(18) Distribution of Shares and Dividends to the Shareholders

What is a share?

A stockholder's proprietary interest in the corporation arising from the corporation's acceptance of the subscriber's consideration.

What rights does a share generally represent?

The right to receive dividends, the right to receive a portion of corporate assets upon liquidation, and, if voting stock, the right to vote.

What right do shareholders have regarding dividends?

The right to receive dividends declared by the board of directors.

What right does a shareholder have upon corporate liquidation?

The right to receive a portion of the corporation's assets.

When does a shareholder have voting rights?

When the shares are voting shares.

How are different classes of shares created?

By authorization in the articles of incorporation.

Must at least one class of shares have voting rights?

Yes.

What is common stock?

Stock that entitles its holders to pro rata dividends, voting rights, and a proportionate share of assets upon liquidation without priority over other common shares.

What dividend rights do common shareholders have?

The right to receive pro rata dividends.

What voting rights do common shareholders have?

The right to vote.

What liquidation rights do common shareholders have?

The right to share proportionately in corporate assets upon liquidation.

What is preferred stock?

Stock having preferences over other classes of stock.

Where must preferred stock preferences be stated?

In the articles of incorporation.

What is the most common preference given to preferred stock?

The right to receive dividends at a specified rate before dividends are paid to other classes of stock.

What is a dividend?

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

Do shareholders have an absolute right to receive dividends?

No.

Who decides whether dividends will be paid?

The board of directors.

May dividends be withheld even if legally available funds exist?

Yes.

When should you question the board's decision not to declare dividends?

When there is evidence of abuse of discretion, bad faith, or an attempt to freeze out minority shareholders.

What defense may directors raise when challenged for refusing to declare dividends?

The Business Judgment Rule.

May a declared dividend be revoked under the majority rule?

No.

What is the effect of declaring a dividend under the majority rule?

The declared dividend becomes a corporate debt.

What financial condition must exist before dividends may be paid?

The corporation must be solvent.

When is a corporation considered solvent for dividend purposes?

When its assets exceed its liabilities and it can meet its current obligations.

What are proper sources for cash dividends?

Capital surplus or earned surplus.

May property be distributed as dividends?

Yes.

May a corporation distribute stock dividends?

Yes.

May paid-in surplus be used for dividends?

It depends on the jurisdiction.

May revaluation surplus be used for dividends?

The minority rule permits it.

What are nimble dividends?

Dividends paid from the current year's net profits.

What source may never be impaired to pay dividends?

Stated capital.

Who is personally liable for unlawful dividends?

The directors.

When are directors protected from liability for unlawful dividends?

When they relied in good faith on financial statements showing funds were legally available.

May shareholders have to return unlawful dividends?

Yes, if the corporation was insolvent when the dividends were distributed.

Testable Issue:What rights does ownership of a share provide?

The right to declared dividends, liquidation proceeds, and voting rights if the shares are voting shares.

Testable Issue:What distinguishes common stock from preferred stock?

Common stock has voting rights and pro rata distributions, while preferred stock has contractual preferences stated in the articles.

Testable Issue:Who has discretion to declare dividends?

The board of directors.

Testable Issue:When may a court review the board's refusal to declare dividends?

When there is abuse of discretion, bad faith, or a minority freeze-out.

Testable Issue:When may dividends legally be paid?

Only when the corporation is solvent and the dividends come from a lawful source.

Testable Issue:What sources may lawfully fund dividends?

Capital surplus or earned surplus for cash dividends, property, stock dividends, paid-in surplus in some jurisdictions, revaluation surplus under the minority rule, and nimble dividends.

Testable Issue:What source may never be used to pay dividends?

Stated capital.

Testable Issue:Who is liable for unlawful dividends?

The directors, unless they relied in good faith on financial statements, and shareholders may have to return the dividends if the corporation was insolvent.

Essay Rule:How do you analyze a dividend issue?

Determine the shareholder's rights, identify the class of shares involved, determine whether the board properly exercised its discretion, analyze whether the corporation was solvent and whether the dividend came from a lawful source, determine whether the Business Judgment Rule applies, and analyze any liability of directors or shareholders for unlawful dividends.

Master Synthesis:What is the framework for analyzing shares and dividends?

Identify the shareholder's rights and class of stock, determine whether the board properly exercised its discretion in declaring or withholding dividends, verify that the corporation was solvent and that the dividend came from a lawful source, determine whether the Business Judgment Rule protects the directors, and analyze any resulting liability for unlawful dividends.