Business Structure and Shareholder Rights

Business Structure and Shareholder Rights

Significant Factors Affecting Business Nature

  • Factors have a significant impact on defining the nature of the business.

Shareholders' Rights

  • Shareholders have the right to inspect the corporate books and records but must provide a valid reason or proper purpose for their request.

Roles of Shareholders and Board of Directors

  • Board of Directors' Role: Manages day-to-day operations of the company.

  • Shareholder's Relationship to the Board: Sometimes overlaps, as shareholders can also be on the board, but they should be considered separate entities for understanding their rights and responsibilities.

Voting Mechanics in Large Corporations

  • Example: Microsoft has millions of shareholders.

  • Quorum Requirement: At least 50% plus one of shareholders must be present to conclude a legitimate vote.

  • Proxy Voting:
      - Shareholders often cannot physically attend meetings due to logistical issues.
      - Proxies are written documents allowing shareholders to authorize a third party (often management) to vote on their behalf.
      - This is standard practice for most large businesses in interstate and international commerce, especially Fortune 500 companies.

Shareholder Actions Against Misconduct

  • In cases where the CEO or board makes detrimental decisions:
      - Shareholders can fight back through direct or derivative lawsuits.

Types of Lawsuits

  • Direct Lawsuit: Filed when personal rights of shareholders are directly violated, such as refusal to access books or denied dividends.
      - Example: Shareholders suing the corporation directly.

  • Derivative Lawsuit:
      - Shareholders step into the corporation's shoes to sue the board or CEO on behalf of the company.
      - Outcomes benefit the corporation, not individual shareholders.
      - Example: Lawsuit Context: ABC Corp versus the Board of Directors.

Conditions for a Derivative Lawsuit

  1. Written Demand: Shareholders must make a formal request for the board to take action against the offending party (e.g., CEO).

  2. Board's Response: If the board refuses or ignores the demand for 90 days, shareholders may proceed with legal action.

  3. Outcome of Lawsuit:
       - If shareholders win, the recovered funds (e.g., $5,000,000 by suing CEO Dave) go to the corporation, not the shareholders directly.

Hypothetical Case Study: Tech Corp

  • Scenario: The CEO, Dave, illegally transferred $5,000,000 to an offshore company owned by his brother.

  • Required Lawsuit: Shareholders need to file a derivative lawsuit due to the harm caused to the corporation as a whole.

  • Winning the Lawsuit: If they win, the Tech Corp is reimbursed, reinforcing its value and potentially increasing share value for shareholders.

Shareholder Motivation for Derivative Lawsuit

  • Raising overall company value, protecting investments, and potentially benefiting from future dividends as the company becomes healthier financially.

Corporate Structures: Publicly Held vs Closely Held Corporations

  • Publicly Held Corporations: Larger companies with shares traded publicly (e.g., Microsoft, Ford) with ownership separated from management and large numbers of passive investors.

  • Closely Held Corporations: Often small businesses owned by a few individuals or families without public trading of shares (e.g. Bob's Plumbing, Menards).
      - Shareholders, board members, and officers often overlap in these setups, leading to potential conflicts of interest and challenges in accountability.

Potential Legal Complications in Closely Held Corporations

  • Closely held corporations are more susceptible to situations where the corporate veil can be pierced due to direct access to corporate assets and funds by owners.

Duties of Corporate Management and Board of Directors

  • Directors owe fiduciary duties to the corporation, functioning as agents.

Key Fiduciary Duties

  1. Duty of Care: Directors must act responsibly, make informed decisions, and supervise adequately.

  2. Duty of Loyalty: Must prioritize the corporation's interests over personal gain.
       - Avoid conflicts of interest and self-dealing, such as unauthorized contracts with personal business interests.

Business Judgment Rule

  • Legal principle protecting directors from personal liability for decisions made in good faith, without conflicts of interest, and with rational justification.

  • Courts do not typically second guess business decisions unless there's a violation of loyalty.

Example of Breach of Duty: Self-Dealing in Closely Held Corporations

  • Hypothetical Situation: A CEO refuses to disclose a lucrative property opportunity to the corporation, instead purchasing it for personal gain, subsequently renting it back to the company at inflated rates.

  • Violation of Duty: This scenario exemplifies a breach of the duty of loyalty.

  • Shareholder Recourse: Shareholders can sue the CEO due to the direct conflict of interest and self-dealing.

Mitigating Self-Dealing through Disclosure

  • If the CEO chooses to disclose the opportunity and the board decides against it, the CEO may proceed with the purchase without breaching fiduciary duties, given that transparency mitigates the risk of legal action.