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Chapter 38
Corporations – Directors,
Officers, and Shareholders
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§ 1: The Role of Directors
Every corporation is governed by a board of
directors that are elected by the shareholders.
Individual directors are not agents of corporation,
only the board itself can act as a “super-agent”
and bind the corporation.
A director can also be a shareholder, especially in
closely-held corporations.
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Election of Directors
Subject to statutory limitations, the number
of directors is set forth in the articles of
incorporation:
 Directors appointed at the first organizational
meeting.
 In closely held companies, directors are generally
the incorporators and/or the shareholders.
 Term of office is generally for one year.
 Director can be removed for cause (for failing to
perform a required duty).
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Directors’ Meetings
Directors hold meetings pursuant to bylaws with
recorded minutes.
Special meetings may be called with sufficient
notice.
Meetings require QUORUM (minimum number
of directors to conduct official corporate
business, usually majority).
Each director generally has one vote.
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Rights of Directors
Directors have the right to:
 Participate in corporate decisions and inspect
corporate books and records.
 Compensation (usually a nominal sum) and
indemnification. If a director is sued for acts as
director, the corporation should guarantee
reimbursement (indemnification) or purchase liability
insurance to protect the board from personal liability.
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Directors’ Management
Responsibilities
Directors have general responsibility for all
management decisions:
 All major corporate policies
 Appointment and removal of all corporate officers
and their compensation.
 Financial decisions, including dividends and retained
earnings.
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§2: Rights of Officers
Officers serve at the pleasure of the Board of
Directors but have fiduciary duties to company
as well.
Their employment relationships are generally
governed by contract law and employment law.
Officers may be terminated for cause.
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§ 2: Role of Corporate Officers
and Executives
Officers and executives are hired by the board of
directors.
Act as agents for the corporation.
Most states same person can be both officer and
director.
Officers are employees of the corporation and
have fiduciary and loyalty duties.
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§ 3: Fiduciary Duties of
Directors and Officers
Directors and officers are fiduciaries of the
corporation. They owe ethical and legal duties to
the corporation and shareholders:
Duty of Care : Directors/officers are expected to
act in good faith and the best interests of the
corporation. Failure to exercise due care may
subject individual directors or officers personally
liable.
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Fiduciary Duties of
Directors and Officers
[2]
Duty of Care (cont’d):
 Make informed and reasonable decisions;
 Rely on competent consultants and experts; and
 Exercise reasonable supervision.
A dissenting director is rarely held liable for
mismanagement of corporation. Dissent
must be registered with the corporate
secretary and posted in the minutes of the
meetings.
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Fiduciary Duties of
Directors and Officers
[3]
Duty of Loyalty: subordination of personal
interests to the welfare of the corporation.

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
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No competition with Corporation.
No “corporate opportunity.”
No conflict of interests.
No insider trading.
No transaction that is detrimental to minority
shareholders
 Case 38.1: In Re Cumberland Farms (2002).
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Fiduciary Duties of
Directors and Officers
[4]
No Conflicts of Interest: full disclosure of any
potential conflicts of interest and abstain from
voting on any transaction that may benefit the
director/officer personally.
However, if transaction was fair and reasonable,
it will not be voidable if approved by majority of
disinterested directors.
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§ 4: Liability of
Directors and Officers
Directors and officers may be liable for negligent
acts that breach the standard of due care:
 Crimes and torts committed by individually and/or
those committed by employees under their
supervision.
 Shareholder derivative suits where shareholder(s) sue
directors on behalf of corporation].
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Business Judgment Rule
Immunizes a director or officer from
liability from consequences of a business
decision that turned sour.
Court will not require directors or officers
to manage “in hindsight.”
As long as decision was reasonable,
informed, made in good faith and in the best
interests of the corporation, BJR will apply.
Case 35.2: FDIC v. Castetter (1999).
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§ 5: Role of Shareholders
Ownership of shares grants an equitable
ownership interest in a corporation.
Shareholders generally have no right to manage
the daily affairs of the corporation, but do so
indirectly by electing directors.
Shareholders are generally protected from
personally liability by the corporate veil of
limited liability.
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Shareholder Powers
Shareholder powers include approving all
fundamental changes to the corporation:
 Amending articles of incorporation or bylaws.
 Approval of mergers or acquisition.
 Sale of all corporate assets or dissolution.
Shareholders also elect and remove the board of
directors.
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Shareholder Meetings [1]
Shareholders’ meetings must occur at least
annually. Voting requirements and procedures
are:
 Quorum of shareholders owning more than 50% of
shares must be present to conduct business;
 Shareholders may appoint a proxy or enter into a
voting trust agreement.
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Shareholder Meetings [2]
For special shareholder meetings:
 Notice and time of meetings must be sent in writing
to each shareholder within a reasonable time ahead of
the meeting.
 Notice must state reason for meeting and only deal
with this matter.
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Shareholder Voting
Common shareholder entitled to one vote per
share.
Articles and by-laws can exclude or limit voting
rights of certain classes of stock.
Quorum must be present -- shareholders
representing more than 50% of outstanding
shares must be present.
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Shareholder Voting
[2]
Shareholders may vote on resolutions.
 Need majority present for most resolutions.
 Need a “super majority” (e.g., 67%) for important
matters: sale of assets, etc..
Voting lists by corporate secretary contains
record of stock ownership. [Cut off date 70 days
ahead of action (notice, dividends, etc..)]
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Shareholder Voting
[3]
Methods of Increasing Minority Shareholder
Power Within the Corporation:
 Cumulative Voting allows minority shareholders to
get a board member elected.
• x # to be elected x shareholders # of shares = shareholder
can cast them all for one board nominee.
 Shareholder Voting Agreements.
 Voting Trusts—Trustee votes the shares.
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Shareholder Voting
[4]
Proxies and Shareholder proposals under
Securities and Exchange Commission Rule 14a8:
 Proxy solicitation must include proposals which will
be discussed at the meeting.
 Shareholders who own $1,000 worth of stock may
submit their own proxy solicitations.
 Company does not have to include shareholder
proposals which relate to “ordinary business
operations.”
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§ 6: Rights of Shareholders
 Shareholders have the right:

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To vote.
To have a stock certificate.
To purchase newly issued stock.
To dividends, when declared by board.
To inspect corporate records.
To transfer shares, with some exceptions.
To a proportionate share of corporate assets on dissolution.
To file suit on behalf of corporation.
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Stock Certificates
Certificate which evidences ownership in a
certain number of shares in the corporation
given to person of record (regardless of who
has certificate) gets notices, dividends &
reports.
Corporate ownership is intangible personal
property.
Some states allow uncertificated stock -- no
tangible certificate.
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Preemptive Rights
Common law concept, which is a preference to
existing shareholders to purchase a pro-rated
share of newly-issued stock within a certain
period of time.
Provided for in the articles of incorporation.
Significant in a close corporation to prevent
dilution and loss of control.
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Stock Warrants
Transferable options to purchase newly-issued
stock at a stated price.
Warrants are publicly traded.
Called “rights” when option is for a short period
of time.
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Dividends
Distribution of corporate profits or income.
Only as ordered by the Board.
Can be stock, cash, property, stock of other
corporations.
State laws control the sources of revenues for
dividends, which may be paid from retained
earnings, net profits and surplus.
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Illegal Dividends
If dividends paid from an unauthorized account
shareholder must return if she knew they were
illegal when received.
Directors can be held personally liable for the
amount of payment.
Dividends paid when corporation is insolvent are
automatically illegal.
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Directors’ Failure
to Declare Dividends
When directors fail to declare a dividend,
shareholders can sue.
Directors do not have to declare if they have a
rational basis for withholding a dividend (a bona
fide purpose).
Often, profits are retained for expansion,
research or upgrades.
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Inspection Rights
Shareholders can inspect books for a proper
purpose.
 But corporation can protect trade secrets, other
confidential information.
 Shareholder must have held a minimum number of
shares for a minimum amount of time.
All shareholders can see list of other
shareholders of record.
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Transfer of Shares
Shares are freely transferable unless restricted
by articles and noted on the stock certificate.
Closely held corporations may have “right of
first refusal” or preemptive rights.
Transfer accomplished by delivery or
endorsement to corporate secretary.
New shareholder must be recorded on corporate
books.
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Rights on Dissolution
Shareholders have right to pro-rata share of
assets upon liquidation.
Shareholder may petition the court for
dissolution of the corporation for following
reasons:
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Board mishandling corporate assets.
Board deadlocked and irreparable injury will result.
Acts of directors are illegal, oppressive, or fraudulent.
Shareholders are deadlocked for two meetings and can’t elect
directors.
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Shareholder Derivative Suit
Shareholders can sue a 3rd party on behalf of the
corporation if the Directors fail or refuse to
correct the wrong or injury.
Directors may refuse to take action because they
might personally be liable.
Any damages recovered go to corporation’s
treasury.
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§ 7: Liability of Shareholders
Shareholders are generally not liable for the
contracts or torts of the corporation.
If the corporation fails, shareholders cannot lose
more than their investment, except when:
 A shareholder hasn’t paid for stock pursuant to the
subscription agreement.
 Shareholder buys “watered stock” which is below the
stock’s par value.
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Stock Subscription Agreements
Subscriptions are written irrevocable contracts to
purchase capital stock of a corporation prior to
incorporation. Failure to sell or buy shares is a
breach of contract.
Par-value shares: corporation must have a value
equal to the total value of the shares.
Watered stock: worth less than FMV of stock.
Shareholder is personally liable for difference.
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§ 8: Duties of Majority
Shareholders
Majority shareholders own enough shares to
exercise de facto (actual) control over the
corporation.
Majority shareholders owe a fiduciary duty to
corporation and the minority shareholders and
creditors when they sell their shares because of
the possibility of transfer of control.
Case 38.3: Hayes v. Olmsted & Assoc. (2001).
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Law on the Web
SEC Edgar database.
Duties from Majority to Minority
Shareholders.
Legal Research Exercises on the Web.
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