Chapter 38: Financial and Operational Features of Corporations

Business Law, Sixth Edition
© 2019 BVT Publishing. All rights reserved.
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Chapter 38:
Financial and Operational
Features of Corporations

S-2
Learning Objectives
• Explain corporate stocks.
• Discuss the rights, roles, and duties of
shareholders.
• Describe the rights, roles, and duties of
directors.
• Understand the liability of officers and
directors.
• Distinguish between duty of loyalty, duty of
due care, and duty of good faith.

S-3
38.0 In the News
Facebook's Directors Can Allegedly Pay
Themselves Up To $156 Million Each In Stock
http://bvtlab.com/97776
A lawsuit filed in Maryland alleges this
compensation is excessive and wasteful as well as
breach of fiduciary duty, waste of corporate
assets, and unjust enrichment.
• Discuss derivative suits.
• Should shareholders be able to sue the corporation?
• Sue the directors?
• Is there a breach of fiduciary duty? Explain.

S-4
38.1a Stock Basics (Slide 1 of 5)
• Stock certificate
– Written evidence of the ownership of a certain
number of shares of stock of a corporation
• Bonds
– Corporation obligated to pay a specified amount
in the future at a specified interest rate.
– Bondholder is a creditor of the corporation.
– Bondholder has no right to vote.
– Bondholder does not participate in the
management.

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• Common and preferred stock
– Common stock
oSimplest type of corporate stock
oEntitles owner to share in control, profits, assets
– Preferred stock
oPriority over other classes of stock in claiming
dividends or assets
oRight to receive a certain specified dividend
– Cumulative
oAny dividends not paid due to lack of earnings
accrued are paid when earnings are available.

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• Common and preferred stock
– Noncumulative
oOnly the current year’s preferred dividend is
paid out of current earnings.
– Participating
oEntitled to the preferred dividend and to any
dividends declared after the common
shareholders have been paid.
– Nonparticipating
oOnly amount of dividend is the preference.

S-7
• Stock warrant
– Certificate giving the right to acquire a given
number of shares of stock at a stated price
• Par value stock
– Dollar amount the corporation must
receive and enter into its stated capital
account for each share of stock sold
• No-par stock
– Value determined by sale price in the open
market or by the price set by a “stated value”

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• Watered stock
– Stock that has been issued as fully paid when,
in fact, its full par value has not been paid in
money, property, or services
• Treasury stock
– Issued by the corporation for value and
returned to the corporation by gift or purchase
– Proceeds are returned to treasury of the
corporation for working capital.

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38.1b Stock Subscriptions
• Agreement to purchase stock in a
corporation
• Subscription is usually drafted in a
manner that creates a contract.
• Constitutes a binding, irrevocable
offer to the corporation

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38.1c Right to Transfer Stock
• A share of stock is personal property, and
the owner has the right to transfer.
• Transferred by an endorsement and delivery
of the certificate of stock
• Surrender of the certificate to the stock
transfer agent for reissue
• Bylaw restricting stock transfers is generally
unenforceable.
• Exceptions for closely held corporations

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38.1d Mechanics of Transfer
• A share may be transferred or assigned by a
bill of sale.
• In a small corporation, the secretary of the
corporation handles all transfers
• Large corporations employ transfer agents.
• Registrar ensures no stock certificates are
issued in excess of the authorized
capitalization of the corporation.
• Article 8 of the Uniform Commercial Code
deals with investment securities.

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38.2a Rights in General of Shareholder
• Right to inspect the books and papers of
the corporation
• Right to attend shareholders’ meetings and
to vote
• Preemptive right
• Right to bring a shareholder’s derivative
suit
• Right to share in the profits when a
dividend is declared.

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38.2c Meetings
• Notice
– Notice must include a statement concerning matters
to be acted on.
– Failure to give proper notice invalidates the action
taken at the meeting.
• Quorum
– Must be present to transact business
– Shareholders may attend in person or by proxy.
– A quorum is majority of voting shares outstanding.
• Purpose

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38.2d Voting
• Shareholders who have the right to vote:
– Election of directors
– Only major policy issues
– Changes in the bylaws
• Every shareholder of common stock is
entitled to as many votes as shares of stock.
• Election of directors:
– Straight voting
– Cumulative voting
• Can vote on matters with personal interest.

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38.2e Preemptive Rights
• Existing shareholders have prior right
over third parties to subscribe to
increased capital stock.
• Based on shareholders’ right to protect
their proportionate control of corporation
• May be waived by contract and by
provisions in the charter or bylaws
• Applicable to new authorizations of stock

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38.2e Critical Thinking
CASE: Benihana
Question is whether the charter of the
corporation prohibited the issuance of preferred
stock with preemptive rights.
• Why was the granting of preemptive rights
important to those involved in this litigation?
• Why did the court find articles of incorporation
allowed the board to issue stock with preemptive
rights?

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38.2f Derivative Suits
A shareholder has the right to bring a suit on
behalf of the corporation to enjoin the officers
of a corporation from entering into ultra vires
contracts.
• Purpose of a derivative action is twofold:
– The equivalent of a suit by shareholders to
compel corporation to sue
– A suit by the corporation against those liable to it
• Before filing suit, shareholders usually must
demand that the directors take action.

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38.2f Critical Thinking
CASE: Citigroup Shareholder
A derivative suit stemming from the losses
suffered as a result of the subprime mortgage
market collapse.
• The court effectively dismissed the shareholder
derivative lawsuit. Why were the allegations in the
complaint insufficient?
• What standard does the court establish for a future
shareholder wishing to substantiate futility in
demanding that the board sue individual directors
for breach of fiduciary duty?

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38.2g Dividends
A stockholder’s pro rata share in the
distributed profits of a corporation
• Granting of dividends is within the discretion of
the board of directors.
• Cash dividend becomes a debt of the
corporation.
• A stock dividend involves a transfer of retained
earnings to the capital account.
• Stock split reduces par value and increases
number of shares.

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38.2g Critical Thinking
CASE: Dodge
In this famous case, the court was asked
whether Henry Ford could properly withhold a
dividend for the purpose of, in part, using
money within the corporation to produce a
less expensive automobile.
• Why was Mr. Ford not inclined to encourage
the board of directors to grant a dividend?
• Why did the appellate court support the trial
court’s decision to order dividends be
granted?

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38.2h Fiduciary Aspects
• No fiduciary relationship between
shareholders in publicly held corporations
• Shareholders in a closely held corporation
owe one another a fiduciary duty.
• Shareholders in a closely held corporation
must act in good faith.

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38.3 Directors
• Powers
– Power to conduct ordinary business of the entity
– Duty to establish general policies and elect/hire
officers to execute the policy
• Meetings
– Bylaws provide the method of calling directors’
meetings and for time and place.
• Compensation
– Bylaws stipulate payment of directors’ fees.
– If not mentioned in bylaws, service is
uncompensated.

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38.4 Liability of Officers
and Directors (Slide 1 of 2)
• Directors and officers may have personal
liability, both in tort and in contract.
• The business judgment rule
– Directors are better equipped than courts to
make business judgments.
• Duty of loyalty
– Prohibits directors from acting with a conflict
of interest
– Corporate opportunity doctrine

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38.4 Liability of Officers
and Directors (Slide 2 of 2)
• Duty of due care
– Directors owe that degree of care that a
businessperson of ordinary prudence would
exercise in the management of own affairs.
• Duty of good faith
– Directors must act in corporation’s best
interest.
• Indemnification and insurance
– Liability insurance to protect directors
– Model Business Corporation Act

Chapter 38: Financial and Operational Features of Corporations

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