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Business Law Chapter 40 Homework Additional Background Derivative Suits The Right Shareholders

Page Count
9 pages
Word Count
7008 words
Book Title
Business Law: Text and Cases 14th Edition
Authors
Frank B. Cross, Kenneth W. Clarkson, Roger LeRoy Miller
16 UNIT EIGHT: BUSINESS ORGANIZATIONS
CHAPTER IISECURITIES AND EXCHANGE COMMISSION
PART 240GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
SUBPART ARULES AND REGULATIONS UNDER THE SECURITIES EXCHANGE ACT OF 1934
REGULATION 14A: SOLICITATION OF PROXIES
§ 240.14a-8 Proposals of security holders.
(a) If any security holder of a registrant notifies the registrant of his intention to present a proposal for action at
a forthcoming meeting of the registrant’s security holders, the registrant shall set forth the proposal in its proxy
statement and identify it in its form of proxy and provide means by which security holders can make the
specification required by Rule 14a-4(b) [17 CFR 240.14a-4(b) ]. Notwithstanding the foregoing, the registrant
shall not be required to include the proposal in its proxy statement or form of proxy unless the security holder
(hereinafter, the “proponent”) has complied with the requirements of this paragraph and paragraphs (b) and
(c) of this section:
(1) Eligibility. At the time he submits the proposal, the proponent shall be a record or beneficial owner of at
least 1% or $1000 in market value of securities entitled to be voted on the proposal at the meeting and have
held such securities for at least one year, and he shall continue to own such securities through the date on
which the meeting is held. If the registrant requests documentary support for a proponent’s claim that he is
the beneficial owner of at least 1% or $1000 in market value of such voting securities of the registrant or that
he has been a beneficial owner of the securities for one or more years, the registrant shall make such request
within 14 calendar days after receiving the security holder proposal and the proponent shall furnish
appropriate documentation within 21 calendar days after receiving the request. Appropriate documentation of
the proponent’s claim of beneficial ownership shall include:
(i) A written statement by a record owner or an independent third party, accompanied by the proponent’s
written statement that the proponent intends to continue ownership of such securities through the date on
which the meeting is held; or
(A) A copy of all subsequent amendments reporting a change in ownership level,
(B) The proponent’s affidavit, declaration, affirmation or other similar document provided for under applicable
state law attesting that the proponent continued to be the beneficial owner of at least 1% or $1000 in market
value of such voting securities of the registrant throughout the required one year period and as of the date of
the affidavit, declaration, affirmation or other similar document provided for under applicable state law, and
(2) Notice and Attendance at the Meeting. At the time he submits a proposal, a proponent shall provide the
registrant in writing with his name, address, the number of the registrant’s voting securities that he holds of
(3) Timeliness. The proponent shall submit his proposal sufficiently far in advance of the meeting so that it is
received by the registrant within the following time periods:
(i) Annual Meetings. A proposal to be presented at an annual meeting shall be received at the registrant’s
principal executive offices not less than 120 calendar days in advance of the date of the registrant’s proxy
statement released to security holders in connection with the previous year’s annual meeting of security
holders except that if no annual meeting was held in the previous year or the date of the annual meeting has
been changed by more than 30 calendar days from the date contemplated at the time of the previous year’s
(4) Number of Proposals. The proponent may submit no more than one proposal and an accompanying
supporting statement for inclusion in the issuer’s proxy materials for a meeting of security holders. If the
proponent submits more than one proposal, or if he fails to comply with the 500 word limit mentioned in
paragraph (b)(1) of this section, he shall be provided the opportunity to reduce the items submitted by him to
the limits required by this rule, within 14 calendar days of notification of such limitations by the registrant.
(2) Identification of Proponent. The proxy statement shall also include either the name and address of the
proponent and the number of shares of the voting security held by the proponent or a statement that such
information will be furnished by the registrant to any person, orally or in writing as requested, promptly upon
the receipt of any oral or written request therefore.
(c) The registrant may omit a proposal and any statement in support thereof from its proxy statement and form
of proxy under any of the following circumstances:
(1) If the proposal is, under the laws of the registrant’s domicile, not a proper subject for action by security
holders.
18 UNIT EIGHT: BUSINESS ORGANIZATIONS
(2) If the proposal, if implemented, would require the registrant to violate any state law or federal law of the
(3) If the proposal or the supporting statement is contrary to any of the Commission’s proxy rules and
(4) If the proposal relates to the redress of a personal claim or grievance against the registrant or any other
(5) If the proposal relates to operations which account for less than 5 percent of the registrant’s total assets at
(7) If the proposal deals with a matter relating to the conduct of the ordinary business operations of the
registrant;
(9) If the proposal is counter to a proposal to be submitted by the registrant at the meeting;
(11) If the proposal is substantially duplicative of a proposal previously submitted to the registrant by another
proponent, which proposal will be included in the issuer’s proxy material for the meeting;
(12) If the proposal deals with substantially the same subject matter as a prior proposal submitted to security
holders in the registrant’s proxy statement and form of proxy relating to any annual or special meeting of
security holders held within the preceding five calendar years, it may be omitted from the registrant’s proxy
materials relating to any meeting of security holders held within three calendar years after the latest such
previous submission: Provided, That
(ii) If the proposal was submitted at only two meetings during such preceding period, it received at the time of
(13) If the proposal relates to specific amounts of cash or stock dividends.
(d) Whenever the registrant asserts, for any reason, that a proposal and any statement in support thereof
(1) The proposal;
(2) Any statement in support thereof as received from the proponent;
and
(4) Where such reasons are based on matters of law, a supporting opinion of counsel. The registrant shall at
the same time, if it has not already done so, notify the proponent of its intention to omit the proposal from its
proxy statement and form of proxy and shall forward to him a copy of the statement of reasons why the
registrant deems the omission of the proposal to be proper and a copy of such supporting opinion of counsel.
(e) If the registrant intends to include in the proxy statement a statement in opposition to a proposal received
from a proponent, it shall, not later than 30 calendar days prior to the date the definitive copies of the proxy
statement and form of proxy are filed pursuant to Rule 14a-6, or, in the event that the proposal must be
C. SHAREHOLDER VOTING
1. Quorum Requirements
A shareholder quorum is generally more than 50 percent. (Unanimous written, shareholder
2. Voting Lists
Persons whose names appear on the corporation’s records as owners, as of a record date, are en-
titled to vote.
CASE SYNOPSIS
Case 40.3: Case v. Sink & Rise, Inc.
During a shareholder meeting of Sink & Rise, Inc., James Case was the only shareholder present. He
elected himself and another shareholder to be directors, replacing his estranged wife, Shirley Case, as the
corporation's secretary. In Shirley’s suit in a Wyoming state court to set aside the election, the court ruled in
the corporation’s favor. Shirley appealed.
The Wyoming Supreme Court affirmed. “Shares of stock owned by husband and wife with rights of
survivorship were properly counted to establish a quorum at shareholder meeting, * * * where corporate
bylaws required that, in determining a quorum, the shares had to be entitled to vote and represented in
person or by proxy, and the shares were represented in person by husband.”
..................................................................................................................................................
Notes and Questions
Were the shares that Cale owned jointly with Shirley voted at the meeting? How did the jointly
owned shares affect the business conducted? Explain. Cale and Shirley jointly owned sixteen shares of
Sink & Rise stock. All of the Sink & Rise shares were common stock with equal voting rights. But the lower
court noted, the parties to the suit agreed, and the state supreme court repeated, that the Cases’ jointly
owned shares could not be voted without an agreement between the owners. And those owners did not agree
to the actions that were voted on during the shareholders’ meeting at the center of this case.
What policy reasons support the application of lower, instead of higher, quorum requirements?
Lower quorum requirements could allow corporate business to be accomplished more quickly and easily, with
less formality. This could permit actions to be taken with less intra-corporate resistance and with at least the
appearance of unanimity.
Thus, lower quorum requirements are arguably supported by policies to facilitate business, encourage
3. Cumulative Voting
In most states, shareholders elect directors by cumulative voting; otherwise, the vote is by a
majority of shares at the meeting.
a. Formula
Each shareholder casts a number of votes equal to the number of board members to be
elected multiplied by the number of voting shares the shareholder owns. The shareholder
casts all votes for one candidate or splits them among nominees.
b. How Cumulative Voting Works
The text provides an example.
4. Other Voting Techniques
IV. Rights of Shareholders
A. STOCK CERTIFICATES
In jurisdictions that require the issuance of stock certificates, shareholders can demand a certificate
and that their names and addresses be recorded in the corporate record books.
B. PREEMPTIVE RIGHTS
The articles of incorporation determine the existence and scope of preemptive rights. Generally,
they apply only to additional, newly issued stock sold for cash and must be exercised within a
specified time period.
C. STOCK WARRANTS
When preemptive rights exist and a corporation is issuing additional shares, each shareholder is given
transferable options to acquire a given number of shares from the corporation at a stated price.
Warrants are often publicly traded on securities exchanges.
D. DIVIDENDS
Dividends can be paid in cash, property, stock of the corporation that is paying the dividends, or stock of
other corporations. The sources of funds from which dividends may be paid are
Retained earnings.
1. Illegal Dividends
A dividend paid while a corporation is insolvent is illegal and must be repaid if the shareholders
knew that it was illegal when they received it. Directors may be personally liable for paying such a
dividend.
2. The Directors’ Failure to Declare a Dividend
That corporate earnings or surplus is available to pay a dividend is not enough for a court to compel
directors to distribute funds that, in the board’s opinion, should not be paid. Abuse of discretion
must be clearly shown.
E. INSPECTION RIGHTS
1. Proper Purpose
2. Potential for Abuse
A shareholder can be denied access to prevent harassment or to protect trade secrets or other
confidential corporate information.
F. TRANSFER OF SHARES
Although stock certificates are negotiable and freely transferable, transfer of stock in closely held
corporations is generally restricted by contract, the bylaws, or a restriction stamped on the certificate.
Any restrictions on transferability must be noted on the face of the certificate.
G. THE SHAREHOLDERS DERIVATIVE SUIT
If directors fail to sue in the corporate name to redress a wrong suffered by the corporation,
shareholders can bring a shareholder’s derivative suit.
1. When Acts of Directors and Officers Cause Harm to the Corporation
This right is especially important when the wrong suffered by the corporation results from the
actions of corporate directors or officers.
2. Any Damages Awarded Go to Corporation
Any damages recovered by the suit usually go into the corporation’s treasury.
ADDITIONAL BACKGROUND
Derivative Suits
The right of shareholders to sue derivatively on the behalf of their corporation was indicated as early as
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 23
the 1830s. In 1855, the United States Supreme Court upheld a shareholder’s right to sue on behalf of a
corporation whose officer had paid a tax that the shareholder claimed was unconstitutional [Dodge v.
Woolsey, 59 U.S. 331, 15 L.Ed. 401 (1855)].
The derivative suit developed more fully in the second half of the nineteenth century. Procedural
restrictions on derivative suits also developed in the federal courts late in the nineteenth century and in the
CRITICAL THINKING
Are the circumstances significantly different when the shares of a close corporation are involved
in a case including allegations of oppression? Yes. The lack of marketability of the shares of a closely
held corporation means that minority shareholders are especially vulnerable to the loss of their investments.
The ‘squeeze-out’ tactics of majority shareholders often deprive minority shareholders of management
participation, employment income or other advantages that they reasonably have come to expect, and which
Do corporations benefit from shareholders’ derivative suits? If so, how? A corporation can benefit
directly from a derivative suit because any damages recovered by the suit normally go into the corporation’s
treasury, not to the shareholders. A corporation benefits indirectly by the extra protection offered by the
existence of a derivative suit as a possible course of action.
If a group of shareholders perceives that the corporation has suffered a wrong and the directors
refuse to take action, can the shareholders compel the directors to act? If so, how? The shareholders
cannot compel the directors to act to redress a wrong suffered by the corporation, but if the directors refuse to
ENHANCING YOUR LECTURE
  DERIVATIVE ACTIONS IN OTHER NATIONS
 
24 UNIT EIGHT: BUSINESS ORGANIZATIONS
Today, most of the claims brought against directors and officers in the United States are those alleged in
shareholders’ derivative suits. Other nations, however, put more restrictions on the use of such suits. German
law, for example, does not provide for derivative litigation, and a corporation’s duty to its employees is just as
FOR CRITICAL ANALYSIS
Should shareholder derivative actions be abolished in the United States? Why or why not?
V. Duties and Liabilities of Shareholders
Shareholders are not usually personally liable for the debts of a corporation.
A. WATERED STOCK
A shareholder may be liable personally if he or she receives watered stock without paying the share’s
stated value. In that case, the shareholder may be liable not only to the corporation for difference
between the price paid and the stock’s stated value, but to creditors for corporate debts.
B. DUTIES OF MAJORITY SHAREHOLDERS
Shareholders are not usually personally liable for the debts of a corporation.
A majority shareholder has a fiduciary duty to the corporation and to the minority shareholders
when he or she (or a few shareholders acting together) owns enough shares to exercise de facto
control over the corporation.
ENHANCING YOUR LECTURE
  CREATING AN E-DOCUMENT RETENTION POLICY
 
If a corporation becomes the target of a civil lawsuit or criminal investigation, the company may be
required to turn over any documents in its files relating to the matter during the discovery stage of litigation.
These documents may include legal documents, contracts, e-mail, faxes, letters, interoffice memorandums,
notebooks, diaries, and other materials, even if they are kept in personal files in the homes of directors or
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 25
to convince a jury that the company or its directors or officers had condoned a certain action that they later
denied condoning.
WHICH E-DOCUMENTS SHOULD BE RETAINED?
How does a company decide which e-documents should be retained and which should be
destroyed? By law, corporations are required to keep certain types of documents, such as those specified in
the Code of Federal Regulations and in regulations issued by government agencies, such as the
Occupational Safety and Health Administration. Generally, any records that the company is not legally
MODIFICATIONS MAY BE NECESSARY DURING AN INVESTIGATION
If the company becomes the target of an investigation, it usually must modify its document-retention
policy until the investigation has been completed. Company officers, after receiving a subpoena to produce
specific types of documents, should instruct the appropriate employees not to destroy relevant papers or e-
documents that would otherwise be disposed of as part of the company’s normal document-retention
program.
Generally, to avoid being charged with obstruction of justice, company officials must always exercise
CHECKLIST FOR AN E-DOCUMENT RETENTION POLICY
1. Let employees know not only which e-documents should be retained and deleted but also which types of
documents should not be created in the first place.
3. Retain other e-documents only if their retention is in the corporation’s interest.
4. If certain corporate documents are subpoenaed, modify your document-retention policy to retain any
document that is even remotely related to the dispute until the legal action has been resolved.
TEACHING SUGGESTIONS
1. Ask students to discuss the extent to which a director should be held liable for breaching his or her duty of
care if he or she simply neglects to read materials regarding issues to be voted on at board meetings or ne-
glects to show up for these meetings. Should such a person be equally or less liable than a director who
knowingly votes to approve an illegal or harmful act?
2. Ask students to discuss whether a director’s duty of care is absolute. Should a director always be pre-
26 UNIT EIGHT: BUSINESS ORGANIZATIONS
vented from having an interest in another company? Can any potential conflict of interest problems
be avoided by complete disclosure of the conflict to the boards of both companies?
3. Note that companies seeking to prevent a shareholder from exercising his or her right to inspect company
records and books will often argue that the inspection will reveal important trade secrets and should thus be
barred. How can a company protect itself from having confidential information revealed by
shareholder inspections? One way might be to segregate trade secrets (formulas, engineering plans, etc.)
from the standard corporate books. Another method would be to ask the court to recognize that some of the
information sought might be misused and to issue an order prohibiting the shareholder from misappropriating
such information or disseminating it to third parties.
Cyberlaw Link
Could a corporation meet its obligation to hold board of directors meetings and shareholder
meetings by conducting those meetings online? Why or why not?
DISCUSSION QUESTIONS
1. Why is it incorrect to characterize a director as either an agent or a trustee of a corporation? Even
though directors act for and on behalf of the corporation, no individual director can act as an agent to bind the corpo-
ration. Moreover, directors, as a group, collectively control the corporation in a way that no agent can control a
2. What are the most common situations in which directors allegedly violate their duty of loyalty? A director
typically breaches his or her duty of loyalty when he or she (1) competes with the corporation; (2) usurps a corporate
opportunity; (3) has an interest that conflicts with the interest of the corporation; (4) engages in insider trading; (5)
authorizes a corporate transaction that is detrimental to minority shareholders; and (6) sells control over the
corporation.
3. What actions must a director or officer take to avoid liability when a corporation enters into a contract or
engages in a transaction in which an officer or director has a material interest? The director or officer must
make a full disclosure of the interest and must abstain from voting on the proposed transaction. Although standards
vary from state to state, a contract will generally not be voidable if it was fair and reasonable to the corporation at the
4. What sort of legal protection is offered to directors and officers by the business judgment rule? The
business judgment rule immunizes directors and officers from liability when a decision is within managerial authority,
as long as the decision complies with management’s fiduciary duties and as long as acting on the decision is in the
5. Are directors entitled to be indemnified for any legal costs they incur in defending suits against the
corporation? Because directors are often named as defendants in suits filed against their respective corporations,
6. What are some of the more important powers that may be exercised by shareholders? Shareholders must
approve fundamental changes affecting the corporation before the changes can be effected. Hence, shareholders
are empowered to amend the articles of incorporation (charter) and bylaws, approve the merger or dissolution of the
7. Describe how cumulative voting works. Most states permit or require shareholders to elect directors by
cumulative votinga method of voting designed to allow minority shareholders representation on the board of
8. What are the limits on the shareholder’s right to inspect corporate records and books? A shareholder is
limited to inspecting and copying corporate records and books for a proper purpose if the request is made in advance.
possessing his or her shares for a minimum period of time prior to his making the demand to inspect the records.
9. What are some of the ways in which a corporation or its shareholders can restrict the transferability of
shares? A corporation or its shareholders can restrict transferability by reserving the option to purchase any shares
10. Can a shareholder institute an action to dissolve a corporation and liquidate its assets? Yes. In some
states, a shareholder has the right to petition a court to appoint a receiver and to liquidate the business assets of the
ACTIVITIES AND RESEARCH ASSIGNMENTS
1. Ask each student to write a brief report on a case in which directors or officers of a corporation were accused of
2. Different companies use different styles and levels of detail to inform their shareholders of their equal
employment and affirmative action policies. Have students obtain some of the different versions and compare them.
For example, in the past, Bristol-Myers Squibb and The Travelers Corporation have produced magazine-style reports.
Campbell Soup Company produced a four-page document. General Motors Corporation disclosed its policies in its
“Public Interest Report.” J. C. Penney Company produced a one-page analysis as part of its annual report. CIGNA
Corporation made available to its shareholders a five-page internal memorandum on the subject. What has
Microsoft, Wal-Mart, or any of the “dot com” companies done?
EXPLANATION OF A SELECTED FOOTNOTE IN THE TEXT
Footnote 4: The board of Chugach Alaska Corp. (CAC) split into two factionsone led by Sheri Buretta,
who had chaired the board for several years, and the other by director Robert Henrichs. A coalition of directors voted
to remove Buretta and install Henrichs. During his term, Henrichs committed a variety of acts of misconduct with
respect to CAC’s directors, shareholders, and employees. After six months, the board voted to reinstall Buretta. CAC
filed a suit in an Alaska state court against Henrichs, alleging a breach of fiduciary duty. A jury found Henrichs liable.
Do acts such as those in which Henrichs engaged satisfy any of the elements for the application of
the business judgment rule? No. The business judgment rule applies to protect a director or officer from liability for
a mistake of judgment or a bad business decision as long as (1) the director or officer took reasonable steps to
Why do courts in their application of the business judgment rule give significant deference (weight) to
the decisions of corporate directors and officers? Courts give significant deference to the decisions of corporate
directors and officers by considering the reasonableness of a decision at the time it was made, without the benefit of
hindsight. Corporate decision makers are not subjected to second-guessing. This is because judges are not business
experts, and courts do not have access to all of the information and factors that a corporate director or officer may
weigh and balance in making a decision.
Does misbehavior such as the conduct at the heart of this case constitute a breach of business
ethics? Yes. Business ethics focuses on what is right or wrong in the business world. Henrichs exhibited unethical
behavior when he breached his fiduciary duty to his corporation by holding mini-board meetings and making decisions

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