978-1305575080 Chapter 44 Solution Manual Part 1

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Chapter 44

SHAREHOLDER RIGHTS IN CORPORATIONS

RESTATEMENT

Ownership in a corporation is represented by stock. Stock ownership does not give the shareholder rights in any

particular property. Rather, the shareholder is an owner with the other shareholders of all corporate property.

Capital is the net assets of a corporation. Shares issued to holders are outstanding. Capital stock refers to the

value received by the corporation for its outstanding stock. Corporate stock may have a par value depending

upon the state’s corporation law. Book value is found by dividing the value of the corporate assets by the number

of shares outstanding. Market value is the price of the shares in the open market.

Stock ownership is evidenced by a certificate of stock or share certificate. The kinds of stock are common stock,

preferred stock, cumulative preferred stock and participating preferred stock. The classes of stock provide

different priorities as well as different dividend rights.

A bond is an instrument issued by a corporation to persons lending it money. A bond has a specified principal

amount, interest rate and repayment debt. Other contract terms may require a sinking fund for purposes of

ensuring repayment.

Shares can be acquired from the corporation by subscription or purchased on the open market. Contracts for

sale of shares need not be in writing under the most recent revision of Article 8 of the UCC. Stock subscriptions

are agreements in advance to purchase shares of a corporation when the shares are sold. Preincorporation

subscriptions carry the protection of being irrevocable by the subscriber for six months.

Restrictions on transfers of shares are valid so long as they are reasonable and noted on the shares. Shares are

transferred by indorsement and delivery. The corporation treats those persons listed on its records as the owners

of the shares. Notification of transfer is required for the transferee to receive notices and dividends from the

corporation. If a certificate is lost, stolen or destroyed, it can be replaced if the owner obtains an indemnity bond.

Increasingly, shares are uncertificated and are recorded electronically.

Shareholders have the right to certificates evidencing ownership, the right to transfer shares, and the right to

vote. Voting may be either a one share/one vote process or a process of cumulative voting whereby each share

gets the votes equal to the number of directors being elected. Shareholders can vote by proxy and can enter into

voting agreements or assign voting rights to a trust in order to pool their voting power.

Preemptive rights, if provided, give the shareholder a right of first refusal if new capital stock is issued so that the

shareholder can retain his or her ownership interest level in the corporation.

Shareholders have a right of access to books and records for business purposes and are entitled to annual

financial statements.

Dividends can be declared by the board and are valid if the corporation is solvent. A dividend may be paid in the

form of shares, as a stock dividend.

Shareholders have the right to sue officers and directors for damages they cause to the corporation. These

lawsuits are referred to as derivative lawsuits because shareholders enforce the rights of the corporation.

Shareholders enjoy limited liability. The most they stand to lose is their investment in the payment for their

shares. They have personal liability to creditors only if they have not paid their subscriptions or have paid less

than par value for those shares.

Professional corporations are statutory creatures that limit liability for the owners with the exception of

malpractice liability. Whether other owners are liable for the malpractice of an associate varies from state to

state.

STUDENT LEARNING OUTCOMES

LO.1: Explain how to calculate the book value of a share of stock.

LO.2: Distinguish between stocks and bonds.

LO.3: Distinguish between subscriptions for and transfers of stock.

LO.4: Explain the rights of shareholders.

LO.5: Explain the nature of a shareholder derivative lawsuit.

LO.6: Explain the exceptions to the limited liability of shareholders.

INSTRUCTOR’S INSIGHTS

Break the chapter down into four components – related Learning Outcomes are indicated in ( ):

1. What is the nature of corporate stock and bonds?

Cover the nature of stock (LO.1)

2. How is stock acquired?

Describe the requirements for stock acquisition (LO.3)

3. What are the rights of corporate shareholders?

List the ownership rights (LO.4)

Discuss voting rights (LO.4)

4. What is the liability of shareholders?

Emphasize the shareholders’ limited liability

CHAPTER OUTLINE

I. What is the Nature of Corporate Stock and Bonds?

A. Nature of stock

1. Capital and capital stock

2. Valuation of stock

a. Par

b. RMBCA = no par

B. Certificates of stock and uncertificated shares

C. Kinds of stock

1. Classification by preferences

4. Duration of shares

5. Fractional shares – allowed

D. Characteristics of bonds

1. Characteristics of bonds

E. Terms and control

II. How is Stock Acquired?

A. Acquisition of shares

1. Nature of acquisition

2. Statute of frauds

3. Subscription

B. Transfer of shares

1. Restrictions on transfer

CASE BRIEF: Fought v. Morris

543 So. 2d 167 (Miss. 1989)

FACTS: Fought, Morris, and two other individuals organized a corporation, each receiving an equal

amount of shares. They all agreed to a stock redemption agreement requiring the shareholder

wishing to sell his stock to offer proportionate shares to each shareholder. This redemption

plan was followed when one individual retired in 1979. In 1983, a second individual left the

enterprise and sold all of his shares to Morris, thus giving Morris control of the corporation.

Fought sued Morris for breach of his fiduciary duty and for his pro rata number of shares.

Judgment was for Morris. Fought appealed.

ISSUE: Is an agreed upon restriction on the transfer of shares binding on a shareholder?

HOLDING: Yes. Directors and officers of a corporation owe fiduciary duties to a corporation and its

shareholders. The stock redemption agreement is important for shareholders in a close

REASONING: Closely held corporations present special problems in corporate governance. In a close

corporation the shareholders know each other very well and the line between a business

dispute and a personal grievance often overlap. Also the formal roles of officers and corporate

formalities such as regular meetings are often overlooked since informal communications are

the norm in the closely held company. Minority shareholders occupy the most unenviable

position in the structure of the closely held corporation. In a dispute with the majority, they

cannot prevail since their share of ownership control is regularly overruled by the majority.

Should matters become intolerable for the minority shareholder, since there is no market for

such stock, the shareholder is stuck with his ownership share in the company and the decisions

of the majority. To protect oneself from potential oppression by the majority, a potential

shareholder should always secure buyout provisions in a shareholder agreement with the

company. In Fought, this is exactly what occurred and it was Morris’ attempt to circumvent the

shareholder agreement that led to the case presented.

2. Interest transferred – pledge, full transfer, partial transfer

C. Mechanics of transfer

D. Effect of transfer

1. Validity of transfer

2. Negotiability

E. Lost, destroyed, and stolen share certificates

III. What are the Rights of Corporate Shareholders?

A. Ownership rights

CASE BRIEF: Shoaf v. Warlick

380 S.E. 2d 865 (S.C. App. 1989)

FACTS: Warlick was the president, the chief executive officer, and a shareholder of Coca-Cola Bottling

Co. of Anderson, South Carolina. He controlled 273.5 shares of stock of the total of 480 shares

of stock outstanding. Warlick agreed to sell his controlling interest for $4,000,000, which

included a premium to be paid to him for his controlling interest. Shoaf, a minority shareholder,

brought suit against Warlick, contending that Warlick had violated his fiduciary duty to the

corporation and received an unlawful premium for the sale of his majority interest. Judgment

was for Warlick. Shoaf appealed.

ISSUE: Does a shareholder, who controls the majority of the corporation’s shares, have a duty to refrain

from selling his controlling block of shares at a premium?

HOLDING: No. South Carolina has long followed the general rule that corporate stock is personal property

that the owner may dispose of as he or she sees fit. When selling stock, shareholders must

REASONING: Compare this case to that in Alpert v. 28 Williams Street Corp. Absent fraud or

misrepresentation, a controlling shareholder is entitled to sell his stock for the best price he can

get for the stock. While control of the corporation is transferred with the shares, it is a transfer

of control that is proportional to the number of shares owned. Any premium paid for the shares

is in consideration of the convenience of buying the block at once rather than piecemeal. Such

a sale is not a “sale of the office” since control is transferred by virtue of the number of shares

transferred. On the other hand, a “sale of office” occurs when a minority shareholder wields

control over the corporation through control of the directors and is strictly forbidden. Such a

situation can occur when the minority shareholder who was once the majority shareholder and

used that position to pack the Board of Directors with allies, after which the shareholder sold off

his controlling interest. If this same minority shareholder sells his stock at a premium above the

market price and then effects a substitution of the current board with the nominees of the

purchaser, this is a “sale of office.” The new purchaser has control of the corporation through

the machinations of the shareholder that is unrelated to the purchaser ’s proportional ownership

of the corporation.

B. Right to vote

1. Who may vote – registered shareholders with the corporation

2. Number of votes

a. Straight voting vs. cumulative voting

b. The concept of cumulative voting needs to be explained in some detail to the students. In

starting your discussion on shareholder voting, begin with a discussion of how shareholder

meetings are called, the proper notices that must be given, who can call shareholder meetings,

quorum requirements, etc. Make certain that the students understand the reason behind

cumulative voting before they see the mechanics of its operation. Use the following formula to

demonstrate how to determine the number of shares necessary to elect a director:

X = W x N + 1

1 + T

Plug in any numbers you want, and you can compute the number of shares necessary to elect a

representative of the minority to act as a spokesperson on the board of directors. Once you

have computed the number of shares needed, show the students how the votes could be cast

C. Preemptive offer of shares

D. Inspection of books

1. Inspection may require a certain percentage of shares

CASE BRIEF: Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW

2014 WL 3638848 (Del. 2014)

FACTS: After reading a New York Times article that raised allegations about bribery by Wal-Mart

executives at its Mexico store, WalMex, shareholders demanded to inspect corporate

documents, including some that the corporation claimed were privileged.

ISSUE: Can shareholders demand access to corporate documents for purposes of investigating the

possibility of breaches of fiduciary duty by the corporation?

HOLDING: Yes. Although corporations may assert attorney-client privilege, there may be an exception to

REASONING: Under the Delaware Code, shareholders may inspect documents that are “necessary and

essential” for a “proper purpose.” After showing that the documents were necessary to their

case, the shareholders had to show that there was good cause to demand the privileged

documents.

Good cause includes a variety of issues. In this case, the court found good cause because the

shareholders had a “colorable claim” that corporate wrongdoing occurred and it would be

difficult to get the documents from another source.

4. Financial statements – annual requirements under the RMBCA

E. Dividends

1. Funds available for declaration of dividends

2. Discretion of directors

3. Form of dividends – money or property or stock

4. Effect of transfer of shares