DISTRIBUTION OF SHARES AND DIVIDENDS TO THE SHAREHOLDERS

Q: What rights does a share of stock represent?

• A share represents the shareholder's proprietary interest in the corporation,

• which arises when the corporation accepts the subscriber's consideration.

• A share generally carries the right to:

  • Receive dividends declared by the board;

  • Receive a portion of the corporation's assets upon liquidation; and

  • Vote, if it is a voting share.

Q: When should you discuss the rights represented by corporate shares?

Whenever an essay involves disputes over:

• dividend rights,

• liquidation distributions, or

• shareholder voting rights.

CLASS OF SHARES: Q: What does Fleming say about classes of shares in terms of authorization of, and voting rights?

A corporation may authorize one or more classes of shares in its Articles of Incorporation, but at least one class must have voting rights.

Q: What rights does common stock carry?

Common stock generally entitles its owners to:

• pro rata dividends without priority over other common shareholders,

• voting rights, and

• a pro rata share of assets upon liquidation.

Q: What is preferred stock?

Preferred stock is stock that has one or more preferences over other classes of stock, and those preferences must be expressly stated in the Articles of Incorporation.

Q: What is the most common preference given to preferred stock shareholders?

Preferred shareholders have the right to receive dividends at a specified rate before dividends are paid to any other class of stock.

Q: What is a dividend?

A dividend is any distribution of cash, property, or the corporation's own shares paid to shareholders because of their ownership of stock.

Q: Do shareholders have an absolute right to receive dividends whenever legally available funds exist?

No. Even when legally available funds exist, shareholders have no absolute right to dividend distributions. Whether to declare dividends is within the discretion of the board of directors.

Q: When should you challenge the board's decision not to declare dividends?

Look for evidence that the board:

• abused its discretion,

• acted in bad faith, or

• attempted to freeze out minority shareholders.

Also remember the Business Judgment Rule may protect the board's decision.

Q: Once a dividend has been declared, may a dividend be revoked?

Generally no. Under the majority rule, a declared dividend becomes a corporate debt and cannot be revoked.

RESTRICTIONS ON DIVIDENDS: Q: What solvency requirement must be met before a corporation may pay dividends?

The corporation must be solvent, meaning:

1. Its assets exceed its liabilities, and

2. It is able to meet its current obligations.

Q: From what sources may dividends properly be paid?

Fleming identifies the following proper sources:

• Cash dividends (capital surplus or earned surplus)

• Property dividends

• Stock dividends

• Paid-in surplus (split of authority)

• Revaluation surplus (minority rule)

• Nimble dividends (current year's net profits)

Q: What is an unlawful source for paying dividends?

Stated capital may not be impaired to pay dividends.

Remedies for Unlawful Dividends: Q: When are directors personally liable for unlawful dividends?

Directors are personally liable unless they relied in good faith on financial statements showing that funds were properly available for distribution.

Q: When may shareholders be required to return dividends?

Shareholders may have to return dividends if the corporation was insolvent when the distribution was made.

Q: A corporation has sufficient profits but the board refuses to declare dividends while paying itself excessive compensation. What issues should you immediately recognize?

• Abuse of the board's discretion.

• Bad faith.

• Possible minority shareholder freeze-out.

• Business Judgment Rule defense.

Q: A corporation pays dividends after becoming insolvent. What issues should you immediately recognize?

• Whether the dividend came from an unlawful source.

• Director liability.

• Whether shareholders must return the dividends received.

IRAC checklist for Distribution of Shares and Dividends?

1. What rights do the shares give the shareholder?

2. What class of stock is involved (common or preferred)?

3. Does the shareholder have a right to the claimed dividend?

4. Was the board's exercise of discretion proper?

5. Is the corporation solvent?

6. Was the dividend paid from a lawful source?

7. Are directors personally liable?

8. Must shareholders return the dividend?

This follows the organization of Fleming's Section X.