Ðåôåðàò: Business associations
Ðåôåðàò: Business associations
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«BUSINESS ASSOCIATIONS»
BUSINESS ASSOCIATIONS
Corporate
bargain--limited liability
I.CHARACTERISTICS
OF A CORPORATION
A.PRINCIPAL
CHARACTERISTICS OF A CORPORATION
a)Entity
Status--a corporation is a legal entity created under the authority of
legislature
b)Limited
Liability--as a legal entity, a corp is responsible for its own debts;
its sh’s liability is limited to their investment;
c)Free
Transferability of Interest--shares, representing ownership interests,
are freely transferable;
d)Centralized
Management and Control--a corp’s management is centralized in a board
of dirs and officers. Shs have no direct control over the board’s activities;
e)Duration--Continuity
of Existence--a corp is capable of perpetual existence;
f)Taxation--a
corp, as an entity, pays taxes on its own income; shs are taxed only on
dividends;
g)Remember
Attributes of the Corporation--CLIFF:
1)Centralization of management;
2)Limited liability;
3)Forever (perpetual duration);
4)Freely alienable (shares can be sold).
B.CORPORATIONS DISTINGUISHED FROM OTHER FORMS OF BUSINESS ASSOCIATIONS.
1.GENERAL
PARTNERSHIPS--in most states, p’ships are governed by the Uniform
Partnership Act (UPA). However, the Revised UPA (RUPA) has been adopted by a
few states
a)Aggregate
Status--a p’ship is an aggregation of two or more persons who are
engaged in business as co-owners. Although not a legal entity, a p’ship is
treated as one for certain purposes, e.g., ownership and transfer of property.
RUPA confers entity status on p’ships;
b)Unlimited
Liability--every partner is subject to unlimited personal liability on
p’ship debts;
c)Transferability
of Interests--a partner cannot make a transferee a member of the
p’ship. She can, however, assign his interest in the p’ship, thus permitting
the assignee to receive distributions of profits. Because the assignee does not
become a member of the p’ship, he is not entitled to participate in p’ship
business or management.
d)Duration
and Dissolution--a p’ship cannot have perpetual existence. It is
terminable at will unless a definite term is expressed or implied, and is also
dissolved by death, incapacity, or withdrawal of any partner.
1)Wrongful dissolution--p’ships can also be dissolved in contravention
of the p’ship agreement, by the express will of any partner, by a court or by a
partner’s conduct. Upon wrongful dissolution, nonbreaching partners may seek
damages for breach and, if they choose to do so, may continue the p’ship upon
payment to the breaching partner of the value of his interest.
1)Compare--dissociation under RUPA--termination results in either the
winding up of the p’ship or buyout of the dissociating partner, depending on
the event triggering the termination. A buyout may be reduced by damages if
dissociation was wrongful.
e)Management
and Control--absent a contrary agreement, every partner has a right to
participate equally in the partnership management.
f)Autority--each
partner, as an agent of the firm, may bind the p’ship by acts done for the
carrying on, in the usual way, the business of the p’ship.
1)RUPA--a p’ship is bound by a partner’s act for carrying on in the
usual way either the actual p’ship business or a business of the kind
carried on by the p’ship.
g)Ownership
of Property--title may be held in the name of the p’ship, but property
is owned by the individual partners as tenants in p’ship. There is no
tenancy in p’ship under RUPA, which provides that property acquired by p’ship
is owned by p’ship, not individual partners.
h)Capacity
to Sue and be Sued--under the UPA, a lawsuit may be brought by or
against individual partners, rather than p’ship. Partners are jointly and
severally liable for wrongful acts and breaches of trust; they are only jointly
liable for debts and obligations of the p’ship.
1)Statutory reforms--many state statutes specifically allow a p’ship to
be sued in its own name. Other states make all p’ship liabilities joint and
several. Other reforms provide that not all joint obligors need to be joined in
a suit.
2)RUPA--a p’ship may sue and be sued in its own name, and partners are
jointly and severally liable for all p’ship obligations. A claim against
the p’ship cannot be satisfied from a partner’s personal assets unless p’ship
assets have been exhausted.
2.JOINT
VENTURE--a p’ship formed for some limited investment or operation,
as opposed to a continued business enterprise. Joint ventures are governed by
the rules applicable to p’ships
3.LIMITED
PARTNERSHIP--this is a p’ship consisting of two classes of partners: general
partners (with rights and obligations as in an ordinary p’ship) and limited
partners (with no control and limited liability).
4.LIMITED
LIABILITY PARTNERSHIPS--in a LLP, a general partner is NOT personally
liable for all p’ship obligations arising from negligence, wrongful
acts, and misconduct absent his involvement in the misconduct. There is no
exclusion for liability for contractual obligations.
5.LIMITED
LIABILITY COMPANIES--LLC is a non-corporate business entity whose owners
(members) have limited liability and can participate actively in its
management. An LLC may be either for a term or at will. It can be managed
either by its members or nonmember managers. Depending on the statute,
distributions are made either equally to each member or in proportion to each
member’s contribution.
a)Withdrawal
and Dissolution--some statutes provide that any event that terminates a
member’s membership (death, resignation) causes dissolution. Other statutes
distinguish between fault events(member misconduct...) and non-fault events
(death, bankruptcy), and some provide that dissolution can be avoided by paying
the withdrawing member fair value for his interest.
b)Advantages
of LLCs--An LLC for a business association, not publicly held, has
strong advantages: partnership taxation, virtually no restrictions in
structuring ownership interests and management, limited liability for owners
and managers, and no limitations on the number or nature of owners.
C.DISREGARD
OF CORPORATE ENTITY--since a corp is a distinct legal entity, shs are
normally shielded from corporate obligations. In certain instances, however,
the corporate entity will be disregarded.
1.PIERCING
THE CORPORATE VEIL--(Suits by corporate creditors against shs)--it’s
more common in contract claims than in tort claims. The most important elements
considered by the courts:
a)Commingling
of Assets--commingling of corp assets and personal assets of shs (e.g.,
paying private debts with corp funds) may lead to piercing of the corporate
veil;
b)Lack
of Corporate Formalities--whether basic corp formalities (e.g., regular
meetings, corporate records maintained, issuance of stock) were followed is
also relevant. Statutory close corps are permitted more flexibility regarding
corp formalities;
c)Undercapitalization--if
the corp was organized without sufficient capital or liability insurance to
meet obligations reasonably expected to arise, the corp veil may be pierced;
d)Domination
and Control By Shareholder--the corp veil is often pierced when an
individual or other corp owns most or all of the stock, so that it completely
dominates policy or business decisions.
e)”Alter
Ego,” “Instrumentality,” “Unity of Interest”--when no separate entity
exists and the corp is merely the alter ego or instrumentality of its shs
(could be a corporate shareholder), or when there is a unity of interest
between the corp and its shs, the corp veil is often pierced. These terms are
usually applied only if other grounds are present;
f)Fraud,
Wrong, Dishonesty, or Injustice--generally, the veil will be pierced
only if one of these elements is available, e.g., no piercing of veil if there
is a lack of corp formalities without resultant injustice. Piercing the veil
usually involves corps with a small number of shs.
2.PIERCING
HAPPENS MOST OFTEN WHEN:
1)The number of shs is small--the chance of one sh dominating the corp
is greater;
2)Deception--There is some kind of deception;
3)Agency--individual is a “principal” and corp is his “agent”
4)Estoppel--outsider was led to believe that he was dealing with an
individual, while in fact he was dealing with the
corporation.
5)Direct tort--individual and corp acted together and should be
jointly/severally liable
6)Instrumentality requirement is satisfied:
I)control of a subsidiary by parent
ii)to commit fraud
iii)to cause loss or injury.
3.PIERCING
THE WALL BETWEEN AFFILIATED CORPORATIONS--this occurs when a P with a claim
against one corp attempts to satisfy the claim against the assets of an
affiliated corp under common ownership. This type of aggregation is permitted
only when each affiliated corp is NOT a free-standing enterprise but merely a
fragment of an entity composed of affiliated corps.
4.USE
OF CORPORATE FORM TO EVADE STATUTORY OR CONTRACT OBLIGATIONS--the corp form
may be ignored when it is used to evade a statutory or contractual obligation.
The issue is whether the contract or statute was intended to apply to the shs
as well as the corporation. Only third parties, not the corp or its shs,
are generally allowed to disregard the corp entity.
5.TWO
EXTREMES TO AVOID IN PIERCING THE CORPORATE WALL:
a)Old
model--Superman (sh) used corp as his puppet;
b)New
Model--Superman (sh) and corp are inseparable (alter ego)
D.SUBORDINATION OF SHAREHOLDER DEBTS--”DEEP ROCK” DOCTRINE--if a corp goes into bankruptcy, debts to
its controlling shs may be subordinated to claims of other creditors. When
subordination occurs, shareholder loans are treated as if they were invested
capital (stock). Major factors in determining whether to subordinate
include fraud, mismanagement, undercapitalization, commingling, excessive
control, etc.
II.ORGANIZING
THE CORPORATION--generally,
corps are created under and according to statutory provisions of the state in
which formation is sought.
A.FORMALITIES
IN ORGANIZING CORPORATION:
1.CERTIFICATE
OR ARTICLES OF INCORPORATION--state law governs the content of the
articles, which are filed with the secretary of the state. Usually, the
articles must specify the corp name, number of shares and classes of stock
authorized, address of the corp’s initial registered office, name of initial
registered agent, and the name and address of each incorporator.
a)Purpose
Clause--under most statutes, no elaborate purpose clause is needed. It
is sufficient to state that the purpose of the corp is to engage in any lawful
business activity.
b)State
of Incorporation--incorporators need to consider how flexible the
state’s corporate law is versus the costs associating with incorporating in
that state
2.ORGANIZATIONAL
MEETING--filling the articles in proper form creates the corporation, after
which an organizational meeting is held by either the incorporators or dirs
named in the articles. Matters determined at meeting:
1)Incorporators elect directors, if no dirs are named in the articles;
2)Directors choose officers;
3)Directors ratify pre-incorporation transactions;
4)Directors authorize issuance of shares
5)Directors adopt by-laws (if necessary), corporate seal and stock certificate
B.DEFECTS IN FORMATION PROCESS--”DE JURE” AND “DE FACTO” CORPS--when there is a defect or irregularity in
formation, the question is whether the corp exists “de jure,” “de facto,” “by
estoppel,” or not at all. This issue usually arises when a third party seeks to
impose personal liability on would-be shs. Another method of challenging
corporate status, used only by the state, is a quo warranto proceeding.
Note: where there has not been compliance with the statute, we apply principles
of de facto, de jure and corp by estoppel. Where there has been compliance with
the statute, we apply principles of disregard of corporate fiction, a/k/a
“piercing the corporate veil,” which is an exception, rather than a rule.
1.DE
JURE CORPORATION--this exists when the corp is organized in compliance
with the statute. Its status cannot be attacked by anyone--not even the
state. Most courts require only “substantial compliance”; others require exact
compliance with the mandatory requirements.
2.DE
FACTO CORPORATION (substantially abolished)--this exists when there is
insufficient compliance as to the state (i.e., state can attack in quo warranto
proceeding), but the steps taken are sufficient to treat the enterprise as a
corp with respect to its dealings with third parties. Requirements:
1)Colorable or apparent attempt;
2)Good faith;
3)Some use of corporate franchise; Then ct will recognize status as to all but
state
3.CORPORATION
BY ESTOPPEL
a)Definition--estoppel
is an equitable evidentiary rule which prevents a party from denying the existence
of a fact notwithstanding that he fact is not true. Thus, certain parties are
estopped from asserting defective incorporation when they have dealt with the
corp as though properly formed.
b)Example--shs
who claimed corp status in an earlier transaction are estopped to deny that
status in a suit brought against the corp. The estoppel theory normally does
NOT apply to bar suits against would-be shs by tort claimants or other
involuntary creditors.
c)Overlap
With De Facto--many of the facts which we would point to support a
claim of de facto status are the same ones we point for estoppel. However,
substantial abolition of de facto concept doesn’t necessarily abolish estoppel.
d)De
Facto is For All; Estoppel is For One--estoppel depends on relationship
between party and corp.
4.WHO
MAY BE HELD LIABLE--when a would-be corp is not a de jure or de facto or a
corp by estoppel, the modern trend imposes personal liability against only
those owners who actively participated in management of the enterprise.
5.EFFECT
OF STATUTES:
a)On
De Facto Doctrine--states following the prior version of the Model Act
have abolished the de facto doctrine, thus making all purported “shs” jointly
and severally liable for all liabilities incurred as a result of the purported
“incorporation.” However, statutes based on Revised Model Business Corporation
Act require a person acting on behalf of the enterprise to know that
there was no incorporation before liability attaches.
b)On
Estoppel Doctrine--the effect of both acts is an unsettled issue.
c)On
Liability--under the prior Model Act, liability extends to investors
who also exercise control or actively participate in policy and operational
decisions. It is expected that the Revised Model Act will be interpreted in the
same manner.
III.LIABILITIES
FOR TRANSACTIONS BEFORE INCORPORATION.
A.PROMOTERS--a
promoter participates in the formation of the corp, usually arranging
compliance with the legal requirements of formation, securing initial capital,
and entering into necessary contracts on behalf of the corp during the time
it’s being formed.
a)Fiduciary Duties to Each Other--Full disclosure and fair dealing are required
between the promoters and the corp and among promoters themselves.
B.CONTRACTS
MADE BY PROMOTERS ON CORP’S BEHALF
1.RIGHTS
AND LIABILITIES OF CORPORATION:
a)English
Rule--the corp is not directly liable on pre-incorporation
contracts even if later ratified. Rationale: the corp was not yet in existence
at the time the promoter was acting.
b)American
Rule--the corp is liable if it later ratifies or adopts
pre-incorporation K.
c)Corporation’s
Right to Enforce Contract--under either rule, the corp may enforce the
contract against the party with whom the promoter contracted, if it chooses to
do so.
2.RIGHTS
AND LIABILITIES OF PROMOTERS.
a)Liability
on Pre-incorporation Contract--generally, promoters are liable if the
corp rejects the pre-incorporation contract, fails to incorporate, or adopts a
contract but fails to perform, unless the contracting party clearly
intended to contract with the corporation only and not with the promoters
individually.
b)Right
to Enforce Against the Other Party--if a corp is not formed, the
promoter may still enforce the contract.
C.OBLIGATIONS
OF PREDECESSOR BUSINESS--a corporation that acquires all of the assets of a
predecessor business does not ordinarily succeed to its liabilities, with
exceptions:
a)Exceptions--the
successor corp may be liable for its predecessor liabilities if:
1)the new corp expressly or impliedly assumes the predecessor obligations (the
creditors of the old corp may hold the new corp liable as third-party
beneficiaries);
2)the sale was an attempted fraud on the creditors; or
3)the predecessor is merged into or absorbed by the successor.
IV.POWERS OF
THE CORPORATION.
A.CORPORATE
POWERS--generally, corporate purposes and powers are those expressly
set forth in the corporation’s articles, those conferred by the statute, and
the implied powers necessary to carry out the express powers.
Transactions beyond the purposes and powers of the corporation are ultra
vires.
1.TRADITIONAL
PROBLEM AREAS--the following three powers are particularly significant
express powers, since older statutes did not specifically confer them:
a)Guarantees--modern
statutes confer the power to guarantee the debts of others if it is in
furtherance of the corporate business;
b)Participation
in a Partnership--present-day statutes explicitly allow the corp to
participate with others in any corp, partnership, or other association;
c)Donations--because
the general rule is that the objective of a business corporation is to conduct
business activity with a view to profit, early cases held that charitable
contributions were ultra vires; the modern view permits reasonable
donations without showing the probability of a direct benefit to the corp.
B.AGENCY
1.DEFINITION--agency
is the fiduciary relation which results from the manifestation of consent by
one person to another that the other shall act on his behalf and subject to his
control, and consent by the other to so act." Rest2dAg
a)Parties
to an agency relationship--Principal & Agent. Thus, three essential
elements of an agency relationship:
1)Manifestation by principal that agent shall act for him in some undertaking;
2)Acceptance by the agent; and
3)Understanding that the principal is in control of the undertaking.
I)Note that these are factual issues; if they are satisfied, then the
relationship is one of agency, regardless of what the parties themselves call
it (but the parties' labels may provide evidence of their intent)
2.CATEGORIES
OF AGENCY
a)Actual
Express Authority--authority is the power of the agent to affect the
legal relations of the principal by acts done in accordance with the
principal's manifestations of consent to him." Rest §7. Operative word is
"manifestation" . If he says, do something, it's express ‑‑
but the manifestation may include implied assent to other things as well, which
is-->
b)Actual
Implied Authority--unless otherwise agreed, authority to conduct a
transaction includes authority to do acts which are incidental to it, usually
accompany it, or are reasonably necessary to accomplish it." Rest § 35
c)Apparent
Authority ‑‑ a.k.a. "ostensible
authority"--apparent authority is the power to affect the legal
relationships of another person by transactions with third persons, professedly
as agent for the other, arising from and in accordance with the other's
manifestations to such third persons." Rest §8. But note that the
manifestation includes allowing the agent to represent accurately his own
authority.
d)Inherent
Authority--this is the authority that inheres in an office. General
agent (agent authorized to conduct a series of transactions involving
continuity of service): P is bound if A is acting in the interests of P and A
does an act usual or necessary with respect to the authorized transactions ;
1)Unusual
activities--depositing corporate checks on a personal account is an unusual
activity, and the bank should make inquiry if the person is authorized to do
that; otherwise, the bank is liable to the principal for lost money (Mohr)
e)Ratification--ratification
is the affirmance by a person of a prior act which did not bind him but which
was done or professedly done on his account, whereby the act, as to some or all
persons, is given effect as if originally authorized by him." Rest § 82.
The principal can affirm by words, or by deeds. This includes the failure to
repudiate the subject matter when presented, suing to enforce the obligation,
retaining the benefits of the transaction. Note several things:
1)Ratification assumes that the principal was not previously bound. If the
principal had been previously bound, then the liability would be based on
another agency theory.
2)It doesn't matter to whom the affirmance is made. It could be to the agent,
to the third party, or anyone else or nobody at all. Why? Because what was
lacking in the original contract was merely his expression of assent to the
relationship of agency. The terms are fixed, the third party believes he has an
agreement, all that's missing is the opposite party. So the President of the
firm's note to himself that the affirms may be sufficient. If there are some
formalities required to authorize an act ‑‑e.g., sealed
instruments, deeds ‑‑ then there might be additional formality required
for affirmance.
f)Estoppel--purported
principal either (a) intentionally or carelessly causes the belief that a
purported agent is acting on his behalf, or (b) sits silently knowing that such
belief exists without taking reasonable steps, and the third party relies
detrimentally.
C.ULTRA
VIRES TRANSACTIONS--those beyond the purposes and powers, express and
implied, of the corporation. Under common law, shareholder ratification of an
ultra vires transaction nullified the use of an ultra vires defense by the
corporation.
1.TORT
ACTIONS--ultra vires is NO defense to tort liability.
2.CRIMINAL
ACTIONS--claims that a corporate act was beyond the corp’s authorized
powers are NO defense to criminal liability.
3.CONTRACT
ACTIONS--at common law, a purely executory ultra vires
contracts were NOT enforceable against either party; fully
performed contracts could NOT be rescinded by either party; and, under the
majority rule, partially performed contracts were generally enforceable
by the performing party, since the nonperforming party was estopped to assert
an ultra vires defense.
4.STATUTES--most
states now have statutes that preclude the use of ultra vires as a defense in a
suit between the contracting parties, but permit ultra vires to be raised in
certain other contexts:
a)Suits
Against Officers or Directors--if performance of an ultra vires
contract results in a loss to the corp, it can sue the officers or dirs for
damages for exceeding their authority.
b)Suit
By State--these limiting statutes do NOT bar the state from suing to
enjoin a corp from transacting unauthorized business.
c)Broad
Certificate Provisions--when the certificate of incorporation states
that the purpose is to engage in any lawful activity for which corp may be
organized, ultra vires is unlikely to arise.
V.MANAGEMENT
AND CONTROL
A.ALLOCATION
OF POWERS BETWEEN DIRECTORS AND SHAREHOLDERS
1.MANAGEMENT
OF CORPORATION’S BUSINESS--corporate statutes vest the power to manage in
the board of directors, except as provided by valid agreement in a close
corp. He board’s power is limited to proper purposes.
2.SHAREHOLDER
APPROVAL OF FUNDAMENTAL CHANGES--shs must approve certain fundamental
changes in the corp, e.g., amendment of articles, merger, sale of substantially
all assets, and dissolution.
3.POWER
TO ELECT DIRECTORS--shs have the power to elect dirs and to remove them for
cause, absent provisions for removal without cause in the certificate,
bylaws, or in statutes. Some statutes also permit the board or the courts to
remove a dir for certain specific reasons (e.g., felony conviction).
4.POWER
TO RATIFY MANAGEMENT TRANSACTIONS--shs have the power to ratify certain
management transactions and insulate the transactions against a claim that managers
lacked authority, or shift the burden on the issue of self-interest.
5.POWER
TO ADOPT PRECATORY RESOLUTIONS--shs may also adopt advisory but nonbinding
(precatory) resolutions on proper subjects of their concern.
6.BYLAWS--shs
usually have the power to adopt and amend bylaws, although some statutes give
the board of dirs the concurrent power to do this.
7.CLOSE
CORPORATION--this is a corp owned by a small number of shs who may actively
manage; it has no general market for its stock, and it has some limitations
regarding transferability of stock.
8.STATUTORY
CLOSE CORPORATION STATUS--the basic requirements to qualify for special
treatment under the statutes are that, in its cert of incorp’n, a statutory
close corp must identify itself as such, and must include certain limitations
as to the number of shs, transferability of shares, or both.
a)Functioning
As a Close Corporation--there may be sh agreements relating to any
phase of the corp affairs.
B.DIRECTORS
1.APPOINTMENT
OF DIRECTORS--initial dirs are either designated in the articles of
incorporation or elected at a meeting of incorporators. Subsequent elections
are by shs at their annual meetings. The number of dirs is usually set by the
articles or bylaws.
a)Qualifications--absent
a contrary provision in the articles or bylaws, dirs need not be shs of the
corp or residents of the state of incorporation.
b)Vacancies--statutes
vary, but under Model Act, a vacancy may be filled by either the shs or dirs.
1)Compare--removal: some statutes require that vacancies created by
removal of a dir be filled by the shs unless the articles or bylaws provide
otherwise.
2.TENURE
OF OFFICE
a)Term
of Appointment--under most statutes, office is held until the next
meeting, although on a classified board, dirs may serve staggered multi year
terms.
b)Power
to Bind Corporation Beyond Term--unless limited by the articles, the
board has the power to make contracts biding the corp beyond the dirs’ term of
office.
c)Removal
of Director During Term--at common law, shs can remove a dir for cause
(e.g., fraud, incompetence, dishonesty) unless an article or bylaw provision
permits removal without cause. a dir being removed for cause is entitled to a
hearing by shs before a vote to remove. a number of statutes permit removal
without cause.
1)Removal by Board--board can NEVER remove a dir unless
authorized by statute;
2)Removal by Court--there is a split authority as to whether a court can
remove a dir for cause.
I)Statutes--some statutes permit courts to remove a dir for specified reasons.
Usually, a petition for removal can be brought only by a certain percentage of
shs or the attorney general.
3.FUNCTIONING OF BOARD
a)Meetings--absent
a statute, dirs can act only at a duly convened meeting consisting of a quorum.
In most jurisdictions, a meeting can be conducted by telephone or other means
whereby participants can hear each other simultaneously. Most statutes also
allow board action by unanimous written consent without a meeting.
1)Notice--although formal notice is unnecessary for a regular meeting,
special meetings require notice to every dir of date, time, and place. Usually,
notice can be waived in writing before or after a meeting. Attendance waives
notice unless the dir attends only to protest the meeting.
2)Quorum--a majority of the authorized number of dirs constitutes
a quorum. Many statutes permit the articles or bylaws to require more than
simple majority or less than that.
3)Voting--absent a contrary provision, an affirmative vote of a majority
of those present, not a majority of those voting, is required for board
action.
b)Effect
of Noncompliance With Formalities--today, most courts hold that informal
but unanimous approval of a transaction is effective, as is a matter
receiving the explicit approval by a majority of dirs without a meeting, plus
acquiescence by the remaining dirs.
c)Delegation
of Authority--the board has the power to appoint committees of its own
members to act for it either in particular matters or to handle day-to-day
management between board meetings. Typically, these committees cannot amend
the articles or bylaws, adopt or recommend major corporate changes (e.g.,
merger), recommend dissolution, declare a dividend, or authorize issuance of
stock unless permitted by the articles or bylaws. Note that while the
board may delegate operation of the business to an officer or management
company, the ultimate control must be retained by the board.
d)Provisional
Directors--some statutes allow them to be appointed by court if the
board is deadlocked and corporate business is endangered. a provisional dir
serves until the deadlock is broken or until removed by a court order or by
majority of shs.
e)Voting
Agreements--an agreement in advance among dirs as to how they will vote
is void as contrary to public policy. There are certain exceptions for
statutory close corps.
4.COMPENSATION--dirs
are NOT entitled to compensation unless they render extraordinary services or
such compensation is otherwise provided for. Officers are entitled to
reasonable compensation for services.
5.DIRECTORS’
RIGHTS, DUTIES, AND LIABILITIES
a)Right to Inspect Corporate Records--if done in good faith for purposes germane to
his position as dir, this right is absolute.
b)Duty
of Care--dirs must exercise the care of an ordinarily prudent and
diligent person in a like position, under similar circumstances. There is
no liability (absent a conflict of interest, bad faith, illegality, or gross
negligence) for errors of judgment (business judgment rule--the
rebuttable presumption that action was taken on an informed basis, in good
faith and exercising reasonable care), but the dir must have been reasonably
diligent before the rule can be invoked (Shlensky)
1)The duty of care requires:
I)Education--a dir should acquire at least a rudimentary understanding
of the business of the corporation;
ii)Information--a dir is under a continuing obligation to keep informed
about the activities of the corp;
iii)Participation--dirs must “generally monitor” corporate affairs, but
need NOT involve themselves in the day-to-day operations; (i.e. they should
attend board of dirs meetings with reasonable regularity).
iiii)Inquiry--a dir has a duty to inquire when circumstances would
alert a reasonable person for the need of inquiry.
iiiii)Action--where wrongdoing is revealed, a dir should object,
correct, or resign. Object to the course of conduct, steer toward correction,
and resign if it isn’t corrected.
2)Extent of liability--dirs are personally liable for corporate losses
directly resulting from their breach of duty or negligence in falling to
discover wrongdoing. a director may seek to avoid being held personally liable
for acts of the board by recording his dissent.
I)Many statutes permit the articles to abolish or limit dir’s liability for
breach of the duty of care absent bad faith, intentional misconduct, or knowing
violation of law.
3)Defenses to liability--these include good faith reliance on management
or expert’s reports. Disabilities may be considered in determining whether the
dir has met the standard of care.
c)Duty
of Loyalty--a catch-all duty designed to prevent unfairness--the duty
to act in good faith (BJR applies). Application:
1)Self-dealing transactions
I)Common Law:
(1)early absolute prohibition against self-dealing renders transactions void
or voidable;
(2)permissive self-dealing: dirs and officers may contract with the corp if
(a)done in “strictest good faith.”; (b)with full
disclosure; and (c)consent of “all concerned.”
[1]--burden of proof is on the dir to establish good faith, honesty &
fairness;
[2]--courts weigh self-dealing transactions with “closest scrutiny”
(3)self-dealing prohibition also applies to intercorporate transactions where
dirs are common.
ii)Statutory (example):
(1)quasi-safe harbor approach (Iowa statute)--transaction is not void or
voidable because of dirs’ interest, if either:
[1]--interest is disclosed and approval is made without counting the vote of
the interested dir.
[2]--interest is disclosed to shs and shs authorize
[3]--transaction is fair and reasonable
(2)Note--dir must still establish that he acted in good faith, honesty, and
fairness
2)Domination of subsidiary by parent--courts look at the transaction to
see if self-dealing has occurred. Example (Sinclair Oil):
I)declaration of dividends shared pro rata was NOT self-dealing; BJR applies
ii)contract between parent and sub was self-dealing; apply intrinsic fairness
test
3)Manager’s compensation:
I)Ordinary corporations--conflicts are inevitable but all firms need to
set compensation. The burden of proof is placed on challengers as a matter of
convenience.
ii)Close corporations--the income generated by the firm may be diverted
to salaries, so there is an option for self-dealing by the parties in control
to take tax-advantaged compensation in the form of salaries (taxed once) as
opposed to dividends (taxed twice).
d)Statutory
Duties and Liabilities--in addition to general duty of care, federal
and state laws also impose certain duties and liabilities, e.g., registration
requirements under the Securities Act of 1933, liability for rule 10b-5
violations, liability for illegal dividends. Some statutes also impose criminal
liability on corporate managers for unlawful corporate actions.
C.OFFICERS
1.ELECTION--officers
are usually elected by the board of dirs. Some statutes permit election of
officers by shs.
2.AUTHORITY
OF CORPORATE OFFICERS (liability of corp to outsiders)--only authorized
officers can bind the corp. Authority may be: actual (expressed in
bylaws or by valid board resolution), apparent (corp gives third parties
reason to believe authority exists), or power of position (inherent to
position). If ratified by the board, even unauthorized acts can bind the
corp.
a)Authority
of President--the majority rule is that the president has the power to
bind the corp in transactions arising in regular course of business.
3.DUTIES
OF CORPORATE OFFICERS--the duty of care owed by a officer is similar to
that owed by dirs ( and sometimes higher).
D.CONFLICTS
OF INTEREST IN CORPORATE TRANSACTIONS.
1.DUTY
OF LOYALTY--because of their fiduciary relationship with the corp, officers
and dirs have the duty to promote the interests of the corp without regard for
personal gain.
2.BUSINESS
DEALINGS WITH THE CORPORATION--conflict of interest issues arise when a
corp transacts business with one of its officers or dirs, or with a company in
which an officer or dir is financially interested.
a)Effect
of Self-Interest on Right to Participate in Meeting--most statutes
permit an “interested” dir to be counted toward quorum, and interested dir’s
transactions are NOT automatically voidable by the corp because the interested
dir’s vote was necessary for approval.
b)Voidability
Because of Director’s Self-Interest--today, such transactions are
voidable only if unfair to the corporation. The burden of establishing
fairness is on the interested director. Note that a dir’s failure to fully
disclose material facts may be per se unfair.
1)Unanimous
shareholder ratification--if, after full disclosure, shareholder
ratification is unanimous, the corp will be estopped from challenging the
transaction with the interested dir (except at to creditors).
I)Less-than-unanimous ratification--courts then will look at whether the
majority shares were owned or controlled by the interested director. Courts are
more likely to uphold ratification by a disinterested majority so as to
preclude the transaction from being attacked by the corp or by a sh in a
derivative suit.
2)Statutes--most statutes provide that such transactions are NOT
voidable if: (1)approved, after full disclosure, by a disinterested board
majority or by majority of shs, or (2)the transaction is fair to the
corp notwithstanding disclosure.
I)”Interested”--an “interested” dir or officer is one who has a
business, financial, or familial relationship with a party to the transaction
that would reasonably affect the person’s judgment so as to adversely affect
the corp.
c)Remedies--the
corp may rescind, or affirm and sue for damages.
3.INTERLOCKING
DIRECTORATES--generally, transactions between corps with common dirs are
subject to the same rules of interested director transactions. There is no
conflict of interest if one corp is the wholly owned subsidiary of the other.
However, a question of fairness arises where the parent owns only a majority of
the subsidiary’s shares.
4.CORPORATE
OPPORTUNITY DOCTRINE (Also see duty of loyalty)
a)Definition--COD
bars dirs from taking any business opportunity belonging to the corp without
first offering it to the corp.. If the corp is unwilling to pursue an
opportunity (after an independent board is fully informed of the opportunity),
then the dir may pursue it.
b)Defenses
(available in most, but not all jurisdictions):
1)Inability--If the corp is legally or financially unable to take
the opportunity, then the dir generally may take advantage of it. (But the
question of who caused the financial inability is quite relevant. Example: Irving
Trust Co--the defense of inability was rejected).
2)Rejection, abandonment, or approval--then the fiduciary has a valid
defense.
c)Remedies--constructive
trust or damages--the fiduciary must account to the firm for all the profits he
has made as a result of usurpation.
d)Definition
of a Corporate Opportunity:
1)Line of business test--does the firm have fundamental knowledge,
practical experience, and ability to pursue the opportunity? If yes, then it is
within the firm’s line of business. It should be a natural fit, and not a mere
desire by a firm to pursue the opportunity.
2)Interest/expectancy test
e)Application--Guth
Rule and Corollary:
1)Guth rule (offered in corporate capacity)--if there is
presented to O/D a business opportunity which the corp is (1)financially able
to undertake, which is from its nature (2a) in the line of business and is of
practical advantage to it OR (2b)is one in which the corp has an interest or
reasonable expectancy (under an established corporate policy or plan), and,
(3)by embracing the opportunity the self-interest of the dir will be brought
into conflict with that of his corp, then officer or dir may NOT take the
opportunity.
2)Guth corollary (a safe harbor; satisfy all provisions and dir can
take)--if a business opportunity (1)comes to O/D in his individual capacity
and (2) is not essential to the corp and is (3)one in which corp has no
interest or expectancy, then the O/D can treat it as his own, IF he has not
taken corporate resources to pursue the opportunity.
I)”Essential”--indispensably necessary to the continued viability of the
firm;
ii)Individual
or corporate? Look at O/D capacity to determine how offer was made
5.COMPETING
WITH CORPORATION--such competition by a dir or officer may be a breach of
fiduciary duty even when the competing business is not a corporate
opportunity
6.COMPENSATION
FOR SERVICES TO THE CORPORATION--the compensation plan must be duly
authorized by the board, and its terms must be reasonable. Good faith and the
BJR ordinarily protect disinterested dirs from liability to the corp for
approving compensation.
a)Publicly
Held Corporations--The SEC has authorized shs to make proposals about
executive pay in management’s proxy statements. Further, the tax code now
limits expense deductions for executive pay over $1mln, unless it is tied to
the corp’s performance.
b)Past
and Future Services--compensation for past services is generally
invalid. Compensation for future services is proper if there is
reasonable assurance that the corp will receive the benefit of the services.
VI.INSIDER
TRADING--purchase or sale
of securities by someone with access to material
nonpublic
information. It may be illegal. It affects corps with more than $1 mln in total
assets and with at least 500/750 shs.
a)Who
may be hurt by insider trading:
1)Target shareholders--they sell too early;
2)Other
arbitrageurs--they lose a portion of the gain that they make from honest
effort
3)Other issuers--they lose confidence in the stock market
4)The acquiring company--insider trading drives up their cost of
acquisition, since the target may adopt defensive measures otherwise not in
place.
b)Possible
Sources of Liability:
1)Common Law;
2)10b-5 traditional;
3)10b-5 misappropriation theory (O’Hagan);
4)Mail
or wire fraud;
5)14e-3;
6)Statutory liability under 16(b)--insiders are forced to give their profits to
the corp, if the y buy and sell securities within a 6-month period regardless
of whether they are using insider info. (Need to know 2, 3, 6)
c)O’Hagan--insider
trading violation where a partner in law firm took info rom his firm regarding
the firm’s client’s plans for acquisition of Pillsbury and used that info to
buy shares in Pillsbury
d)Penalties
For Insider Trading--ITSA (Insider Trading Sanctions Act)--3 measures:
1)Out-of-pocket measure--if a sh buys a share for $10, while in fact it
costs $9, his out-of-pocket expense is $1.
2)Causation-in-fact--because an insider engaged in insider trading, it
caused a loss
3)Disgorgement--we look at D’s profit. ITSA measures the damage to sh by
the amount of profit that D received from the transaction.
2)SEC civil penalties--treble damages; SEC may seek penalty capped by
three times profit gained or loss avoided.
A.COMMON
LAW--under the majority rule, there was no duty to disclose to the
shs inside info affecting the value of shares. Therefore, the protection of
investors was very weak.
a)For
lability to exist there should be:
1)At least fraud or deceit upon purchasers;
2)May
also be a device or scheme;
3)May also be an implied misrepresentation.
b)Two
Elements (relationship and unfairness):
1)Relationship--existence of a relationship giving access, directly or
indirectly, to information intended to be available for a
corporate purpose and no other.
I)Insiders include at least officers, dirs, controlling shs (In re Cady
Roberts)
ii)Persons charged with confidentiality by contractual or fiduciary
relationship
2)Unfairness--inherent unfairness that results when a party takes
advantage of such information knowing it is unavailable to person with whom he
is dealing.
B.SECURITIES
EXCHANGE ACT OF 1934--IN GENERAL--the act superseded common law. Section 12
of the Act requires registration of any security traded on a national
exchange, or any equity security (held by 500 or more persons) of a corp with
assets exceeding $5 million.
C.SECTION
10(B) AND RULE 10B-5--section 10(b) prohibits any manipulation or deception
in the purchase or sale of any security, whether or not it’s registered. Rule
10b-5 prohibits the use of the mails or other instrumentality of interstate
commerce to defraud, misrepresent, or omit a material fact in connection with a
purchase or sale of any security.
1.COVERED
CONDUCT--rule 10b-5 applies to nondisclosure by dirs or officers, as
well as to misrepresentations. It applies not only to insider trading
but also to any person who makes a misrepresentation in connection with
a purchase or sale of stock.
2.COVERED
SECURITIES--rule 10b-5 applies to the purchase or sale of any security,
registered or unregistered. a jurisdictional limitation requires that the
violation must involve the use of some instrumentality of interstate
commerce.
3.WHO
CAN BRING SUIT UNDER 10B-5--private plaintiffs and the SEC. Private
plaintiffs must be either purchasers or sellers of security.
4.MATERIALITY--for
rule 10b-5 to apply, the information misrepresented or omitted must be material
(i.e., a reasonable sh would consider it important in deciding whether to buy
or to sell).
5.FAULT
REQUIRED (SCIENTER)--a defendant is not liable under rule 10b-5 if he was
without fault or merely negligent. The scienter requirement is satisfied by recklessness
or an intent to deceive, mislead, or convey a false impression. Scienter is
also required for injunctive relief.
a)Recklessness
Defined:
1)D knew the hazard and proceeded nonetheless (subjective test);
2)D proceeded despite what a reasonable person would perceive (objective test);
b)Recklessness
Under PSLRA:
1)Knowing conduct-- yields jointly and severally liable;
2)Non-knowing conduct (e.g., recklessness)--yields fair share
(proportionate liability), found in accordance with special interrogatories.
6.CAUSATION
AND RELIANCE--a plaintiff must prove that violation caused a loss (i.e., he
must establish reliance on the wrongful statement or omission). However, in omission
cases, there is a rebuttable presumption of reliance once materiality is
established.
a)Fraud
On The Market--where securities are traded on a well-developed market
(rather than in a face-to-face transaction), reliance on a misrepresentation
may be shown by alleging reliance on the integrity of the market.
b)Face-to-Face
Misrepresentations--a plaintiff can show actual reliance in these cases
by showing that the misrepresentation was material, testifying that he relied
upon it, and showing that he traded soon after misrepresentation.
7.WHEN
NONDISCLOSURE CONSTITUTES a VIOLATION
a)Mere
Possession of Material Information--generally, nondisclosure of
material, nonpublic information violates rule 10b-5 only when there is a
duty to disclose independent of rule 10b-5
b)Insider
Trading--insiders (dirs, officers, controlling shs and corporate
employees) violate rule 10b-5 by trading on the basis of material, nonpublic
info obtained through their positions. They have a duty to disclose before
trading.
c)Misappropriation--the
liability of noninsiders who wrongfully acquire (misappropriate) material
nonpublic info has not been ruled upon by the US Supreme Court, although some
lower level federal courts have imposed criminal liability.
1)Duty to Employer--using the misappropriation theory, criminal
liability under rule 10b-5 has been imposed where an employee trades on
info used in violation of the employee’s fiduciary duty to his employer. An
employee’s duty to “abstain or disclose” with respect to his ER does NOT extend
to the general public. However, the Insider Trading and Securities Fraud
Enforcement Act of 1988 makes any person who violates rule 10b-5 by trading
while in possession of material, nonpublic info liable to any person
who, contemporaneously to the transaction, purchased or sold securities of the
same class. Liability is limited to the defendant’s profit or avoided loss.
2)Mail and wire fraud--the application of the federal mail and wire
fraud statute to this situation lessens the importance of the misappropriation
theory in imposing criminal liability under rule 10b-5.
3)Special rule for tender offers--once substantial steps toward making a
tender offer have begun, it is a fraudulent, deceptive, or manipulative act for
a person possessing material information about the tender offer to purchase or
sell any of the target’s stock, if that person knows that the info is nonpublic
and has been acquired from the bidder, the target, or someone acting on the
bidder’s or the target’s behalf.
d)”Disclose
or Abstain”--nondisclosure by a person with a duty to disclose violates
rule 10b-5 only if he trades (Cady rule)
8.LIABILITY
OF NONTRADING PERSONS FOR MISREPRESENTATION--a nontrading corp or person
who makes a misrepresentation that could cause reasonable investors to rely
thereon in the purchase or sale of securities is liable under rule 10b-5,
provided the scienter requirement is satisfied.
9.LIABILITY
OF NONTRADING CORPORATION FOR NONDISCLOSURE--the basic principle is
“disclose or abstain.” Thus, a nontrading corp is generally not liable under
rule 10b-5 for nondisclosure of material facts.
a)Exceptions--a
corp has a duty to:
1)Correct misleading statements (even if unintentional);
2)Update statements that have become materially misleading by subsequent
events; 3)Correct material errors in statements by
others (e.g, analyst’s report) about the corp, but only if the corp was
involved in the preparation of the statements; and
4)Correct inaccurate rumors resulting from leaks by the corp or its
agents.
10.TIPPEE
AND TIPPER LIABILITY--a person, not an insider, who trades on info received
from an insider is a tippee and may be liable under rule 10b-5 if he received
info through an insider who breached fiduciary duty in giving the info, AND the
tippee knew or should have known of the breach (Dirks)
a)Breach
of Insider’s Fiduciary Duty--whether an insider’s fiduciary duty was
breached depends largely on whether the insider communicated the info to
realize the gain or advantage. Accordingly, tips to friends or relatives and
tips that are a quid pro quo for a past or future benefit from the tippee
result in fiduciary breach. Note that if a tippee is liable, so is the tipper.
11.”TEMPORARY
INSIDERS”--corporate info legitimately revealed to a professional or
consultant (e.g., accountant) working for the corp may make this person a
fiduciary of corp
12.AIDERS
AND ABETTORS--liability cannot be imposed solely because a person aided and
abetted the violation of the rule.
13.APPLICATION
OF RULE 10B-5 TO BREACH OF FIDUCIARY DUTY BY DIRECTORS, OFFICERS, AND
CONTROLLING SHAREHOLDERS.
a)Ordinary
Mismanagement--a breach of fiduciary duty not involving
misrepresentation, nondisclosure, or manipulation does NOT violate rule 10b-5;
b)Misrepresentation
or Nondisclosure--if this is the basis of a purchase from or sale to
the corp by a dir or officer, the corp can sue the fiduciary under rule 10b-5 and
also for breach of fiduciary duty. If the corp doesn’t sue, a minority sh can
maintain a derivative suit on the corporations behalf.
c)Purchase
or Sale By Controlling Shareholder--when a corp purchases stock from or
sells stock to a controlling sh at an unfair price, and material facts aren’t
disclosed to minority shs, a derivative action may lie if the nondisclosure caused
a loss to the minority shs. The plaintiffs must establish causation
by showing that an effective state remedy (e.g., injunction) was foregone
because of nondisclosure.
14.BLUE
CHIP RULE--PRIVATE PLAINTIFF--a plaintiff can bring a private cause of
action only if he actually purchased or sold the relevant securities. “Sale”
includes an exchange of stock for assets, mergers and liquidations, contracts
to sell stock, and pledges. The SEC can bring action under rule 10b-5 even
though it has neither purchased or sold securities.
15.DEFENSES
a)Due
Diligence--if a plaintiff’s reliance on a misrepresentation or omitted
fact could have been prevented by his exercise of due diligence, recovery may
be barred. Mere negligence does NOT constitute a lack of due diligence,
although a plaintiff’s intentional misconduct and his own recklessness (if D
was merely reckless) will bar recovery.
b)In
pari delicto--a private suit for damages under rule 10b-5 will be
barred if:
1)The plaintiff bears substantially equal responsibility for the
violations, AND
2)Preclusion of the suit would not significantly interfere with the
enforcement of securities law.
16.REMEDIES
a)Out-of-pocket
Damages--this is the difference between the price paid for stock and
its actual value.
1)Compare--benefit-of-the-bargain damages--these are measured by the
value of the stock as it really is and the value it would have had if a
misrepresentation had been true.
2)Standard
measure of conventional damages--out-of-pocket damages is the standard
measure in private actions under rule 10b-5; benefit-of-the-bargain damages are
usually not granted.
b)Restitutionary
Relief--this may be sought instead of conventional damages:
1)Rescission--returns the parties to their status quo before the
transaction
2)Rescissionary or Restitutionary damages--money equivalent of
rescission
3)Difference between conventional damages and Restitutionary relief--out-of-pocket
damages are based on the P’s loss, while Restitutionary relief is based on the
D’s wrongful gain. Rescission or Rescissionary damages may be attractive
remedies when the value of the stock changed radically after the transaction.
However, Restitutionary relief is usually unavailable in cases involving
publicly held stock.
c)Remedies
Available to the Government--although the SEC cannot sue for damages,
it can pursue several remedies including special monetary remedies:
1)Injunctive Relief--the SEC often seeks injunctive relief accompanied with a
request for disgorgement of profits or other payments that can be subject to criminal
sanctions (fines and jail sentences) and civil penalties (up to
three times the profit gained or loss avoided).
17.JURISDICTION,
VENUE, AND SERVICE OF PROCESS--suits under 10b-5 are based on the 1934 Act,
and exclusive jurisdiction is in the federal district courts. State
claims arising out of the same transactions may be joined with the federal
claim under the supplemental jurisdiction doctrine. Venue can be wherever any
act or transaction constituting a violation occurred, or where the D is found
or transacts business. Process can be served where the D can be found or where
he lives.
18.STATUTE
OF LIMITATIONS--the 1934 Act contains no SOL; however, the SCt has held
that private actions must be brought within one year after
discovery of the relevant facts and within three years following accrual
of the cause of action. The tolling doctrine is inapplicable.
a)Exceptions--the
time limitations don’t apply to all rule 10b-5 private actions, e.g., SEC
limitations period of five years for private suits by contemporaneous traders
against purchasers or sellers who violate rules regarding trades while in
possession of material, nonpublic information. Further, the SEC is not subject
to any limitations period in civil enforcement actions.
D.SECTION
16 OF THE 1934 ACT--Section
16 concerns purchases followed by sales, or sales followed by purchases, by
certain insiders, within a six-month period.
1.FIRMS
AND SECURITIES AFFECTED UNDER SECTION 16--Section 16 applies to those firms
and securities that must be registered under section 12 of the 1934 act.
a)Reason--16(a)
references registered securities under S12; S12(a) and 12(g) create the
registration requirement for securities; S12(g)creates an asset ($1 mln total) and
distribution (500 to 700 depending on timing); 16(b) references “such”
officers, etc., which refers to sub(a)
b)Note--trading
in all of a corp’s equity securities is subject to section 16 if any
class of its securities is registered under section 12.
2.DISCLOSURE
REQUIREMENT--Section 16(a) requires every beneficial owner of more
than 10% of the registered stock and directors and officers of the
issuing corp to file periodic reports with the SEC showing their holdings and
any changes in their holdings.
a)Who
is an Officer (16a-1f)--issuer’s president, principal financial
director, principal accounting officer, any vice-president of the issuer in
charge of a principal business unit, any other officer who performs similar
policy-making functions for the issuer.
3.LIABILITY--to
prevent the unfair use of information, section 16(b) allows a corp to recover
profits made by an officer, dir, or more-than-10% beneficial owner on the
purchase and sale or sale and purchase of its securities within a
six-month period.
a)Coverage--Section
16(b) does NOT cover all insider trading and is NOT limited to trades based on
inside info. The critical element is short-swing trading by officers, dirs, and
more-than-10% beneficial owners.
1)Note--beneficial owner must own 10% or more BOTH at he time of sale
and purchase to be liable under 16(b).
b)Calculation
of short-swing profit--the profit recoverable is the difference between
the price of the stock sold and the price of the stock purchased within six
month before or after the sale.
1)Multiple transactions--if there is more than one purchase or sale
transaction within the six-month period, the transactions are paired by
matching the highest sale price with the lowest purchase price, the next
highest price with the next lowest price, etc. a court can look six month
forward or backward from any sale to find a purchase, or from any purchase to
find a sale
c)Who
May Recover--the profit belongs to the corp alone. Although not a
typical derivative action, if the corp fails to sue after a demand by a sh, the
sh may sue on the corp’s behalf. The cause of action is federal, so there is no
posting of security requirement, and no contemporaneous sh requirement. Remedy:
1)All sales and purchases within 6 months are included;
2)Damages calculated as to maximize the gain to he company;
3)Match highest sale price against lowest purchase price within relevant
period; continue until you can go no further.
d)Insiders--insiders
are officers (named officers and those persons functioning as officers), dirs
(actually serving or who authorized deputization of another), and beneficial
owners of more than 10% of the shares. Insider status for officers and dirs is
determined at the time they made a purchase or sale. Transactions made before
taking office is NOT within section 16(b), but those made after leaving office
are subject to the statute if they can be matched with a transaction made while
in office. Liability is imposed on a beneficial owner only if he owned more
than 10% of the shares at the time of both the purchase and sale.
e)”Purchase
or Sale”--this includes any purchase of stock. Unorthodox transactions
that result in the acquisition or deposition of stock (e.g., merger for stock,
redemption of stock) are also purchases and sales.
E.SECTION
16(B) COMPARED TO RULE 10B-5:
a)Covered
Securities--Section 16(b) applies to securities registered under
the 1934 act; rule 10b-5 applies to all securities.
b)Inside
Information--Section 16(b) allows recovery for short-swing profits regardless
of whether they are attributable to misrepresentations or inside info; rule
10b-5 recovery is available only where there was a misrepresentation or
a trade based on inside info.
c)Plaintiff--recovery
under section 16(b) belongs to the corp, while rule 10b-5 recovery belongs to
the injured purchaser or seller.
d)Overlapping
Liability--it is possible that insiders who make short-swing profits by
use of inside info could be liable under both section 16(b) and rule 10b-5.
F.COMMON
LAW LIABILITY FOR INSIDER TRADING--insider trading constitutes breach of
fiduciary duties owed to the corp, so the corp can recover profits made from
insider trading
a)Common
Law Liability Compared To Section 16(b) Liability--both common law and
section 16(b) liability run against insiders and in favor of the corp. However,
unlike section 16(b), the common law theory applies to all corps (not
just those with registered securities), recovery can be had against
any corporate insider, the purchase and sale is NOT limited by a six-month
period, and the transaction must be based on the inside info.
b)Common
Law Liability Compared to Rule 10b-5 Liability--the theories of
recovery are similar except that under the common law recovery runs to the corp
(not to the injured purchaser or seller), there is no purchaser or seller
requirement, and noninsiders (tippees) have not yet been held liable.
VII.RIGHTS OF
SHAREHOLDERS
A.VOTING
RIGHTS
1.RIGHT
TO VOTE IN GENERAL--shs may generally vote for the election and removal of
dirs, to amend the articles or bylaws, and on major corporate action or
fundamental changes.
a)Who
May Vote--the right to vote is held by shs of record as of the record
date;
b)Restrictions
on Right--shares may be either voting or nonvoting, or have multiple
votes per share.
2.SHAREHOLDER
MEETINGS--generally, shs can act only at meetings duly called and noticed
at which a quorum is present.
a)Compare--informal
action--statutes permit sh action without a meeting if there is
unanimous written consent of all shs entitled to vote.
3.SHAREHOLDER
VOTING
a)Straight
Voting--this system of voting allows one vote for each share
held and applies to all matters other than director elections, which may be
subject to cumulative voting. Certain fundamental changes (e.g., merger)
frequently require higher shareholder approval.
b)Cumulative
Voting For Director--this system allows each share one vote for each
director to be elected, and the votes may be cast all for one candidate or
divided among candidates as the sh chooses, thereby helping minority shs to
elect a dir. Cumulative voting may be mandatory or permissive.
4.VOTING
BY PROXY--a proxy authorizes another person to vote a shareholder’s shares.
The proxy usually must be in writing, and its effective period is
statutorily limited unless it is validly irrevocable.
a)Revocability--a
proxy is normally revocable by the sh at any time, although it may be made
irrevocable if expressly stated and coupled with an interest in
the shares themselves. Absent written notice to the corp, the death or
incapacity of a sh does NOT revoke a proxy. a sh may revoke a proxy by
notifying the proxy holder, giving a new proxy to someone else, or by
personally attending the meeting and voting.
b)Proxy
Solicitation--almost all shs of publicly held corps vote by proxy.
Solicitations of proxies are regulated by the Securities Exchanges Act of 1934
Section 14a, federal proxy rules and, in some cases, state law. Federal proxy
rules apply to the solicitation of all proxies of registered securities, but NOT
to nonmanagement solicitation of 10 or fewer shs. The term “solicitation” is
broadly interpreted by the SEC to include any part of a plan leading to a
formal solicitation, e.g., inspection of shareholder list.
1)1992 amendments--the SEC revised the proxy rules to make it easier for
shs to communicate with each other. Significant changes include: a safe harbor
for communications that don’t involve solicitation of voting authority,
relaxation of requirements involving broadcast of published communications,
relaxed preliminary filing requirements for solicitations, and removing
communications between shs concerning proxy voting from definition of
“solicitation.”
2)Requirement of Full Disclosure--the proxy rules require full and
accurate disclosure of all pertinent facts and the identities of all proxy
participants, disclosure of compensation paid to certain officers and dirs, and
disclosure of conflict-of-interest transactions involving more than $60, 000.
3)Inclusion of Shareholder Proposal--shareholder proposals must be
included in corporate proxy materials if the proponent is a record owner or
beneficial owner of at least 1% or $1000 worth of securities entitled to vote
on the matter. The proposal must not exceed 500 words.
I)Exceptions--a proposal need NOT be included if it: is not a proper
subject for shareholder action, would be illegal, is false or misleading, seeks
redress of a personal claim, relates to operations accounting to less than 5%
of the corp’s total assets and is not otherwise related to the corp’s business,
concerns a matter beyond the corp’s power to effectuate, relates to ordinary
business operations, relates to an election to office, is counter to a proposal
submitted by the corp at the same meeting, is moot or duplicate, deals with the
same subject matter as a very unsuccessful prior proposal, or relates to
specific amounts of cash or stock dividends.
ii)Private right of action--a private right of action is available to a
sh whose proposal was rejected by the corp on the ground that it fails within
one of the exceptions.
iii)Providing shareholder lists--a sh has a right to obtain a list of
shs or to have his communication included with the corporate proxy materials.
4)Remedies for violation of proxy rules--these include suit by the SEC
to enjoin violations or to set aside an election and individual suits, class
actions, or derivative suits by the shs (In a private suit, the P must show materiality
and causation, but causation is normally presumed from materiality.
Fairness to the corp is NOT a defense to a violation of proxy rules ). The
court may rescind corporate action resulting from a misleading proxy
solicitation or award damages.
c)Expenses
Incurred In Proxy Contests--corporate funds may be used by management
with respect to reasonable proxy solicitation expenses incurred in order to
obtain a quorum for the annual meeting or regarding controversy over corporate
policy (as opposed to a personnel controversy). The corp may, with sh approval,
voluntarily pay the reasonable expenses to insurgents who win a proxy
contest involving policy.
5.OTHER
METHODS TO COMBINE VOTES FOR CONTROL (CLOSE CORPORATIONS)--other
methods include shareholder voting agreements which may be enforced by specific
performance, agreements regarding greater-than-majority approval, shareholder
agreements binding the discretion of dirs, and voting trusts.
B.RESTRICTIONS
ON TRANSFER OF SHARES--although most frequently used in close corps, stock
transfer restrictions may also be imposed by larger corps (e.g., to restrict
ownership to employees). The two most common types of restriction are a right
of first refusal and a mandatory sell-buy provision. Restrictions
must be reasonable and will be strictly construed.
a)Notice
Requirements--a lawful stock transfer restriction is of no effect
unless noted conspicuously on the stock certificate. If there is no such
notice, an innocent transferee is entitled ti have the shares transferred to
him.
C.SHAREHOLDERS’
INFORMATIONAL RIGHTS:
1.TYPES
OF BOOKS AND RECORDS--these include shareholder lists, minutes, financial
records, and business documents.
2.COMMON
LAW--at CL, a sh has a right to inspect records for proper purpose.
3.STATUTES--statutes
govern these rights in most states. Many statutes apply only to certain shs but
are usually interpreted to supplement the common law. Most statutes preserve
the proper purpose test, but place the burden on the corp to prove improper
purpose.
4.PROPER VERSUS IMPROPER PURPOSES--the test is whether the sh is seeking to protect the sh interest.
Multiple purposes that include a proper one usually will not preclude
inspection. Generally, a sh can inspect the sh list because it is often
necessary to the exercise of other rights like proxy fights, sh litigation,
etc. Inspection of a sh list for proxy contest is a proper purpose. However, it
has been held that corporate records cannot be examined solely for the purpose
of advancing political and social views or to aid a sh as a litigant on a
personal, non-shareholder claim.
5.COMPARE--MANDATORY
DISCLOSURE OF INFORMATION--a sh’s inspection right is separate and distinct
from the statutory requirements governing the affirmative disclosure of certain
information by corps (e.g., Section 12 of Securities Exchange Act of 1934,
proxy rules, state statutes).
D.FIDUCIARY
OBLIGATIONS OF CONTROLLING SHAREHOLDERS--a controlling sh owes a fiduciary
duty in his business dealings with the corp, in taking advantage of corp
opportunities (rules more lenient than those applied to dirs and officers), and
in causing fundamental changes.
1.ACTIONS
ENTIRELY IN SHAREHOLDER CAPACITY--a controlling sh must NOT act to benefit
himself at the expense of the minority shs; i.e., in a transaction where
control of the corp is material, he must act with good faith and inherent
fairness toward the minority.
2.OBLIGATIONS
OF SHAREHOLDERS IN CLOSE CORPORATIONS--both majority and minority shs owe
each other an even stricter duty (utmost good faith and loyalty) than is owed
by controlling shs in publicly held corps. This duty has been interpreted to
mean that there must be equal treatment of all shs, i.e., they must be
afforded equal opportunities.
3.DISCLOSURE--a
controlling sh must make full disclosure when dealing with minority shs.
4.SALE
OF CONTROL--in most jurisdictions, a controlling sh is permitted to sell
his stock at a premium, i.e, a price not available to other shs. Exceptions to
these rule include a bare sale of office (invalid), the corporate action
theory, sales involving fraud or nondisclosure, and knowing sales to
transferees who plan to loot or deal unfairly with the corp.
E.SHAREHOLDER
SUITS
1.DIRECT
(INDIVIDUAL) SUITS--a direct suit may be brought by a sh on his own
behalf for injuries to sh interests. If the injury affects a number of shs,
the suit may be brought as a class action.
2.DERIVATIVE
SUITS--if a duty owed to the corp has been abridged, suit may be brought by
a sh on behalf of the corp.
a)Distinguish
Direct From Derivative Suits--the test is whether the injury was
suffered by the corp directly or by the sh, and to whom the D’s duty was owed
1)Close corporations--in some cases, minority shs have been allowed to
bring a direct action against controlling shs for breach of fiduciary duty
b)Prerequisite
to Suit--Exhaustion of Corporate Remedies--the P-sh must specifically
plead and prove that he exhausted his remedies within the corporate structure
1)Demand on directors--the P-sh must make a demand on the dirs to remedy
the wrong, unless such demand would have been futile. Note that in the absence
of negligence, self-interest, or bias, the fact that a majority of dirs
approved the transaction does NOT itself excuse the demand.
I)Model
statutes--under both model statutes, demand should be excused only if it is
shown that irreparable injury to the corp would result;
ii)Effect of rejection of demand--if the matter complained of does not
involve wrongdoing by the dirs, the board’s good faith refusal to sue bars the
action, unless the P-sh can raise a reasonable doubt that the board exercised
reasonable business judgment in declining to sue. If the suit alleges
wrongdoing by a majority of dirs, the board’s decision not to sue will NOT
prevent the derivative suit.
2)Demand on shareholders--in most states, the p-sh must also make a
demand on shs unless excused (e.g., the alleged wrongdoing is beyond the power
of the shs to ratify). Where demand on shs is required, a good faith refusal to
sue by the majority of disinterested shs will preclude the suit.
c)Qualifications
of Plaintiff--a few states require the P to be a registered sh; most
states also allow a beneficial owner of shares to bring suit. Also, a sh of a
parent corp can bring a derivative suit on a subsidiary’s cause of action. Shs
cannot complain of wrongs committed before they purchased their shares except:
1)where the P acquires shares by operation of law;
2)in section 16(b) violations;
3)where serious injustice will result;
4)where the wrong is continuing in nature.
The P must
fairly and adequately represent the interests of all shs
d)Securities
For Expenses--in a number of states, the P, under certain
circumstances, must post a bond to indemnify the corp against certain of its
litigation expenses, including attorney’s fees, in the event the P loses the
suit. a p-sh who loses may also be liable for the court costs incurred by the
parties.
e)Defenses--defenses
to derivative suit include the SOL and equitable defenses (laches, unclean
hands, etc);
f)Settlement
And Recovery--any settlement or judgment belongs to the corp, absent
special circumstances. Settlement or dismissal of the suit is generally subject
to court approval after notice to all shs.
g)Reimbursement
to Plaintiff--a victorious plaintiff may be entitled to reimbursement
from the corp for litigation expenses;
h)Indemnification
of Officers And Directors--indemnification issues arise when officers
and dirs are sued for conduct undertaken in their official capacity. If the
officer or dir wins on the merits, he may be indemnified. Most statutes also
authorize the corp to advance (not pay) expenses in defending against the
claim. Statutes vary where the officer or dir settles or loses; they are most
liberal concerning indemnification in a third-party suit as opposed to a
derivative suit.
I)Liability
Insurance--in most states, a corp can obtain liability insurance for
its indemnification costs and for any liability incurred by its officers in
serving the corporation.