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Chapter 44 - Shareholders' Rights and Liabilities
CHAPTER 44
SHAREHOLDERS’ RIGHTS AND LIABILITIES
I. OBJECTIVES
This chapter is intended to inform students of the rights and liabilities of shareholders. After
reading the chapter and attending class, a student should:
A. Know the types of shareholder control devices and their uses.
B. Understand the shareholder input required for fundamental corporate changes.
C. Understand the dissenters’ rights (right of appraisal).
D. Appreciate the limits of a shareholder’s right to inspect corporate books and records.
E. Know the types of distributions that a corporation may make to its shareholders and when
such distributions may be made.
F. Know what types of lawsuits a shareholder may initiate.
G. Appreciate the risks when a controlling shareholder oppresses minority shareholders.
H. Know how a corporation is dissolved and terminated.
II. ANSWER TO INTRODUCTORY PROBLEM
A. The corporation should have six classes of shares. Four classes will be identical, each
owning 22.5% of the equity of the company and having the right to elect its own director.
One of the four classes will be issued to each associate, giving each associate equal
ownership of the corporation and the power to elect herself as a director. The corporation
should create two additional classes, each owning 5% of the company and each electing its
own director, who will be a nonvoting member of the board of directors. One of these two
classes will be issued to the IT engineer and one to the general manager. To protect the rights
of the shareholders who own each class, no additional shares may be created or issued
without the consent of the four associates’ classes of shares. No changes to rights of any
class may be made without the consent of that class.
B. If classes of shares are used, each of the four associates may elect herself as a director.
Nothing will interfere with that power, not even the inability of an associate to vote her shares
at an annual shareholder meeting. The existing director for that class will continue if not
replaced. If one class of shares with cumulative voting rights is used, each associate has
sufficient power to elect herself as a director, but only if she attends the shareholder meeting
or otherwise exercises her voting power. If she does not, the other three associates can elect
not only themselves, but also a fourth board member. More importantly, with only one class
and cumulative voting, it is difficult for the IT engineer and the GM to elects themselves as
nonvoting directors.
III. SUGGESTIONS FOR LECTURE PREPARATION
A. Introduction
Note that shareholders, who primarily are investors, have few rights and fewer
responsibilities. Their rights and duties relate to their status as owners of the corporation,
except for the special rights and duties existing in close corporations.
Concept Review: Role of Shareholders and the Board of Directors (p. 1178): You may use
this concept review as a preview of your coverage of the chapter.
B. Shareholders’ Meetings
1. Review the formalities of shareholders’ meetings, noting their primary importance: the
election of directors.
2. Note that ordinarily only shareholders of record may vote at a shareholder meeting.
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Chapter 44 - Shareholders' Rights and Liabilities
3. Consider the alternatives available to a shareholder who wants to prevent shareholders
from taking action: he must ensure that a quorum of the shares are not present. Note that
the MBCA holds that a quorum cannot be broken by a shareholder’s leaving a meeting.
However, if the shareholder never attended the meeting, there would be no quorum; in
addition, the non-attending shareholder cannot be compelled to attend.
Example: Problem Case # 1.
C. Shareholder Control Devises
1. Straight voting versus cumulative voting for directors
a. Explain these two types of voting. Note the effect of cumulative voting by using an
example:
Example: X owns 55 shares and Y owns 45 shares. Four directors are to be elected.
Under straight voting, X will cast 55 votes for each of his 4 nominees. Y will cast 45
votes for each of her 4 nominees. Since the 4 nominees with the highest number of
votes win, X’s nominees win.
Now institute cumulative voting. X will have 55 [his number of shares] times 4 [the
number of directors to be elected] votes, equaling 220 votes, to allocate as he pleases.
Y will have 45 times 4 votes, equaling 180 votes, to vote as she pleases. If Y
allocated her votes wisely, she will cast 91 votes for one nominee and 89 votes for
another. [She does not want to give them equal votes to avoid a tie.] X, in an attempt
to frustrate Y, may vote 93 votes for one nominee and 92 votes for another nominee,
but will have only 35 votes to vote for a third nominee. The four highest nominees
win, giving X two representatives on the board and Y two representatives.
b. Note that having classes of directors reduces the effectiveness of cumulative voting
to empower minority shareholders to obtain representation on the board.
2. Classes of shares
a. Explain the function of having several classes of shares possessing different dividend
and voting rights. The example on page 1152 be useful.
b. Note that classes of shares are the best way to distribute ownership and voting rights
in a close corporation. Classes are the cleanest way to ensure that each shareholder
has not only the percentage equity ownership he wants but also the ability to elect
himself as a director.
c. Example: Chapter Introductory Problem (p. 1150).
d. Additional Example: Problem Case # 2.
3. Voting trusts, shareholder voting agreements, and proxies.
a. Define each of these. Note the courts’ initial hostility to them, which has been
overcome by the recognition that they should be treated like any other contract.
b. Reynolds Health Care Services, Inc. v. HMNH, Inc. (p. 1153). Of what value is a
revocable proxy? As this case shows, not much. It is good only as long as the
shareholder granting the proxy doesn’t revoke it.
Points for Discussion: Why did the court hold that the shareholders’ contract was a
proxy and not a shareholder voting agreement that could be enforced for the term of
the contract? The court defined a shareholder voting agreement as a contract in
which the shareholders stipulate how their shares will be voted. A proxy merely
gives another person the right to vote shares as the person with the proxy decides.
Because this contract gave RHCS the power to vote without indicating how the
shares were to be voted, it was a proxy.
Additional Point for Discussion: Why did the court rule that the proxy was
revocable? The agreement did not state on its face that it was irrevocable. Why does
that conclusion make sense? Irrevocability is not preferred, because it takes away a
shareholder’s power to vote. Absent a clear statement of irrevocability, the
shareholder may revoke the proxy at any time.
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Chapter 44 - Shareholders' Rights and Liabilities
Additional Point for Discussion: Note that the Sheppards got lucky. They clearly
wanted RHCS to vote their shares, but Reynolds fouled up by writing the agreement
wrongly. The lesson: make sure shareholder agreements do what one intends them
to do.
c. Note that shareholder voting agreements are the preferred manner of granting
someone voting power, because they may exist for an unlimited period of time.
Example: Problem Case #3.
4. Ethics in Action (p. 1155). A profit maxmizer would dominate the corporation by having
such a classes-of-shares arrangement. It is legal, there is no deception, and you would
give no greater rights to anyone who did not have sufficient bargaining power to obtain
greater rights. A profit maximizer would not complain if he bought the shares with fewer
rights, because he would have understood his rights when he bought the shares and
should have paid the fair value for them or not purchased them. A utilitarian would make
a similar analysis. A justice or rights theorist might argue that the minority class should
obtain some greater rights than those granted by them by the majority, but only if some
greater right was at stake or if the minority was in greater need of protection, such as if
their investments were larger or if the majority shareholders are taking advantage of a
public market created by the minority shareholders.
D. Fundamental Corporate Changes and Dissenters’ Rights
1. Define the various types of fundamental corporate changes. Note that the procedures for
effecting these changes vary with the type of change. In addition, the articles may
require procedures that are not in the corporation statute. Note especially the simplified
procedures for the short-form merger.
2. Mention that courts prefer substance over form when determining what type of
transaction is involved. Corporations frequently will attempt to circumvent the
shareholders’ right of appraisal by making a merger look like a different type of
transaction. In such situations, courts apply the de facto merger doctrine: if the
transaction has the same effect on shareholder rights as a merger, then a right of appraisal
exists. The MBCA eliminates the potential for this abuse by preserving the right of
appraisal for transactions that materially affect liquidation, dividend, redemption,
preemptive, or voting rights of shareholders.
3. The Global Business Environment (p. 1156). This box illustrates how shareholders
worldwide, especially institutional investors, are exercising their rights to oppose
management.
4. Dissenters’ Rights (Right of Appraisal)
a. Review the actions, shareholders, and shares covered by the right of appraisal. Note
that the MBCA was recently changed to eliminate dissenters’ rights when the
corporation’s shares are traded on a recognized stock exchange. This is the majority
rule in the United States today. The old MBCA rule did not exclude any shares from
the right. The MBCA’s old approach made sense, because the news of the action to
which the shareholder dissents will affect the market price of the shares. The new
MBCA rule is based in an interest not to unduly burden a corporation when a public
market exists.
Example: Problem Case # 4.
b. Note that judges and juries are not well equipped to value shares, especially shares of
close corporations. Even in cases in which market value is an excellent determinant
of the value of shares (such as when there is a highly liquid market for the shares),
courts consider other factors. The Delaware block method [which essentially is
followed in most states, although it has in part been repudiated by the Delaware
Supreme Court in Weinberger v. U.O.P., Inc., 457 A.2d 701 (Del. 1983)] requires
courts to consider current asset value, book value, market value of the shares,
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Chapter 44 - Shareholders' Rights and Liabilities
dividend value, earnings value, and the nature of the enterprise in an attempt to
determine the intrinsic value--whatever that may be--of the corporation and its
shares. The Weinberger case was an important step forward, for it authorized courts
to adopt methods generally accepted in the financial community. The next case
showed how a modern court that understands finance can make rational financial
valuations.
Montgomery Cellular Holding Co., Inc. v. Dobler (p. 1157). In this is a very long but
very good decision by the Delaware Supreme Court. We’ve been waiting all our
lives for a case like this in which a court really understands finance. Your accounting
and finance students will especially appreciate this case.
Points for Discussion: Unless you are a sadist or finance freak (like we are), you will
probably not want to cover his case in excruciating detail. But there are some salient
points, especially regarding the expert witnesses. Note that both sides’ expert
witnesses had good credentials, having worked for Big Four accounting firms. Ask
your students why the court rejected Gartrell’s valuation. First, he didn’t value
MCHC as a going concern. Second, his discounted cash flow methodology was
flawed, because he used a generic growth rate rather than one for MCHC’s industry.
Ask your students why a generic rate isn’t valid. They will know that different
industries are at different stages of development, and the cell phone service industry
was a high growth industry at the time of this case. Third, his comparable company
analysis switched between mean and median data. The court almost seemed to say
that Gartrell selected comparable company data that would minimize the value of
MCHC.
Additional Points for Discussion: The court didn’t accept Sherman’s valuation fully
either, but mostly it did. Ask your students which valuation methods they have been
taught in their accounting and finance classes. They will immediately say DCF and
comparable company. Some of them may also say comparable transaction. Did
Sherman use these methods? Yes, but Gartell also used the first two, which are the
most acceptable valuations methods. Why then did the court mostly accept
Sherman’s valuation, but not Gartell’s? Because he used better data. The court spent
most of its opinion dealing with the adjustments that either the chancery court or
Sherman made, especially the chancery court’s adding a 15% premium to the
comparable transaction valuation and Sherman’s eliminating from the DCF valuation
management fees that an affiliate company charged MCHC. Why did the Supreme
Court add the 15% premium to the CD settlement price? It believed that the
chancery court was correct in eliminating the settlement haircut. What was that? It
was the lower price the minority shareholders of CD agreed to just to get the matter
over with. Why did the Supreme Court accept Sullivan’s elimination of the affiliate’s
management fees? Because the fees were apparently paid to an affiliate that did
nothing for MCHC and were, according to one credible witness (the CEO of the
company that controlled the affiliate and MCHC) “accounting bullshit.”
E. Shareholders’ Inspection and Information Rights
Note that shareholders today have easier access to corporate information than previously was
available. The MBCA is typical of modern statutes that specifically spell out the inspection
rights and information rights of shareholders. Even so, the MBCA and other statutes require
that a shareholder have a proper purpose to inspect most corporate documents. List for your
students several of the proper and improper purposes.
City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc. (p. 1163). In a
decision that is not a model of clarity, the Supreme Court of Delaware held that a shareholder
attempting to bring a derivative action against the directors had not proved it had a proper
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Chapter 44 - Shareholders' Rights and Liabilities
purpose to inspect corporate records that might help the shareholder prove its case against the
directors. Why is this case not a model of clarity that would be helpful to future litigants?
The court stated a standard for review that used general language with no concrete definition:
that is, the shareholder must have a “credible basis” for its accusations against management
from which the court can infer possible mismanagement of the directors that warrants further
investigation. The court does not define “credible basis” or give examples of it. Moreover,
the court empowers the trial court, that is, the chancellor in the court of chancery, to draw
different logical conclusions than the shareholder draws. The Delaware Supreme Court
accepted the logical conclusion of the chancellor over that of the shareholder.
Points for Discussion: Does this mean the Delaware Supreme Court and the chancellor
reached the wrong conclusion that the shareholder did not prove a proper purpose to inspect
the records of the corporation? Probably not. After all, as far as we can tell from the facts in
the case, the shareholder alleged only that the directors made a decision it did not like and
that the decision by itself must have been self-interested. That is not enough evidence to
justify inspection. As the court implied, to allow inspection under the purpose proposed by
the shareholder here would amount to nothing more than a fishing expedition.
Additional Points for Discussion: What would have been sufficient evidence justifying
inspection in this case? We can only guess, because the court gave no guidance. Most likely,
had the shareholder shown that directors received significant fees that they would likely lose
because SHI would likely replace them with other directors, that the value of the shares was
less than the price offered by SHI (best shown by the market price being less before and after
the SHI offer), and that synergies between SHI and Axcelis were already reflected in
Axcelis’s market price, there would have been some “credible basis” to believe that the
Axcelis directors opposed the SHI offers not to protect Axcelis, but instead to protect their
positions as directors.
Additional Example: Problem Case # 5.
F. Preemptive Right
1. Define the preemptive right and its importance in preserving the proportionate ownership
rights of shareholders. You may want to review the examples at page 1164.
2. Note that most statutes eliminate the preemptive right in the absence of a contrary
provision in the articles of incorporation. Stress the need for including a preemptive right
in close corporations, in which maintaining a balance of power may be essential. A better
alternative to the preemptive right in a close corporation is a ban on new shares or
issuances of shares without the consent of all shareholders. Such a ban does not require a
shareholder to buy shares to maintain her ownership and voting rights. Buying shares
may incur a severe financial strain on a shareholder and may be a burden a shareholder
cannot shoulder.
G. Distributions to Shareholders
1. Distinguish the various types of distributions. Note that cash and property dividends and
share repurchases are essentially the same transaction, since they result in a reduction of
corporate assets. Note that share splits and share dividends are not distributions, since no
assets leave the corporation. Consequently, there is no need to impose any restrictions on
these actions to protect creditors. Note, however, that a share dividend in shares of a
different class of shares may harm the shareholders of the different class of shares,
therefore requiring their approval.
2. Explain the consequences of distributions. Note that the MBCA rules get to the essence
of what is going on: the MBCA protects creditors when assets are distributed by requiring
the corporation to be solvent. The MBCA protects shareholders with liquidation
preferences by requiring that assets be sufficient to pay creditors and the shareholders’
preferences. Note the simplicity and the rationality of the MBCA rules in contrast to
archaic rules of other statutes that purport to protect creditors to a great extent, yet do not,
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Chapter 44 - Shareholders' Rights and Liabilities
because of the freedom granted to corporations to circumvent the protection. In this
regard, you may want to read Manning, Legal Capital (2d ed. 1981), which explains the
ease with which corporations can circumvent the legal capital requirements designed to
protect creditors.
3. Note that the declaration of a dividend is a business judgment of the board of directors
protected by the business judgment rule. The business judgment rule is covered in detail
in Chapter 43.
Dodge v. Ford Motor Co. (p. 1165). Compare this case with Shlensky v. Wrigley, which
appears as Problem Case # 4 in Chapter 43. In both cases, a dominant shareholder
expressed his views publicly about some important matter, yet a court deferred to
Wrigley but not Ford.
Points for Discussion: Ask your students why this different treatment exists in the two
cases? Because the court was convinced that Wrigley’s views would result in increased
shareholder wealth. The court here was convinced that Ford’s view would reduce
shareholder wealth. Ask your students what Ford should have argued if he wanted to
convince the court that it should pay no special dividend so it could employ more people
and sell cars to more people. Should he not have argued that these actions would
increase future profitability by improving employee morale and loyalty and by securing
customer loyalty? Would this argument have been enough by itself? Probably not,
although it would have increased the equities in favor of Ford. The biggest obstacle here
was that Ford had an excessively high amount of net cash inflow far above its present and
predicted needs.
Additional Point for Discussion: You may want to tell your students that it has been
alleged that Ford’s real reason for not declaring a dividend was to prevent the Dodge
brothers from using the money in their competing automobile manufacturing business.
Additional Example: Problem Case # 6.
H. Ensuring a Shareholder’s Return on Investment
1. You can cover this material at the same time you cover close corporations and
shareholder powers at the start of this chapter or when you cover the same material in
Chapter 43.
2. Example: Problem Case # 2.
I. Shareholders’ Lawsuits
1. Shareholders’ direct actions. There is nothing unusual about allowing a shareholder to
sue for compensation for suffering harm to himself or his property. So a shareholder may
sue to force a dividend, to inspect corporate records, to assert a preemptive right, to
enforce a right to vote, to enjoin an ultra vires act, to recover from insiders for trading on
inside information, and to compel dissolution. A shareholder may sue for himself only or
on behalf of himself and other shareholders (class action). Point out the requirements to
certify a class action.
Log On (p. 1168): At this website, you can find good information on shareholder class
actions.
2. Shareholders’ derivative actions
a. State the rationale for allowing shareholders to sue on behalf of the corporation:
shareholders are indirectly harmed by persons who harm the corporation.
b. Note the formalities required for a shareholder to bring a derivative suit. Especially
note the requirement that there be a demand on the directors. Note what
circumstances excuse demand.
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Chapter 44 - Shareholders' Rights and Liabilities
Example: Problem Case # 7.
c. Note the divergent attitudes of the courts toward whether the business judgment rule
protects the decision of a shareholder litigation committee that votes not to sue
directors. The Zapata case states the reasons why courts are distrustful of
shareholder litigation committees. Note that the Zapata rule has been applied only in
demand-excused situations.
Zapata Corp. v. Maldonado (p. 1169). This is the most important case in this area of
the law, and represents the majority rule for demand-excused situations. Go through
the facts carefully, especially regarding the defendant directors’ selection of the two
directors who composed the shareholder litigation committee.
Points for Discussion: What is the court’s rationale for refusing to give shareholders
an absolute right to bring derivative suits? Too much leverage is given to
shareholders. What does the court fear? Meritless and harmful litigation and strike
suits, which will be brought purely for their settlement value. What is the court’s
rationale for not applying the business judgment rule to the decision of a shareholder
litigation committee? That directors have difficulty judging their colleagues, due to a
“there but for the grace of God go I” empathy.
What did the court put in place of the business judgment rule? The Zapata Two-Step.
Note that the first step is no different from the business judgment rule. The second
step is novel, requiring the court to apply its own business judgment to determine
whether the action is in the corporation’s best interest. The second step is
extraordinary, allowing the court to intrude into an area that the courts had always left
to the board: business judgments. The Delaware Supreme Court believed the
intrusion necessary to protect the legitimate interest of shareholders in litigating
claims of a corporation.
Additional Points for Discussion: Ask your students whether they understand what
kind of inquiry the court will make under the second step of the Zapata Two-Step.
Essentially, the court must consider the merits of the suit. If the court determines that
a recovery is possible, the court must consider the likely amount of the recovery, then
balance that expected benefit against the detriments the corporation will suffer, such
as reduction in employee morale, payment of attorneys’ fees, and loss of business due
to adverse publicity. The court also listed ethical factors as ones that should be
considered. Ostensibly, a court could decide to allow the suit to continue even if the
costs exceed benefits, if the suit will help maintain ethical conduct in the boardroom.
d. Ethics in Action (p. 1171): Another way to discipline directors is removing them as
directors of the corporation and forbidding them from serving as directors or officers
of public corporations in the future. Shareholders have the former power, and the
SEC holds the latter power has under federal securities law, which it may enforce
against public companies. Removal and disqualification can be significant deterrents
for directors and executives who receive substantial compensation as directors and
officers of public companies.
A utilitarian or profit maximizer may conclude that the cost of litigating against a
director, including legal fees, and the diversion of executive time outweigh the
benefits of litigation, especially if the director is bankrupt or for other reasons is
unlikely to be able to pay the full amount of the judgment against him. A utilitarian
may, nonetheless, be more willing to bring the action than a profit maximizer,
because the utilitarian will consider the society’s members’ dissatisfaction with bad
people escaping liability. A rights theorist may elevate the right to hold wrongdoers
liable above the right to maximize corporate profits. You’ve often heard people say,
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Chapter 44 - Shareholders' Rights and Liabilities
“It’s not the money; it’s the principal of the thing.” The categorical imperative may
require the same response: we may want a rule that requires injured people to sue
those who harm them.
I. Shareholder Liability
1. Review the rules for shareholder liability for illegal corporate distributions and for
corporate debts.
2. Sale of control
a. Explain why control shares are worth more than non-control shares.
b. Note the chief potential for abuse that results when one sells a controlling block of
shares: the sale may be made to someone who will loot the corporation.
Most courts, were they to be presented with the facts of Perlman v. Feldman
(discussed at page 1172) would find no liability. Wilport, the corporation buying
Feldman’s shares, was required to pay full value for the steel it bought from Newport.
Therefore, it is difficult to find any damage in that case. Newport could have
exploited its market advantage by selling at the market price to Wilport. If Wilport
paid less than market price, then it would be looting Newport, for which it would
have liability. And Feldman could have liability for such looting if he reasonably
should have known that Wilport would loot Newport when he sold his shares.
c. There are two ways for a controlling shareholder to reduce her risk of liability when
she sells her shares:
1) investigate carefully the buyer before selling her shares;
2) require that the buyer make the same offer to the non-controlling shareholders.
Although the second alternative can be a deal killer, it is the only sure way to
avoid a lawsuit.
3. Oppression of minority shareholders
This area is confusing because it is not clear whether the managers only or whether
controlling shareholders also owe a duty not to oppress minority shareholders. You may
want to refer to the oppression materials in Chapter 43 at pages 1137.
Examples: Problem Cases ## 8, 9, and 10.
Brodie v. Jordan (p. 1173): Massachusetts courts have a long history of creating special
remedies in the close corporation context. Several of those cases are cited in this case.
Here the court was willing to consider ordering the corporation to pay dividends to the
minority shareholder or to allow her to participate in corporate governance, but it was not
willing to allow her to obtain the windfall of having her shares purchased.
Points for Discussion: Where was the evidence of oppression in this case? Jordan and
Barbuto were the only directors and both received salaries or other compensation for the
work they or businesses they controlled performed for the corporation. What did Mary
get? Nothing. And she was not a director who had any control of the company. Jordan
and Barbuto made all the decisions. They had not held a shareholders’ meeting in five
years. Mary was an investor whose investment provided no real rights and no real return.
Additional Points for Discussion: On what basis did the court decide to fashion a remedy
for Mary? It based its decision on her reasonable expectations. It believed that she could
reasonably expect to receive a profit from her investment and to participate in the
corporation’s governance, and the court remanded the case to determine whether she
possessed those or other reasonable expectations. Why did the court not require Jordan
and Barbuto to purchase her shares? The court held that she should have expected there
would be no market for her shares in a close corporation. If she wanted to sell her shares,
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Chapter 44 - Shareholders' Rights and Liabilities
she or Walter should have obtained at the time he or she became a shareholder a
requirement that the corporation or other shareholders purchase his or her shares when a
certain event, such as retirement from working for the corporation, occurred in the future.
The court also noted that by requiring her shares to be repurchased, she would be put in a
better position than the other shareholders, because there was no market for their shares.
The court also distinguished this case from the famous Donahue case, in which the
majority had preferred themselves by ordering the corporation to repurchase their shares
at a favorable price while denying the minority the same right. No such preference
existed here.
Additional Points for Discussion: Ask your students whether they feel sorry for the
position Mary is in. Wasn’t this predictable when Walter first formed the corporation
with Jordan and Barbuto? Couldn’t Walter have prevented his and Mary’s ouster from
management by 1) insisting on a class of shares or a proxy or a shareholder voting
agreement that would guarantee he or Mary would be elected to the board of directors
and 2) requiring unanimous director votes so no one could be an officer or receive any
salary without his or Mary’s approval? Absolutely. Wasn’t the domination and
oppression that occurred just as predictable as the absence of a market for the shares?
Yes, it was. Why then should the court provide Mary a remedy to give her a return on
investment or a share in corporate governance, but not a sale of her shares? Isn’t the
court inconsistent? We think it is, and this is why most states’ courts rarely, if ever, step
in to protect minority shareholders, unless the majority is looting the corporation or
abusing discretion in violation of the business judgment rule. The rebuttal to this
Massachusetts case might be that the absence of a market for the shares is normal and
unaffected by the majority’s actions. Being frozen out of management and profits is only
the result of the majority’s actions.
Additional Point for Discussion: Mary was lucky she was in Massachusetts. Your
students and their clients may not be so lucky. Ask your student what should have been
done when the corporation was created? They should have created a class of shares for
each shareholder. Each class would elect its own director or directors. That would have
ensured that Walter or Mary could retain her position on the board. In addition, the
directors should have been restricted in their power to act in most areas, certainly to elect
or remove officers and to set salaries, only by unanimous vote. They could also have had
long-term employment contracts requiring payments to shareholders-employees even if
they were fired as employees or officers. These business planning devices are essential to
avoid domination and to obtain a return on investment in a close corporation.
J. Members’ Rights and Duties in Nonprofit Corporations
1. Note the great flexibility that nonprofit corporation law grants members in establishing
their rights and liabilities. Essentially, there is freedom of contract.
2. Point out the leniency of rules requiring membership approval of matters like
amendments of the articles, mergers, and dissolution. Ask your students whether the for-
profit rules (generally requiring approval of a majority of shares) or the nonprofit rules
(permitting approval by a small minority) provide a fairer result. Your students should
debate whether it is sufficient that a shareholder or member has been informed about a
meeting at which a matter will be considered and can choose whether or not to attend or
to send a proxy. Does the absence of a profit motive justify differences in treatment?
3. Members of a nonprofit corporation have inspection rights much like shareholders of a
stock corporation.
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Chapter 44 - Shareholders' Rights and Liabilities
4. A nonprofit corporation is greatly restricted in distributing its assets to its members due to
the nonprofit nature of the corporation. There is no such thing as a dividend paid by a
nonprofit corporation.
5. Note the great latitude given to nonprofit corporations to expel members. Note that
freezing out shareholders requires not only fair procedures, but also a fair price, if not a
proper business purpose. (See pages 1137-1139 of Chapter 43.) Ask your students why it
is easier to expel members from a nonprofit corporation than it is to freeze-out
shareholders from a for-profit corporation: the lack of a profit motive reduces the
likelihood of economic injury; non-economic injuries are not preferred in the corporation
context.
K. Shareholders Rights Globally
1. Log On (p. 1176): The CIPE website is a propaganda tool to advance the American style
of capitalism worldwide.
2. The Global Business Environment (p. 1177): Note some of the differences between
American and German law regarding the rights of shareholders.
L. Dissolution of Corporations
1. Briefly review the ways in which a corporation may be dissolved. Give special attention
to judicial dissolution due to a deadlock of directors or shareholders.
Example: Problem Case # 11.
2. Note that the liability of persons who act for a dissolved corporation is similar to that of
promoters and of persons acting for a defectively formed corporation.
3. Note that dissolution of nonprofit corporations is substantially like dissolution of for-
profit corporations, with the exception that third-party approval may be required.
IV. RECOMMENDED REFERENCES
See the references in Instructor’s Manual Chapter 41.
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© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
