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CHAPTER 44
SHAREHOLDERS’ RIGHTS AND LIABILITIES
I. OBJECTIVES
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.
II. ANSWER TO INTRODUCTORY PROBLEM
A. The corporation should have six classes of shares. Four classes will be identical, each
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
nonvoting directors.
III. SUGGESTIONS FOR LECTURE PREPARATION
A. Introduction
Note that shareholders, who primarily are investors, have few rights and fewer
B. Shareholders’ Meetings
1. Review the formalities of shareholders’ meetings, noting their primary importance: the
election of directors.
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2. Note that ordinarily only shareholders of record may vote at a shareholder meeting.
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:
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
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.
2. Classes of shares
in a close corporation. Classes are the cleanest way to ensure that each shareholder
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
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
shares were to be voted, it was a proxy.
Additional Point for Discussion: Why did the court rule that the proxy was
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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.
away a shareholder’s power to vote. Absent a clear statement of irrevocability, the
shareholder may revoke the proxy at any time.
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.
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
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
D. Fundamental Corporate Changes and Dissenters’ Rights
1. Define the various types of fundamental corporate changes. Note that the procedures for
procedures for the short-form merger.
2. Mention that courts prefer substance over form when determining what type of
transaction has the same effect on shareholder rights as a merger, then a right of
preemptive, or voting rights of shareholders.
3. The Global Business Environment (p. 1156). This box illustrates how shareholders
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
Example: Problem Case # 4.
b. Note that judges and juries are not well equipped to value shares, especially shares
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essentially is followed in most states, although it has in part been repudiated by the
shares. The Weinberger case was an important step forward, for it authorized courts
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.
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
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
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
E. Shareholders’ Inspection and Information Rights
Note that shareholders today have easier access to corporate information than previously was
that a shareholder have a proper purpose to inspect most corporate documents. List for your
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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
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
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
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
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
shares, therefore requiring their approval.
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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.
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, 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
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.
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
to certify a class action.
Log On (p. 1168): At this website, you can find good information on shareholder class
actions.
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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.
Example: Problem Case # 7.
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.
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
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,
boardroom.
d. Ethics in Action (p. 1171): Another way to discipline directors is removing them as