Chapter 35
MANAGEMENT STRUCTURE
I. Corporate Governance
II. Role of Shareholders
A. Voting Rights of Shareholders
1. Shareholder Meetings
2. Quorum and Voting
3. Election of Directors
a. Straight Voting
b. Cumulative Voting
4. Removal of Directors
5. Approval of Fundamental
Changes
6. Concentrations of Voting
Power
1. Election, Number, and Tenure of
Directors
2. Vacancies and Removal of Directors
3. Compensation of Directors
C. Exercise of Directors’ Functions
1. Quorum and Voting
2. Action Taken Without a Meeting
3. Delegation of Board Powers
4. Directors’ Inspection Rights
D. Officers
1. Selection and Removal of Officers
2. Role of Officers
Cases in This Chapter
Compaq Computer Corporation v.
Horton
Strougo v. Bassini
Donahue v. Rodd Electrotype Co.,
Inc.
Brehm v. Eisner
Beam v. Stewart
Chapter Outcomes
After reading and studying this chapter, the student should be able to:
Compare the actual governance of closely held corporations, the
actual governance of publicly held corporations, and the statutory
model of corporate governance.
TEACHING NOTES
I. CORPORATE GOVERNANCE
*** Chapter Outcome***
Compare the actual governance of closely held corporations, the actual
governance of publicly held corporations, and the statutory model of corporate
governance.
The statutory model of governance can be described as a pyramid with the
shareholders at the base, their elected representatives — the board of
directors — above the shareholders, and the ocers who handle the day to
day corporate business at the top of the pyramid.
NOTE: See Figure 35-1.
The statutory model, however, does not re ect reality in the majority of
corporations, which are closely held. Typically, in closely held corporations
there is little separation of ownership and management; most shareholders
actively participate in management. The corporate formalities required by
law are burdensome to closely held corporations. Some states have relaxed
management recommends. Thus, in many large corporations, the reality is
the opposite of the statutory model. The corporation’s ocers (employees)
are actually in control.
Typically a strong CEO is not only a board member but also serves as
chairman as well. There may be several other ocers on the board; if so,
their loyalty is to their chief. The CEO may hand pick his outside board
members and keep their loyalty with generous compensation and perks.
Thus, though voted in by shareholders, the directors are actually beholden to
the CEO. One of the great business stories of the 1990s has been a
shareholders’ revolt against ocer-dominated boards, a revolt typically led
by very large institutional owners of shares.
II. ROLE OF SHAREHOLDERS
The role of shareholders in managing the corporation generally is restricted
to electing directors, approving certain extraordinary matters, approving
corporate transactions that are void or voidable unless rati)ed, and bringing
suits to enforce these rights.
*** Chapter Outcome***
Explain the role of shareholders in the management of a corporation.
A. VOTING RIGHTS OF SHAREHOLDERS
Voting is a fundamental right of shareholders in corporations. In most states,
shareholders have one vote for each share they own, unless the charter
provides otherwise. Also, incorporation statutes usually permit the issuance
of one or more classes of nonvoting stock, in addition to the voting classes of
stock. Whereas a great majority of institutional investors exercise their right
to vote their shares, most individual investors do not. Nonetheless, virtually
all shareholders who vote for the directors do so through the use of a proxy
Shareholder Meetings
Shareholders can vote at both annual and special shareholder meetings. The
Revised Act requires annual meetings to be held at a time )xed by the
bylaws. If the annual meeting is not held at the proper time, any shareholder
may petition the court to require that a meeting be held. In contrast, the
Close Corporation Supplement provides that no annual meeting of
shareholders need be held unless a shareholder makes a written request at
least 30 days in advance of the requested meeting date.
Quorum and Voting
In order for a vote to be valid, quorum of all outstanding shares (not counting
unissued shares and treasury stock) entitled to vote must be presented at
the meeting, either in person or by proxy.
A quorum is a simple majority unless the articles of incorporation specify a
di6erent figure. In many states and under the Model Act, a quorum may not
be less than one-third of voting shares. Under the Revised Act and some
states, there is no minimum. State statutes do not impose an upper limit, so
it may be set higher than a simple majority and may even require all
outstanding shares.
Once a quorum is present (in person or by proxy), most states require
shareholder actions to be approved by a majority of the shares represented
at the meeting and entitled to vote. But many states permit the articles of
incorporation to require a “supermajority.” Close corporations often use
these to protect minority shareholders from oppression by the majority.
Election of Directors
Directors are elected each year at the annual meeting. Most states provide
that where there are 9 or more directors, the charter or bylaws may provide
for the directors to be divided into 2 or 3 classes with a nearly equal number
Straight and Cumulative Voting — Straight voting means a shareholder
has one vote per share owned, and the directors are elected by a plurality of
votes. Cumulative voting, permissible in most states and under the Revised
Act, entitles shareholders to multiply the number of votes they are entitled
to cast by the number of directors for whom they are entitled to vote and to
cast the product for a single candidate or to distribute the product among 2
Removal of Directors
By a majority vote (except where cumulative voting is permitted),
shareholders may remove any director or the entire board, with or without
cause, in a meeting called for that purpose.
Approval of Fundamental Changes
Extraordinary matters involving fundamental changes in the corporation
require shareholder approval — including amendments to the corporate
charter, sale or lease of all or substantially all of the corporate assets not in
the regular course of business, most mergers, consolidations, compulsory
share exchanges, and dissolution.
Concentrations of Voting Power
Shareholders can combine voting power to obtain or maintain control or to
maximize the impact of cumulative voting.
Proxies — are shareholders’ authorizations to an agent to vote their shares.
A proxy either may specify how the vote is to be cast or may authorize the
agent to vote as he chooses. A proxy generally must be in writing and is
typically limited to no more than 11 months. The proxy is revocable unless
on a trustee the right to vote or otherwise act by signing an agreement.
Voting trusts are permitted in most states but are usually limited to 10 years’
duration.
Restrictions on Transfer of Shares
Usually shares of stock are freely transferable, but there are some situations
in which the shareholders may restrict such transfers in order to select who
can be a shareholder or to limit the number of shareholders. These
restrictions are upheld by common law if they are made for a lawful purpose.
B. ENFORCEMENT RIGHTS OF SHAREHOLDERS
By law, a shareholder has enforcement rights: (1) the right to obtain
information, (2) the right to sue the corporation directly or to sue on the
corporation’s behalf, and (3) the right to dissent.
Right to Inspect Books and Records
Most states have statutes granting shareholders the right to inspect, for a
proper purpose, books and records in person or through an agent and to
copy parts of them. The Revised Act provides that every shareholder is
entitled to examine specified corporate records upon prior written request if
the demand is made in good faith, for a proper purpose, and during regular
business hours at the corporation’s principal oce. However, a number of
CASE 35-1
COMPAQ COMPUTER CORPORATION v. HORTON
Supreme Court of Delaware, 1993
631 A.2d 1
http://scholar.google.com/scholar_case?case=1308314219087891838&q =631
+A.2d+1&hl=en&as_sdt=2,34
Moore, J.
This is a stocklist case arising under §220(b) of our [Delaware] General Corporation Law. The issue
is whether a shareholder states a proper purpose for inspection under our statute in seeking to solicit
the participation of other shareholders in legitimate non- derivative litigation against the defendant
corporation. The Court of Chancery found that the litigation concerned alleged corporate
wrongdoing that affected the value of the plaintiff’s stock. Accordingly, the trial court concluded that
plaintiff’s desire to contact other stockholders, and solicit their involvement in the litigation, was a
purpose reasonably related to one’s interest as a stockholder. We agree and affirm.
I
Compaq Computer Corporation (“Compaq”) refused to permit Charles E. Horton (“Horton”), a
Compaq stockholder, to inspect its stock ledger and other related materials. Horton has beneficially
owned 112 shares of Compaq common stock continuously since December 6, 1990. * * *
On September 22, 1992, Horton, through counsel, delivered a letter demanding to inspect
Compaq’s stock ledger and related information for the period from October 1, 1990, to June 30,
1991, to the extent such information is available and in the possession or control of Compaq. The
demand letter stated that the purpose of the request was:
[T]o enable Mr. Horton to communicate with other Compaq shareholders to inform them of the
pending shareholders’ suit of Charles E. Horton, et al. v. Compaq Computer Corporation and
Joseph R. Canion and to ascertain whether any of them would desire to become associated with
that suit or bring similar actions against Compaq, and assume a pro rata share of the litigated
expenses.
On September 30, 1992, Compaq refused the demand, stating that the purpose described in the
letter was not a “proper purpose” under Section 220(b) of the General Corporation Law of the State
of Delaware * * *. Compaq conceded that Horton had met all of the technical requirements for
making a demand under 8 Del. C. §220, and that the only issue remaining for the trial court to
resolve was whether Horton stated a proper purpose for inspecting the various documents.
of Horton’s Compaq stock. [Citation.] Accordingly, Horton stated a proper purpose reasonably
related to his interest as a Compaq stockholder.
II
The question of a “proper purpose” under Section 220(b) of our General Corporation Law is an issue
of law and equity which this Court reviews de novo. [Citations.] * * * §220(b) * * * provides in
pertinent part:
Any stockholder * * * shall, upon written demand under oath stating the purpose thereof, have
the right during the usual hours for business to inspect for any proper purpose the corporation’s
stock ledger * * *. A proper purpose shall mean a purpose reasonably related to such person’s
interest as a stockholder. [Citation.]
Under Section 220, when a stockholder complies with the statutory requirements as to form and
manner of making a demand, then the corporation bears the burden of proving that the demand is for
an improper purpose. [Citation.] If there is any doubt, it must be resolved in favor of the statutory
right of the stockholder to have an inspection. [Citation.]
Essentially, Horton alleges that it is in the interests of Compaq’s shareholders to know that acts
of mismanagement and fraud are continuing and cannot be overlooked. Thus, it is assumed that the
resultant filing of a large number of individual damage claims might well discourage further acts of
misconduct by the defendants. In this specific context, the antidotal effect of the Texas litigation may
indeed serve a purpose reasonably related to Horton’s current interest as a Compaq stockholder.
We recognize that even though a purpose may be reasonably related to one’s interest as a
stockholder, it cannot be adverse to the interests of the corporation. [Citations.] In this respect, it
becomes clear that a stockholder’s right to inspect and copy a stockholder list is not absolute. Rather,
it is a qualified right depending on the facts presented. [Citation.]
Horton’s ultimate objective, to solicit additional parties to the Texas litigation, may impose
substantial expenses upon the company. Compaq argues, therefore, that such a purpose is per se
improper as adverse to the interests of the corporation. Significantly, however, Compaq conceded at
oral argument that it could cite no authority in support of its proposition that the purpose behind a
demand must benefit the defendant corporation.
policy dictate that a proper purpose may be stated in these circumstances, notwithstanding the lack of
a direct benefit flowing to the corporation.
Equally important is the fact that if damages are assessed against Compaq in the Texas litigation,
the company is entitled to seek indemnification from its co-defendant managers and advisors or to
pursue its own claims against them. The availability of this diminishes the possibility that Compaq
will suffer any harm at all. It is well-settled that the mere prospect of harm to a corporate defendant
is insufficient to deny relief under Section 220. [Citation.] * * * Accordingly, we are satisfied that the
purpose for which Horton seeks to inspect the stock ledger and related materials is not adverse to the
legitimate interests of the company.
This conclusion does not suggest that Compaq’s burden of showing an improper purpose is
impossible to bear. Previous cases provide valuable examples of the degree to which a stated purpose
is so indefinite, doubtful, uncertain or vexatious as to warrant denial of the right of inspection. In
Shareholder Suits
The ultimate recourse of a shareholder, short of selling her shares, is to bring
suit against or on behalf of the corporation.
Direct suits — In direct suits, a shareholder attempts to enforce a claim
against a corporation, based on his ownership of shares. Any recovery goes
to the shareholder plainti6.
Examples of direct suits: shareholder actions to compel payment of
dividends properly declared, to enforce the rights to inspect corporate
records and to vote, to protect preemptive rights, and to compel dissolution.
A class suit is a direct suit in which one or more shareholders act as a
representative for a class of shareholders to recover for injuries to the entire
class.
Derivative suits — are brought by one or more shareholders on behalf of
the corporation to enforce a right belonging to the corporation. Shareholders
may bring a derivative action when the board of directors refuses to act on
the corporation’s behalf.
bring suit against the corporation’s ocers or directors. Thus, a shareholder
derivative suit is the only recourse. Recovery usually goes to the
corporation’s treasury, so that all shareholders can benefit proportionately.
Usually, a shareholder must own his shares at the time of the transaction in
question in order to bring a derivative suit. In addition, the shareholder must
first make demand on the board of directors to enforce the corporate right
before he brings suit.
NOTE: See Figure 35-5: Shareholder Suits.
CASE 35-2
STROUGO v. BASSINI
Sack, J.
* * * The plaintiff is a shareholder of the Brazilian Equity Fund, Inc. (the “Fund”), a non-diversified,
publicly traded, closed-end investment company incorporated under the laws of Maryland * * *. As
its name implies, the Fund invests primarily in the securities of Brazilian companies. The term
“closed-end” indicates that the Fund has a fixed number of outstanding shares, so that investors who
wish to acquire shares in the Fund ordinarily must purchase them from a shareholder rather than, as
in open-end funds, directly from the Fund itself. Shares in closed-end funds are thus traded in the
same manner as are other shares of corporate stock. Indeed, shares in the Fund are listed and traded
Although closed-end funds do not sell their shares to the public in the ordinary course of their
business, there are methods available to them to raise new capital after their initial public offering.
One such device is a “rights offering,” by which a fund offers shareholders the opportunity to
purchase newly issued shares. Rights so offered may be transferable, allowing the current
shareholder to sell them in the open market, or non-transferable, requiring the current shareholder to
use them him- or herself or lose their value when the rights expire. It was the Fund’s employment of
a non-transferable rights offering that generated the claims at issue on this appeal.
On June 6, 1996, the Fund announced that it would issue one “right” per outstanding share to
every shareholder, and that every three rights would enable the shareholder to purchase one new
share in the Fund. The subscription price per share was set at ninety percent of the lesser of (1) the
average of the last reported sales price of a share of the Fund’s common stock on the New York
Stock Exchange on August 16, 1996, the date on which the rights expired, and the four business days
preceding, and (2) the per-share net asset value at the close of business on August 16.
The plaintiff asserts that this sort of rights offering is coercive because it penalizes shareholders
who do not participate. Under the Fund’s pricing formula for its rights offering, the subscription
price could not have been higher than ninety percent of the Fund’s per-share net asset value. Thus,
the introduction of new shares at a discount diluted the value of old shares. Because the rights could
At the close of business on August 16, 1996, the last day of the rights offering, the closing
market price for the Fund’s shares was $12.38, and the Fund’s per-share net asset value was $17.24.
The Fund’s shareholders purchased 70.3 percent of the new shares available at a subscription price
set at $11.09 per share, ninety percent of the average closing price for the Fund on that and the
preceding four days. Through the rights offering, the Fund raised $20.6 million in new capital, net of
underwriting fees and other transaction costs.
On May 16, 1997, the plaintiff brought this action against the Fund’s directors, senior officers,
and investment advisor. * * * It alleges that the defendants, by approving the rights offering,
breached their duties of loyalty and care at common law. * * * It asserts that these breaches of duty
resulted in four kinds of injury to shareholders: (1) loss of share value resulting from the
On April 6, 1998, the district court dismissed the direct claims on the ground that the injuries
alleged “applied to the shareholders as a whole.” * * *
* * * The plaintiff now appeals.
* * *
In deciding whether a shareholder may bring a direct suit, the question the Maryland courts ask
is not whether the shareholder suffered injury; if a corporation is injured those who own the
corporation are injured too. The inquiry, instead, is whether the shareholders’ injury is “distinct”
from that suffered by the corporation. [Citation.]
* * *
Thus, under Maryland law, when the shareholders of a corporation suffer an injury that is distinct
from that of the corporation, the shareholders may bring direct suit for redress of that injury; there is
lawsuit to compensate for the injury to the corporation, and thereby ultimately redress the injury to
the shareholders.
* * * To sue directly under Maryland law, a shareholder must allege an injury distinct from an
injury to the corporation, not from that of other shareholders.
* * *
Applying Maryland’s law of shareholder standing to the plaintiff’s four alleged injuries, we
conclude that one that he alleges does not support direct claims under Maryland law. The remaining
alleged injuries, however—describing the set of harms arising from the alleged coercion—do.
The plaintiff alleges a loss in share value resulting from the “substantial underwriting and other
transactional costs associated with the Rights Offering.” * * * Underwriter fees, advisory fees, and
other transaction costs incurred by a corporation decrease share price primarily because they deplete
the corporation’s assets, precisely the type of injury to the corporation that can be redressed under
Maryland law only through a suit brought on behalf of the corporation. [Citation.]
The plaintiff’s remaining alleged injuries can be read to describe the set of harms resulting from
the coercive nature of the rights offering. The particular harm allegedly suffered by an individual
* * *
* * * On the other hand, participating shareholders may have suffered harm in the form of
transaction costs in liquidating other assets to purchase the new shares, and the impairment of their
right to dispose of their assets as they
prefer if they purchased new shares to avoid dilution.
* * *
Thus, in the case of both the participating and non-participating shareholders, it would appear
that the alleged injuries were to the shareholders alone and not to the Fund. These harms therefore
constitute “distinct” injuries supporting direct shareholder claims under Maryland law. The
corporation cannot bring the action seeking compensation for these injuries because they were
suffered by its shareholders, not itself.
* * *
Shareholder’s Right to Dissent
A shareholder has the right to dissent from certain corporate actions that
require shareholder approval — including most mergers, consolidations,