Shareholder Rights and Issues
Shareholder issues arise from the very formation of a corporation. Similarly, members of a limited liability company face the same issues. These issues include voting rights within the company as well as rights upon liquidation.
Generally, closely-held companies often have shareholders and boards of directors which are one and the same. However, director actions may be able to be overridden by shareholder action, and thus when there are unequal holdings by the shareholders, voting power by the shareholders will be disproportionate as compared to the one director equals one vote rule for Boards.
In those companies where all shareholders are not actively participating in management, shareholders may wish to have reserved to them power beyond what minimums are required under state statutes. One of the absolute rights of the shareholders is to elect the directors, who in turn appoint the officers. One seemingly innocuous provision can create substantial power in the Board, that being the right to amend the By-Laws. If the shareholders reserve that power, the Board of Directors cannot unilaterally change provisions such as the date and time of the annual meetings, the number of shareholders, if any, which are authorized to call a special meeting of the shareholders and even more detailed and perhaps onerous provisions. Less common, but nonetheless important in the right situation, are the rights of shareholders, or classes of shareholders, to have the right to elect that class of shareholders’ Board member, thereby creating a voice on the Board if certain metrics are not achieved or triggering events occur.
After the corporation is formed, shareholder rights are then those established by virtue of the Articles of Incorporation, the By-Laws which have been adopted, and those provisions which are granted by the laws of the state of incorporation. If those rights are not observed, such as the holding of the annual meeting, distribution of dividends or, in the case of corporations electing to be taxed under Subchapter-S of the Internal Revenue Code, “S-Distributions,” the shareholders’ rights are triggered.
Not exercising certain of these shareholder rights in a timely fashion can create the situation where even if not waived as a matter of law, as a practical matter, there is no good way to restore the affected shareholders to the position previously enjoyed prior to such rights being disregarded.
Although addressing such issues at the early stages of starting a company may seem to be unnecessary, experience has shown us that changing later almost never occurs. Moreover, those shareholders who will be neither a minority nor the top management will have the greatest leverage at the time of formation, not at a later date when a line in the sand may have already been drawn.
To read about what happens when proper planning does not occur or goes awry, read our article Shareholder Disputes.
With our extensive experience in shareholder rights and issues, we can help sort through the options available to achieve your objectives. Planning always beats litigation.