Chapter Two: Corporations – Subchapter C
3. (A) A successful shareholder derivative suit would probably result in the $1,000,000 being considered available for distribution as a dividend. To allow the $1,000,000 to be used for bonuses would be financially rewarding the officers and directors for their illegal actions. The only other choice that would be grammatically correct is (L), surplus or earnings held for expansion. This would not be a likely choice of a court in that the sole reason dividends were not distributed was because of the $1,000,000 in penalties.
4. (C) If the $1,000,000 were distributed in 1995, it would be characterized as a cash dividend. The only other answers that are grammatically correct are (J) property dividend and (K) stock dividend. The distribution of cash is a cash dividend and not property or stock.
5. (O) The cumulative preferred stock holders are entitled to dividend carryovers if dividends are not paid in a given year. Thus they are entitled to dividends in both 1994 and 1995. 5% of $100 face value would equal
$5 for each year for a total of $10. Only answer (O) reflects $10.
6. (N) There are 10,000 shares of preferred stock which will receive a dividend of $10 per share for a total of
$100,000. This leaves $900,000 remaining to be distributed to the common stockholders. With 100,000 shares of common stock outstanding, each share will receive a dividend of $9. Only answer (N) reflects $9.
ANSWER 3
1. (A) A Corporation must be formed pursuant to a state statute. Answer (b) is incorrect because the names of the stockholders need not be contained in the articles of incorporation. The only names that are required in the articles of incorporation are the names of all incorporators, the name of the registered agent and the name of the corporation. Answer (c) is incorrect because the bylaws need not be included in the incorporation documents.
2. (C) The bylaws are adopted by the board of directors of the corporation, usually at the organizational meeting.
Directors are in charge of setting overall corporate policy. Answer (a) is incorrect because stockholders do not vote on the bylaws. Stockholders elect the board of directors and get to vote on fundamental changes in the corporation (mergers and consolidations, dissolution and amending the articles of incorporation).
Answer (b) is incorrect because the officers do not adopt the bylaws, the directors do. Officers handle day-to-day affairs. Overall policy is set by the directors
3. (C) Stockholders elect the board of directors. Answers (a) and (b) are incorrect because directors are not selected by the officers or by outgoing directors.
4. (B) The officers of a corporation are selected by the board of directors. Answers (a) and (c) are incorrect because officers are not selected by the stockholders or the outgoing officers.
5. (C) The day-to-day affairs of a corporation are handled by its officers. Answer (a) is incorrect because directors handle the overall management of the corporation and set corporate policy. Answer (b) is incorrect because stockholders do not handle day-to-day affairs. They only may vote on fundamental changes in the corporation or to elect the board of directors.
6. (C) Adams, Frank and Berg executed a written contract that they would vote for each other as directors. Thus, they are required by contract to do so. Answer (a) is incorrect because there is no requirement that majority stockholders must serve as directors. If the majority stockholders did not choose to be directors, they need only vote for others to insure that they were not elected. Answer (b) is incorrect because there is no requirement that majority stockholders must serve as officers.
2S-9
ANSWER 4
a. Edwards will not win the suit to have Olsen removed as president. The right to hire and fire officers is held by the board of directors. Individual stockholders. regardless of the size of their holding, have no vote in the selection of officers. Individual stockholders may exert influence in this area by voting for directors at the annual stockholders’ meeting.
b. Edwards will lose the suit to have National purchase the stock. A stockholder who dissents from a merger may require the corporation to purchase his or her shares if the statutory requirements are met and would be entitled to the fair value of the stock (appraisal remedy). To compel the purchase, Edwards would have had to file an objection to the merger before the stockholders meeting at which the merger proposal was considered, vote against the merger proposal, and make a written demand that the corporation purchase the stock at an appraised price. Edwards will lose because the first two requirements were met but Edwards failed to make a written demand that the corporation purchase the stock.
c. 1. Queen will lose its suit against National to enforce the contract, even though Edwards was a National director. Jenkins may have assumed that Edwards was acting as National’s agent, but Edwards had no authority to contract with Queen. A director has a fiduciary duty to the stockholders of a corporation but, unless expressly authorized by the board of directors or the officers of the corporation, has no authority to contract on behalf of the corporation. There is no implied agency authority merely by being a director.
2. Queen will win its suit against Edwards because Edwards had no authority to act for National. Edwards will be personally liable for Queen’s damages.
ANSWER 5
West’s assertion that Ace should have recorded the dividends in arrears for 1987 and 1988 as a liability is incorrect.
A shareholder of cumulative preferred stock is entitled to receive all dividend arrearages plus any dividends for the current year before any dividends may be distributed to the shareholders of common stock. However, preferred stock represents a contribution of capital, not a debt of the corporation, and until a dividend is declared, a shareholder of cumulative preferred stock is not a creditor of the corporation. Thus, Ace was correct in not classifying the dividend arrearages as a liability because a dividend was not declared by Ace’s board of directors.
Ace should disclose the dividend arrearages in notes to its financial statements.
West’s assertion that West is entitled to examine Ace’s book and records is correct. A shareholder, upon written demand, is entitled to examine, at reasonable times, the books and records of the corporation, so long as the examination is for a proper purpose (in good faith). If the corporation refuses to permit the examination, the shareholder may obtain a court order compelling access to the books and records.
ANSWER 6
A limited partnership is formed by two or more persons under a state’s limited partnership statute, having as members one or more general partners and one or more limited partners. Two or more persons desiring to form a limited partnership must execute a certificate of limited partnership that must be filed in the office of the secretary of state, or other appropriate state or local office. A corporation may be formed only under a state incorporation statute that requires that one or more incorporators sign articles of incorporation which must be filed with the secretary of state.
Unless otherwise provided in the partnership agreement, or other agreements among the partners, a limited partnership interest is assignable in whole or in part. Similarly, in the absence of a restriction in the corporation’s organizational documents or other agreements among the shareholders, shares of stock are freely transferable.
A limited partner’s liability for partnership debts is generally limited to the partner’s investment (capital contribution) in the partnership if the interest is fully paid and non-assessable and the partner does not participate in the daily management of the business. Likewise, a shareholder’s liability for a corporation’s debts is generally limited to the shareholder’s investment (capital contribution) in the corporation.
A limited partner cannot participate in the daily operations of the partnership’s business without losing limited liability. A shareholder who is not also an officer or a director cannot participate in the daily operations of the corporation’s business. However, a shareholder owning voting stock has the right to vote for a board of directors, which will manage the business affairs of the corporation. The board of directors elects officers to run the daily operations of the corporation.
A limited partner is entitled to receive a share of the partnership’s profits in the manner provided in the partnership agreement. On the other hand, whether a shareholder receives dividends is generally within the discretion of the board of directors.
ANSWER 7
The action to compel reinstatement of prior dividends would fail. The declaration of dividends is a matter within the discretion of the board of directors. There are very few instances in which the board’s discretion will be disturbed, and the facts of this problem are not within any of them unless Cox can prove the fraudulent purpose of the board, which she asserts.
The predominant rule gives a corporation the right to acquire its own shares. Such purchase may be made only to the extent of unreserved and unrestricted earned surplus. Capital surplus may be used only if the articles of incorporation so provide or if there is an affirmative majority vote by shareholders. The law and the facts indicate that in all probability there was no problem from the standpoint of the proper source of funds. With respect to the sale below par value there is no requirement to sell treasury shares at par value. The corporation laws require only that newly issued shares be sold at or above par value.
Cox’s action to demand repayment of the salary increases would fail. The board of directors has broad discretionary power to fix salaries of officers, even if the officers also are members of the board. The courts have supported the board’s determination of salary unless the amounts are grossly unreasonable. A 10 percent per year raise and the fact that the salaries are within the upper one-third of those paid by other similar corporations do not suggest salaries that would likely be found unreasonable and a waste of corporate assets.
Cox’s action for dissolution would fail. The courts have power to dissolve a corporation in an action by a shareholder when the directors are deadlocked in the management of the corporate affairs and the shareholders are unable to break the deadlock. To obtain a court-ordered dissolution Cox must also prove that irreparable injury to the corporation is being suffered or is threatened. None of these facts are present. The fact that there is bitterness and animosity does not constitute a deadlock of the management. The corporation is continuing to increase its earnings at a 10 percent per year rate. Courts are loath to grant an order for an involuntary dissolution even if there is a serious deadlock, provided the corporation continues to be a viable economic entity.
2S-11