P A R T P A R T Corporations History & Nature of Corporations Organizational and Financial Structure of Corporations Management of Corporations 10 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

P A R T P A R T Corporations Shareholders’ Rights & Liabilities Securities Regulation Legal & Professional Responsibilities of Auditors, Consultants, and Securities Professionals 10 McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

Shareholders’ Rights and Liabilities PA E TR HC 44 “Management have been allowed to act like owners. But it is the stockholders who own companies …and the stockholders are just beginning to realize it.” T.Boone Pickens, Sunday Times (London, Dec. 1, 1985)

Learning Objectives  Shareholders’ meetings  Shareholders’ and dissenters’ rights  Distributions to shareholders  Shareholders’ lawsuits  Shareholder liability  Dissolution and termination of corporations

 Shareholders are the owners, but not the managers of a corporation  Shareholder rights in a publicly-owned corporation are limited to electing and removing directors at the annual meeting, approving vital matters at special meetings, and ensuring that management actions are consistent with state corporation statutes, bylaws, and articles of incorporation Overview

 Notice of meetings must be given to shareholders of record (entitled to vote) as of date fixed by the board  A quorum of outstanding shares required  Issues decided by majority of votes  Shareholders have right of full participation, including right to offer resolutions, speak for or against proposed resolutions, and ask questions of corporate officers Conduct of Meetings

 Directors generally elected by a single class of shareholders in straight voting : each share has one vote for each director-nominee  Majority shareholder could elect entire board  Cumulative voting : shareholders accumulate votes by multiplying number of directors to elect by the number of shares held  Class voting : each class may be entitled to elect one or more directors to balance power Voting

 Voting Trusts: shareholders transfer their shares to one or more voting trustees to achieve control of corporation  Shareholder Voting Agreements: shareholders may agree how they will vote their shares  Proxies: shareholder may appoint a proxy to vote his/her shares; allows minority owners to collectively own a majority of shares Other Shareholder Devices

 Amendment of the articles of incorporation  Merger : First corporation dissolves into second corporation  Consolidation: Two corporations join to create a new corporation  Share exchange : One corporation becomes owner of all outstanding shares of second corporation through compulsory exchange Changes Requiring Shareholder Action

 Sale of all or substantially all of the assets of the business other than in regular course of business  Drastically changes shareholders’ investment  Dissolution : First step in the termination of the corporation’s business Changes Requiring Shareholder Action

 MBCA grants shareholders an absolute right of inspection of the shareholder list and the articles, bylaws, and minutes of shareholder meetings within the past three years  Shareholders have right to receive important information about the corporation, such as financial statements, including a balance sheet, an income statement, and a statement of changes in shareholders’ equity Shareholder Rights of Inspection

 Shareholders may receive asset distributions as cash or property dividends  Statutes limit extent to which dividends paid  Corporation may distribute “new” shares to shareholders instead of cash or property  Corporation may also distribute assets by repurchasing shares from its shareholders  Right of redemption or open-market repurchase Distributions to Shareholders

 A shareholder has right to file suit to prevent or redress a breach of shareholder’s contract  If several shareholders similarly affected by a wrongful act, a shareholder may bring a class action on behalf of affected shareholders  One or more shareholders may bring a derivative action for the corporation if board fails to pursue a cause of action against a firm that harmed the corporation Shareholder Lawsuits

 Person bringing suit (1) must be a current shareholder who held shares at time alleged wrong occurred, and (2) first demand that board of directors bring the suit  If board refuses, shareholder cannot bring derivative action since business judgment rule insulates board’s decision  Shareholder may still sue directors! Derivative Action Rules

 Shareholder may be liable to corporation if:  Dividends or distributions received with knowledge of illegality  Shareholder responsible for defective incorporation or piercing corporate veil  Shares sold wrongfully for premium over fair market value of minority shares  Controlling shareholder controls corporation unfairly and thus breaches the fiduciary duty Shareholder Liability

 With a few exceptions, rules for nonprofit corporation meetings, voting, and inspection are similar to rules of corporations for profit  A nonprofit corporation (e.g., country club) generally is prohibited from making asset distributions to members Nonprofit Corporations

 Voluntary dissolution : corporation must file articles of dissolution with secretary of state  Involuntary dissolution : without corporation’s consent by judicial action or administrative action of the secretary of state  Dissolved corporation continues for sole purpose of winding up: orderly collection and disposal ( liquidation ) of assets and distribution of proceeds from sale of assets Dissolution & Winding Up

 Distribution of proceeds: creditor claims are paid first, then preferred shareholders, then common shareholders  After completing winding up process, corporation’s existence terminates Termination

Test Your Knowledge  True=A, False = B  Shareholders are the owners and managers of a corporation.  In a shareholder’s meeting, issues are decided by majority vote and a quorum is required.  In class voting, each shareholder class may be entitled to elect one or more directors to balance power  The board of directors has the sole power to dissolve a corporation

Test Your Knowledge  True=A, False = B  In a shareholder voting agreement, each shareholder appoints someone to vote his/her shares.  Corporations may only distribute cash or property dividends to shareholders.  Shareholders have no duty to the corporation.  In a merger, the first corporation dissolves into the second corporation

Test Your Knowledge  Multiple Choice  Which of the following actions does not require shareholder approval?  (a) Consolidating two companies  (b) Amending the articles of incorporation  (c) Dissolving the corporation  (d) Merger of the corporation into another  (e) Acquiring another corporation’s assets

Test Your Knowledge  Multiple Choice  Candy Corp. lost $1 million in sales when SweetsLLC made serious, defamatory statements about Candy Corp. to the press. Bob Cratchit, a shareholder, brought a lawsuit on behalf of Candy Corp. against SweetsLLC. Which of the following is true?  (a) Bob Cratchit brought a class action  (b) Bob Cratchit brought a derivative action  (c) Bob Cratchit brought an illegal action

Thought Question  Is it ethical for a Shareholders Litigation Committee or directors to recommend dismissing an action against officers who, like some in the Adelphia, Tyco, and Enron scandals, either looted the corporation or caused it to overstate earnings or understate liabilities?