(3) A statement of the reasons why the registrant deems such omission to be proper in the particular case; 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.
C. SHAREHOLDER VOTING
1. Quorum Requirements
A shareholder quorum is generally more than 50 percent. (Unanimous written, shareholder consent is, in
2. Voting Lists
3. Cumulative Voting
4. Other Voting Techniques
Shares can be voted in accord with a shareholder voting agreement or voting trust.
IV. Rights of Shareholders
1. The Purpose of Preemptive Rights
2. Preemptive Rights in Closely Held Corporations
Preemptive rights are most significant in a close corporation because of the relatively few number of shares
and the substantial interest each shareholder controls.
C. STOCK WARRANTS
1. Illegal Dividends
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
possible course of action.
Case 40.2: Bezirdjian v. O’Reilly
Lawrence Bezirdjian read an article in The New York Times stating that Chevron Corp. had made illicit payments to
Saddam Hussein for Iraqi oil. Bezirdjian demanded that Chevron commence legal action against certain members of its
board of directors in connection with the payments. A committee of Chevron directors refused to act on the ground
that it would not be in the best interests of the corporation. Bezirdjian filed a shareholder derivative suit in a California
state court against O’Reilly and others, alleging a breach of fiduciary duties and other transgressions with respect to the
illicit payments. But the plaintiff did not specifically address the board’s refusal to act on his demand that the
corporation file suit. The defense filed a motion to dismiss, which the court granted. Bezirdjian appealed.
…………………………………………………………..……………………………………………………………………
Notes and Questions
Do corporations benefit from shareholders’ derivative suits? If so, how? A corporation can benefit directly from a
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 989
ANSWERS TO QUESTIONS AT THE END OF CASE 40.2
1. Given that the shareholder was suing the directors and not a third party (an outsider to the corporation), is it fair
to him to require that the first demand from the directors undertake the suit? Why or why not? In the words of the
court, “The purpose of pre-suit demand is to assure that the stockholder affords the corporation the opportunity to
address an alleged wrong without litigation, to decide whether to invest the resources of the corporation in litigation,
and to control any litigation which does occur.” This rule makes a certain amount of sense when the shareholders are
suing a third party, but there are some who question its fairness when the shareholders are suing the directors
themselves. Given the deference the courts generally show to directors’ decisions under the business judgment rule,
the scales of justice seem to be weighted in favor of the directors in such a situation. In this case, the shareholder who
brought the suit contended that it would be useless to make a pre-suit demand that the directors undertake the suit,
because it would not be in the directors’ interest to do so. Yet the court insisted that the pre-suit demand be made
2. Assuming that the plaintiff’s accusations were true, what should the plaintiff have done to prevent the case from
being dismissed? The court made it clear that the plaintiff could have rebutted, or tried to rebut, the directors’
decision not to bring the suit. The court noted that a plaintiff “must plead with particularity facts that create a
reasonable doubt as to the good faith or reasonableness of a board’s investigation. Mere conclusory allegations are
insufficient.” The plaintiff in this case, however, did nothing. In his amended complaint, the plaintiff stated only that
he had “made demand on Chevron to commence legal action,” that the demand was refused, and that he “need do no
more.” In other words, the plaintiff had an opportunity to “plead with particularity” facts that would support his
complaint and his conclusion that the directors’ decision not to sue was not reasonable or not made in good faith. Had
the plaintiff done so, the outcome of this case might have been significantly different.
ADDITIONAL BACKGROUND—
A Brief History of Derivative Suits
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The right of shareholders to sue derivatively on the behalf of their corporation was indicated as early as 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 state courts in the first
half of the twentieth century. In 1980, at least one study found that during the 1970s, there was only a slight increase
in the amount of shareholder litigation [Jones, “An Empirical Examination of the Incidence of Shareholder Derivative
and Class Action Lawsuits, 1971–1978,” 60 Boston University Law Review 306 (1980)].
During the 1980s, however, the amount of shareholder derivative litigation for alleged breaches of management
duties was extensive.
ENHANCING YOUR LECTURE—
DERIVATIVE ACTIONS IN OTHER NATIONS
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 significant as its
duty to the shareholder-owners of the company. The United Kingdom has no statute authorizing derivative actions,
which are permitted only to challenge directors’ actions that the shareholders could not legally ratify. Japan authorizes
derivative actions but also permits a company to sue the plaintiff-shareholder for damages if the action is unsuccessful.
FOR CRITICAL ANALYSIS
Should shareholder derivative actions be abolished in the United States? Why or why not?
V. Liability of Shareholders
Shareholders are not usually personally liable for the debts of a corporation.
A. WATERED STOCK
B. DUTIES OF MAJORITY SHAREHOLDERS
Case 40.3: Mazloom v. Mazloom
Four brothers, Iraj, Ahmad, Manooch, and Aboli Mazloom, incorporated a business known as AMBI, Inc. AMBI
owned real estate in South Carolina on which the brothers operated a Mini Mart, a liquor store, and a one-bedroom
apartment. Each brother had a 25 percent interest in AMBI. After seventeen years, three of the brothers—Ahmad,
Manooch, and Aboli—dissolved AMBI, filed articles of organization for a new firm—AMA, LLC—and transferred AMBI’s
assets to AMA for $5. When Iraj learned of the changes, he had Manooch and Aboli file an amendment to AMA’s
articles stating that “Iraj Mazloom owns 25% (or 1/4) shares of stock in AMA.” Less than five months later, Ahmad sold
his interest in AMA to Manooch and Aboli, who then sold AMA’s assets to Ganesh Mini Mart, LLC, for $345,000. They
misconduct. And they had sufficient personal assets, including their proceeds from the AMA sale, to pay the award.
…………………………………………………………..……………………………………………………………………
Notes and Questions
Did Manooch and Aboli commit any crimes in their actions toward Iraj? Yes. In South Carolina, it is a crime for a
person to “sign a document he knows is false in any material respect * * * with intent that the document be delivered
to the Secretary of State for filing.” Also, a party may be personally liable for false statements made in filed records to
“one who suffers loss by reliance on the statement.”
What purposes does an award of punitive damages serve? How are those purposes met in this case? An award of
punitive damages can serve two purposes: (1) punishing the wrongdoers and deterring them and others from engaging
in similar reckless, willful, wanton, or malicious conduct; and (2) vindicating a private right of the injured party by
requiring the wrongdoers to pay money to that party.
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
992 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
tages that they reasonably have come to expect, and which are the essential benefits of their investment. But a court
must defer to the business decisions made by the majority shareholders of a close corporation, as long as they are
genuine. Moreover, the existence of one or more badges of oppression in isolation does not necessarily justify relief. A
court must examine the pattern of conduct of those in control and the effect of that conduct on the minority to
determine whether, in sum, they show oppression.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 40.3
Why is an award of punitive damages is almost completely at the discretion of a jury and trial judge? Awarding
punitive damages is left almost entirely in the hands of a jury or a trial judge because these factfinders hear all of the
evidence and are more familiar with the “evidentiary atmosphere” at trial. They can more accurately weigh credibility
and other qualities that may not be wholly communicated by a record on appeal.
ANSWER TO “THE ETHICAL DIMENSION” QUESTION IN CASE 40.3
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 officers. Under the current Federal Rules of
Civil Procedure, which govern civil litigation procedures, a defendant in a lawsuit must disclose all relevant electronic
data compilations and documents, as well as all relevant paper documents.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 993
Although certain documents or data might free a company of any liability arising from a claim, others might serve
to substantiate a civil claim or criminal charge. It is also possible that information contained in a document—an
interoffice e-mail memo, for example (or even a memo referring to that memo)—could be used 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 required to keep or that the company is sure it
will have no legal need for should be removed from the files and destroyed. A partnership agreement, for example,
should be kept. A memo about last year’s company picnic, however, should be removed from the files and destroyed;
obviously, it is just taking up storage space.
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
Generally, to avoid being charged with obstruction of justice, company officials must always exercise good faith in
deciding which documents should or should not be destroyed when attempting to comply with a subpoena. The
specter of criminal prosecution would appear to encourage the retention of even those documents that are only
remotely related to the dispute—at least until it has been resolved.
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
2. Find out which documents must be retained under the Code of Federal Regulations and under other government
agency regulations to which your corporation is subject.
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 neglects to show up
994 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
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 prevented 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?
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
2. What are the most common situations in which directors allegedly violate their duty of loyalty? A director typically
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
4. What sort of legal protection is offered to directors and officers by the business judgment rule? The business judgment
5. Are directors entitled to be indemnified for any legal costs they incur in defending suits against the corporation? Because
6. What are some of the more important powers that may be exercised by shareholders? Shareholders must approve
7. Describe how cumulative voting works. Most states permit or require shareholders to elect directors by cumulative
8. What are the limits on the shareholder’s right to inspect corporate records and books? A shareholder is limited to
9. What are some of the ways in which a corporation or its shareholders can restrict the transferability of shares? A
10. Can a shareholder institute an action to dissolve a corporation and liquidate its assets? Yes. In some states, a shareholder
996 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
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 breaching
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 in-
ternal memorandum on the subject. What has Microsoft, Wal-Mart, or any of the “dot com” companies done?
EXPLANATIONS OF SELECTED FOOTNOTES IN THE TEXT
Footnote 1: MM Companies, Inc., owned 7 percent of the stock of Liquid Audio, Inc. In October 2001, MM offered
to buy all of the stock. Liquid Audio’s board rejected the offer. Liquid Audio’s bylaws provide for a board of five directors divided
into three classes. One class is elected each year. The next election, at which two directors would be chosen, was set for
September 2002. By mid–August, it appeared that MM’s nominees would win the election. The board amended the bylaws to
increase the number of directors to seven, and made two appointments to fill the new positions. In September, MM’s nominees
were elected, but their influence was diminished because there were now seven directors. MM filed a suit in a Delaware state
court against Liquid Audio and others, challenging the board’s actions. The court ruled in favor of the defendants. MM
appealed. In MM Companies, Inc. v. Liquid Audio, Inc., the Delaware Supreme Court reversed and remanded. The board’s
amending the bylaws to increase the number of directors and filling the new positions with appointments was invalid, because
the board acted primarily to impede the shareholders’ right to vote in an impending election for successor directors. “The most
fundamental principles of corporate governance are a function of the allocation of power within a corporation between its
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 997
How could MM’s newly elected nominees, or any two directors, affect the decisions of a five-member board? The court
noted that the impact of MM’s two directors can occur “on a five-member Board by eliminating either the possibility of a
deadlock on the board or of MM controlling the Board, if one or two [directors] resigned from the Board.”
Footnote 13: In Dodge v. Ford Motor Co., in the interest of setting aside money for future investment and
expansion, the Ford Motor Company announced that it would pay no special dividends after October 1915, even though
surplus capital in 1916 exceeded $111 million. The minority stockholders, who owned one-tenth of the shares of the
corporation, petitioned a Michigan state court to compel the directors to declare a dividend. The court ordered the payment,
Footnote 14: Roy Disney is a shareholder of Walt Disney Co. and was a director until he resigned in November
2003. Disney encouraged other shareholders to vote “no” on the reelection of Michael Eisner and three other directors at the
company’s March 2004 annual meeting. As part of this effort, Disney sought access to corporate records related to
compensation for the five senior executives. The company designated some of the information “confidential” and asked Disney
not to disseminate it. He agreed only to hold it in “strict confidence.” On review of the material, however, Disney objected to
the designation. He filed a suit in a Delaware state court against the company. In Disney v. Walt Disney Co., the court denied
Disney’s request to remove the confidentiality designation and dismissed the case. Opening the confidentiality limit in this case
would lead to the disclosure of non-public information in other cases, which would not “advance the best interests of the
corporation or its stockholders.” The court found “no basis in the language of the [inspection rights] statute to limit the
proposed use . . . to executive compensation issues. Instead, the court would have to recognize a right to make a books and
records demand for the purpose of investigating any well grounded suspicion of mismanagement and then publicly disclosing
information discovered from that investigation. In addition, the expansion . . . would extend equally to any single stockholder,
not only to those thought to adequately represent the interests of the corporation or the stockholders as a whole.”
998 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
order in formulating a complaint, and, in many cases, that information will become publicly available in the course of that
litigation.” Also, the information may be used “to bring suit attacking some aspect of the Company’s public disclosures, under
either federal or state law.” Another context is “an active proxy solicitation
ANSWERS TO ESSAY QUESTIONS IN
STUDY GUIDE TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
BY HOLLOWELL & MILLER
1. How do the duty of care and the duty of loyalty govern the conduct of directors and officers in a corporation? Duty of
Care. In exercising their duty of care, directors are obligated to be honest and to use prudent business judgment in the conduct
of corporate affairs. Directors must exercise the same degree of care that reasonably prudent people use in the conduct of
their own personal business affairs. As such, directors can be held liable to the corporation and its shareholders for breaching
their duty of care. When directors delegate work to corporate officers and employees, the directors are required to make
reasonable efforts to supervise them or else the directors will normally be held liable for negligence or mismanagement of
corporate personnel. Furthermore, if a director fails to attend board meetings and takes no actions to prevent illegal actions
undertaken by the board, then that director could be held liable for any losses suffered by the company even though that
director was not actively involved in the illegal actions. Although the standard of care has been variously described in many
court decisions, it essentially requires that directors carry out their responsibilities in an informed, businesslike manner.
or (6) sells control over the corporation.
2. What are the rights of the shareholders of a corporation? Shareholders own the corporation. Although they have no legal
title to corporate property vested in the corporation, they do have an equitable interest in the firm. The rights of shareholders
are established in the articles of incorporation and under the state’s general incorporation laws. Stock Certificates. In
jurisdictions that require the issuance of stock certificates, shareholders have the right to demand that the corporation issue a
certificate and record their names and addresses in the corporate stock record books. Notice of shareholding meetings,
dividends and operational and financial reports are all distributed according to the recorded ownership listed in the corpora–
tion’s books, not on the basis of possession of the certificate. Preemptive Rights. A preemptive right is a preference given to a
shareholder over all other purchasers to subscribe to or purchase a prorated share of a new issue of stock; this right allows the
shareholder to maintain his or her portion of control, voting power, or financial interest in the corporation. In general, the
articles of incorporation determine the existence and scope of preemptive rights. Preemptive rights apply only to additional,
newly issued stock sold for cash and must be exercised within a specified time period. Such rights are far more significant in a
close corporation because of the relatively few number of shares and the substantial interest each shareholder controls. Stock
Warrant Rights. When preemptive rights exist and a corporation is issuing additional shares, each shareholder is usually given
stock warrants, which are transferable options to acquire a given number of shares from the corporation at a stated price.
When the warrant option is for a short period of time, the stock warrants are usually referred to as rights. Dividend Rights. A
dividend is a distribution of corporate profits or income ordered by the directors and paid to the shareholders in proportion to
their respective shares in the corporation. Dividends can be paid in cash, property, or corporate stock. Once declared, a cash
dividend becomes a corporate debt enforceable at law like any other debt. In general, corporations can only use certain funds,
1000 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
REVIEWING—
CORPORATE DIRECTORS,
OFFICERS, AND SHAREHOLDERS
David Brock is on the board of directors of Firm Body Fitness, Inc., which owns a string of fitness clubs in New
Mexico. Brock owns 15 percent of the Firm Body stock and he is also employed as a tanning technician at one of the
fitness clubs. After the January financial report showed that Firm Body’s tanning division was operating at a substantial
net loss, the board of directors, led by Marty Levinson, discussed the possibility of terminating the tanning operations.
Brock successfully convinced a majority of the board that the tanning division was necessary to market the clubs’
overall fitness package. By April, the tanning division’s financial losses had risen. The board hired a business analyst,
who conducted surveys and determined that the tanning operations did not significantly increase membership. A
shareholder, Diego Peñada, discovered that Brock owned stock in Sunglow, Inc., the company from which Firm Body
purchased its tanning equipment. Peñada notified Levinson, who privately reprimanded Brock. Shortly thereafter Brock
and Mandy Vail, who owned 37 percent of Firm Body stock and also held shares of Sunglow, voted to replace Levinson
on the board of directors. Ask your students to answer the following questions, using the information presented in the
chapter.
1. What duties did Brock, as a director, owe to Firm Body? As a director, Brock is in a fiduciary relationship with the
2. Does the fact that Brock owned shares in Sunglow establish a conflict of interest? Why or why not? The duty of
loyalty requires officers and directors to disclose fully to the board of directors any possible conflict of interest that
3. Suppose that Firm Body brought an action against Brock claiming that he had breached the duty of loyalty by not
disclosing his interest in Sunglow to the other directors. What theory might Brock use in his defense? The business
4. Now suppose that Firm Body did not bring an action against Brock. What type of lawsuit might Peñada be able to
bring based on these facts? If the corporation does not bring suit against Brock for breaching his duty of loyalty, then
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 1001
DEBATE THIS:
Because most shareholders never bother to vote for directors, shareholders have no real control over
corporations. The statistics are indeed shocking—almost no shareholders of corporations ever bother to vote for
directors. Most shareholders don’t know who the directors are and clearly don’t know how publicly held companies
are governed. Therefore, even though on paper shareholders control corporations because they can vote out bad
directors, they really never do.