Corporations

The primary players in a corporation are the shareholders, directors, and officers. Shareholders are the investors in, and owners of, a corporation. They elect, and sometimes remove, the directors, and occasionally they must vote on specific corporate transactions or operations. The board of directors is the top governing body. Directors establish corporate policy and hire officers, to whom they usually delegate their obligations to administer and manage the corporation's affairs. Officers run the day-to-day business affairs and carry out the policies the directors establish.

Shareholders Shareholders' financial interests in the corporation is determined by the percentage of the total outstanding shares of stock that they own. Along with their financial stakes, shareholders generally receive a number of rights, all designed to protect their investments. Foremost among these rights is the power to vote. Shareholders vote to elect and remove directors, to change or add to the bylaws, to ratify (i.e., approve after the fact) directors' actions where the bylaws require shareholder approval, and to accept or reject changes that are not part of the regular course of business, such as mergers or dissolution. This power to vote, although limited, gives the shareholders some role in running a corporation.

Shareholders typically exercise their VOTING RIGHTS at annual or special meetings. Most statutes provide for an annual meeting, with requirements for some advance notice, and any shareholder can get a court order to hold an annual meeting when one has not been held within a specified period of time. Although the main purpose of the annual meeting is to elect directors, the meeting may address any relevant matter, even one that has not been mentioned specifically in the advance notice. Almost all states allow shareholders to conduct business by unanimous written consent, without a meeting.

Shareholders elect directors each year at the annual meeting. Most statutes provide that directors be elected by a majority of the voting shares that are present at the meeting. The same number of shares needed to elect a director normally is required to remove a director, usually without proof of cause, such as FRAUD or abuse of authority.

A special meeting is any meeting other than an annual meeting. The bylaws govern the persons who may call a special meeting; typically, the directors, certain officers, or the holders of a specified percentage of outstanding shares may do so. The only subjects that a special meeting may address are those that are specifically listed in an advance notice.

Statutes require that a quorum exist at any corporation meeting. A quorum exists when a specified number of a corporation's outstanding shares are represented. Statutes determine what level of representation constitutes a quorum; most require one-third. Once a quorum exists, most statutes require an affirmative vote of the majority of the shares present before a vote can bind a corporation. Generally, once a quorum is present, it continues, and the withdrawal of a faction of voters does not prevent the others from acting.

A corporation determines who may vote based on its records. Corporations issue share certificates in the name of a person, who becomes the record owner (i.e., the owner according to company records) and is treated as the sole owner of the shares. The company records of these transactions are called stocktransfer books or share registers. A shareholder who does not receive a new certificate is called the beneficial owner and cannot vote, but the beneficial owner is the real owner and can compel the record owner to act as the beneficial owner desires.

Those who hold shares by a specified date before a meeting, called the record date, may vote at the meeting. Before each meeting, a corporation must prepare a list of shareholders who are eligible to vote, and each shareholder has an unqualified right to inspect this voting list.

Shareholders typically have two ways of voting: straight voting or cumulative voting. Under straight voting, a shareholder may vote his or her shares once for each position on the board. For example, if a shareholder owns 50 shares and there are three director positions, the shareholder may cast 50 votes for each position. Under cumulative voting, the same shareholder has the option of casting all 150 votes for a single candidate. Cumulative voting increases the participation of minority shareholders by boosting the power of their votes.

Shareholders also may vote as a group or block. A shareholder voting agreement is a contract among a group of shareholders to vote in a specified manner on certain issues; this is also called a pooling agreement. Such an agreement is designed to maintain control or to maximize voting power. Another arrangement is a voting trust. This has the same objectives as a pooling agreement, but in a voting trust, shareholders assign their voting rights to a trustee who votes on behalf of all the shares in the trust.

Shareholders need not attend meetings in order to vote; they may authorize a person, called a proxy, to vote their shares. Proxy appointment often is solicited by parties who are interested in gaining control of the board of directors or in passing a particular proposal; their request is called a proxy solicitation. Proxy appointment must be in writing. It usually may last no longer than a year, and it can be revoked.

Federal law generates most proxy regulation, and the Securities and Exchange Commission (SEC) has comprehensive and detailed regulations. These rules define the form of proxy-solicitation documents and require the distribution of substantial information about director candidates and other issues that are up for shareholder vote. Not all corporations are subject to federal proxy law; generally, the law covers only large corporations with many shareholders and with shares that are traded on a national securities exchange. These regulations aim to protect investors from promiscuous proxy solicitation by irresponsible outsiders who seek to gain control of a corporation, and from unscrupulous officers who seek to retain control of management by hiding or distorting facts.

In addition to voting rights, shareholders also have a right to inspect a corporation's books and records. A corporation almost always views the invocation of this right as hostile. Shareholders may only inspect records if they do so for a "proper purpose"; that is, is a purpose that is reasonably relevant to the shareholder's financial interest, such as determining the worth of his or her holdings. Shareholders can be required to own a specified amount of shares or to have held the shares for a specified period of time before inspection is allowed. Shareholders generally may review all relevant records that are needed, in order to gather information in which they have a legitimate interest. Shareholders also may examine a corporation's record of shareholders, including names and addresses and classes of shares.

Directors Statutes contemplate that a corporation's business and affairs will be managed by the board of directors or under the board's authority or direction. Directors often delegate to corporate officers their authority to formulate policy and to manage the business. In closely held corporations, directors normally involve themselves more in management than do their counterparts in large corporations. Statutes empower directors to decide whether to declare dividends; to formulate proposed important corporate changes, such as mergers or amendments to the articles of incorporation; and to submit proposed changes to shareholders. Many boards appoint committees to handle technical matters, such as litigation, but the board itself must address important matters. Directors customarily are paid a salary and often receive incentive plans that can supplement that salary.

A corporation's articles or bylaws typically control the number of directors, the terms of the directors' service, and the directors' ability to change their number and terms. The shareholders' power of removal functions as a check on directors who may wish to act in a way that is contrary to the majority shareholders' wishes. The directors' own fiduciary duties, or obligations to act for the benefit of the corporation, also serve as checks on directors.

The bylaws usually regulate the frequency of regular board meetings. Directors also may hold special board meetings, which are any meetings other than regular board meetings. Special meetings require some advance notice, but the agenda of special directors' meetings is not limited to what is set forth in the notice, as it is with shareholders' special meetings. In most states, directors may hold board meetings by phone and may act by unanimous written consent without a meeting.

A quorum for board meetings usually exists if a majority of the directors in office immediately before the meeting are present. The quorum number may be increased or decreased by amending the bylaws, although it may not be decreased below any statutory minimum. A quorum must be present for directors to act, except when the board is filling a vacancy. Most statutes allow either the board itself or shareholders to fill vacancies.

Directors' fiduciary duties fall under three broad categories: the duty of care, the duty of loyalty, and duties imposed by statute. Generally, a fiduciary duty is the duty to act for the benefit of another—here, the corporation—while subordinating personal interests. A fiduciary occupies a position of trust for another and owes the other a high degree of fidelity and loyalty.

A director owes the corporation the duty to manage the entity's business with due care. Statutes typically define using due care as acting in GOOD FAITH, using the care that an ordinarily prudent person would use in a similar position and situation, and acting in a manner that the director reasonably thinks is in the corporation's best interests. Courts seldom second-guess directors, but they usually find personal liability for corporate losses where there is self-dealing or NEGLIGENCE.

Self-dealing transactions raise questions about directors' duty of loyalty. A self-dealing transaction occurs when a director is on both sides of the same transaction, representing both the corporation and another person or entity who is involved in the transaction. Self-dealing may endanger a corporation because the corporation may be treated unfairly. If a transaction is questioned, the director bears the burden of proving that it was in fact satisfactory.

Self-dealing usually occurs in one of four types of situations: transactions between a director and the corporation; transactions between corporations where the same director serves on both corporations' boards; by a director who takes advantage of an opportunity for business that arguably may belong to the corporation; and by a director who competes with the corporation.

The usurping of a corporate opportunity poses the most significant challenge to a director's duty of loyalty. A director cannot exploit the position of director by taking for himself or herself a business opportunity that rightly belongs to the corporation. Most courts facing this question compare how closely related the opportunity is to the corporation's current or potential business. Part of this analysis involves assessing the fairness of taking the opportunity. Simply taking a corporation's opportunity does not automatically violate the duty of loyalty. A corporation may relinquish the opportunity, or the corporation may be incapable of taking the opportunity for itself.

Directors who are charged with violating their duty of care usually are protected by what courts call the BUSINESS JUDGMENT RULE. Essentially, the rule states that even if the directors' decisions turn out badly for the corporation, the directors themselves will not be personally liable for losses if those decisions were based on reasonable information and if the directors acted rationally. Unless the directors commit fraud, a breach of good faith, or an illegal act, courts presume that their judgment was formed to promote the best interests of the corporation. In other words, courts focus on the process of reaching a decision, not on the decision itself, and require directors to make informed, not passive, decisions.

State statutes often impose additional duties and liabilities on directors as fiduciaries to a corporation. These laws may govern conduct such as paying dividends when a statute or the articles prohibit doing so; buying shares when a statute or the articles prohibit doing so; giving assets to shareholders during liquidation without resolving a corporation's debts, liabilities, or obligations; and making a prohibited loan to another director, an officer, or a shareholder.

If a court finds that a director has violated a duty, the director still might not face personal liability. Some statutes require or permit corporations to indemnify a director who violated a duty but acted in good faith, who received no improper personal benefit, and who reasonably thought that the action was lawful and in the corporation's best interests. Indemnification means that the corporation reimburses the director for expenses incurred defending himself or herself and for amounts he or she paid after losing or settling a claim.

Officers The duties and powers of corporate officers can be found in statutes, articles of incorporation, bylaws, or corporate resolutions. Some statutes require a corporation to have specific officers; others merely require that the bylaws contain a description of the officers. Officers usually serve at the will of those who appointed them, and they generally can be fired with or without cause, although some officers sign employment contracts.

Corporations typically have as officers a president, one or more vice presidents, a secretary, and a treasurer. The president is the primary officer and supervises the corporation's business affairs. This officer sometimes is referred to as the chief executive officer, but the ultimate authority lies with the directors. The vice president fills in for the president when the latter cannot or will not act. The secretary keeps minutes of meetings, oversees notices, and manages the corporation's records. The treasurer manages and is responsible for the corporation's finances.

Officers act as a corporation's agents and can bind the corporation to contracts and agreements. Many parties who deal with corporations require that the board pass a resolution approving any contract negotiated by an officer, as a sure way to bind the corporation to the contract. In the absence of a specific resolution, the corporation still may be bound if it ratified the contract by accepting its benefits or if the officer appeared to have the authority to bind the corporation. Courts treat corporations as having knowledge of information if a corporate officer or employee has that knowledge.

Like directors, officers owe fiduciary duties to the corporation: good faith, diligence, and a high degree of honesty. But most litigation about fiduciary duties involves directors, not officers.

An officer does not face personal liability for a transaction if he or she merely acts as the corporation's agent. Nevertheless, the officer may be personally liable for a transaction where the officer intends to be bound personally or creates the impression that he or she will be so bound; where the officer exceeds his or her authority; and where a statute imposes liability on the officer, such as for failure to pay taxes.