Legal Rights of Shareholders in Corporations

Key Takeaways:

• Shareholder rights depend on stock type and state laws, often aligning with the Model Business Corporations Act.
• Rights include voting, receiving dividends, and accessing financial information, among others.
• Shareholders influence mergers, asset sales, and dissolutions through voting.
• Common shareholders are last in bankruptcy claims but benefit most when companies thrive.
• Legal rights such as dissent, proposing resolutions, and transferring ownership ensure shareholders' voices are heard and their investments protected.

The exact rights of shareholders in a corporation will depend on the type of stock the shareholders own and the state laws, which usually follow the Model Business Corporations Act.

Shareholders' Levels of Ownership Rights

Ownership of stock makes shareholders partial owners of the company and grants them certain rights. Three primary classes of corporate securities are:

• Bonds
• Preferred stock
• Common stock.

The rights of each class of the security shareholders are assigned in the order of absolute priority, i.e., a set of rules for distributing assets when a company goes bankrupt. In the event of a bankruptcy:

• Bondholders are the first in line for the company's assets.
• Preferred shareholders are next in line for the company's assets.
• Common shareholders are the last to claim the company's assets.

Understanding Preferred vs. Common Shareholder Benefits

Preferred and common shareholders differ in how they participate in a corporation’s success and withstand its challenges:

• Preferred Shareholders:
  • Have priority over common shareholders when dividends are distributed.
  • May have fixed dividend rates regardless of company performance.
  • Generally, lack voting rights in corporate decisions.
• Common Shareholders:
  • Participate in corporate growth through fluctuating stock values.
  • Retain voting rights, giving them influence over corporate governance.
  • Receive dividends only after preferred shareholders.

This distinction ensures that corporations cater to different investor priorities, balancing fixed returns with growth potential.

Risks and Rewards of Shareholders

Common shareholders may be at a disadvantage when a company suffers bankruptcy, as they receive only what is left after the distribution of assets among:

• Creditors
• Bondholders
• Preferred shareholders.

In the opposite scenario, when the company thrives and generates profits, common shareholders get the most reward as their share price grows.

Balancing Shareholder Risks with Protections

Shareholders face risks tied to corporate performance, but legal frameworks aim to provide balanced protections:

• Bankruptcy Risks:
  • Bondholders and preferred shareholders are prioritized in asset claims.
  • Common shareholders assume greater risk but enjoy higher rewards when companies succeed.
• Legal Protections:
  • State laws regulate fiduciary duties, ensuring executives act in shareholders' best interests.
  • Class-action lawsuits provide recourse against corporate misconduct or mismanagement.

By diversifying investments and leveraging legal protections, shareholders can mitigate risks while participating in corporate success.

The 10 Basic Rights of Common Shareholders

1. The right to information: Shareholders have the right to investigate the company's administrative and financial records. While public companies have to make this information publicly available, private companies don't have to disclose any of it, not to the public nor to the shareholders. To review financial statements or governing documents, shareholders of private entities need to request those documents specifically.

2. The right to vote: During yearly meetings, shareholders can cast their votes to elect directors. They can choose to vote either for the director that the board of directors nominating committee proposes, or they could propose their own candidate. In the latter case, shareholders must provide justification for their choice and hand out their own proxy materials. The two standard voting methods are straight voting and cumulative voting.

• The straight voting method gives a shareholder one vote per share for each seat on the board of directors.
• To determine the number of a shareholder's votes in cumulative voting, you must multiply the number of the shares by the number of available director seats. The shareholder may use these votes to vote for one director or split them among several seats.

3. The right to influence the fundamental changes in a corporation: Any cardinal changes require the shareholders' approval.

• Mergers: When two companies become one, the shareholders of the entity being taken over must agree to the merger. The approval of the consuming company's shareholders might be necessary or not, depending on the bylaws. When two entities become an altogether new company, the shareholders of both companies must agree to the merger.
• Sale of assets: To sell any corporate assets, the company must get the approval of the shareholders.
• Dissolution: Unless it is an involuntary dissolution that the state initiated, the dissolution of a company requires the shareholders' approval.

4. The right to make changes in governing documentation: Shareholders can vote for any changes to the governing documents, such as the charter or the bylaws amendments.

5. The right to hold meetings: All corporations must hold yearly shareholder meetings to vote and to discuss any necessary governance actions. Directors and large shareholders have the right to request special meetings for any type of an issue.

6. The right to make proposals: Shareholders with 1 percent of outstanding shares can suggest topics for corporate meeting discussions and voting. Except for regular business operations, shareholders can make proposals pertaining to any other aspects of the company, such as environmental or labor practices, political spending, and other.

7. The right to dissent: Dissenter rights protect shareholders and allow them to sell their shares if they do not approve of the core corporate management or governance. This way, shareholders can make the corporation buy their shares back at “fair value.”

8. The right to transfer ownership: Shareholders can trade their stock on the exchange market.

9. The right to dividends: Shareholders are entitled to profits in the form of dividends. The board of directors determines the percentage of profits to be paid out.

10. The right to sue for wrongful acts: Executed in the form of shareholder class-action lawsuits, this right protects shareholders against poor management.

Additional Protections for Minority Shareholders

Minority shareholders often lack the majority voting power but are protected by specific rights to ensure fair treatment:

• Oppression Protections:
  • Laws safeguard minority shareholders from unfair actions by majority stakeholders, such as unauthorized dilution of shares or exclusion from key decisions.
• Access to Mediation:
  • Shareholders may pursue alternative dispute resolution methods before litigation, which can expedite conflict resolution while preserving relationships.
• Proportional Buyouts:
  • In the event of majority stakeholder buyouts, minority shareholders are entitled to fair compensation for their shares.

These protections ensure inclusivity and equity within corporate governance.

Frequently Asked Questions

1. What legal rights do common shareholders have?
   Common shareholders have voting rights, dividend entitlements, and the ability to influence significant corporate changes, such as mergers.
2. How are preferred shareholders protected in a corporation?
   Preferred shareholders receive prioritized dividend payments and are ahead of common shareholders in asset claims during bankruptcy.
3. What happens to shareholder rights during bankruptcy?
   Bondholders and preferred shareholders receive priority in asset claims, while common shareholders receive residual assets if any remain.
4. Can minority shareholders block corporate decisions?
   While minority shareholders often lack majority voting power, legal protections prevent unfair treatment and ensure equitable participation in major decisions.
5. How can shareholders enforce their legal rights?
   Shareholders can file lawsuits, participate in class actions, or seek alternative dispute resolution to address grievances and protect their investments.

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