder has an interest other than voting in the share, such as an option to purchase the shares.

Question 15

Requirement for a Valid Pooling Agreement

Answer 15

A pooling agreement is valid if it is (1) in writing and (2) signed.

Question 16

Annual Shareholder Meeting

Answer 16

An annual shareholder meeting must take place within 15 months of the previous annual shareholder meeting.

Question 17

Special Shareholder Meeting

Answer 17

A special shareholder meeting may be called by:

1. The board;
2. The president;
3. The holders of 10 percent of outstanding shares;
4. Anyone authorized by the bylaws.

Notice: Notice must be given to shareholders 10-60 days before the vote AND include a full description of the purpose. A shareholder may waive a violation expressly or by attending the meeting without objecting at the outset.

Question 18

What do shareholders vote on?

Answer 18

Shareholders vote to elect directors, to remove directors, and on fundamental corporate changes recommended by the board.

Question 19

Quorum Requirement at Shareholder Meeting

Answer 19

At a shareholder meeting, quorum is a majority of outstanding shares. Unlike a director meeting, quorum is not broken if shareholders leave during a meeting.

Question 20

Voting Requirements:

1. Elect a director?
2. Remove a director?
3. Other matters?

Answer 20

1. Directors are elected by plurality.
2. Directors are removed by a majority of the shares entitled to vote.
3. Other matters are controlled by a majority of the shares that actually vote.

Question 21

Cumulative Voting

Answer 21

In a cumulative voting scheme, shareholders are entitled to votes equal to the number of shares they hold multiplied by the number of directors the shareholders will elect. Shareholders may allocate their votes however they please. The directors are ranked according to the number of votes they recieved and alloted places as directors accordingly.

Question 22

When may a restriction on stock transfers be enforced?

Answer 22

A restriction on stock transfer may be enforced if it is:

1. Not an undue restriction on alienation;
2. It is prominently noted on the stock certificate, or the shareholder has actual knowledge of the restriction.

Rights of first refusal are generally okay.

Question 23

Types of Distributions

Answer 23

1. Dividends;
2. Repurchase shareholder’s stock;
3. Redeem stock at the price set in the articles of incorporation.

Question 24

When do distributions occur?

Answer 24

Distributions occur at the board’s discretion. Shareholders may force a distribution only if they can make a very strong showing of abuse of discretion.

Question 25

Which shareholders recieve a distribution?

Answer 25

**Preferred shareholders** are paid first according to the terms of their preferrence. Common stock is paid the remainder proportionally.

Question 26

What funds may be used to make a distribution?

Answer 26

A corporation may not make a distribution if it is **insolvent** or if making a distribution would **render the corporation insolvent.** A corporation is insolved if it is **unable to pay its debts** or its **liabilities exceed its assets.**

Question 27

Who is liable for an improper distribution?

Answer 27

Directors are jointly and severally liable for an improper distribution.