Issuance of Shares | Distributions to Investors

Case #1: Stokes v. Continental Trust Co

a)     A stockholder has an inherent right to a proportionate share of new stock that is issued for money. [Corp must allow shareholder to purchase newly issued stock at the fixed price to allow him to keep his proportionate share of stock.]  

(1)   Though this right can be waived, the stockholder cannot be deprived of that right without his consent, unless the new stock is issued at a price that is at par or greater, and the stockholder is allowed to take his same proportion of the new shares at that price or in some other equitable way.

b)     NOTE: It has now been established that this is not a preemptive right – unless otherwise included in the articles of incorporation, default rule is no right to this.

Case #2: Katzowitz v. Sidler

a)     In a closely held corporation (not publicly traded), where the issuing price for new stock is significantly and unjustifiably below par value, a stockholder who chooses not to purchase the new stock should nonetheless be permitted to receive his proportionate share of the new stock.

(1)   Preemptive rights created to protect shareholders against dilution of their equity in a corp & against dilution of proportionate voting control.

(2)   New price of shares must be justifiable based on a valid business reason. Diluting shares in a way that freezes out a shareholder may be seen as breach of FD.

(a)   Just as shareholder has right to purchase shares to maintain his proportionate equity in a corp., he has the right not to purchase additional shares if there is no business justification for the dilution.   

Distributions to Investors

1. Distribution

2. Dividend

Distribution

a)     Payment to shareholder out of capital; a direct or indirect transfer of money or other property (except its own shares) or incurrence of indebtedness by a corp to or for the benefit of its shareholders.

(1)   May be in form of declaration or payment of a dividend; purchase, redemption, or other acquisition of shares; a distribution of indebtedness, etc.

Dividend

A distribution from current or retained earnings.

Case #1: Dodge v. Ford Motor Co

a)     Biz org is carried on primarily for profit of stockholders. Company cannot take actions that harm its shareholders and are motivated solely by non-business concerns (such as humanitarian issues).

(1)   Discretion of BOD is to be exercised to profit those stockholders – this discretion does not extend to the reduction or non-distribution of profits to stockholders in order to devote them to other, non-business purposes.

b)     NOT within the lawful powers of the BOD to shape/conduct the biz w/ incidental benefits to shareholders and for the primary purpose of benefiting others.

c)     Company must pay dividends to shareholders if there is an adequate corporate surplus available to do so.

d)    NOTE: This is a rare holding and not the norm. BOD normally has vast discretion.

Traditional Rule for BOD

Rule: If an adequate surplus is available for the purpose, directors may not withhold the declaration of dividends in bad faith. BUT, the mere existence of an adequate corporate surplus is not sufficient to invoke court action to compel such dividend. There must also be bad faith on the part of the directors.

No bright-line test for bad faith, but factors to be considered:r

(a)   Intense hostility of the controlling faction against the minority; exclusion of the minority from employment by the corporation; high salaries or bonuses or corporate loans made to the officers in control; the fact that majority group may be subject to high personal income taxes if substantial dividends are paid; existence of a desire by controlling directors to acquire the minority stock interests as cheaply as possible.

(b)   If these factors are not MOTIVATING causes behind withholding dividends, they do not constitute “bad faith” as a matter of law. Gottfried v. Gottfried. Must also show that majority of the board, not just 1 member, acted with bad faith.  

MCBA § 6.40(a): Distributions

payments to shareholders out of capital – can be dividend) may be limited by the BOD.

Reasons for BOD restricting distributions:

a)     The distribution would result in equity insolvency (takes away the corp’s ability to pay bills or time or will create a cash-flow problem)

b)     Distribution would result in balance sheet insolvency (corp’s total assets are less than the sum of its liabilities). 

Shareholders and Stakeholders:

a)     PA statute – BOD can take into account interests of shareholders, long-term interests of business, etc. when conducting business

b)     DE Public Benefit corp statute – directors balance interests of shareholders with identified public benefit