Fundamentals of Business Law

If a group of shareholders perceives that the corporation has suffered a wrong and the directors refuse to take action, can the shareholders compel the directors to act? If so, how?

The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What are the duties of corporate directors and officers?

The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: From what sources may dividends be paid legally? In what circumstances is a dividend illegal? What happens if a dividend is illegally paid?

What must directors do to avoid liability for honest mistakes of judgment and poor business decisions?

From what sources may dividends be paid legally? In what circumstances is a dividend illegal? What happens if a dividend is illegally paid?

Wonder Corporation has an opportunity to buy stock in XL, Inc. The directors decide that instead of Wonder buying the stock, the directors will buy it. Yvon, a Wonder shareholder, learns of the purchase and wants to sue the directors on Wonder's behalf. Can she do it? Explain. (See Shareholders.)

Rights of Shareholders. Lucia has acquired one share of common stock of a multimillion-dollar corporation with more than 500,000 shareholders. Lucia's ownership is so small that she is wondering what her rights are as a shareholder. For example, she wants to know whether owning this one share entitles her to (a) attend and vote at shareholders' meetings, (b) inspect the corporate books, and (c) receive yearly dividends. Discuss Lucia's rights in these three matters. (See Shareholders.)

What must directors do to avoid liability for honest mistakes of judgment and poor business decisions?

Role of Directors. The board of directors of a property management corporation in Oregon meets on a regular basis. The company paid the directors $6,000 each in the third quarter of 2003. It did not report the payments as part of its payroll and did not pay unemployment tax on the payments. The Oregon Employment Department contended that the company owed $700 in unemployment taxes on the payments to the directors. The company protested. The administrative law judge (ALJ) for the Employment Department held that the company owed the taxes because directors' fees are the same as wages for employment. The company appealed. The court of appeals affirmed the ALJ's ruling. The company appealed again. Are payments to directors the same as wages for tax purposes? Explain. [ Necanicum Investment Co. v. Employment Department, 345 Or. 138, 190 P.3d 368 (2008)]

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text. What are the duties of corporate directors and officers?

Liability of Directors. Starboard, Inc., has a board of directors consisting of three members (Ellsworth, Green, and Morino) and approximately five hundred shareholders. At a regular meeting of the board, the board selects Tyson as president of the corporation by a two-to-one vote, with Ellsworth dissenting. The minutes of the meeting do not register Ellsworth's dissenting vote. Later, during an audit, it is discovered that Tyson is a former convict and has openly embezzled $500,000 from Starboard. This loss is not covered by insurance. The corporation wants to hold directors Ellsworth, Green, and Morino liable. Ellsworth claims no liability. Discuss the personal liability of the directors to the corporation. (See Directors and Officers.)

David Brock is on the board of directors of Firm Body Fitness, Inc., which owns a string of fitness clubs in New Mexico. Brock owns 15 percent of the Firm Body stock, and he is also employed as a tanning technician at one of the fitness clubs. After the January financial report showed that Firm Body's tanning division was operating at a substantial net loss, the board of directors, led by Marty Levinson, discussed terminating the tanning operations. Brock successfully convinced a majority of the board that the tanning division was necessary to market the club's overall fitness package. By April, the tanning division's financial losses had risen. The board hired a business analyst, who conducted surveys and determined that the tanning operations did not significantly increase membership. A shareholder, Diego Peñada, discovered that Brock owned stock in Sunglow, Inc., the company from which Firm Body purchased its tanning equipment. Peñada notified Levinson, who privately reprimanded Brock. Shortly thereafter, Brock and Mandy Vail, who owned 37 percent of the Firm Body stock and also held shares of Sunglow, voted to replace Levinson on the board of directors. Using the information presented in the chapter, answer the following questions. 1. What duties did Brock, as a director, owe to Firm Body? 2. Does the fact that Brock owned shares in Sunglow establish a conflict of interest? Why or why not? 3. Suppose that Firm Body brought an action against Brock claiming that he had breached the duty of loyalty by not disclosing his interest in Sunglow to the other directors. What theory might Brock use in his defense? 4. Now suppose that Firm Body did not bring an action against Brock. What type of lawsuit might Peñada be able to bring based on these facts? DEBATE THIS Because most shareholders never bother to vote for directors, shareholders have no real control over corporations.

Moving Company Information to the Internet Anyone who has ever owned shares in a public company knows that such companies often are required to distribute voluminous documents relating to proxies to all shareholders. Traditionally, large packets of paper documents were sent to shareholders, but in 2007 the Securities and Exchange Commission (SEC) permitted publicly held companies to voluntarily distribute electronic proxy (e-proxy) materials. In 2009, the SEC's e-proxy rules became mandatory. Now, all public companies must post their proxy materials on the Internet, although they may still choose among several options-including paper documents sent by mail-for actually delivering the materials to shareholders. Notice and Access: E-Proxy Rules Companies that want to distribute proxy materials only via the Internet can choose the notice and access delivery option. Under this model, the corporation posts the proxy materials on a Web site and notifies the shareholders that the proxy materials are available online. The notice and access model involves the following steps: 1. The company posts the proxy materials on its publicly accessible Web site. 2. Subsequently, the company sends a (paper) notice to each shareholder at least forty calendar days before the date of the shareholders' meeting for which the proxy is being solicited. 3. No other materials can be sent along with the initial notice (unless the proxy is being combined with the meeting notice required by state law). 4. The notice must be written in plain English, and it must include a prominent statement of the following: the date, time, and location of the shareholders' meeting; the specific Web site at which shareholders can access the proxy materials; an explanation of how they can obtain paper copies of the proxy materials at no cost; and a clear and impartial description of each matter to be considered at the share holders' meeting. 5. Next, the company must wait at least ten days before sending a "paper" proxy card to the shareholders. This ten-day waiting period provides shareholders with sufficient time to access the proxy materials online or to request paper copies. 6. If a shareholder requests paper proxy materials, the company must send them within three business days. 7. After receiving the initial paper notice, a shareholder can permanently elect to receive all future proxy materials on paper or by e-mail. Other Delivery Options Rather than using notice and access delivery, public companies can choose to deliver the full set of proxy materials to the shareholders in paper or electronic form, such as on a CD or DVD. They can also use a blend of these two options, as long as they also post the materials on a Web site. Many corporations choose one option for certain shareholders and another option for other shareholders, depending on the number of shares owned or whether the shareholders are domestic or foreign. The shareholder can always choose to receive paper documents rather than accessing materials online. Some corporate executives want the SEC to go even further and allow corporations to disseminate important information to the public via CEO blogs. Thus far, however, the SEC has not allowed companies to distribute proxy materials (or disclose material information to the public as required before issuing shares-see Chapter 26) via blogs. FOR CRITICAL ANALYSIS Why might a company or other party choose to solicit proxies the old-fashioned way-by providing paper documents instead of Internet access-despite the added costs?

The five Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: If a group of shareholders perceives that the corporation has suffered a wrong and the directors refuse to take action, can the shareholders compel the directors to act? If so, how?

What is a voting proxy? What is cumulative voting?

Voting Techniques. Algonquin Corp. has issued and has outstanding 100,000 shares of common stock. Four stockholders own 60,000 of these shares, and for the past six years they have nominated a slate of candidates for membership on the board, all of whom have been elected. Sergio and twenty other shareholders, owning 20,000 shares, are dissatisfied with corporate management and want a representative on the board who shares their views. Explain under what circumstances Sergio and the twenty other shareholders can elect their representative to the board. (See Shareholders.)

Fiduciary Duties and Liabilities. Harry Hoaas and Larry Griffiths were shareholders in Grand Casino, Inc., which owned and operated a casino in Watertown, South Dakota. Griffiths owned 51 percent of the stock and Hoaas 49 percent. Hoaas managed the casino, which Griffiths typically visited once a week. At the end of 1997, an accounting showed that the cash on hand was less than the amount posted in the casino's books. Later, more shortfalls were discovered. In October 1999, Griffiths did a complete audit. Hoaas was unable to account for $135,500 in missing cash. Griffiths then kept all of the casino's most recent profits, including Hoaas's $9,447.20 share, and, without telling Hoaas, sold the casino for $100,000 and kept all of the proceeds. Hoaas filed a suit in a South Dakota state court against Griffiths, asserting, among other things, a breach of fiduciary duty. Griffiths countered with evidence of Hoaas's misappropriation of corporate cash. What duties did these parties owe each other? Did either Griffiths or Hoaas, or both of them, breach those duties? How should their dispute be resolved? How should their finances be reconciled? Explain. [ Hoaas v. Griffiths, 2006 SD 27, 714 N.W.2d 61 (2006)]

What is a voting proxy? What is cumulative voting?

CASE PROBLEM WITH SAMPLE ANSWER: Duties of Directors and Officers. First Niles Financial, Inc., is a company whose sole business is to own and operate a bank, Home Federal Savings and Loan Association of Niles, Ohio. First Niles's directors included bank officers William Stephens, Daniel Csontos, and Lawrence Safarek; James Kramer, president of an air-conditioning company that serviced the bank; and Ralph Zuzolo, whose law firm served the bank and whose title company participated in most of its real estate deals. First Niles's board put the bank up for sale and received three bids. Farmers National Bank Corp. stated that it would not retain the board. Cortland Bancorp indicated that it would terminate the directors but consider them for future service. First Financial Corp. said nothing about the directors. The board did not pursue Farmers' offer, failed to timely respond to Cortland's request, and rejected First Financial's bid. Leonard Gantler and other First Niles shareholders fled a suit in a Delaware state court against Stephens and the others. What duties do directors and officers owe to a corporation and its shareholders? How might those duties have been breached here? Discuss. [ Gantler v. Stephens, 965 A.2d 695 (Del.Sup.Ct. 2009)]

Nico is Omega Corporation's majority shareholder. He owns enough stock in Omega that if he were to sell it, the sale would be a transfer of control of the firm. Discuss whether Nico owes a duty to Omega or the minority shareholders in selling his shares. (See Shareholders.)