Articles Posted in Corporations

As a business lawyer representing many closely held corporations, I often see shareholders elect board members without much thought, either because they are family members or employees of the business. The board of directors serves a very important management role for a corporation and the decision of who you put on the board should not be taken lightly. If an elected board member is no longer a good fit for your company, do not wait too long to replace him/her or you could be missing an opportunity to find a board member who will add value to your company.

Electing a Director

In most corporations, the bylaws provide that directors will be elected at each annual shareholders’ meeting and will hold office until the next annual shareholder meeting and until their successors are elected and qualified, unless they are removed from the board before that time. Each year when it is time to renew your board, make sure you stop to consider whether the same directors should continue serving the company, or if it is time for some new blood. It is much easier to not re-elect a director, than it is to remove one during his/her term.

Removing a Director

Directors can be removed for cause, which means the director being removed did something wrong. The board can declare a director’s seat to be vacant if that director is convicted of a felony or declared incompetent. A director can also be removed for cause by a court order, but the court will require at least 10% of the outstanding shares to petition for removal, and a showing of fraudulent or dishonest acts or gross abuse of authority by the director to be removed.

Shareholders may remove directors without cause if the removal is approved by a majority of the outstanding shares entitled to vote for the election of directors. However, no individual director can be removed over an objection by one or more shareholders who, collectively, have enough votes to elect that director under cumulative voting.

Filling a Vacancy on the Board

Generally, the shareholders are supposed to elect the board of directors. However, depending on how the seat was vacated, either the board itself, or the shareholders, can fill a vacant board seat. If a director dies, is incapacitated, or resigns, the remaining directors can usually appoint a replacement director (unless the corporate documents say otherwise). If a director is removed, the vacancy must be filled by the shareholders unless the corporate documents authorize the board to fill such a vacancy. In the event that a majority of the directors have been appointed by the board, there is a safeguard to make sure the shareholders have the ultimate authority. Holders of 5% or more of the outstanding shares may call a special meeting of the shareholders and elect an entirely new board.

Whether or not your entire board is in place, in order to maintain your corporate liability shield, the corporation must follow the statutory rules regarding regular and special board meetings for the board to make decisions on behalf of the company. The rules for board meetings will be covered in another blog.

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As a corporate lawyer representing small businesses here in San Jose and throughout Silicon Valley, I often need to walk my clients through the process of forming a corporation, whether in California, Delaware, or another state, but also the ongoing requirements of maintaining their corporation. It is important to remember that California law provides limited liability to shareholders, so long as the corporation is treated appropriately. When corporate formalities are not followed, creditors and claimants can “pierce the corporate veil” to allow for a judgment against shareholders for a liability that should only have been an obligation of the corporation. One of the most important corporate formalities is the shareholder meeting.

Every California corporation is required to have an annual meeting of the shareholders, and can have additional ‘special’ meetings at any other time when properly called. In order to hold a proper meeting, the meeting must be properly called, noticed, and held. This is a general roadmap on how to do that, but any corporation is subject to the specifics of its corporate documents and should only rely on legal counsel familiar with its documents for requirements specific to its company.

When should the annual shareholder meeting be held?

The annual meeting should be held on a date and time that is stated in the bylaws. Recently I began representing a client that controlled multiple different corporations formed by his previous corporate attorney. Each of the corporations had a different annual meeting date, making it much more difficult for the client to remember to hold his meetings on time. We held a special meeting of the shareholders to amend the bylaws of each corporation to have the meetings on the same date, and then held the meetings back to back in his office. In this case, the shareholders and the board of directors were essentially the same people, so we actually noticed and held a joint annual meeting.

What action is required at the annual shareholder meeting?

The only action required to be taken by the shareholders at an annual meeting is the election of the board of directors. Any other proper business may also be acted upon, so long as it was included in the meeting notice.

Required Notice – What should the notice say?

All shareholders who are entitled to vote are entitled to written notice of the annual meeting (and any special meeting). The bylaws cannot override this requirement. However, most of the time, my small business clients with closely held corporations hold their meetings without formal notice, and we just have the shareholders sign a written waiver of the notice requirement at the meeting. Of course, you should not depend on this if there is any hint of a potential disagreement between the shareholders. Otherwise, a disagreeable shareholder could refuse to waive the notice requirement, and delay or block the shareholders from taking any action at the meeting.

The notice to shareholders must include the date, time and place of the meeting, and whether shareholders can attend by telephone or electronic meeting. For annual meetings, or any other meetings where directors will be elected, the notice must also state the names of the persons nominated for the election. Any other matters the board intends to present to the shareholders for any action at an annual meeting must also be stated in the notice. Although at an annual meeting the shareholders may still be able to act on a matter that was not included in the notice, certain matters may require the unanimous vote of the shareholders, including those not attending the meeting, if the shareholders were not given notice of them in advance.

At a special meeting, the shareholders are not allowed to act on business not included in the notice unless all shareholders provide written waiver of notice for that matter. For this reason, if the corporation has any adverse interests among its shareholder, I recommend that a very specific agenda be provided with the notice of any special meeting. The safest method is to provide the actual language of proposals the board will be presenting to the shareholders at the meeting.

In addition to providing notice before the meeting, in California the corporation must provide an annual financial report to the shareholders at least 15 days before the annual meeting, and no later than 120 days after the end of the corporation’s fiscal year. However, if the corporation has less than 100 shareholders, this requirement can be waived in the bylaws.

Required Notice – How do you give notice?

You should always check to see what the corporation’s bylaws say about notice, but for most corporations, notice can be given by first class mail, in person, or by electronic delivery such as facsimile or e-mail. Notice should go to the address or contact information provided by the shareholder to the corporation. If you do not have an address, or if the electronic notice gets rejected twice, you can mail the notice to the shareholder care of the corporation at its principal executive office, or you can publish it in a local newspaper. In other words, if you cannot find a shareholder you do not have a legal requirement to spend your time looking for them.

The corporation is considered to have provided notice as of the date it mails the notice, or delivers it personally, by fax or electronically. I recommend that the secretary of the corporation sign an affidavit of mailing or electronic transmission for the corporate minute book. I may be able to provide notice and sign the affidavit as the transfer agent for corporations that are my clients.

Required Notice – When should it go out?

Written notice of a shareholder meeting must be given no less than 10 days and no more than 60 days before the scheduled meeting. Corporations will often provide at least 15 days notice so that the annual financial report can be sent to the shareholders at the same time.

Improper Notice

As I mentioned earlier, shareholders can waive the required meeting notice if they did not get notice, or they can waive any problem with the notice they received. If a shareholder does not attend a meeting, they can waive notice in writing either before or after the meeting. If a shareholder shows up at a meeting and does not actually object to the improper notice at the beginning of the meeting, the shareholder is deemed to have waived the notice requirement. However, a shareholder can still object at any time during the meeting if a matter is raised that was not included in the meeting notice. Be very careful about the content of the waiver. Although usually the waiver does not have to include information about what was supposed to be considered at the meeting, certain matters do require a more specific waiver, otherwise unanimous vote of the shareholders may be required on those matters.

Once a company has set a date for its shareholder meeting and either provided proper notice or had the notice requirement waived, the company must now determine who has the right to vote at that meeting, and what votes are required.

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I recently taught a program in San Jose to lawyers concerning California B corporations, a subject I covered in prior blogs. As a corporate lawyer, I have been asked by current and prospective business owners whether this new type of entity was the right choice of entity for them. B corporations were created to enable a for-profit company to include as a criteria in its management decisions its pursuit of a public purpose. The B corporation, however, must disclose its public purpose activities.

California recently created two types of B corporations, a “Benefit Corporation” and a “Flexible Purpose Corporation”. Although there are a number of differences between the two, each requires that a company list in its formation documents that it is devoted, among other things, to a public purpose. Each type of B corporation must also discuss its activities directed toward satisfying its public purpose. Each type of B corporation must also post the required disclosure on its website, although financial or proprietary information can be excluded in the website posting, and the company must send the disclosure to its shareholders within 120 days after its fiscal year end. If the disclosure is not posted on its website, a free copy must be made available to anyone, in the case of the Benefit Corporation, or must be made available to anyone through “similar electronic means,” in the case of the Flexible Benefit Corporation.

Benefit Corporation Disclosures

The content of the disclosure differs with the type of B corporation. The Benefit Corporation must provide an Annual Benefit Report. In the report, the company must discuss the process and rationale behind choosing the third party standard which it uses to assess performance toward providing a public benefit. The company must also explain how it pursued the benefit, the extent to which the benefit was achieved, and the circumstances that hindered achievement. Last, the company must list the names of all persons owning 5% or more of the Benefit Corporation’s outstanding stock.

Flexible Purpose Corporation

The disclosure requirements of a Flexible Purpose Corporation roughly parallel those that exist for publicly held companies. The company must provide a Special Purpose Management Discussion and Analysis. The Special Purpose MD&A must identify and discuss short and long term objectives relative to its special purpose, and any changes made during the prior fiscal year. Among other things, the company must also disclose the material operating and capital expenditures required over the next three years to achieve its purpose.

In addition to the annual Special Purpose MD&A, a Special Purpose Current Report must be disclosed no later than 45 days after certain events have occurred. These events include such things as making or withholding a material operating and capital expenditure for achieving the corporation’s purpose, or a determination that the special purpose has been satisfied or should no longer be pursued. Because the law is so new, the extent of the disclosure required is a bit unclear, and best practices are expected to develop that will serve as the basis for a presumption that disclosure is complete.

One “advantage” of the Flexible Purpose Corporation, as opposed to the Benefit Corporation, is that the disclosure can be waived, but it is tricky. The waiver option only exists for corporations with less than 100 holders of record. Holders of 2/3 of the shares of record must waive the disclosure requirements, and the waiver must be provided annually within set time limits. The waiver is also revocable. Disclosure cannot be waived for a Benefit Corporation.

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