Shareholder Obligations: Everything You Need to Know
Shareholder obligations vary depending on the type of business and shares involved, the shareholder's agreements, and the company's articles of incorporation.3 min read
2. Derivative Suits
Shareholder obligations vary depending on the type of business and shares involved, the shareholder's agreements, and the company's articles of incorporation. Even the type of shareholder makes a difference.
However, because a shareholder holds important stakes in the company, there are some similarities of obligations:
- If a shareholder violates or contributes to a violation of the law or articles of association, or causes the company, a third party, or another shareholder harm, they can be held liable for damages.
- Shareholders are not required to attend general meetings, but if stipulated in the articles of association, they should alert the company if they will be doing so. Notice is also required if they obtain more shares that should be added to the shareholder register.
- If a shareholder controls more than nine-tenths of the company's shares and votes, they can redeem the rest of the minority shares.
The main goal of corporate managers and directors is to build long-term shareholder wealth. The reason for this goal is to provide accountability to the managers. If these leaders were tasked with pursuing the interests of everyone in the company, no one's interests would be realized.
Personal Liability of Shareholders
Shareholders are generally not responsible for the corporation's debts and obligations, but in some cases, courts will pierce the corporate veil if a plaintiff sues the shareholder directly. The "alter ego theory" is invoked when arguing shareholders should be accountable for the corporation. For a plaintiff to successfully argue the alter ego theory, they must prove the corporation is essentially a shell and not a separate business entity from the shareholder. If the corporation is proven to be an alter ego of the shareholder, limited personal liability protections of the shareholder should be ignored.
To evaluate the plaintiff's allegations, courts will investigate the following:
- Were business formalities, such as meeting minutes or organizational filings, maintained?
- Were personal and business funds kept separate?
- Does the corporation have liability protection in place or has it been capitalized?
- Did shareholders neglect or disregard their responsibilities to the corporation?
Even if a shareholder is damaged by a wrong done to the corporation, they can't personally pursue litigation because the corporation is a separate entity. Should a shareholder feel their stock depreciated unfairly, they cannot take action for their own interests alone. To receive restitution, the shareholder must file a derivative lawsuit in the name of the company, which will allow all shareholders to be made whole if compensation is received for wrongdoing.
Even though the plaintiff shareholder will be representing the company's interests, they will need to name their company as the nominal defendant. Typically, derivative suits allege that directors, officers, or someone in control of the company has breached their fiduciary duties -- such as compensating themselves or others excessively -- thereby damaging the corporation.
Often, the corporation's regular counsel will represent both parties, the shareholder bringing the suit or the company, and those accused of looting it. This results in the defendant's attorney arguing against the corporation obtaining damages.
The choice to involve outside counsel for joint representation is left up to the corporation, not the court. However, even forcing the defendants to retain an independent legal counsel will not fix the issue. Since the independent counsel would still work for the corporation, which is controlled by the defendants, it would take orders from them, even if they weren't technically defending them. The result would be the same — the corporation's best interests would be ignored and legal counsel would still oppose the company.
To remedy this from happening, courts will sometimes allow the counsel who has been providing joint representation to continue representing the corporation, while the defendants are required to obtain outside counsel. However, even if two different counsels are used, the defendants still control the corporation, and by extension, its legal counsel. It's important for the corporation's lawyer to realize that a conflict of interest can arise if they direct their litigation to favor the defendants. It's easier for the attorney if there are disinterested directors and legal teams they can take direction from.
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