Lesson 23 2018

LESSON 23
PRIVATE CORPORATIONS – PART II

About the Editorial Staff
Program Reviewer: John DeLeo

As a professor and director of the paralegal program at Central Penn College, John DeLeo has
been educating paralegals for over 17 years. He has taught courses such as Torts, Contracts, Civil
Procedure, Real Estate, Family Law, Administrative Law, Legal Writing, Constitutional Law, Evi-
dence, Criminal Law, Business Law, and Wills. DeLeo is a 1984 graduate of Loyola University of
New Orleans School of Law (J.D.) and a 1976 graduate of Pennsylvania State University. He is a
published author, a former paralegal, and a member of the Pennsylvania Bar Association.
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CONTENTS
LESSON 23 1
Lesson 23 Preview .......................................................................................................................1
CHAPTER 8 3
ULTRA VIRES TRANSACTIONS...............................................................................................3
Definition of Ultra Vires................................................................................................................3
Ultra Vires Distinguished From Illegality.....................................................................................3
Development of the Doctrine.........................................................................................................4
Acquisition of Property..................................................................................................................4
Executory Contracts.......................................................................................................................5
Executed Contracts........................................................................................................................5
Partially Executed Contracts..........................................................................................................6
Rescission of Ultra Vires Contract ...............................................................................................8
Modern Tendencies .......................................................................................................................9
CHAPTER 9 10
CORPORATE CRIMES AND TORTS........................................................................................10
Early Doctrine..............................................................................................................................10
Development of Corporate Liability............................................................................................10
Liability for Torts.........................................................................................................................11
Torts Involving Malice.................................................................................................................11
Criminal Liability.........................................................................................................................12
Crimes Involving Malicious Intent..............................................................................................13
CHAPTER 10 15
DIRECTORS, OFFICERS, AND AGENTS................................................................................15
Directors Defined.........................................................................................................................15
Relation Between Corporation and Its Directors.........................................................................15
Powers..........................................................................................................................................16
Meetings.......................................................................................................................................16
Delegation of Authority...............................................................................................................17
Removal.......................................................................................................................................18
Compensation..............................................................................................................................18
Liability for Unauthorized or Illegal Acts....................................................................................19
Effect of Good Faith....................................................................................................................20
Duty of Diligence.........................................................................................................................21
Dealings of Directors With Their Corporations...........................................................................23
Secret Profits................................................................................................................................25
Contracts Between Corporations With Interlocking Directors....................................................26
Duty Toward the Individual Stockholder.....................................................................................27
Functions of Corporate Officers...................................................................................................28
CHAPTER 11 29
CORPORATE MEMBERSHIP, CAPITAL STOCK, AND SHARES OF STOCK....................29
Necessity of Members..................................................................................................................29
Acquisition of Membership.........................................................................................................29
The One‑Person Company...........................................................................................................29
Stockholders’ Meetings................................................................................................................30
Capital Stock and Capital.............................................................................................................30
Capital Stock Distinguished From Shares of Stock.....................................................................31
Nature of Shares of Corporate Stock...........................................................................................32
Kinds of Stock.............................................................................................................................32
Transfer of Shares of Stock..........................................................................................................33
Restraints on Transfer..................................................................................................................35
Effect of Executed Transfer.........................................................................................................36
Registration of Transfer...............................................................................................................37
Provisions of the Uniform Commercial Code.............................................................................38
CHAPTER 12 39
THE RIGHTS OF STOCKHOLDERS........................................................................................39
Right to Perform Extraordinary Corporate Acts..........................................................................39
Right to Vote................................................................................................................................39
Voting by Proxy...........................................................................................................................40
Voting Trusts................................................................................................................................40
Cumulative Voting.......................................................................................................................41
Right to Make Bylaws.................................................................................................................41
Right to Dividends.......................................................................................................................42
Stock Dividends...........................................................................................................................43
When Equity Will Decree Declaration........................................................................................43
Who Is Entitled............................................................................................................................44
Setting Apart of Specific Fund.....................................................................................................44
Right to Subscribe to New Issue of Stock...................................................................................44
Right to Inspect Corporate Books and Records...........................................................................45
Right of Stockholder to Sue on Own Behalf...............................................................................46
Right of Stockholder to Sue on Behalf of the Corporation..........................................................46
Conditions of Suit........................................................................................................................48
Who Can Sue...............................................................................................................................48
Defenses.......................................................................................................................................48
Practical Importance....................................................................................................................49
CHAPTER 13 50
CORPORATE CREDITORS.......................................................................................................50
Relation Between Creditor and Corporations..............................................................................50
The Trust Fund Theory................................................................................................................50
Modern Theory............................................................................................................................51
Relation Between Creditor and Director......................................................................................52
Relation Between Creditor and Stockholder................................................................................52
Unpaid Subscriptions...................................................................................................................53
Stock Issued for Property.............................................................................................................53
Watered Stock..............................................................................................................................54
Statutory Liability........................................................................................................................54
Effect of Transfer of Shares.........................................................................................................55
CHAPTER 14 56
DISSOLUTION OF CORPORATIONS......................................................................................56
Methods.......................................................................................................................................56
Transfer of Entire Corporate Property.........................................................................................57
Forfeiture Clauses in Charters.....................................................................................................57
Abuse or Misuse of Franchise......................................................................................................57
Jurisdiction of Equity...................................................................................................................58
Effect on Corporate Property.......................................................................................................58
Corporate Suit..............................................................................................................................58
Voluntary Dissolution..................................................................................................................59
CHAPTER 15 60
FOREIGN CORPORATIONS.....................................................................................................60
Status of National Corporations...................................................................................................60
Status of Foreign Corporations....................................................................................................60
The Rule of Comity.....................................................................................................................61
Methods of Exclusion..................................................................................................................62
Right to Engage in Interstate Commerce.....................................................................................62
EXAMINATION..........................................................................................................................65
LESSON 23
Lesson 23 Preview
Lesson 23 in this book covers Chapters 8 through 15, pages 73-133. When you are sure you
understand the material in this lesson, complete the examination at the end of the lesson.
Welcome to Lesson 23. In Chapter 8, you’ll be introduced to the term ultra vires and what it
means in terms of a corporation and its contracts. You’ll learn which contracts are binding to a cor-
poration and which are flexible. Chapter 9 will teach you about corporate crimes and what acts will
render a corporation liable.
Chapter 10 moves into the corporation itself and explains the different positions within a corpo-
ration and their authorities. You’ll learn who has the power to delegate authority to remove a person
from a position, as well as the duties that accompany such powers.
The next chapter discusses corporate membership and why this is necessary for a corporation to
function. This chapter will teach you about a corporation’s stock; the different types, their function,
and how shares of stock may or may not be transferred. You’ll also learn about the Uniform Com-
mercial Code and how it applies to a corporation’s stock. Chapter 12 covers all of a stockholder’s
rights, including rights in a court.
As a corporation continues its business, it most often acquires creditors. Chapter 13 discusses
a creditor’s relationship with individual corporate components and how a creditor may collect the
debts of a corporation.
Chapter 14 explains when a corporation should be dissolved, how this is done, and what process-
es are involved. In Chapter 15, that last chapter of this lesson, you’ll learn about foreign corpora-
tions. This chapter defines the “rule of comity” and how it relates to foreign corporations, as well as
the ways a corporation may do business outside of the area in which it resides.
When you finish this lesson, you’ll be able to:
• Tell how a stockholder in a corporation relates to contracts

• Detail the position of corporations as they relate to contracts
• Describe the rights of creditors of a corporation
• Identify how shares of stock are evidence
• Determine how directors of a corporation stand in relation to the corporation and its stock-
holders
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Lesson 23: Private Corporations - Part II
• Give the name that describes the number of shares of stock that must be present in order
that business may be validly transacted at a stockholders’ meeting
• Elaborate on the term “bylaws”
• Recall who controls all the ordinary and usual business affairs of the corporation
• Illustrate what’s meant by the term “forfeiture”
• Define “proxy”
2
CHAPTER 8
ULTRA VIRES TRANSACTIONS
Definition of Ultra Vires

As you learned earlier, an ultra vires act is one that’s beyond corporate powers. In other words,
it’s an act that the articles of association don’t authorize either expressly or by implication. A cor-
poration possesses the power, the physical might, to perform an ultra vires act. However, it doesn’t
have the right to do so. As to the exact nature of an ultra vires act, the decisions are inconsistent.
Some courts regard an ultra vires act as they would an illegal act. Others regard it as a mere nullity.
Still others regard it as perfectly valid and binding, unless the sovereign state sees fit to interfere.
Logically, an ultra vires act goes beyond the area the company should go. For example, if a corpora-
tion enters into an ultra vires contract, the contract is beyond the powers of the company. If it’s ultra
vires at its beginning, it was void because the company couldn’t rightfully make the contract. Even
if every shareholder of the company was present, consented, and authorized the directors to enter
into the contract, it’s nevertheless unauthorized. This is because the shareholders performed an act
that their corporate charter didn’t authorize them to do. But many courts refuse to go to this extent in
interpreting ultra vires transactions, and they cite strong reasons for their refusal.
Ultra Vires Distinguished From Illegality

An ultra vires act isn’t necessarily an illegal act. Much confusion in decisions has arisen from the
failure to distinguish between the two. An ultra vires act may also be an illegal act. The two overlap,
but they aren’t the same. For example, suppose that a corporation organized to run a retail butcher
and made business contracts to purchase two tame elephants. This could never be called an illegal
act. It’s neither inherently wicked or forbidden by statute. At most, the purchase is simply unauthor-
ized. The butcher company is doing something which is ultra vires and quite unauthorized by the
terms of its charter. But it surely is doing nothing illegal. The contract is neither malum prohibitum
(a wrong that’s forbidden) or malum in se (an inherently vicious act contrary to good public mor-
als). On the other hand, suppose that a corporation organized to operate a department store hires
John Doe, a notorious criminal, to murder a competing rival, Joe Jones. Doe proceeds to murder
Jones. This contract isn’t only ultra vires of the department store, but illegal as well. The distinction
between the two—ultra vires and illegality—seems obvious. This distinction is very important, not
3
only theoretically, but from a practical point of view as well. It’s settled within the law that there
never can be a recovery upon an illegal contract. As an ultra vires contract isn’t necessarily an illegal
one, the rules that apply to illegal contracts aren’t decisive in the cases of ultra vires contracts.
Development of the Doctrine

Originally, ultra vires corporate acts were treated just as though they were illegal acts. Most of
the early corporations were more or less public in their nature. It was therefore highly important to
keep them within their chartered powers. As corporations increased and entered the domain of the
purely private business and partnership, this rigid rule didn’t work fairly. Ultra vires acts were then
treated as void, but not necessarily illegal. Where it was necessary for justice, a recovery on an ultra
vires contract was allowed. More recently, the courts have been inclined to rule that the question of
corporate power can’t be raised collaterally, but that only the sovereign state may raise the question.
In fact, this theory is backed by many state statutes.
The doctrine of ultra vires seems to be working itself out along the same general lines as the de
facto corporation doctrine. Questions relating to irregular or defective organization are now most of-
ten asked by the state. Likewise, the courts are leaning to the view that the state alone may challenge
the validity of the exercise of a corporate body’s given power.
Acquisition of Property
Suppose that a corporation conveys real estate that’s unauthorized by its charter. Is the convey-
ance to the corporation void? Today, the courts almost always answer this question in the negative.
Generally, where a corporation’s charter names it incompetent to take a real estate title, a conveyance
to it isn’t void, but only voidable. Only the sovereign state can object. In other words, the convey-
ance is perfectly valid until assailed in a direct proceeding instituted by the state, through its attorney
general, or other legal officer. This rule, while recognizing the authority of the state that has created
the corporation and to which the corporation is amenable, has the beneficial effect of assuring the
security of real estate titles and of preventing the injurious consequences that would otherwise result.
The corporation’s real estate title and its right to enjoy the same can’t be collaterally inquired into in
actions between private parties or between the corporation and private parties. It can be questioned
only by the state.
However, if a mortmain doctrine still exists in a state, it might be difficult for a corporation to
retain property willed to it. In the early days of common law, the courts looked with little favor on
the acquisition of real property by corporations. Mortmain, literally, means “dead hand.” The term’s
significance lies in the circumstance that a corporation was supposed to hold onto acquired property
with the grip of a dead man’s hand. This was naturally frowned on because it tended to restrain the
free alienation and circulation of property. A mortmain policy may be found in a statute in relation
to wills, prohibiting a devise to a corporation, unless specially permitted by its charter or by some
statute to take property by devise. The doctrine is no longer followed.
4
Executory Contracts
Where a contract is purely executory, meaning nothing has been done by either party, there can’t
be any recovery for breach of an ultra vires contract. A mere executory ultra vires contract can never
be the foundation of an action either by or against the corporation.
The theory on which our courts refuse to sanction a recovery on an executory ultra vires corpo-
rate contract is very simple. After all, a corporate contract that’s ultra vires is an unauthorized con-
tract and one that the state hasn’t permitted or sanctioned. Therefore, the courts, which are agencies
of the state, shouldn’t lend their aid in order to carry out such a contract, which is still wholly unex-
ecuted. In fact, it’s the duty of either party to withdraw from such a contract. When this is done, no
action for breach of contract will lie at law, and in equity, specific performance won’t be decreed.
There are three main reasons why a corporation can’t sue or be sued upon such an ultra vires
contract:
1. The public’s interest that the corporation doesn’t exceed the powers granted to it.
2. The shareholders’ interest that the corporation’s capital stock won’t be subjected to
the risk of enterprises not contemplated by the corporate charter, and therefore not
authorized by the stockholders when they subscribed for stock in the company.
3. The duty of everyone who enters into a contract with a corporation to take notice that
it’s a creature with limited powers and to take notice of the legal limits of its powers.
Executed Contracts
Just as the court won’t interfere with executory ultra vires contracts, it also won’t interfere with
ultra vires contracts when fully executed by those parties. It won’t disturb such an executed contract
on the complaint either of the corporation or of the other contracting party. However, the court will
leave the parties in status quo—that is, where they have placed themselves by their own actions and
where it finds them. In a typical case, L and his wife executed a deed of certain valuable mineral
property to a railroad company and received a valuable consideration for it. Subsequently, L brought
a bill in equity to rescind the conveyance on the ground that the corporation was without power
to purchase and hold the land or the mineral interests in the land. The bill sought to have the deed
declared void because of the corporation’s incapacity. The bill wanted the deed canceled as a cloud
upon L’s title. The court decided not to interfere, since the contract was duly executed on both sides.
The court said:
“The law will not interfere, at the instance of either party, to undo that which it was originally
unlawful to do, and to the doing of which, so long as the contract to that end remained executory,
neither party could have coerced the other.”
The court left the parties where they had placed themselves.
5
Partially Executed Contracts
There are two views to a contract that has been legally executed. The rule maintained in the U.S.
Supreme Court, followed by several state courts, is that an ultra vires contract is absolutely null and
void, and that no action in any form, shape, or manner can be maintained on the contract itself. In
New York and the majority of state courts, the rule is that if the contract is partially executed, the
party who has performed may sue and recover on the contract, and the other party is estopped from
denying the agreement’s validity.
For example, suppose an iron manufacturing corporation orders three tame lions from X, an ani-
mal trainer. Suppose X delivers the lions, and they’re left in the corporation’s possession and control.
In the federal courts, X couldn’t sue and recover the agreed purchase price from the corporation.
In other words, X would have no remedy upon the contract itself. Whatever remedy X would have
would be in an action of quasi‑contract, to recover the reasonable value of the lions from the corpo-
ration and to prevent the unjust enrichment of the company at the expense of X. But in New York, X
would be allowed to recover the agreed purchase price of the lions in an action brought against the
iron corporation for breach of contract. The iron corporation, having received the benefits of the con-
tract—namely, the lions—would be estopped from raising the defense that it was unauthorized by
its charter to purchase animals of that sort. It should not lie, says the New York court, in the mouth
of the corporation to say that it’s without authority, where it has received and retained the benefits of
the contract. Consequently, in New York, the partially executed ultra vires contract is unquestionably
enforceable, according to its terms, by the party who has performed on its side.
In the federal courts, the view is taken that there can never be a recovery upon the contract itself.
As stated by one federal judge:
“All contracts made by a corporation beyond the scope of its powers are unlawful and void,
and no action can be maintained upon them in the courts, and this upon three distinct grounds:
The obligation of everyone contracting with a corporation, to take notice of the legal limits of
its powers; the interest of the stockholders not to be subjected to risks which they have never
undertaken; and, above all, the interest of the public, that the corporation shall not transcend the
powers conferred upon it by law.”
A contract that’s unlawful and void because it’s beyond the scope of corporate powers doesn’t
become lawful and valid by being executed. No action, under any circumstances, can be maintained
on the unlawful contract or according to its terms. Therefore, where a railroad corporation acted
in excess of its powers and leased its property to another corporation, it was held that the lessor
couldn’t recover rental that had accrued under the lease contract.
In this instance, what’s the lessor corporation’s remedy? The U.S. Supreme Court answered that
the lessor should disaffirm the contract of the lease and sue to recover, as on a quantum meruit (how
much worth), the reasonable value of what the defendant has benefited from. To maintain such an
6
action is to disaffirm the ultra vires contract. It recognizes that there can’t be recovery on the con-
tract itself. But, in order to do justice between the parties, it permits property or money parted with
on the faith of the unlawful contract to be recovered or compensated for. You can see that while
federal courts don’t permit a recovery on the contract itself, they nevertheless recognize that a party
shouldn’t receive and retain property without making compensation for it. Accordingly, resort is had
in the doctrine of quasi‑contract, a promise is implied, and a recovery for the reasonable value of that
which has been received and retained is permitted.
In New York and in many other states, one who has received the full consideration of his promise
from a corporation can’t avail himself of the objection that the contract fully performed by the corpo-
ration was ultra vires not within its chartered privileges or powers. The New York courts insist that
it would be contrary to the first principles of equity to allow such a defense to prevail in an action by
the corporation. For instance, in one case, X corporation entered into a contract with a corporation
organized to manufacture firearms and other implements of warfare, to give it twenty thousand rail-
road locks. The plaintiff—the arms company—made and delivered ten thousand locks under the con-
tract, and the contract was rescinded by mutual consent. It was conceded that the manufacturing and
selling of railroad locks wasn’t within the purposes for which the arms company was incorporated or
within the powers conferred on it by its charter. Yet it was unanimously held that the pleas of ultra
vires couldn’t prevail as the defendant had received the full benefit of the contract. The court said:
“It is now very well settled that a corporation cannot avail itself of the defense of ultra vires
when the contract has been, in good faith, fully performed by the other party, and the corporation
had the full benefit of the performance and of the contract. The same rule holds e converse (con-
versely). If the other party had had the benefit of the contract fully performed by the corporation,
he will not be heard to object that the contract and performance were not within the legitimate
powers of the corporation.”
In other words, a party who has had the benefit of the ultra vires contract can’t be permitted to
question its validity. In another case, the plaintiff was insured against loss or damage from hail by an
insurance company only authorized to insure against loss by fire or lightning. The premium was paid
and a heavy loss occurred. The corporation denied liability, insisting that it didn’t have the power to
enter into the insurance contract in question. It was held that the plaintiff could recover.
The New York rule has been criticized because it allows a recovery on unauthorized contracts.
The New York courts have answered this complaint by saying that it’s as logical as denying a recov-
ery on the contract, as the federal courts do, and in the next breath, permit a recovery on an implied
contract. The New York courts insist that the federal rule is a “mere evasion.” This much is said on
behalf of the New York rule: that it’s a shorthand cut to justice. Besides, the measure of recovery in
the action of quasi‑contract, to which the federal courts resort, is seldom substantially different from
the agreed contract price.
7
In a few jurisdictions, the courts have attempted to draw a distinction between want of power and
abuse of power. Where there is an absolute want of power to make the contract, the courts held that
there can never be any recovery on the agreement itself. According to them, it would be contradic-
tory to say that a contract is void for an absolute want of power to make it, and then say that it may
become legal and valid as a contract by way of estoppel, by some other act of the party under some
incapacity, or by some act of the other party chargeable by law with notice of the want of power.
Nevertheless, where there is only an abuse of power and the act is within the general scope of the
corporate powers, the doctrine of estoppel (as applied in New York) is invoked. Of course, the border
line between want of power and abuse of power is shadowy at best. Hence, the value of the distinc-
tion is questionable.
Rescission of Ultra Vires Contract

According to a federal case, the X railroad corporation leased its entire railroad property and
franchises to the Y railroad corporation for a term of 999 years. The Y corporation was supposed
to pay the X corporation a certain portion of the gross receipts. The contract was fully executed by
the actual transfer of the railroad property. The Y corporation held the property and paid the stipu-
lated consideration for 17 years. Then, for the first time, the X corporation became dissatisfied and
brought suit in equity to set aside and cancel the instrument as beyond the corporate powers of both
companies. The U.S. Supreme Court, though conceding that the contract was ultra vires, decided
that no suit could be maintained to set aside and cancel the contract. The court declared that the par-
ties should remain in the situation. The maxim that where both parties are equally to blame, the court
resorts to the view that the defendant’s condition and position are better. This decision seems open
to the criticism that it forbids a corporation to renounce that portion of an ultra vires contract that re-
mains unexecuted. The decision is defended on the ground that the court shouldn’t interfere to afford
affirmative relief either to inforce or to set aside an ultra vires contract. You should know, however,
that the reasoning behind the decision is extremely confusing and fails to distinguish between illegal
and ultra vires contracts. The court repeatedly refers to the rules that govern illegal agreements.
On the other hand, in an early Massachusetts case, the court permitted a disaffirmance and
permitted the consideration money to be recovered. In a Wisconsin case, an action was brought by
a corporation engaged in the business of a common carrier, on a contract for the sale of wheat to be
delivered to the plaintiff’s ship. One thousand dollars had been paid on account. The contract was
repudiated as ultra vires, and the plaintiff sought judgment for one thousand dollars paid on account
and for damages for breach of contract. The court said that the plaintiff wasn’t entitled to damages
but was entitled to the return of the consideration paid. The right of rescission was recognized.
In general, it might be said that a corporation, on principle, should be permitted to withdraw from
an agreement that is ultra vires. Only in a sense is the court interfering; really, the consummation of
an unauthorized agreement is being prevented.
8
Modern Tendencies
Recently, progressive jurisdictions have insisted that the question and principle of ultra vires
is close or identical to the rule of law that forbids the regularity of the corporation’s validity to be
inquired into except at the state’s direct instance. After all, the only offense is against the sovereignty
of the state. If the state doesn’t interfere, why should private persons be permitted to raise the issue
collaterally? If this doctrine is adopted—that only the state can challenge the acts done under color
of a corporate charter—it must necessarily protect an executory ultra vires contract from collateral
attack. Hence, if the state is satisfied with the construction on which the corporation acts, and doesn’t
intervene, and if there isn’t a question of public policy involved, there’s no real reason why the issue
should be open to question by either a stranger, or a person who has dealt with the company. Not all
courts have taken this view but most have been leaning in this direction.
9
CHAPTER 9
CORPORATE CRIMES AND TORTS
Early Doctrine
In the early days of common law, it was thought that a corporation couldn’t commit a tort or be
guilty of a crime. This was because a corporation had no body, so it couldn’t beat or be beaten. It
had no soul, so it couldn’t have good or bad intentions. It also had no mind, so it couldn’t entertain
a malicious or wicked intention or possess a mens rea (guilty mind). The reasoning is faulty. If a
corporation could build bridges, encircle the world with ships and planes, bank millions of dollars,
and control the destinies of hundreds and thousands of human beings, surely it isn’t so intangible that
it can’t be held accountable for its crimes or torts. Suppose X, a corporation agent, commits a tort on
behalf of the corporation while engaged in its business. The remedy against X is generally worthless.
In nine cases out of ten, X is insolvent or irresponsible, and a judgment against him is valueless. If
there’s no remedy against the corporation, the injured person will be helpless. On well-settled prin-
ciples of the law of agency, a master or principal is held responsible for the acts of servants or agents
under their authority, and while they’re acting for the benefit of their principal. Corporations should
be no exception to this general doctrine. They should be responsible not only for the conditions on
their contracts, but also for the torts and crimes of their agents and servants. The argument has some-
times been made that a corporation is a creature of limited powers, that it isn’t chartered to commit
torts and crimes, and therefore can’t commit them. This argument, characteristic of the early days of
the common law, isn’t plausible. It’s true that a corporation’s charter doesn’t authorize it to commit
torts or crimes. It doesn’t have the right to commit these, but it certainly has the power to commit
them, therefore it should be held responsible and be forced to right its wrongs. A human being isn’t
created to commit wrongs, yet human beings frequently do so. When they do, they’re held respon-
sible. Precisely the same reasoning is applicable to artificial persons, subject only to the limitations
on corporations because of their peculiar nature.
Development of Corporate Liability

U.S. corporations have almost always been held liable for their torts. In fact, it’s now well-settled
that, in an action for tort, a corporation may be held responsible for damages for the acts of its agents
within the scope of their employment. Recent cases also recognize that it’s no more difficult to attri-
10
bute a specific intent to a corporation in criminal proceedings than in civil. Accordingly, corporations
today are frequently indicted. It’s true that a corporation can’t be arrested and imprisoned in either
civil or criminal proceedings, but its property may be taken either as compensation for a private
wrong or as punishment for a public offense.
Liability for Torts

Corporations today may be held liable in damages for assault, battery, false imprisonment, tres-
pass, and similar torts committed by the corporate representatives while acting for the corporation. A
corporation can act only through its servants or agents. It’s held responsible for torts they committed
while acting on behalf of the corporation. A corporation is held liable for torts even though they arise
from a corporate action that’s ultra vires. As said by the Supreme Judicial Court of Massachusetts:
“It is a general rule that corporations are liable for their torts as natural persons are. It is no
defense to an action for a tort to show that the corporation is not authorized by its charter to do
wrong. Recovery may be had against corporations for assault and battery, for libel and for mali-
cious prosecution, as well as for torts resulting from negligent management of the corporate busi-
ness. If a corporation, by its officers or agents, unlawfully injures a person, whether intentionally
or negligently, it would be most unjust to allow it to escape responsibility on the ground that its
act is ultra vires.”
In the case where this language was employed, an educational corporation had assumed to oper-
ate a public ferry and to carry passengers on it for hire. This business was, of course, ultra vires. X
took passage on one of the ferry boats and was injured negligently. First, it was held that a corpora-
tion could commit a tort. Second, it was held that although the business of running a ferry boat was
ultra vires, the corporation should be made to respond in damages. The point is that the corporation,
while running the ferry boat and taking the profit from running it, accepted the plaintiff as passenger
to be transported and did so negligently. Therefore, it should be held liable for torts, whether they’re
committed in the course of an intra vires or of an ultra vires undertaking. The rule might properly
be formulated that corporations are liable for every wrong they commit, and that in such cases the
doctrine of ultra vires has no application whatsoever.
Torts Involving Malice

Even in recent years it has been contended that a corporation can’t be held responsible for a tort
where malicious intention is an essential element of the offense. For instance, in one case, an action
of trespass on the case for malicious prosecution was brought against the Erie Railroad Co. It main-
tained that it was an ideal entity, a mere fiction of the mind, and therefore incapable of entertaining
malice, which is a requisite in an action of tort for malicious prosecution. This argument was unani-
11
mously overruled. The court said that corporations had been held liable for false and fraudulent rep-
resentations, maliciously obstructing a party in its business and maintaining a vexatious suit. Each
of these actions involve an intention, which is just as much involved as in an action for malicious
prosecution.
Corporations have frequently been held liable for malicious libel and slander. It must appear that
the corporation expressly directed or authorized the agent to speak or write the untrue words in ques-
tion. If this doesn’t appear, the corporation isn’t liable. In an English case involving an action for
wrongfully and maliciously annoying the plaintiff in his trade, the corporation urged that the action
couldn’t be maintained on the ground that malice actual (wicked malice) was the gist of the action. It
claimed that a corporation couldn’t be actuated by such malice. The court said that the basis of this
argument—that a corporation, having no soul, cannot be actuated by malice—was more quaint than
substantial. Today, a corporation can be held liable even for torts where a wrongful frame of mind is
part of the offense.
On the same principle that a corporation is held liable for a tort involving malice, it may also be
held liable to pay punitive or exemplary damages. Suppose a newspaper publishes a story recklessly,
with little regard for what is and isn’t true. Under such circumstances, it has been held that the cor-
poration that owns and operates the newspaper may be held liable in punitive damages. This is sound
on both principle and authority.
Criminal Liability
Some writers on the common law held the law to be that a corporation couldn’t commit a crime.
In one case, Lord Chief Justice Holt, said that “a corporation is not indictable, although the particular
members of it are.” In his immortal commentaries, Blackstone said: “A corporation cannot commit
treason, or felony, or other crimes in its corporate capacity, though its members may in their distinct
individual capacity.”
Universal modern authority goes the other way. Many federal and state statutes contain criminal
provisions, and there seems to be no valid reason why a corporation can’t be held responsible and
charged with the knowledge and purposes of its agents, if these agents act in defiance of such provi-
sions. Without this rule, a corporation could commit any crime it chooses with absolute immunity.
As a result, more unlawful acts would be committed.
There’s a dictum in the opinion of one judge to the effect “that there are some crimes which in
their nature cannot be committed by corporations.” The Supreme Court, however, indicates that most
crimes can be committed by corporations and explodes the old doctrine that a corporation is immune
from punishment. True, the corporation can’t be locked up in jail. But it can be fined, its charter can
be taken away, and its guilty agent can be personally punished. It isn’t enough to fine a few individ-
ual corporate agents. In fact, many statutes historically couldn’t be effectually enforced, as long as
individuals only were liable to punishment. It’s necessary to punish the corporation as well. Oth-
12
erwise, the law would be overlooking the fact that many large business transactions are carried out
through corporations. The modern tendency is to hold corporations liable in criminal proceedings;
this includes proceedings for criminal contempt as well.
Crimes Involving Malicious Intent

The courts have been a little slower in adopting a general rule as to whether a corporation can
be held liable for a crime involving a malicious intent. Logically, there seems to be no reason why
the intent of its officers and agents can’t lawfully be attributed to the corporation. In some cases, of
course, this has been done. For instance, some corporations have been indicted under the provisions
of the Sherman Anti‑Trust Act and were criminally liable for conspiracy. One judge said, “It seems
to me as easy and logical to ascribe to a corporation an evil mind as it is to impute to it a sense of
contractual obligation.”
In another case, a newspaper company was indicted for “knowingly depositing” an obscene and
unmailable newspaper in the U.S. mail. The corporation demurred to the indictment on the ground
that it couldn’t knowingly deposit and know the contents of an obscene newspaper. The court over-
ruled the demurrer to the indictment and said that it was enough that the directors were or ought to
have been aware of the improper and obnoxious matter in the newspaper. As said by the judge in the
case,
“To fasten this species of knowledge upon a corporation requires no other or different kind of
legal inference than has long been used to justify punitive damages in cases of tort against an
incorporate defendant. If a corporation can corporately know that an engineer is a habitual drunk-
ard, it can even more surely know the ordinary contents of a newspaper, the publication of which
is its sole reason for existence.”
In general, the modern tendency is to hold corporations responsible for all crimes committed by
them, whether they arise from nonfeasance or misfeasance, and whether they involve a malicious
intent or not. In fact, corporations can be held liable for any and every criminal offense, even for
such felonies as murder. This is true except for the circumstance that, as a general rule, the criminal
law doesn’t provide for penalties and punishments applicable to corporations. Of course, they can be
held liable for all such crimes as may be punished by fines, but the U.S. system of criminal proce-
dure needs amendment to provide for adequate punishment of a corporation whose duly accredited
agents or officers are guilty of a felony while engaged on its business and in its behalf. In this re-
spect, a court indicated that a definition of certain forms of manslaughter which would be applicable
to a corporation might be formulated. But in interpreting a current statute, it defined homicide as “the
killing of one human being by the act, procurement or omission of another.” It ruled that a corpora-
tion couldn’t be guilty, since “another” means another human being. On the other hand, a corporation
has been held guilty of manslaughter, resulting from the lack of life‑preservers on one of its boats.
13
Similarly, corporations have been held liable for criminal libel.
Suppose that the directors of a corporation being prosecuted determine that it’s in the corpora-
tion’s best interests to have a certain prosecuting officer murdered, or at least disabled. They, accord-
ingly, hold a stockholders’ meeting and the stockholders approve this determination of the directors.
A “gunman” is hired with instructions to do the job neatly and with dispatch. The prosecuting officer,
accordingly, is murdered. The corporation is indicted for murder. Is there any logical reason why it
shouldn’t be held? There can be no question of want of authority, for not only the directors but the
stockholders also authorized the hiring of the gunman. Besides, the act was plainly done on the cor-
porate behalf and supposedly with its interests in view. A corporation may be held criminally liable
even for offenses where a specific criminal intent is an essential element.
14
CHAPTER 10
DIRECTORS, OFFICERS, AND AGENTS
Directors Defined
A corporation’s directors are the general managers of the corporation’s ordinary and usual busi-
ness. They’re selected by the stockholders, but they’re more than the mere agents of the stockhold-
ers; they have the power to adopt a course of action that may not be in accord with the wishes of the
stockholders, provided they act in good faith. Therefore, it’s incorrect to say that directors are merely
the agents of the corporation and its stockholders. They’re also a good deal more.
Directors are sometimes also regarded as trustees. This isn’t entirely correct either. In many
respects, a corporate director’s duties are similar to those of a trustee. For example, the director owes
to the corporation and its stockholders the duty of the utmost good faith. However, there’s no sepa-
ration of the property into legal and equitable estates. The legal title to the corporate property isn’t
vested in the directors. Therefore, it’s incorrect to talk of the directors as trustees and of the stock-
holders as cestuis que trust (beneficiaries). If a true trust existed, the equitable estate would be in
the stockholders and the legal estate in the directors. This, however, isn’t the case. The stockholders’
interest is decidedly more than a mere equitable interest. And the trustees don’t have the legal title to
the corporate property. The legal title is in the corporate entity, the artificial personality.
Sometimes corporate directors have been regarded as bailees or mandataries. This is also an un-
satisfactory classification. In a bailment (persons holding a formal order), the legal possession of the
property is vested in the bailee or mandatory. He has a special property interest. On the other hand,
the director isn’t vested with any special property in the corporate possessions. While the director re-
sembles the agent, trustee, and bailee or mandatory, he or she isn’t exactly analogous to any of these.
The position of corporate director is really sui generis (unique and characteristic).
Relation Between Corporation and Its Directors

The directors of a private corporation aren’t only the corporation’s quasi‑agents; when convened
as a board, they’re the primary possessors of all powers the charter confers on the directors. They’re
entrusted with the guidance of the company’s business, and the stockholders can’t interfere with
them as long as the directors are acting within the scope of their authority.
15
The peculiar relationship that the directors have with a corporation and its stockholders stems
from the corporation’s need to act through managing officers and agents. The corporation is the
owner of the corporate property, but the directors possess this property and may act in every way as
if they owned it. The stockholders can’t act in relation to the corporation’s ordinary business, nor can
they properly control the directors by exercising their own judgment. The courts, however, are by
no means unanimous. There are many decisions to the effect that the stockholders’ will must prevail
because they’re the real parties in interest. But the business community would be somewhat startled
if it were true that a corporation’s directors were mere employees and that, as a result, the stockhold-
ers could control or remove them at any time.
Powers
The directors control all of the corporation’s ordinary and usual business affairs. It’s often ques-
tioned what falls within the scope of a corporation’s ordinary business transaction. Suppose the
corporation wishes to increase the amount of its capital stock. May the directors do this? The U.S.
Supreme Court answered this question negatively. It said:
“The general power to perform all corporate acts does not extend to a reconstruction of the body
itself, or to an enlargement of its capital stock. Changes in the purpose and object of an associa-
tion or in the extent of its constituency or membership, involving the amount of its capital stock,
are necessarily fundamental in their character, and cannot, on general principles, be made with-
out the express or implied consent of the members.”
The test is always whether or not the act sought to be performed is within the scope of ordinary
corporate business. Questions of vital importance, such as the restoration of lost capital, are matters
for the stockholders to pass on. It would be going far beyond the usual powers conferred on directors
to permit them to perform extraordinary and fundamental acts.
It has been held that the directors possess authority to execute a lease of corporate property. They
may make an assignment for the general benefit of creditors. They may enter into contracts, select
inferior officers, fix their salary, control the performance of their duties, execute mortgages, and
even compromise doubtful claims. However, directors have no authority to increase or decrease the
amount of capital stock, release a stock subscription, accept a vital amendment to the corporation’s
charter, or change the nature or scope of the corporate enterprise. These are all regarded as extraor-
dinary acts. Even in jurisdictions where directors are held to have the power to perform them, a wise
board of directors won’t do so without first consulting the shareholders and, if possible, calling a
stockholders’ meeting.
Meetings
Except where statute has given some leeway to “close corporations” or one‑person corpora-
tions, the directors’ authority is vested in them only when duly convened as a board. Thus, where the
16
stockholders, including the directors, met and passed on a matter that was in the directors’ control,
it was held that the action was invalid. The directors must be duly assembled as a board of direc-
tors. Suppose the board of aldermen of a town was vested with the authority to perform a certain act.
Would an ordinance passed by the citizens of the town, assembled in public meeting, and including
the aldermen, be valid? The question answers itself. That isn’t the mode in which the corporation,
whether private or municipal, is authorized by the law of its creation to manifest its will and exercise
its corporate powers. In an early New York case, a lease of the iron works of a corporation was made
in pursuance of a resolution adopted at a stockholders’ meeting, at which the directors were present.
It was held that the resolution imparted no authority to make the lease. The court said:
“The stockholders in this case had no power to make a lease or do any other administrative act
in the management of the affairs of the corporation. If a lease could be made at all, it could be
executed only in pursuance of the act of the directors, who are the body appointed by the charter
for the management of its affairs. It is no answer that the individual stockholders, who were pres-
ent at the meeting when the lease was ordered, were also directors. They did not meet as direc-
tors, but as stockholders. The mayor and common council of a municipal corporation can only
act in the manner prescribed by law. When not acting in their official character and in the mode
prescribed by law, their acts are no more binding than those of other private citizens.”
The board of directors must, moreover, be legally assembled. Where the statute requires that
their meetings be held within the state, this must be done or their acts will be invalid. The directors
must, if possible, attend the meetings. They can’t delegate their right to attend to anyone else. Some
modern statutes now allow directors of certain corporations to transact business in lieu of a physical
meeting as long as the directors agree to the action that is taken.
Delegation of Authority
As a general rule, a board of directors has no right to delegate its authority to others. The stock-
holders elected them individually as directors, and presumably relied on their individual efficiency,
integrity, and capacity. For example, a corporation’s directors are vested with the power to declare
dividends. This manifestly involves the exercise of a great amount of judgment and discretion.
Should a surplus be distributed in the form of dividends to the stockholders, or should it be accu-
mulated against a rainy day? This, and similar questions, involve the exercise of personal judgment.
The directors can’t delegate the disposition of such matters to other persons. On the other hand, the
directors may delegate their purely ministerial duties. For example, the directors aren’t personally re-
quired to draw up a corporate conveyance. They may authorize an agent or attorney to do it. Suppose
a board of directors wishes to delegate its powers to an executive committee consisting of three to
five of the directors. Can it do so? The courts usually hold that this may lawfully be done. The New
York Court of Appeals has held that in the absence of statute, the directors may invest an executive
17
committee with power to transact the company’s business during the intervals between meetings of
the board of trustees. Sometimes the board of trustees or board of directors practically abrogates its
powers by committing all corporate powers to a superintendent or general manager. Where this is
done, and the board abdicates its authority, the corporation will be bound by the officer’s act, al-
though the act performed is one vested in the board of directors. Usually, where an officer or agent
is entrusted with performing the entire functions of the corporation, on a regular basis the act of the
officer will be held binding.
The above result is substantiated by the following remarks of a judge in a pertinent case:
“The proof was ample to show that the corporation practically devolved the powers of the board
of directors upon its executive officers, and that this method of doing business was not casual
and temporary merely, but continuous from the date of its commencing to do business to the end.
The board of directors was dormant. The rule is that where, by the direction or acquiescence of
the stockholders, the executive officers of a corporation assume and exercise the functions of
the board of directors, the corporation and those deriving rights from it while it is so managing
its affairs are bound by the acts of its officers to the same extent as if they had been directed by
the board. In so far as the duties of the directors are not expressly prescribed by the charter, they
derive their powers from the stockholders, who may, if they see fit, select other agencies for the
transaction of the corporate business.”
Removal
A corporation’s directors may be removed by a court for misconduct. But the shareholders have
no authority to remove them during their term of office simply because a difference of opinion ex-
ists between the stockholders and directors. The stockholders may, of course, amend the bylaws to
increase the number of directors.
In many jurisdictions, it’s provided by statute that an action may be maintained against a director
to procure a judgment suspending him from the exercise of his office, if it appears that he has abused
his trust; or to remove him from office on proof of positive misconduct. It may also be provided that
a director can’t be suspended or removed from office other than by the final judgment of a competent
court. Without some statute or provision of the corporate charter authorizing a director’s removal or
suspension, a director can’t be removed or suspended from office until the end of his term, at least
without cause.
Compensation
A corporation’s directors are supposed to act without compensation, even though it isn’t uncom-
mon for stipulated fees to be paid to directors for attending board meetings. The law’s theory is that
18
the position’s honor and distinction is a sufficient reward. No one is under the slightest compulsion
to accept the position. And if she’s unwilling to do so without compensation, public policy requires
that her compensation be fixed and certain before she enters on the discharge of the duties of her
office. This rule applies only to services rendered by persons holding of the office of directors, who
have the control of the funds of the body. A person who isn’t a director and has no control over the
corporation’s funds and property but renders services doesn’t occupy the relation of trustee to the
company. Therefore, this person doesn’t fall within the rule, and may recover a reasonable compen-
sation for services rendered. But the law has never given trustees the authority to profit by exercising
the powers and duties of their position.
The law, in other words, regards the director as a trustee, at least in this respect. It was a well-
settled rule of common law that a trustee wasn’t entitled to compensation and couldn’t recover even
the reasonable value of his services. The law doesn’t require a company to pay directly or indirectly
for the services of directors, since they’re regarded as standing in a fiduciary relation to the corpora-
tion. In an early Connecticut case, the court said: “It would be a sad spectacle to see the managers of
any corporation assembling together and parceling out among themselves the obligations and other
property of the corporation in payment for past services.”
Directors may, however, recover for the performance of duties if they performed them outside
of those placed on them as directors. For example, suppose that a director who’s also a noted archi-
tect draws up a set of plans for the corporation. It’s reasonable and just that he should be allowed to
recover a fair compensation for such services, even in the absence of an express agreement. Such
services are extraordinary and not included in the ordinary functions of the office of director, so an
implied promise to pay for them arises. The same result follows where a director of a corporation is
employed as the corporation’s attorney. The question is also whether the duties are performed by the
director in his capacity and as part of his duty as a director, or if he’s performing them as the com-
pany’s special agent and is acting outside of his duties as a corporate director.
The general rule is, then, that a director isn’t ordinarily entitled to compensation, but that when
he performs duties outside of those imposed on him as a director, he’s entitled to recover, just as
though he was a director. It should also be noted that directors are entitled to indemnity from their
corporation against all losses and expenses properly incurred by them in the performance of their du-
ties. In a sense, the corporation is their cestui que trust (beneficiary of a trust) and is therefore bound
to indemnify the directors, just as a trust estate’s beneficiary is equitably bound to indemnify its
trustee. It’s not uncommon today for directors to be paid although the law doesn’t require it.
Liability for Unauthorized or Illegal Acts

The directors of a corporation owe it certain well‑defined duties. These duties are chiefly obedi-
ence, diligence, and loyalty. First and foremost is the duty of obedience. This means that the direc-
tors must keep within the scope of their chartered powers. They’re liable to the corporation for all
ultra vires acts that they perform. The shareholders may resort to injunction proceedings to enjoin
19
the performance of such acts where they haven’t yet been performed. Where they have already been
carried out, the stockholders’ remedy is to hold the directors liable in equity and compel them to ac-
count, or seek a recision. Just as an agent must keep within the scope of the authority vested in him
by his principal, so the corporation’s directors must keep within the scope of the authority vested in
them. Thus, dividends can’t be paid out of capital, and directors are personally liable if they’re dis-
obedient or negligent and pay dividends out of the capital stock.
Effect of Good Faith

Suppose that the directors have acted in good faith and with as much care and discretion as an
ordinary person would use in his or her own affairs. However, despite this they have fallen into a
mistake in regard to their powers. Are they liable for such an innocent mistake or error? In a leading
case, it was held that the law requires only a reasonable degree of care and discretion of directors,
and that if the directors practiced this, they aren’t answerable for a mere honest mistake. You’ve
already seen the difficulty of determining whether a certain act is within the corporate powers. It
would be unfair in many cases to hold directors liable where, though acting in good faith, they’ve
exceeded the extent of the corporate authority.
On the other hand, the English cases adopt a stricter rule. They hold that if directors exceed the
limits of their authority, they should be held liable for their improper and unauthorized conduct. For
instance, in a well‑known English case the directors, acting in good faith, divided part of the corpo-
rate capital among the shareholders. This, of course, was ultra vires. The question arose whether or
not the directors were liable to account. Said the presiding judge:
“Ought I to make them account? I think I ought. As to saying they did it bona fide. I think it
is impossible to come to that conclusion; a man may not intend to commit a fraud, or may not
intend to do anything which casuists might call immoral, and he may be told that to misapply
money is the right thing to do; but when he has the facts before him—when the plain and pat-
ent facts are brought to his knowledge—as I have often said, and I say now again, I will not dive
into the recesses of his mind to say whether he believed, when he was doing a dishonest act, that
he was doing an honest one. I cannot allow that man to come forward and say, ‘I did not know
I was doing wrong when I put my hand into my neighbor’s pocket and took so much money out
and put it into my own.’ It is impossible in a court of justice to call a particular act a bona fide act
simply because a man says that he did not intend to commit a fraud.”
A good illustration of this question is found in the case of a vice president and director of an in-
surance company, who contributed fifty thousand dollars out of the corporation’s funds to the presi-
dential campaign fund of the Republican National Committee. This act was obviously ultra vires. By
a vote of four to three, the court decided that the director wasn’t guilty of grand larceny—that is, he
wasn’t guilty of criminal liability. But the judges intimated, in strong language, that he was civilly
20
liable in spite of the fact that he had acted in the honest belief that he had benefited the company,
although he had derived no personal advantage. Even the majority judges said that a mistake had
been made which wouldn’t relieve him from liability in a civil suit.
Duty of Diligence
The second great duty owed by the directors to the corporation is the duty of diligence. They owe
the duty to exercise ordinary care and diligence and to use a reasonable degree of business judgment
and prudence in managing the corporation’s affairs. If they fail to do this, the corporation may hold
them personally liable in a suit for damages. There is, of course, some conflict in the authorities as to
the extent of diligence owed by corporate directors. Some cases insist that the director is only liable
if he’s guilty of fraud or willful misconduct. The cases claim a director isn’t liable for mistakes of
judgment, even though these mistakes may be so gross as to appear absurd. At the other extreme, the
cases hold that a director must exercise the same degree of care and diligence that he would use in
his own affairs or in the conduct of his own private business.
In general, a director owes a corporation the degree of reasonable business knowledge and skill,
care, and diligence that a corporation’s director would be expected to give under the same circum-
stances. The idea is that directors shouldn’t serve merely as the corporation’s gilded ornaments.
They shouldn’t lend their names simply for advertising purposes. They must actually participate in
managing the company, and if they’re guilty of negligence, they should be held liable even though
they haven’t profited personally or acted fraudulently. Too often, prominent individuals simply lend
their names to corporations and fail to perform any of the functions or duties of a director. The courts
are discouraging this kind of conduct by holding directors to a strict degree of personal responsibility
for lack of prudence, caution, and careful diligence.
It’s impossible to lay down any arbitrary rule as to what constitutes the amount and measure
of diligence. The degree of care required depends largely on the subjects that it’s applied to. What
would be slight neglect in the care of a quantity of iron might be gross neglect in the care of a jewel.
What would be slight neglect in the care exercised in a manufacturing corporation’s affairs might be
gross neglect in the care exercised in the management of a savings bank entrusted with the savings
of a multitude of people, depending for its life on credit and liable to be wrecked by the breath of
suspicion. The only general rule that can be formulated is that directors must exercise that amount
of ordinary care and prudence that a reasonable individual would use under the circumstances in the
director of the corporation’s office.
In a few cases it has been insisted that a corporation’s directors are only responsible for gross in-
attention and negligence. The theory of these decisions is that ordinary directors act without compen-
sation, and that therefore they shouldn’t be held to too strict a degree of diligence. This rule amounts
to saying that the directors only owe a slight degree of care in the performance of their duties. This
proposition is, of course, untrue. To hold that directors—entrusted with the management of the prop-
21
erty, interests, and business of the shareholders—owe only slight care to the duties of their trust, is a
proposition that refutes itself. As said by a judge in one leading case on the subject:
“It is true that authorities are found which hold that trustees are liable only for crassa negligen-
tia, which, literally, means gross negligence; but that phrase has been defined to mean absence of
ordinary care and intelligence applicable to the particular case.”
Perhaps the basis of this argument is that people won’t act as directors if the rule applied is too
strict. However, it really isn’t unreasonable to require directors to use ordinary care in attending to
their duties.
A director isn’t required to personally supervise each act of the inferior officers of her corpora-
tion. This would be an impossibility. But she is required to exercise an ordinary and reasonable
degree of supervision. The business of life couldn’t go on if people couldn’t trust those put into a
position of trust to attend to the details of management. On the other hand, too much trust shouldn’t
be confided, and a periodic review of the corporate business’ conditions is requisite. A degree of care
commensurate with the evils sought to be avoided is necessary. As said by a judge in another leading
case:
“As to the degree of diligence and the extent of supervision to be exercised by directors, there
can be no room for doubt under the authorities. It is such diligence and supervision as the situ-
ation and the nature of the business requires. Their duty is to watch over and guard the interests
committed to them. In fidelity to their oaths, and to the obligations they assume, they must do all
that reasonably prudent and careful men ought to do for the protection of the interests of others
intrusted to their charge.”
To illustrate this point, suppose that a savings bank’s directors embark on an elaborate advertis-
ing campaign, construct a new and magnificent building, and purchase expensive ornamental fur-
nishings and fixtures, believing that this will bring them more deposits. Assume that they’re acting
honestly and doing what they believe is best for the institution. Assume further that at the time of
these operations, the bank was already weak and these purchases would surely weaken it further.
After the purchases, insolvency ensued. The receiver of the bank sued the directors personally to re-
cover the losses by their alleged misconduct. A New York court held the directors liable, saying that
their duty was to safeguard the accounts of the old depositors before seeking to obtain new accounts.
The court declared that the directors had acted as no ordinary business person of reasonable intel-
ligence and prudence would have acted under the same circumstances. Notice that the directors acted
honestly. Notice further that they made no personal profit out of the transaction. Nerverthelesss, the
directors were held responsible because their stupidity and unsoundness were inexcusable. They
failed to exhibit a degree of ordinary human intelligence that one has a reasonable right to expect in
corporate directors.
22
Similarly, suppose that for several years the bank’s directors have failed to exercise any supervi-
sion over its officers and agents. As a result, blatant frauds are committed. Under these circumstanc-
es, the case would be one of supine, continuous negligence, and the directors would be liable in the
event of a loss. The question is one of compound fact and law under the circumstances of each in-
dividual case. No comprehensive rule to govern all cases can be lain down. It must be remembered,
however, that directors owe more than a mere duty of good faith. They also owe the absolute duty of
using that amount of intelligence and diligence that an ordinary human being would be expected to
exhibit under the same circumstances.
Dealings of Directors With Their Corporations

A corporation’s directors stand in a fiduciary relation to the corporation and its stockholders.
They aren’t trustees in the technical sense of the term, and yet they stand in a position very similar to
that of trustees. A director of a corporation, like a trustee, is bound to act in the utmost good faith and
is forbidden to take part in any transaction in which he has an interest adverse to that of the corpora-
tion. As you’ll see, the director isn’t absolutely prohibited from dealing directly with the corporation
of which he’s a director; but if he does engage in such dealings, he must act in the utmost good faith
and refrain from doing anything unfair or treacherous. In fact, it might be said that the third great
duty that the directors owe to the corporation is loyalty. The director should always remember that he
owes a duty of the utmost good faith toward the corporation and the shareholders who elected him.
In many cases, the director’s personal interest may conflict with his duty to the corporation. Where
this is the case, the director must always submerge his personal interest, and should keep in mind this
rule from Biblical times: a man can’t serve two masters.
In the early days of common law, directors were incapacitated from dealing with their corpora-
tion. In a leading decision of the House of Lords, the director of a railway corporation brought suit
against the company to recover the agreed purchase price of certain iron chairs, which he had sold
to the company. The principal defense was that the plaintiff was the railroad company’s director and
chairman at the time of the contract. He was incapacitated from dealing with his own corporation.
The court decided that the contract was void, without regard to the fairness or unfairness. The Lord
Chancellor said:
“The directors are a body to whom is delegated the duty of managing the general affairs of the
company. A corporate body can only act by its agents, and it is of course the duty of those agents
so to act as best to promote the interests of the corporation whose affairs they are conducting.
Such agents have duties to discharge of a fiduciary nature toward their principal. And it is a rule
of universal application that no one, having such duties to discharge, shall be allowed to enter
into engagements in which he has, or can have, a personal interest conflicting, or which possibly
may conflict, with the interests of those whom he is bound to protect. So strictly is this principle
adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so
entered into.”
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Few American cases go to this extreme, and the general American rule regards such contracts as
only voidable. If the director has acted in good faith, if the contract is fair and reasonable, and if no
advantage was taken of the corporation, such contracts are generally upheld.
The ultimate test of a contract’s validity between a corporation and its directors is whether or
not the director has acted in good faith, and whether or not the contract itself is fair and just. If these
two questions are answered in the affirmative, the contract should hold. Under these circumstances,
it would be unfair to declare that the directors can’t recover the amount of their loan from the corpo-
ration. This would penalize the director, who’s usually the only person likely to be willing to make
such a loan.
The director, however, shouldn’t take part in the votes in the board of directors’ meeting where
his contract is negotiated. For instance, in a Massachusetts case, a director entered into a contract
with his corporation, where he was to be allowed a certain percentage on all corporate claims that
he could collect. The contract was held valid, and the court laid special stress upon the circumstance
that the director took no part in the vote. Said the chief justice in the case:
“In this country it very generally has been deemed impracticable to adopt a rule which absolutely
prohibits such contracts. Whatever small conflict of interest between himself and the company
there may have been was no greater or other than that between a broker paid by a percentage and
his principal.”
In fact, a few jurisdictions are even more liberal, holding that the contract isn’t vitiated simply
because the interested director was present at the meeting and voted, provided that without his vote
there was a disinterested majority. However, a director’s contract in these states is voidable without
regard to good faith or fairness if there’s no disinterested majority. Where a salary or compensation
is paid to the officer or director, the law is that it’s illegal if it’s carried by his vote or produced by his
influence.
On the other hand, some jurisdictions may regard it as the director’s duty to vote on contracts in
which he has an interest. To support this belief, one judge said:
“Nor is it proper for one of a board of directors to support his contract with his company upon
the ground that he abstained from participating as director in the negotiations for and final adop-
tion of the bargains by his co‑directors; the very words in which he asserts his right declare his
wrong; he ought to have participated, and in the interest of the stockholders, and if he did not,
and they have thereby suffered loss, of which they shall be the judges, he must restore the rights
he has obtained—he must hold against them no advantage that he has got through neglect of his
duty.”
Many authorities on corporation law feel that it would have been wiser for the common law to
adhere to the early doctrine that a director deal with his corporation. This, however, seems extreme
24
and unreasonable. Such a doctrine would offer the corporation little protection against actual fraud
or oppression and it would also deprive it of the aid the directors in aiding the corporation and most
qualified to do so. In a U.S. Supreme Court decision, it was held that a director could lend money to
his corporation when it became embarrassed, taking in return a promissory note secured by a deed
of trust of the corporate property. It was also held that on default, he could foreclose and buy in the
security in order to prevent loss to himself. It appeared that this particular director had loaned the
money in good faith to assist the corporation in its difficulties. When his money was due, the trustee
sold the property, and the director bought fairly, and at a reasonable price. There was no actual fraud
or oppression, and the director didn’t take advantage of his official position. It was contended that
the purchase was absolutely void, but the Supreme Court, rejecting this proposition, said:
“While it is true that the defendant, as the director of the corporation, was bound by all those
rules of conscientious fairness which courts of equity have imposed as the guides for dealing in
such cases, it cannot be maintained that any rule forbids one director among several from lending
money to the corporation when money is needed and the transaction is open, and otherwise free
from blame.”
If a director may loan money to his corporation in good faith and take its bond secured by mort-
gage, it follows that he may protect himself even to the extent of becoming a purchaser at a foreclo-
sure sale, just like any other mortgage. This rule, however, isn’t universal, and some decisions deny
this right.
Secret Profits
A corporation’s director is forbidden to enter into an agreement where he may make a secret or
unfair profit at his corporation’s expense. In an early Massachusetts case, the directors of a corpora-
tion purchased a steamboat. The purchase was made while they were acting on behalf of the corpora-
tion in their official capacities as corporate directors. They purchased this vessel for themselves, as
individuals, at a very considerable advance in price. It was held that the transaction was invalid and
that the directors were bound to account for all the profits made from the purchase.
In a more recent case decided by the Appellate Division of the Supreme Court of New York, P,
a director of a corporation, was promised $500 by D, if P would procure a contract for D for certain
building work from his corporation. D obtained the contract and received the stipulated payment
for his work. P demanded the $500 promised to him and was met with a refusal. The court held
unanimously that P couldn’t recover, that the contract was illegal and void as against public policy.
It was held immaterial that P had told the majority of his co‑directors about his arrangement with
D. This decision is sound. P occupied a fiduciary relation to the corporation as director, and was a
quasi‑trustee for it and its stockholders. As a trustee, it was his duty to obtain as low a price as he
was able from D for the work. If D could afford to pay to P $500 from the amount which D was to
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receive from the corporation for the work, it stands to reason that D could have afforded to make a
contract to do it for $500 less than the stipulated price. And it was P’s plain duty as a director to ob-
tain the contract for his corporation at such reduced amount. Such arrangements are invalid and void
because they tend to induce a director to violate his duty towards his corporation and to betray the
confidence and trust placed in. Such contracts aren’t valid because the unfaithful director’s actions
resulted in benefiting his corporation. Nor are they validated by the fact that the unfaithful director
may have informed his fellow directors of the corrupt bargain. It might be noted that this general
proposition applies not only to directors, but also to the corporate officers.
Contracts Between Corporations With Interlocking Directors

In an early New York case, a contract was entered into between two corporations, some of whose
directors held office in each corporation. It was held that the contract was invalid and void because
the divided allegiance could lead to temptations for a breach of trust. Few modern cases go to this
extreme, however. The same rule is generally applied to contracts between corporations with inter-
locking directors as is applied to contracts between a director and his corporation. The test is one of
fairness and good faith. As said in a leading California decision:
“Where two corporations, through their boards of directors, make a contract with each other, the
directors who are common to both are not within the rigid rule of the cases which hold that one
who acts in a fiduciary capacity cannot deal with himself in his individual capacity, and that any
contract thus made will be declared void without any examination into its fairness, or the benefits
derived from it to the cestui que trust. Two corporations have the right, within the scope of their
chartered powers, to deal with each other; and this right is certainly not destroyed or paralyzed
by the fact that some, or a majority, of the directors are common to both. Of course, if such direc-
tors should wrongfully and wilfully use their powers to the prejudice of one of the corporations,
their action, if not acquiesced in, and if contested at the proper time, could be avoided, as in any
other case of actual fraud. But such common directors owe the same fidelity to both corporations,
and there is no presumption that they will deal unfairly with either; therefore, their acts as such
common directors are not void.”
Corporations are certainly competent to contract with each other. Their mutual directors are
presumably interested in both companies, owe duties to each, and are bound to be faithful to both.
Therefore, while acting within the scope of their powers in each corporation, no presumption of ille-
gality or unfairness exists in contracts between the two companies. They’re the chosen agents of both
corporations. Distinct charges of misconduct supported by adequate proof are needed to prove their
acts are invalid and make them personally responsible. Some jurisdictions may have an inclination
to regard transactions made by interlocking directors as invalid and void, or as voidable although
fair. However, this seems unsound on principle. The case isn’t the same as a trustee, agent, or direc-
26
tor, bargaining individually with the party reposing trust and confidence in him. Courts shouldn’t be
influenced by public clamor to place serious and unreasonable obstacles in the corporate pathway.
Duty Toward the Individual Stockholder

It’s a well-settled law that a corporation’s director stands in a fiduciary relation to the corpora-
tion; that is, to the entire body of stockholders considered as a collective unit. The law isn’t as well
settled, however, as to whether or not a corporation’s director stands in a fiduciary relation to the in-
dividual stockholder. In an early case, a director of a corporation, who was also its president, bought
the shares of stock of an individual stockholder. He paid the market value of the stock, but he knew
he was paying a lot less than its real value. He was well acquainted with the condition of the cor-
porate affairs and knew that the stock was a very good purchase. Actual fraud was established. The
court held that the director wasn’t the individual stockholder’s trustee and didn’t stand in a relation
of trust and confidence to him. The reasoning was that a stockholder’s stock is his or her own private
property, free from the dominion and the control of the directors. Accordingly, in a director’s pur-
chase of stock from a stockholder, the court said, “The relation of trustee and cestui que trust does
not exist between them.”
This kind of decision rests on the proposition that there’s no legal privity between the stockhold-
ers in their individual capacity and the corporation’s directors. The cases in which the corporation’s
directors are regarded as trustees for the stockholders are distinguished on the ground that they refer
to the directors’ management of the property or the business of the corporation itself. In fact, it has
been held the “officers of a corporation may purchase the stock of stockholders on the same terms
and as freely as they might purchase of a stranger.” Even if the director has certain inside informa-
tion affecting the value of the stock, it has been held that in the absence of actual fraud, a purchase
from a shareholder under these circumstances won’t be set aside for the mere failure to disclose the
information.
On the other hand, many courts are inclined to establish a more stringent rule, insisting that “no
process of reasoning and no amount of argument can destroy the fact that the director is, in a most
important and legitimate sense, trustee for the stockholder.” Of course, the director isn’t a strict trust-
ee, since he doesn’t hold the share titles and isn’t under an absolute prohibition from dealing with the
stockholders. But it’s insisted that he’s at least a quasi‑trustee. Suppose that the director possesses
certain information that his duty to the corporation compels him to keep secret. Can he purchase the
stock of a shareholder whom he knows doesn’t possess this information? The answer is usually no.
The court will say: “The very fact that he cannot disclose prevents him from dealing with one who
does not know, and to whom material information cannot be made known.” Suppose the director
doesn’t have a duty to keep the information secret. Under these circumstances, the same courts hold
that if the director doesn’t disclose the information, which in a certain sense is a quasi‑asset of the
company, the sale will be set aside. It’s insisted that any other position would leave the stockholders
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at the directors’ mercy. The courts’ tendency to adopt a more stringent rule in this respect follows
current state and federal statutes as well as the regulations of stock exchanges.
Functions of Corporate Officers

The chief officers of every corporation are the president, vice president, secretary, and treasurer,
although variations of these offices may exist, especially in larger corporations. These officers are
ordinarily elected by the directors and sometimes by the shareholders. They’re the corporation’s
agents. By virtue of its very nature, a corporation can only act through such officers or agents. It’s
bound by all acts of such officers within the actual or apparent scope of their authority. The man-
ner in which the corporate business is carried on, as well as the corporation’s objects and purposes,
usually indicates the extent of the power of each officer. For example, a banking corporation’s
cashier ordinarily doesn’t have the power to make representations on the general financial stand-
ing or responsibility of a bank customer. However, the bank’s business may have been carried on in
such a manner as to invest him with authority to do this. The ordinary rules governing the scope of
an agent’s authority apply to the agents and officers of a corporation just as they do to the agents of a
private principal.
Under the more common corporate hierarchy, the president presides over corporate meetings as
president. Under the corporate charter or bylaws, the president is generally given the power to bind
the corporation in all ordinary business transactions. For example, he or she generally signs con-
tracts and stock certificates, and executes the corporate conveyances. The vice president performs
the president’s duties when he or she is absent or incapacitated. When the president makes a contract
in the corporation’s name in the usual course of business, it’s presumed that the contract is binding
on the corporation. However, the directors have the power to authorize or ratify a contract after it’s
made.
As a general rule, a corporation’s secretary keeps the corporate minutes, the records of the cor-
porate meetings and is the custodian of the corporation’s seal. He or she affixes the seal to all formal
corporate documents. The secretary is frequently allowed to issue shares of stock and to act as agent
for the registration and transfer of shares. The treasurer keeps the corporate funds and is authorized
to endorse checks for the corporation. He or she may also have the power to make promissory notes
and draw bills of exchange for the corporation.
Keep in mind that the president’s duties in a corporation organized to sell retail goods may be
very different from those of the president of a banking and trust company. The nature of the business
usually determines the scope of the powers of the different officers.
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CHAPTER 11
CORPORATE MEMBERSHIP, CAPITAL STOCK, AND

SHARES OF STOCK
Necessity of Members
Every corporation must possess members. In a stock corporation, membership is acquired by
purchasing one or more shares of stock, into which the total capital stock of the company is divided.
In a non‑stock corporation, membership is acquired by complying with the conditions set forth in the
corporate charter and the bylaws.
Acquisition of Membership
To become a member of a non‑stock corporation, it’s necessary to obtain the approval of the cor-
poration’s members. An application for membership is usually required, and then a vote is taken on
the subject. Non‑stock corporations are generally organized for purposes other than pecuniary profit.
In such organizations, the dilectus personarum (personal element) plays an important factor.
Suppose, for example, A, B, C, and D incorporate for the purpose of a club. They reserve the
right, in the non‑stock corporation that they’ve formed, to reject a person’s application for club mem-
bership. On the other hand, in the ordinary stock corporation, there’s a rule that the shareholder’s
personality is immaterial. However, even in stock corporations, attempts have been made to prevent
the acquisition of membership by a purchaser of shares until he has been elected and approved, but
this has generally been considered invalid.
The One‑Person Company

Suppose that all of a corporation’s shares of stock come into the possession of one person. Does
the corporation continue to exist? The courts answer this question affirmatively, holding that this has
no effect on the continuance of the corporate life. For example, the owner of all of the corporation’s
shares of stock can’t maintain an action of conversion to recover the value of property unlawfully
taken from the corporate entity. What’s usually meant by the one‑person company, however, is the
corporation that intended to have only one bona fide stockholder from the outset. In England, such
one‑person companies have long been regarded as valid corporations. The theory is, that since the
form of the incorporation act was complied with, the court won’t inquire into the genuineness of the
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corporate organization. Suppose that X wishes to incorporate, and uses M, N, O, and P as dummies
in order to comply with the form of the statutes. He gives each of them enough stock to qualify, but
with a definite understanding that he (X) is to be the beneficial owner of such shares. Very few courts
have gone to the extent of holding that such a corporation isn’t valid. On principle, a one‑person
company of this sort seems illegal, but it isn’t uncommon to see such corporations in existence. In
fact, many state statutes recognize them and provide for their formation and operation.
Stockholders’ Meetings
Since shareholders have a right to control the corporation’s actions, they must act at a stockhold-
ers’ meeting. This meeting must be called by the proper corporate officer. The president or secretary
is generally vested with the authority to do this. In the absence of a provision to this effect in the
corporate articles or bylaws, the corporation’s directors hold the power to do this.
As a general rule, a corporation’s bylaws provide for regular stockholder meetings. The time and
place are usually fixed. These meetings usually take place in the state where the company was orga-
nized. At common law, personal notice of corporate meetings, definite as to place and time, had to
be communicated to each individual stockholder. If this wasn’t done, the proceedings of the meeting
were invalid. In the absence of statutory or charter provision or some rule in the corporate bylaws,
this common law doctrine still prevails. Today the matter is ordinarily regulated in such manner that
notice can be given by publication. Sometimes, notice is also given through the mail. If a special
meeting is called, notice must be published in the newspaper and sent through the mail to the differ-
ent stockholders. This notice should set forth what the nature of the business to be transacted will be.
At common law, a majority of the members present at a corporate meeting were regarded as a
quorum. A quorum is the number of shares of stock that must be present in order to transact valid
business. It’s now ordinarily required that a majority of the outstanding shares of capital stock be
represented at the stockholders’ meeting in order to constitute a quorum. Stockholders aren’t re-
quired to attend meetings in person, but may, if they choose, be represented by proxy. Under this
system, a single stockholder with a sufficient number of proxies to make a majority of the shares of
capital stock might hold a corporate meeting all by him- or herself, transact business, and elect cor-
porate officers for the next year, provided only that the meeting has been properly called.
Capital Stock and Capital

A corporation’s capital stock doesn’t mean its share stock. Capital stock is the total amount of
funds or property that the associates have dedicated to the purposes of the proposed corporate enter-
prise. The sum doesn’t vary. Creditors rely on this fund in dealing with loss, misfortune, or miscon-
duct. A corporation’s capital stock may be reduced below the amount limited by its charter; but what-
ever property it has up to that limit must be regarded as its capital stock. When its property exceeds
that limit, then the excess is surplus. Such surplus belongs to the corporation and is a portion of its
30
property. However, in a strictly legal sense it isn’t a portion of the corporate capital stock. Unlike the
capital stock, the surplus may be divided in the form of dividends among the stockholders. The sur-
plus might be defined as that amount of money over and beyond the capital stock earned through the
judicious business use of the capital stock by the directors and managing officers of the corporation.
A corporation’s capital is the amount of money and property it possesses. It may be the same as
the capital stock, but it’s generally either more or less. It consists of the fattened capital stock, in-
creased by profits and wise management, or capital stock that’s lessened and diminished by losses
and foolish management or unfortunate business reverses. Capital might be defined briefly as the
whole amount of corporate property, existing at any given time, of whatever kind or nature.
Capital Stock Distinguished From Shares of Stock

Suppose that a corporation’s entire capital stock is invested in real estate. Are the shares of stock
in the corporation real estate or personal property? The courts judge that the shares are personal
property because the individual shareholder has only a right of action for a sum of money, namely,
his or her part of the net profits or dividends. In early English cases, this distinction between a corpo-
ration’s property and the rights of its members doesn’t seem to have been made. It was assumed that
each shareholder had an estate in the corporate property and that consequently, his share was also
real estate if that property was real property. However, in this country and also in modern England,
the distinction between the corporation’s capital stock and the shareholders’ shares of stock is fully
recognized. A corporation’s property may be mainly or wholly realty, yet the shares of its members
are personalty.
You’ve already learned that both the corporation’s capital stock and the shareholders’ shares of
stock may be lawfully taxed. This emphasizes the distinction between the two. The shareholders’ le-
gal property is quite distinct from that of the corporation, although the shares of stock have no value
besides that which they derive from the corporate property, surplus, and franchise. The stockholders,
as you’ve learned, don’t own the corporation’s property. The corporation itself, the legal entity, owns
that property. The stockholder in a corporation only has a right to share in the corporation’s profits
and to a proportionate share of its property after dissolution and payment of its debts. He or she has
that interest in the proportion that the number of his shares of stock bears to the whole number of
shares of capital stock.
While the nominal, or so‑called par value, of the capital stock and of the shares of stock are the
same, the actual value is often very different. Suppose a corporation is formed with a capital stock of
one hundred dollars each. We’ll assume that both the shares of stock and the capital stock are worth
one hundred thousand dollars at the outset. If a fire destroys much of the corporate property, the capi-
tal stock may be lessened in amount. Yet the public’s faith in the corporate enterprise may be such
that a share of stock may be sold for two hundred dollars, making the total value of the corporation’s
shares of stock presumably two hundred thousand dollars. This is one reason why stock without par
31
value is favored. Remember that the capital stock belongs to the corporation, whereas the shares of
stock belong to the individual shareholders.
Nature of Shares of Corporate Stock

A share of stock in a corporation is personal property. The stock certificate is evidence of the
shareholder’s title to his or her shares of stock. The shareholder’s interest enables him to participate
in the corporation’s net profits in the employment of its capital during the existence of its charter in
proportion to the number of his shares; and on its dissolution or termination, to his proportion of the
corporate property that may remain after the corporation pays its corporate debts. It’s the right to
participate in a certain proportion in the corporation’s immunities and benefits.
Every corporation’s property may consist of three separate and distinct types: (1) capital stock,
(2) surplus, and (3) franchise. These three things, several in the ownership of the company, are united
in the ownership of the shareholders. Stock market speculation also enters into the value of shares of
stock. This often causes fluctuations in the quote price of a share of stock in a corporation unrelated
in any manner to the actual inherent worth of the stock and of the assets and corporate possibilities
which it represents.
Kinds of Stock
Shares of stock are of various kinds, such as common, preferred, guaranteed, interest‑bearing,
special, treasury, unissued, deferred, founder’s shares, watered, fictitious and surplus.
Common stock. Shares of common stock entitle their owners to an equal proportional participa-
tion in the management, profits, and surplus or assets in case of dissolution.
Preferred stock. Preferred shares entitle the owners to some preference in distributing profits or
assets. They hold this privilege over the owners of common stock. Such shares may be either cu-
mulative or non‑cumulative as to profits up to a certain fixed amount. If cumulative, a deficiency in
paying the profits for any one year must be made up out of the profits of succeeding years before the
common stock is entitled to receive profits. In the absence of preferred stock being expressly made
cumulative, it will still be held to be so. Preferred shareholders have a right to participate in the man-
agement and are subject to liabilities as other shareholders.
Preferred stock isn’t always of the same nature. Ordinarily, it’s understood that such stock is en-
titled to dividends from the income, or the corporation’s earnings, before any other dividend can be
paid. However, although this may be true, the special properties and qualities that it possesses must
be determined in each case, and the statute or contract under which it was issued must be resorted to.
Preferred stock takes a multiplicity of forms, according to the stockholders’ desires and the interests
of the corporation itself. The form can be determined by contract or statute.
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Preferred stock isn’t regarded as corporate indebtedness. With preferred stock, the stockholder’s
right isn’t against the company as a debt, but is a dividend. Very often, preferred stockholders are de-
prived of voting power in consideration of the preferences they receive over the hordes of common
stock. Where there’s provision made for a preferential dividend but not for division of capital on the
corporation’s dissolution, preferred and ordinary shareholders share equally, and the assets must be
distributed without regard to their rights in respect to dividend.
Guaranteed stock. Guaranteed shares in the United States now mean substantially the same as
cumulative preferred shares.
Interest‑bearing stock. Interest‑bearing shares are those that bear interest on all sums paid in un-
til the corporation is completed and profits earned to pay dividends. However, such payment is held
to be illegal as against creditors who might be injured by it.
Treasury stock. Treasury stock is stock that has once been issued but was surrendered or for-
feited to the corporation, and perhaps afterwards reissued by it. It can’t be voted, and it doesn’t draw
dividends while in the corporation’s possession.
Unissued stock. Unissued stock is the part of authorized capital left in the corporation’s posses-
sion to be issued by the corporation in the future or on further subscription.
Deferred stock. This stock doesn’t draw dividends until some other class of shares receive their
dividends.
Founder’s shares. These entitle the holder to all the profits after certain fixed maximum divi-
dends are paid to the other shareholders.
Watered or fictitious stock. Watered stock is stock that claims to have been paid for at its full
value, but which in fact has been issued without the corporation having anything for which to de-
mand its full face value. It has mere “water” instead of substance in back of it.
Spurious stock. When stock is issued in excess of the amount authorized, it’s spurious, or
void. The holder of such stock doesn’t become a member of the corporation. It’s sometimes called
“over‑issued” stock.
Transfer of Shares of Stock

Shares of stock are usually regarded as “goods, wares and merchandise” within the seventeenth
section of the Statute of Frauds. Therefore, the provisions of that statute must be complied with in
order to validly transfer them. In some jurisdictions, however, no written instrument is necessary,
as shares of stock are regarded without the statute’s operation. Since shares of stock are regarded as
33
personal property, they go to the personal representative of a deceased stockholder and are distrib-
uted like other personal property. At the early common law, shares of stock couldn’t be taken on at-
tachment or on execution because of their incorporeal nature. Today, by statute, they may ordinarily
be attached.
Shares of stock are generally evidenced by a stock certificate. Such a certificate is ordinarily
engraved on good-quality paper and generally reads:
“This is to certify that John Doe is the owner of one hundred shares (or any specified number) of
the capital stock of the ABC Corporation, of the par value of one hundred dollars each, fully paid
up, and transferable only upon the books of the company upon the surrender of this certificate
duly endorsed.”
This certificate is usually signed by the president and countersigned by the secretary under the
corporation’s seal. On the back is usually the form of an assignment, which may read:
“For value received, I hereby assign and transfer all my right, title and interest to the shares in
the ABC Corporation, evidenced by this certificate, to YZ, and I do hereby appoint YZ to be my
agent or attorney in fact, for me, and in my name to have the transfer of the same made upon the
books of the company.”
This assignment is signed by the owner and delivered to YZ. It isn’t necessary to fill in the names
of the purchaser or the attorney to make the transfer. These may be left blank, and after the certificate
is delivered to YZ, the purchaser may sell it to someone else by mere delivery of the certificate. This
person may sell it to another, and so on. The last purchaser may fill in his own name and the name of
some person to make the transfer on the corporation’s books. He may then surrender the certificate,
record the transfer in the books, and receive a new certificate in his own name.
The corporate records, such as the subscription or transfer book, are prima facie (presumptive)
evidence as to who are lawful members of the corporation. However, these books aren’t conclusive.
A person whose name happens to be registered on the company’s books may not, in fact, be a stock-
holder. For instance, she may have presented a forged transfer of the certificate of stock to herself,
and the corporation may have entered her name erroneously as a shareholder. In the same way, one
whose name doesn’t appear on the corporate books may, in fact, be a stockholder. For example,
A sells her stock to B, and gives B the duly endorsed certificate of stock. Until B has the transfer
registered in the corporation’s books, his name won’t appear as stockholder, although he’s in fact the
stockholder.
Eventually, a new type of certificate or indication of ownership of stock will be developed. The
present certificate has been susceptible to theft, and the paperwork involved in its transfer has been
too much for stock brokerage houses to handle without considerable delays. If a new form is de
34
vised, it will probably be something that a machine or computer can assimilate, accomplishing a
transfer in seconds rather than in days.
Restraints on Transfer
Unreasonable restraints can’t be imposed upon the transfer of shares of stock because they’re
personal property, and common law doesn’t sanction narrow restraints on alienation. On the other
hand, reasonable restraints have been held valid; for example, a restriction that a certain class of
stock be available only for employees of the corporation. Similarly, it has been held that provisions
in a private corporation’s articles that compel a stockholder who desires to sell his or her shares to
sell them to certain particular persons at a fixed price were valid. These provisions weren’t regarded
as repugnant to, or inconsistent with, absolute ownership. Likewise, options, making it necessary
for a shareholder to offer his stock first to the corporation itself before selling, have been held valid.
For example, an action was brought in tort for the conversion of twenty shares of stock in a brewery
because of a refusal to transfer the stock to the plaintiff on the company’s books. The certificate was
transferable only in accordance with the company’s bylaws, which were printed on the back of the
certificate itself. One of these bylaws forbade a transfer or disposition of the stock unless the stock-
holder made an offer in writing at least thirty days before to sell the stock to the board of directors
and the offer wasn’t accepted. There was no evidence in the records that any such offer had been
made. The court directed a verdict for the defendant. The court said that it saw no reason of public
policy that would dictate the invalidity of the bylaw. The court said:
“Stock in a corporation is not merely property. It also creates a personal relation analogous oth-
erwise than technically to a partnership. Notwithstanding decisions under statute, there seems to
be no more objection to retaining the right of choosing one’s associates in a corporation than in a
firm.”
This would be especially true of a corporation operating a cooperative apartment building, in

which the restriction against transfer would be analogous to any tenant’s right to sub‑lease his or her
apartment. The restriction is also common in the case of close corporations where the original make-
up of the corporation is desired to be retained.
However, the corporation ordinarily doesn’t have the power to prevent a transfer of shares of
stock to a purchaser, even though the corporation may think that the transfer is injurious to it. Sup-
pose that X, an enemy of a particular corporation, purchases one hundred shares of its stock, so that
he may attend the next stockholders’ meeting and protest against the company’s management. An
inquiry into the purchaser’s motive isn’t allowed. It has been decided, however, that registration may
be refused where the purchaser’s purpose was to wreck the corporation. In general, a corporation
isn’t at liberty to inquire into the motives of the vendor and the vendee of the stock, the purpose that
prompts the transfer, or the effect of the transfer.
35
The Uniform Commercial Code has a section relating to the transfer of securities. It provides that
no restriction on transfer imposed by the issuer of a security will be effective against any person un-
less the restriction is shown conspicuously on the security or the person had actual knowledge of it.
This provision applies to any restriction, regardless of whether or not it would otherwise be valid.
Effect of Executed Transfer

The general rule is that a person transferring shares is no longer a member and isn’t liable in any
way to the corporation or its creditors. This is true even though the shares aren’t fully paid. The pur-
chaser, on the other hand, assumes all the obligations and is entitled to all of the seller’s rights. If she
doesn’t know that the shares weren’t paid in full, in the absence of any statute to the contrary, she
isn’t liable to the corporation or its creditors. The assignee of stock takes the shares of stock with all
their rights and liabilities, so that if a liability to a loss has been incurred by the corporation before
she purchased the stock, she may be called on to contribute as soon as she has accepted a transfer
of the shares and has become a stockholder in the company. After the transfer, liability to pay the
call made on shares of stock is shifted from the outgoing to the incoming stockholder. The transfer
of stock works a complete substitution, or novation, of the membership contract. The transferee is
substituted in the place of the transferor, with all the rights and liabilities incident to the holding of
the shares of stock.
If the law implies the original stockholders’ promise to pay the full par value when it may be
called, it follows that an assignee of the stock is equally liable when she comes into privity with the
company by having stock transferred to her on the company’s books. She must fulfill the promises
made by her assignor.
The effect of an executed transfer may also result from a transfer of the corporation’s shares on
the company’s books by the transferor to the name of the transferee, without any delivery or assign-
ment of the certificate of stock. In one such case, an action was brought to recover damages for D’s
failure to deliver certain railroad stock that D had agreed to sell and deliver to P. D alleged that he
had the shares transferred to P on the corporation’s books. P maintained that the delivery of the cer-
tificate of stock to him was essential. D insisted that a transfer of the stock to P on the corporation’s
books was necessary and all that was requisite. The court decided in favor of D, saying:
“The end the parties intended to accomplish was to confer upon the plaintiff’s testator the title
and ownership of the stock contracted for. The delivery of the certificates from one part to the
other would leave the title to the stock just where it was before. The only effectual mode of trans-
ferring the title was by a transfer on the books of the company, and by that means only.”
On the other hand, it’s been held that a valid gift of shares of stock may be made by mere deliv-
ery of the securities to the donee without any assignment or written endorsement. The theory of this
ruling is that shares of stock are the right to recover the value of the shares, the certificates of stock
36
are evidence of the title to them, registration isn’t essential to the validity of the gift, and a mere
delivery of the certificates should invest the donee with an equitable title to the shares. This rule may
not be recognized everywhere, but in such jurisdictions where it is upheld, the effects of a complete
executed transfer follow.
Registration of Transfer
There are two theories as to the necessity of registering the transfer of shares on the corpora-
tion’s books. One is that the legal title doesn’t pass by the delivery of the duly endorsed and assigned
certificate. Registration is essential to pass the legal title, and only the equitable title passes until
registration is made. The other theory is that the whole title passes between the parties themselves
and all other parties claiming through them by the delivery of the duly endorsed certificate of stock
with a power of attorney to have the transfer made on the company’s books. Until registration is
made on the company’s books, the company may choose to recognize only the registered owner until
the transfer is complete. Registration rules become important in the case of attaching the tranferor’s
creditors, and give exactly opposite results, as we shall see. However, registration between the pled-
gor and the pledgee is unnecessary. But in order to prevent the possibility of loss, the pledgee usually
has the stock registered in his name.
Perhaps no subject in the entire law of corporations has caused more dispute than the right of
attaching a stockholder’s creditors where he has transferred his stock to another, and the transferee
has failed to have the transfer recorded on the corporate books. One theory insists that the transferee
of the stock has no rights because the creditor attached the stock before the transferee was registered
as the owner of the shares on the company’s books. This theory, of course, emphasizes the fact that
registration is essential in order to pass the legal title, and that until the stock is registered, the trans-
feree only possesses an equitable interest that may be cut off. This view was adopted in some states,
and the attachment creditor prevailed against the unrecorded transferee. In other important jurisdic-
tions, the unregistered transferee prevailed over the attaching creditor. This followed the common
law rule that the assignee of an ordinary chose in action prevails over subsequent attaching creditors.
If there are several successive assignments, one that happened first prevails. Decisions according to
this theory result from the desire to make corporate stock as nearly negotiable as possible.
There are several strong reasons why an unrecorded transfer to a bona fide transferee should have
preference over an attachment. First, in the absence of statute, creditors take their debtor’s property
that’s subject to all honest and bona fide liens, as well as equitable transfers. The non‑recording of a
stock transfer isn’t evidence of fraud. Second, the delivery of a stock certificate, and the assignment
with power to transfer, is a sufficient delivery at common law. Third, the overwhelming tendency of
modern decisions is to regard stock certificates attached to an executed blank assignment and power
to transfer, as approximating negotiable securities, though they aren’t negotiable in either form or
character. Finally, federal court judges have repeatedly given unrecorded transfers of stock made in
37
good faith and for value precedence over subsequent attachments in behalf of the vendor’s creditors,
or over the creditors’ claims. In most states, the subject is now governed by statute. As a rule, these
statutes protect the unrecorded transferee. These statutes are enacted because business persons, stock
dealers, and the community want stock certificates to be regarded as substantially similar to nego-
tiable instruments. The free transfer of stock is also regarded as substantially similar to negotiable
instruments. The free transfer of stock shares is one reason why the corporate form of organization
has become so popular and prevalent. The law wants to serve the business community and protect
the transferee. This is why many modern cases tend to facilitate quick, simple, and easy transfers
of stock. The legal and equitable title of a stock certificate now passes by the delivery of the duly
endorsed certificate, with a power of attorney to the transferee to have the transfer entered to him and
to his name on the corporate books.
Provisions of the Uniform Commercial Code

Article 8 of the Uniform Commercial Code, which has been adopted by all states in one form
or another, deals with investment securities. Shares of stock in corporations such as we have been
considering fall within the definition of investment securities. Therefore, their transfer and registra-
tion may be affected by the Code. The Code declares shares of stock to be negotiable, whereas previ-
ously the courts have only given them a semi‑negotiable status. As a result, an innocent purchaser
for value, may receive good title on delivery of certificate of stock from a finder, a thief, or one who
forged a necessary signature provided he didn’t know about the defect. However, a purchaser must
take notice of any restriction noted on a certificate of stock. He’s also entitled to demand registration
as owner on the corporation’s registration book, and the corporation is required to make the transfer.
As far as the owner who lost the security is concerned, he may request that the corporation issue new
security to take the place of the lost security. The corporation is required to do so, provided it’s noti-
fied before it receives notice that it has been acquired by a bona fide purchaser. The purchaser must
also give a bond to indemnify the corporation in case it’s called on to register a transfer to a bona
fide purchase to require a transfer of registration against the legitimate owner.
38
CHAPTER 12
THE RIGHTS OF STOCKHOLDERS
Right to Perform Extraordinary Corporate Acts

Such extraordinary acts as the increasing or decreasing of capital stock, adding to or changing
the corporate business, or determining to alienate the entire corporate property, must be performed
by the stockholders. The directors only have authority in ordinary matters that arise in the course of
the corporation’s business. They lack authority to perform vital and fundamental transactions. Where
the stockholders have the authority to perform acts, they must be authorized at a duly assembled
shareholders meeting.
Right to Vote
The stockholders’ most important powers are the right to vote for directors and to vote on propo-
sitions to increase the stock or mortgage the corporate assets. As long as directors are honest and act
within the corporate powers, the stockholders can’t interfere, even though the administration is weak
and unsatisfactory. They must correct such a deficiency through their power to elect other directors.
Hence, the power to vote is vital. This was expressed by one court as follows:
“The right to vote for directors, therefore, is the right to protect (the corporate) property from
loss and make it effective in earning dividends. In other words, it is the right which gives the
property value and is part of the property itself, for it cannot be separated therefrom. Unless the
stockholder can protect his investment in this way, he cannot protect it at all, and his property
might be wasted by feeble administration and he could not prevent it. He might see the value of
all he possessed fading away, yet he would have no power, direct or indirect, to save himself or
the company from financial downfall. With the right to vote, as we may assume, his property is
safe and valuable. Without that right, as we may further assume, his property is not safe and may
become of no value. To absolutely deprive him of the right to vote, therefore, is to deprive him of
an essential attribute of his property.”
Stockholders aren’t disqualified from voting on a matter coming before a stockholders’ meet-
ing because they have a personal interest in the matter to be voted on. For example, stockholders
can vote on a proposition to ratify a purchase of property from themselves, which they, as directors,
39
made on the corporation’s behalf. The stockholder can’t be deprived of his or her voting right be-
cause he proposes to use it for purposes that others may think are detrimental to the corporation’s
interests.
At common law every member of a corporation had only one vote, regardless of how many
shares of stock he owned. But now each stockholder almost universally has the right to one vote for
each share of the corporation’s capital stock that he or she holds. So, if A owns 850 shares of stock in
a corporation, today he or she has 850 votes. At common law, he or she would have had only 1 vote.
The corporation statutes generally make the corporation’s books conclusive evidence of stock
ownership and of the right to vote in virtue of such ownership. The books, however, may be closed
to the transfer of stock for a short period of time prior to a shareholders meeting. Between pledgor
and pledge, the right to vote remains in the pledgor if the legal title is still his. If the legal title was
transferred to the pledgee, his prima facie (presumptive) right to vote would be equally clear. Execu-
tors and administrators may vote the stock of the estate which they represent before distribution. A
corporation can’t vote its own shares itself. It may, however, purchase and vote shares of stock in an-
other corporation. Bondholders have no voting rights. There may be certain classes of stock without
voting rights.
Voting by Proxy
At common law, a stockholder was required to attend all corporate meetings. The corporation’s
right to authorize any stockholder to vote by any power of attorney or proxy was denied. In other
words, shareholders had no common law right to vote by proxy. The reason for this rule was that
each stockholder was expected to exercise individual judgment on all measures. Today, the right to
vote by proxy is ordinarily conceded by statute. In some jurisdictions, corporate bylaws authorizing
proxy voting have been declared valid in the absence of any statutory authorization. Many questions
have arisen as to the extent to which stockholders may authorize their proxies.
Voting Trusts
In recent years, the voting trust has become common. In general, voting trust may be defined as
an agreement between certain corporate shareholders to let the majority of shareholders who are par-
ties in the voting trust agreement direct the vote on shares of stock that they own. A voting trust may
be an agreement to let some designated trustee of the stock also direct the vote. Individual shares of
stock may be given to the trustee, and trust certificates given in exchange.
A proxy is ordinarily regarded as revocable at the stockholder’s will, but where the voting trust-
ees are vested with rights in the nature of a power coupled with an interest, the stockholders can’t
revoke. In general, it might be said that the legality of these agreements will depend almost entirely
on the motives and objectives with which they’re made. If the attempt is to obtain monopoly or
restrain trade by the medium of the voting trust, then it’s void as against public policy. On the other
40
hand, it isn’t illegal simply to separate the voting power of stock from its ownership. The very right
to vote by proxy itself implies that the voting power may be separated from the ownership of stock.
Where stockholders vest the voting rights of stock in trustees, the mere naked legal title to the stock,
coupled with the voting rights, is in the trustees. All the other beneficial rights of stock ownership
remain in the shareholders. For example, they still receive the dividends.
Cumulative Voting
Cumulative voting is a method unknown to common law, but authorized by statute. It’s designed
to allow the minority of shareholders to obtain representation on the directorate of the corporation.
It may be illustrated like this: A owns ten shares of stock in a corporation with five directors. He
would ordinarily only have the right to vote his ten shares for each of the five directors or fifty for all
of them. The cumulative vote permits him to vote his fifty votes for one director, instead of ten for
each of the five directors as he ordinarily might do. Or he may cast twenty‑five votes for each of two
candidates, and none for the others. He may also chose to make such cumulation or separation of his
votes as he believes will best serve his interests in getting representation in the directorate.
Right to Make Bylaws

A bylaw is a rule adopted for the permanent government of the internal management of the cor-
poration and its officers. The stockholders have the primary power to enact bylaws. Directors usu-
ally can’t do this. This is reasonable, for the stockholders should have a right to a say in the rules by
which their corporation will be governed. However, in some states, statute gives the board of direc-
tors the power to adopt bylaws.
Strangers to the corporation can’t be bound by the bylaws adopted for the company’s internal
government. A private corporation’s bylaws bind its members only by virtue of their consent. They
don’t affect outside parties. This is reasonable when you consider that a bylaw’s purpose is to regu-
late the conduct and define the duties of the corporation’s members toward it and between them-
selves.
The following matters are ordinarily governed by provisions in the bylaws:
• Manner of calling and conducting meetings
• Quorums
• Number of votes to be given by the stockholders
• Powers and tenure of office of the corporate officers
• Manner of voting by proxy
The proper office of bylaws is to regulate the transaction of the corporation’s incidental business.
A restriction on the free transfer of corporate stock can’t be imposed by the majority under the form
of a bylaw.
41
A corporation can’t create or declare a lien on its stock by bylaws, although some courts declare
that a bylaw creating a lien on a member’s shares for his debts to the corporation is valid and bind-
ing, though not against innocent purchasers for value. A national bank isn’t allowed to provide for
such a lien either in its articles of association or its bylaws. The ordinary corporation generally isn’t
allowed to provide for such a lien in its articles of incorporation. However, it isn’t the bylaws’ func-
tion to provide for this. Such a bylaw would be unreasonable.
Right to Dividends
A dividend is a corporation’s profit earned through the judicious use of its capital stock. It’s to
be set aside out of the surplus, to be divided among the shareholders in proportion to their respective
holdings of shares of stock. A dividend is always understood as a fund that the corporation sets apart
from its profits to be divided among its members.
Dividends can only be declared and paid out of net profits. The right to declare them depends on
the state of the corporate finances at the time when the dividends are declared. The question usually
is whether or not a net increase would remain on the original investment, after deducting all present
debts from the company’s assets and making provision for future and contingent claims. The declara-
tion of a dividend is an emphatic assertion that the corporation is prosperous and is in a condition to
make a division of profit. This is so generally understood that when the capital must be encroached
on to make a dividend, it’s looked upon as highly discreditable, if not absolutely dishonest and
fraudulent. Most state legislatures have provided for penalties where dividends are declared out of
anything except surplus profits or where the corporate capital stock is divided or withdrawn.
When a dividend has been declared, it becomes a corporation’s debt to its stockholder. Until that
time, the dividend is only something that may possibly come into existence. After a dividend has
been declared, all communication of interest in relation to such dividend, such as between the stock-
holders themselves and between the stockholders and the corporation, must come to an end. The true
principle is that from the time a dividend is declared, it becomes a corporation’s debt to its individual
stockholder. After the stockholder demands payment, it may be recovered by legal action.
Like any other debt, a dividend may be set off by a stockholder’s debt to the corporation. After
declaration, the corporate earnings become the stockholder’s individual property and are treated as
severed from the company’s common fund for the use and benefit of each stockholder in his or her
individual right. If the directors declare a dividend, and it creates a relationship of debtor and credi-
tor between the corporation and a stockholder, it should follow that a board of directors may not
lawfully rescind a dividend. This is generally held to be the case, although it has been suggested that
in case of an irretrievable and disastrous loss between the time of declaration and time of payment,
the directors should be permitted to rescind the declaration, or at least postpone it during a period of
emergency.
42
Stock Dividends
When the corporation has earned a surplus that could be applied to the payment of dividends and
also has the power to increase its total shares of stock, it may lawfully keep the surplus cash or prop-
erty and declare a stock dividend. It does this by issuing shares of stock to the stockholders instead
in an amount equal in face value to the surplus profits to be divided. A stock dividend is lawful when
an amount of money or property equivalent in value to the full par value of the stock distributed as
a dividend has been accumulated and is permanently added to the corporation’s capital stock. As
explained in a leading case,
“Stock dividends never diminish or interfere with the property of a corporation, and hence are
not within the purview of that section (a statute forbidding the distribution of corporate capital
in the shape of dividends). After a stock dividend, a corporation has just as much property as it
had before. It is just as solvent and just as capable of meeting all demands upon it. After such a
dividend the aggregate of the stockholders own no more interest in the corporation than before.
The whole number of shares before the stock dividend represented the whole property of the
corporation, and after the dividend they represent that and no more. A stock dividend does not
distribute property, but simply dilutes the shares as they existed before; and hence that section in
no way prevented or related to a stock dividend. Such a dividend could be declared by a corpora-
tion without violating its letter, its spirit or its purpose.”
When Equity Will Decree Declaration

When a corporation has a surplus, the directors must make a fair and honest decision whether
a dividend should be made, how much it will be, and when and where it will be payable. This dis-
cretion can’t be controlled by the courts and ordinarily won’t be interfered with. However, a court
of equity can afford relief against bad faith or arbitrary and unjustifiable conduct on the part of the
directors in this regard. The directors are vested with a wide discretionary power, and the courts are
hesitant to interfere with their internal management of the company. The mere existence of a large
amount of surplus is insufficient to warrant intervention. A well‑known New York case makes the di-
rectors’ good faith the ultimate test. However, directors shouldn’t accumulate too large a surplus and
roll their profits year after year. If they do, it results in the practical starvation of the stockholders,
especially when the corporation is private, and there’s no ready market for its stock. The stockhold-
ers’ only sure benefit to be derived from the successful prosecution of the corporate business must
come from the distribution of dividends.
43
Who Is Entitled
The law states that whomever owns the corporation’s stock at the time a dividend is declared
also owns the dividend. However, a transfer of the stock afterwards doesn’t carry the dividend with
it, though it may not be paid or payable until after the transfer. Suppose X owns 500 shares of stock
in a corporation. He executes his will on June 1, in which he bequeathed the stock to Y. On July 1,
dividends of 4 percent were declared payable in 30 days. X died on July 20. Who’s entitled to the
dividends? They go to the personal estate of X, and not to Y, the legatee. This is because X owned
the shares at the time the dividends were declared, at which time he was living. It makes no differ-
ence when the dividends were to be paid. As a further example, if A owns shares when a dividend is
declared, it belongs to her, though it doesn’t become due and payable until after A has transferred her
shares to B. If A sells to B before a dividend is declared, it belongs to B, though it’s declared before
the transfer on the corporate books is made to B. The corporation, however, will be justified in pay-
ing A if it has no knowledge of B’s claim. If the corporation has notice, it’s bound to pay the true
owner. The corporation is protected where it has acted in good faith and without notice in making the
payment of the dividend to the registered owner.
Setting Apart of Specific Fund

If dividends are declared by the corporation’s board of directors and a specific fund is set aside
for paying the dividend, a trust fund is created for the stockholders’ benefit. If corporate bankruptcy
follows, the stockholders aren’t required to go in pro rata (to an exact proportion) with the general
creditors for such unpaid dividends. But they may recover the whole of their share of the dividend.
In other words, setting apart a fund to pay a dividend gives a lien to the stockholders on this fund,
which they can enforce to exclude the corporation’s general creditors. Where no specific fund is set
aside to pay the dividend, the shareholder is a mere creditor as to the amount of her dividend, and
must share with the other creditors in case insolvency occurs before payment.
Right to Subscribe to New Issue of Stock

According to common law, a share of stock is also a share in the power to increase the stock, and
this power belongs to the stockholders, just as the stock itself. Hence, it’s the general rule that when
the corporation’s capital stock is increased by issuing new shares, authorized by the charter, the hold-
ers of the original stock are entitled to the new stock. But their number of shares must be in propor-
tion to the whole number before the increase. According to the reasoning of a New York judge,
“It (the right) is inviolable and can neither be taken away or lessened without consent, or a waiv-
er implying consent. The plaintiff had power, before the increase in stock, to vote on 221 shares
of stock, out of a total of 5,000, at any meeting held by the stockholders for any purpose. By the
44
action of the majority, taken against his will and protest, he now has only one‑half the voting
power that he had before, because the number of shares has been doubled while he still owns but
221. This touches him as a stockholder in such a way as to deprive him of a right of property.”
Therefore, it followed that a stockholder had an absolute right to the new stock in proportion to
the old stock that he held. The stock was his property and couldn’t be disposed of without his con-
sent. If the stockholder was so situated that he couldn’t take the new stock himself, he was entitled
to sell the right or privilege, which was frequently done. Where the new stock wasn’t issued for cash
but was issued in payment for property, the stockholder didn’t possess this preemptive right to sub-
scribe.
The preemptive right to subscribe to new shares worked out satisfactorily when shares were
usually of only one kind—with voting rights. It’s still desirable in the case of the closely held corpo-
ration to continue the original proportionate control. However, with the big growth of public corpo-
rations and the development and use of many different classes of stock with varying privileges, the
right proved only a burden. Consequently, statutes now generally cover the matter. Such statutes may
retain preemptive rights, provide for none, or specify in what situations they may be allowed. Re-
gardless of which type of statute exists, there’s usually an exception that the company may provide
otherwise by its articles of incorporation.
Right to Inspect Corporate Books and Records

It was formerly held in England that the right to inspect the corporate books and records could
be exercised against the will of the managing officers only where there was a specific dispute about
some definite corporate matter between the stockholder and the officers. In England, this rule has
been modified by statute. In America, the doctrine was apparently never adopted. The cases that go
furthest in that direction hold that a dispute over the corporation’s alleged mismanagement is enough
to entitle the stockholder to examine the books and accounts to see whether there’s a ground for suit.
A corporation’s stockholders are the equitable owners of its assets, and the officers act in a
fiduciary relation as agents of the corporation and of the stockholders. They should be ready to give
the stockholders an account of their doings at all reasonable times. The stockholders have a right to
inspect their records and accounts and ascertain whether they’re honest and intelligent in performing
their duties. If the stockholders are acting in good faith for the purpose of advancing the corpora-
tion’s interest and protecting their own rights as owners, they should be permitted to examine the
corporate property, including the books and accounts. The right of inspection includes the right to
have the assistance of an expert accountant, an attorney, or other person, in making the examination.
It also includes the privilege of making transcripts from the books and records for subsequent use.
At common law, the right of inspection wasn’t absolute. It couldn’t be exercised merely out of
curiosity or vexatiously. It was the court’s duty to exercise sound discretion in order to determine
45
whether or not the stockholder was acting for an honest purpose, not adverse to the corporate in-
terests. The desire for an examination had to be reasonable. On the other hand, courts of equity
are quick to protect helpless minorities of corporate stockholders from the oppression and fraud of
majorities. The rich shouldn’t be permitted to gain an undue advantage. The remedy for a refusal of
the right is an action at law for damages, or a petition for a writ of mandamus to compel and permit
the inspection.
Stockholders had to resort to the courts so frequently in order to exercise the right of inspec-
tion that some states passed statutes giving the stockholders the absolute right to demand inspection
regardless of the reason. However, the courts have always exercised some degree of discretion in the
matter. Whatever the reason may be for inspection, current statutes usually restrict this right to those
who have owned corporate stock for a certain period of time or who own at least a certain percentage
of the stock.
Right of Stockholder to Sue on Own Behalf

A stockholder has a right to sue on his own behalf, although in the minority, to restrain ultra vires
acts of the directors or a majority of the stockholders. He may also sue in equity to restrain fraudu-
lent and oppressive acts of the majority. Wherever he has been wronged by the corporation, and
his right is against it, he can obtain judgment against the corporation. If the act done is outside the
company’s powers, any of the corporation’s shareholders may come into equity and say in his peti-
tion, “This company is going to do an act that’s beyond its powers; stop it.” The court must issue an
injunction on it. There’s no discretion whatsoever in the matter.
Suppose X is a stockholder in a corporation which proposes to buy a large block of stock in
another corporation, in an attempt to establish and maintain a monopoly of a certain business. Does
the individual shareholder have a right to bring a bill of injunction to restrain this? The question has
been answered in the affirmative. The grievance doesn’t belong to the corporation alone. The indi-
vidual stockholder would be irreparably injured if the corporation were subjected not only to fine,
but also to a possible forfeiture of its franchises for its unlawful course of conduct. The test is al-
ways: Does the stockholder suffer an injury distinct and separate from the general injury to the com-
pany? Some courts return a negative answer in their decisions. They insist that the corporation alone
may proceed. If it refuses to act, a stockholder may sue, but on the corporate behalf, not on his own.
Right of Stockholder to Sue on Behalf of the Corporation

Where the corporate directors or officers have acted fraudulently, in bad faith, oppressively, or
beyond their powers, and the transaction has been consummated, the stockholder can’t sue them.
This is because there’s no direct legal privity between a stockholder and the corporate officers or
directors. A stockholder has an interest in the corporation and in the conduct of the corporation’s offi-
cers and directors affecting its management and property. But the interest in the officers’ transactions
46
isn’t direct and legal, but instead, indirect and equitable. It’s well settled that it can’t be made the
foundation of an action at law against the corporate officers or directors. The stockholder’s remedy
for such a wrong is through a corporate suit against the guilty officers or directors, or through a bill
in equity on the corporation’s behalf, if the stockholder has been unable to induce corporate action
for the stockholders’ benefit. Before bringing suit on the corporation’s behalf, the stockholder must
make every reasonable effort to obtain relief through the corporation. Such an action can’t be main-
tained unless it’s necessary because of the corporate body’s neglect and refusal to act. The action is
only permitted in order to set the judicial machinery of the court of equity in motion. This court will
intervene to afford an adequate remedy.
The extent of the remedy may be judged by what the Supreme Court of the United States has
said:
“We understand the doctrine to be that to enable a stockholder in a corporation to sustain in a

court of equity, in his own name, a suit founded on a right of action existing in the corporation
itself, and in which the corporation itself is the appropriate plaintiff, there must exist as the foun-
dation of the suit:
Some action or threatened action of the managing board of directors or trustees of the
corporation which is beyond the authority conferred on them by their charter or other
source of organization;
Or such a fraudulent transaction completed or contemplated by the acting managers,

in connection with some other party, or among themselves, or with other sharehold-
ers, as will result in serious injury to the corporation, or to the interests of the other
shareholders;
Or where the board of directors, or a majority of them, are acting for their own in-
terest, in a manner destructive to the corporation itself, or to the rights of the other
shareholders;
Or where the majority of shareholders themselves are oppressively and illegally pur-
suing a course in the name of the corporation, which is in violation of the rights of the
other shareholders, and which can only be restrained by the aid of a court of equity.
Possibly other cases may arise in which, to prevent irremediable injury, or a total fail-
ure of justice, the court would be justified in exercising its powers, but the foregoing
may be regarded as an outline of the principles which govern this class of cases.”
47
Conditions of Suit
The corporation is a necessary party defendant in a stockholder’s suit brought on behalf of the
corporation. The misconducting directors must also be parties. The corporation is the plaintiff in sub-
stance though not in form. Where the stockholder sues on the corporation’s behalf, she must show a
cause of action in favor of the corporation with the same detail of facts necessary if the corporation
itself had brought the action. She must also show, definitely and clearly, the facts that entitle her to
maintain the action on the corporation’s behalf. Therefore, she must usually allege and show that she
tried to have corporate action taken through the proper corporate agency to have the wrong righted,
and that they refused, or the wrongdoers were the corporate officers themselves, who had authority
to have the corporation sue. If the offense charged is one that the stockholders could ratify, the courts
won’t interfere until they have been called together in a stockholders’ meeting to pass upon the
question, unless delay would fatally endanger the plaintiff’s rights. Negligent or disloyal acts of the
directors or officers may be ratified. The stockholders may conclude that, after all, the transaction is
for the corporation’s benefit. Ultra vires acts, however, can’t be ratified.
Where the stockholder sues, she must sue on behalf of herself and all other stockholders as repre-
sentative of their collective rights. These suits are sometimes referred to as “derivative” or “represen-
tative” actions.
Who Can Sue

In some states, a stockholder acquiring his shares of stock after the transaction complained of
hasn’t been permitted to maintain an action of this character. Some experts say that a purchaser of
stock can’t complain of the corporation’s management because of sound reason and good author-
ity. However, other states hold that a shareholder’s bona‑fide assignee may sue, even though the act
complained of occurred prior to the transfer. This reasoning is that if the transferor had the right to
bring suit, this right was transferred along with the stock. Even if the transferor had assented to the
wrongful act, his transferee nevertheless would have the right to complain unless he was aware of
the true situation due to the stock’s negotiable character.
Defenses
Since a stockholder’s suit on the corporation’s behalf is brought in equity, it follows that it’s
subject to all the defenses and governed by all the rules of an equitable action. Unreasonable delay,
or laches, as it’s called in equity, will create a bar to the action. Acquiescence is also a defense, on
the theory that one can agree one minute and not the next. It’s a defense to show that the shareholder
bringing the action is suing as the mere puppet of a rival corporation. This constitutes a personal
exception against his right to sue. Where the complaintant sues bona fide in his own interest, and
merely his motives are questionable, the action is generally held to lie. A similar prior suit brought
by another stockholder and decided against him is res judicata (conclusive). Otherwise, there would
48
be no end of litigation, and the court would be open to suit by every stockholder in the company,
one after another, presenting the same old question for consideration over and over again. It’s also a
defense to show that plaintiff isn’t really a stockholder, as where his stock is fictitious or void.
Practical Importance
The subject of stockholders’ suits is important. It furnishes a remedy where the minority stock-
holder may obtain relief against oppressive acts by the directors or the majority of stockholders.
Courts have nothing to do with the internal management of business corporations. The majority must
govern. Corporations could be conducted on no other basis. However, in corporations (as in repub-
lics), the majority must act fairly and must pay reasonable heed to the minority’s rights. It shouldn’t
act illegally, fraudulently, or unjustly. If it does act, the strong arm of equity will restrain it.
49
CHAPTER 13
CORPORATE CREDITORS
Relation Between Creditor and Corporations

Corporate creditors possess the same general rights as the creditors of individuals, with the
exception that corporate property impressed with a public use or employed in connection with some
public duty can’t be taken on execution. However, the income may be applied on the creditor’s
claims. It’s a well-settled rule that creditors can’t interfere with the corporation’s management. They
can’t interfere with the use or disposition of the corporate property, unless fraud or breach of trust is
alleged and shown. Therefore, a bill in equity won’t lie by a creditor to restrain the corporate debtor
from making an alleged improvident contract. While creditors have no right to interfere in the corpo-
rate management, they may interfere to prevent acts that would destroy their security. For example,
they may try to prevent a waste of the corporate funds or have fraudulent conveyances pertaining
to them set aside. The creditor must establish his claim in these cases by a judgment at law before a
court of equity will afford relief.
The Trust Fund Theory

The so‑called “trust-fund doctrine” has caused much confusion. Its origin is found in the case of
Wood v. Dummer, decided by Justice Story in 1835. Justice Story stated that a corporation’s capital
stock is a trust fund for the benefit of the corporation’s general creditors and must be dealt with as
any other trust fund. The case itself called for no such invention: a bank had divided up two‑thirds of
its capital among its stockholders without providing sufficient funds to pay its then outstanding bills.
On old and familiar principles, this was a gross and glaring fraud on its creditors. The judge meant
that corporate property must first be appropriated to the payment of the corporation’s debts before it
can be distributed among the stockholders—a rule that’s sound and honest. However, his expression
was hailed as a great discovery and has been dragged needlessly into the decisions.
Therefore, New York has resorted to the trust-fund doctrine in order to afford relief to a judgment
creditor seeking to set aside a fraudulent conveyance of a debtor corporation’s property and assets. In
a case of this kind, the court said: “The assets of a corporation are a trust fund for the payment of its
debts upon which the creditors have an equitable lien, both as against the stockholders and all trans-
ferees, except those purchasing in good faith and for value.”
50
Such cases could be decided on the most elementary principles in the law of fraud. Dragging in
the trust-fund conception needlessly complicates the law. It’s absurd to say that there’s a direct trust
attached to the corporation’s property. The famous case of Sawyer v. Hoag is largely responsible for
the confusion of judicial thought on this subject. In that case, an insurance company’s stockholder
gave his promissory note for eighty‑five percent of his subscription to the company’s stock. After the
company went bankrupt (which the stockholder was aware of), he brought up an outstanding claim
against the company for one‑third of its face value. In a suit by the assignee in the corporation’s
bankruptcy brought on his note, the stockholder set up this claim as an off‑set. The U.S. Supreme
Court declared “that the capital stock of a corporation, especially its unpaid subscriptions, is a trust
fund.” The same result could be reached without invoking that doctrine. There was at least a moral
fraud committed.
Modern Theory
Modern cases tend to repudiate the idea that the corporate property is a trust fund for creditors.
They say that the corporation’s property is a trust fund only in the same way, and to the same extent,
that an individual’s property is a trust fund. In respect to property, a party may deal with a corpora-
tion in the same manner as an individual owner, with no greater danger of being held to have re-
ceived property burdened with a trust or a lien. It’s ridiculous to hold that creditors have any lien on
the corporation’s actual tangible property. Even in the U. S. Supreme Court, the trust-fund doctrine
is confined to cases when a corporation is insolvent and so far civilly dead that its property may be
administered as a trust fund for the benefit of its stockholders and creditors. Even then, there isn’t a
true and complete trust, and it can be called so only by way of analogy or metaphor. When a corpora-
tion goes bankrupt, creditors of the corporation have priority over stockholders of the corporation.
Modern cases negate the idea of any direct trust or lien attaching to the corporation’s property in
favor of its creditors. For example, X has taken a corporation’s common stock without paying any
consideration whatever either in property or money. It isn’t necessary to invoke the trust-fund doc-
trine in order to hold corporations responsible to creditors. The court has given this answer in one
such case:
“But by putting it upon the ground of fraud, and applying the old and familiar rules of law on
that subject to the peculiar nature of a corporation and the relation which its stockholders bear to
it and to the public, we have at once rational and logical ground on which to stand. The capital
of a corporation is the basis of its credit. It is a substitute for the individual liability of those who
own its stock. People deal with it and give it credit on the faith of it. They have a right to assume
that it has paid‑in capital to the amount which it represents itself as having; and if they give it
credit on the faith of that representation, and if the representation is false, it is a fraud upon them;
and in case the corporation becomes insolvent, the law, upon the plainest principles of com-
mon justice, says to the delinquent stockholder, ‘Make that representation good by paying for
51
your stock.’ It certainly cannot require the invention of any new doctrine in order to enforce so
familiar a rule of equity. It is the misrepresentation of fact in stating the amount of capital to be
greater than it really is that is the true basis of the liability of the stockholder in such cases; and
it follows that it is only those creditors who have relied, or who can fairly be presumed to have
relied, upon the professed amount of capital, in whose favor the law will recognize and enforce
an equity against the holders of ‘bonus’ stock. This furnishes a rational and uniform rule, to
which familiar principles are easily applied, and which frees the subject from many of the dif-
ficulties and apparent inconsistencies into which the ‘trust-fund doctrine’ has involved it; and we
think that, even when the trust-fund doctrine has been invoked, the decision in almost every well
considered case is readily referable to such a rule.”
Relation Between Creditor and Director

As long as a corporation is solvent and continues its regular business, its directors aren’t the
creditors’ agents or trustees. But when it’s insolvent, its creditors have a right to regard the directors
as trustees or custodians of the corporate assets for their benefit. In a loose sense, the assets become
a trust fund in the hands of the trustees or directors. While a corporation remains solvent, a director
may, with the knowledge of the stockholders, deal with the corporation, loan it money, or buy prop-
erty from it, just as a stranger could. But the moment a corporation becomes insolvent, its directors
occupy a different relation. A fiduciary relation then comes into existence between them and the
creditors, and they’re prohibited from purchasing their insolvent company’s assets or from securing a
preference over creditors.
Relation Between Creditor and Stockholder

On principle, there’s no trust relation between a creditor and a stockholder. The two chief ways
in which the shareholders may be liable to creditors arise (apart from statute) when the stockholders
fail to pay the amount of capital stock subscribed for by them in full, or when the shareholders are
paid dividends out of the capital before the creditors are paid. Ordinarily, the creditors’ rights in these
cases arise only after lawful judgment against the corporation has been obtained, and execution has
been returned unsatisfied, or partly so. Then it’s the creditor’s right to sue the shareholders in equity
to have the sums due the corporation paid in to satisfy his claim. He must usually bring a creditor’s
bill in such a way that the other creditors can come in and share in the proceeds in proportion to their
claims.
A judgment against the corporation as to the corporation’s debt is conclusive, and the court’s
assessment against the shareholder can’t be questioned by the shareholder. But the shareholder can
contest his liability on the ground that he isn’t a member, or that the judgment was fraudulently
obtained. In such cases, a receiver is usually appointed by the court. The receiver has authority to sue
any shareholder who owes the corporation in any state. The shareholder’s liability is several, but it’s
usual to join all, though some are out of the court’s jurisdiction.
52
Unpaid Subscriptions
Unpaid stock subscriptions are regarded as a species of trust fund that the corporation holds for
the payment of its debts. A plaintiff creditor who sues to recover them is under no obligation to make
all the stockholders parties defendant to his bill. It isn’t necessarily his duty to marshal the corpora-
tion’s assets or to subject the equities between the stockholders. The courts say that the stockholders
will be required to pay the due balance for the protection of creditors when necessary for their pay-
ment. This rests on the reasoning that it’s the nature of a fraud for the corporation and its stockhold-
ers to claim to have a capital stock up to a certain amount, which has never really been received in
full. This is what’s meant when the courts declare that such unpaid subscriptions are a trust fund for
the creditors’ security. A corporation’s judgment creditor may reach unpaid subscriptions in a credi-
tor’s bill, just as any judgment creditor of an individual may reach all debts due to his debtor.
In general, the previously stated rule applies to subscriptions where less than the par value in
money is paid. However, when the corporation is in failing circumstances, but still has the power to
increase its stock and does so in good faith and under stress of circumstances to reestablish itself, it
may sell such stock at its market value. It may also choose to issue this stock as bonus along with
issued bonds to tide over its difficulties. Those who take the stock or bonds at their market value and
in good faith won’t be held to any further liability in favor of subsequent creditors. A going concern,
which finds its original capital impaired by loss or misfortune, may issue new stock for the purpose
of recuperating itself, put it on the market, and sell it for the best price that can be obtained. As long
as the transaction is bona fide, it will stand.
On principles, only subsequent creditors should be entitled to enforce their claims against stock-
holders whose subscriptions aren’t fully paid. They alone could have trusted the corporation on the
faith of the increased stock. Prior creditors couldn’t have been misled and couldn’t possibly have
dealt with the corporation on the strength of it. Only those who relied on it should have rights.
Stock Issued for Property

A corporation has the right to issue its stock for property. However, it doesn’t have the right to is-
sue $100,000 worth of shares of capital stock against property reasonably worth much less. If shares
of stock are issued this way, the holders of them are liable to the corporation’s creditors for the dif-
ference between what they paid for the stock and its par value.
In some jurisdictions, there can only be recovery where full‑paid stock is issued for received
property when the transaction is actually fraudulent. If there isn’t actual fraud, creditors can’t hold
the stockholders liable. A gross and obvious overvaluation of property is strong evidence of fraud.
In other jurisdictions, either intentional fraud or reckless conduct in fixing the conveyed property’s
value without regard to its actual market value must be established before an intent to defraud may
be inferred. In other jurisdictions, the “good faith” rule prevails. This means that if the parties acted
honestly and in good faith, mere over‑valuation of the property given in exchange for stock won’t
53
render the stockholder liable. In a growing number of states the “true value” rule prevails. This
means that the parties generally have the right in good faith to agree on the value of the property
taken, but this shouldn’t be speculative or fictitious. An honest mistake in judgment won’t neces-
sarily destroy the agreed-on value, but it must be a valuation that a sensible businessperson would
approve of. A reasonable margin may be allowed for an honest difference of opinion, but a grossly
excessive valuation is a fraud on creditors.
Watered Stock
Daniel Drew, a cattle dealer turned stock broker, is said to have actually watered his stock be-
fore selling it. It’s said that before he sold his cattle, he used to feed them salt. This made them very
thirsty. He then gave them water just before they were to be sold and weighed. Of course, many of
the pounds paid for by the vendee were water. People say that Drew carried these methods to Wall
Street and the term “watered stock” may have come from his behavior. At any rate, “watered stock”
is understood to be stock with no real value backing it. For example, if a corporation issues securities
with a par value of $600,000, but actually has only $180,000 in value, clearly the stock is watered
and fictitious. An agreement between the corporation and the stockholder where the stock is issued
for the property taken on over‑valuation is valid. But this type of agreement is invalid against credi-
tors, and the creditors can recover as for a fraud.
It has been held that the holder of “watered stock” is liable even to those creditors who extended
credit to the corporation with knowledge that the stock was watered. However, the general rule is
contrary and declares that the creditor can’t recover when he deals with the corporation with full
notice and knowledge of all the facts. He can’t argue that no payment is received because he is aware
of all relevant facts.
Statutory Liability
The stockholder’s statutory liability to a creditor (in the states where this exists) isn’t strictly in
the nature of a penalty. It isn’t a consensual contract either. It’s more accurately a quasi contractual
obligation. Statutory liability is one imposed on shareholders for the creditors’ protection by special
statute over and above their common law liability. It isn’t a part of the corporate funds for the pur-
pose of carrying on its business, but it’s a security for creditors alone. As to its legal character, this
statutory liability is either contractual or penal.
The contractual statutory liability may be either: (a) a joint and several unlimited secondary
liability; (b) a joint and several unlimited liability; or (c) a limited primary and secondary liability.
If it’s primary, the liability arises at the same time as the corporation’s liability. If it’s secondary, it
arises only after the corporation is unable to pay. If it’s unlimited, it’s substantially that of a partner.
If it’s limited, it extends only to the fixed limit, which is usually a sum equal to the amount of the
subscription, or such a proportion of the debts as the shareholder’s shares are to the total shares. If
54
it’s primary, the Statute of Limitations would begin to run at the same time it does against the corpo-
ration. If it’s secondary, it runs only after it’s established that the corporation can’t pay. This liability
may be provided in constitutional or statutory provisions. If it’s provided for in the constitution, it
will be self‑executing whenever it’s fixed in amount, and no special machinery is necessary for its
enforcement.
A penalty is a punishment or fine imposed for doing something that’s forbidden and is to be re-
covered by the state. It can be changed or modified at any time, and it isn’t enforceable outside of the
state. Some of the shareholders’ statutory liabilities are similar to penalties, but if they’re designed
for the creditors’ protection in such a way that the offender becomes a debtor to the creditor by his
failure, they’re usually considered contractual in nature. This allows suits to be brought in other
states for their enforcement in favor of creditors. If the liability is contractual, subsequent creditors
have a vested right to its enforcement for their protection, so that it couldn’t be taken away without
their consent. Such a liability also survives and attaches to the estate of a deceased shareholder and
may be enforced against it; or the representative of a deceased creditor can enforce it against share-
holders.
Sometimes a special remedy is provided in the state that created the statutory liability. This rem-
edy may be of such a kind that the right can’t be separated from the proceeding. This proceeding is
different from the proceeding in the state where it’s sought to be enforced, it can’t be enforced in the
other state at all. However, if no special remedy is provided, and it’s of a kind that can be enforced
in a foreign jurisdiction it may then be enforced in such foreign jurisdiction. The usual method of
enforcing such statutory liability is by means of a creditor’s bill and the appointment of a receiver.
Effect of Transfer of Shares

Under the English law, a stockholder could transfer his shares to an irresponsible or insolvent
party for a nominal consideration. He could do this even though the transfer’s sole purpose was to
escape a stockholder’s liability under statute, provided the transfer was not merely colorable or col-
lusive with a secret trust attached. Under such circumstances, the person making the transfer was
released from liability, both as to corporate creditors and other shareholders. In the United States, the
transferor of stock isn’t permitted to evade a statutory liability in this manner. For example, a bank’s
stockholder who‘s liable for the association’s debts to the extent of the par value of his shares can’t
transfer his stock if he knows, or should know, that the bank is insolvent. Without this, the transfer
would be valid if made to an individual of established financial responsibility, since the creditors
couldn’t suffer by the substitution of one solvent and reliable shareholder in place of another. In
short, the question of liability is largely determined by the presence or absence of an intent to evade
the double liability or other liability imposed by statute.
55
CHAPTER 14
DISSOLUTION OF CORPORATIONS
Methods
At common law it was said that a corporation could be dissolved by (1) an act of Parliament,
which was boundless in its operations, (2) the natural death of all its members, (3) surrender of its
franchises to the king, which was regarded as a sort of corporate suicide, and (4) the forfeiture of its
charter because of negligence or abuse of its franchises. In this last instance, the regular course was
to bring a request for information in the nature of a writ of quo warranto, to inquire by what warrant
the shareholders were exercising corporate power and forfeiting because of such abuses.
The law has changed greatly in this respect. In England, where Parliament doesn’t have constitu-
tional restraint on the actions of corporations, corporations hold their franchises at their will. In the
United States, however, the legislative power is carefully limited by constitutional provisions. The
second method of dissolution, the natural death of all members, doesn’t apply to today’s business
corporations. The shares are personal property and pass by assignment, bequest, or descent. They
must always remain the property of some person. This is what we mean when we speak of the corpo-
ration as possessing immortality; its succession is perpetual.
A corporation today can’t surrender its charter unless the government is willing to accept the
surrender. Charters are regarded as contracts between the government and the incorporators. Just as
the government can’t deprive the incorporators of their franchises in violation of the compact, the
incorporators can’t put an end to the contract without the government’s consent. The surrender is of
no avail until accepted. Today, a corporation may forfeit its charter by a misuse of its powers, but
only by a judgment of a competent court. Until a judicial decree is entered, the corporate existence
continues.
A corporation may also be dissolved (1) when the time limit mentioned in its charter expires, (2)
by the occurrence of a condition or event prescribed by the charter to have that effect, (3) when the
legislature repeals the corporate charter, (4) when the state has reserved such power, or (5) when a
corporation voluntarily relinquishes its charter in accordance with procedure established by statute.
Insolvency doesn’t extinguish a corporation’s legal existence, nor does the omission to choose direc-
tors or officers necessarily have that effect.
56
Transfer of Entire Corporate Property
If a corporation transfers its entire property, it doesn’t result in the extinction of its legal exis-
tence. It has been held that even if a corporation paid all its liabilities, distributed its remaining assets
among its stockholders, and has made no use since then of its franchises, it’s still not dissolved ac-
cording to the law. For instance, where a corporation transferred a hotel, which was its sole property,
the court said:
“The effect of this transfer of all the hotel property no doubt was to terminate the business of the
corporation; but that was not the necessary effect. It is entirely clear, upon the authorities, that the
disposal of all the property of a corporation has not the effect to end or dissolve the corporation.”
Forfeiture Clauses in Charters

Suppose that incorporated individuals have a provision in their charter that if they don’t com-
mence a business within five years, the corporate existence and powers will cease. There has been
much dispute among the authorities as to whether such a provision automatically executes itself, or
whether a judicial action must be undertaken in order to declare a forfeiture of the charter. In one
case it was decided that the corporation’s existence was absolutely terminated without legal proceed-
ings. In other cases, the same court held that where the legislature declares that the charter will be
null and void under certain conditions, the true meaning is that it will be voidable, and an action by
the attorney‑general is necessary. In that last analysis, the question as to whether a forfeiture clause
is or isn’t self‑executing depends wholly on the legislature’s language.
Abuse or Misuse of Franchise

While information in the nature of a quo warranto is recognized as the correct proceeding to
test a corporation’s right to exercise its functions and as the proper corrective measure for misuses,
non‑use or abuse of the corporate franchises, a charter won’t be declared forfeited for the commis-
sion of every ultra vires act. The abuse must be gross, willful, continued, and related to the essence
of the charter. It must also appear that the abuse is so great that no adequate relief can be obtained in
any other manner. Courts are averse to declaring forfeitures. Generally, a breach of duty to the state
must appear before the courts will act. Courts proceed with extreme caution in these proceedings,
and are clothed with a very wide discretion. They must determine if the public interest demands a
judgment of corporate death. This is obvious from the following opinion of a higher court:
“The transgression must be not merely formal and incidental, but material and serious; and such as
to harm or menace the public welfare. Corporations may, and often do, exceed their authority where
only private rights are affected. When these are adjusted, all mischief ends and all harm is averted.
But, where the transgression has a wider scope and threatens the welfare of the people, they may
summon the offender to answer for the abuse of its franchise or the violation of its corporate duty.”
57
Jurisdiction of Equity
In the absence of statutory authority, courts of equity possess no jurisdiction to decree a corpo-
rate dissolution by declaring a forfeiture of its franchise, either at the state’s suit or that of a private
individual. The mode of enforcing a forfeiture at common law was by scire facias or quo warranto
in courts of law only at the sovereign suit. Over time, the assets came to be treated like a trust fund,
to be administered for the stockholders’ benefit, subject first to the just claims of the corporate credi-
tors. The necessity to invoke the aid of equity in administering these funds led to statutory enact-
ments vesting courts of equity with jurisdiction to dissolve a corporation.
Effect on Corporate Property

At the early common law it was held that on a corporation’s death all its real estate reverted back
to the original grantor and his heirs. They believed that a corporation’s land or money should be
returned to the original donor once a corporation was dissolved. Today, when a corporation dissolves
the directors or managers become the trustees of its property (in the absence of any other custodian)
for the purpose of paying the corporation’s debts and dividing its surplus property among the stock-
holders. Consequently, where lands are conveyed absolutely to a stock corporation, no reversion or
possibility of reverter remains in the grantor. The old common law rule, however, may still apply to
public or charitable corporations.
At common law, a corporation’s personal property escheated to the crown or state. Now it’s pre-
served as an asset for paying the corporation’s creditors or distributed among the stockholders after
the corporate debts are paid.
Also at the early common law, all debts and choses in action, whether due to or from the corpora-
tion, became extinct. Thus, equity would enjoin the collection of notes made payable to a bank, and
the debtor was released by the dissolution. Today, such claims are preserved by statute. It’s ridicu-
lous to consider a corporation’s debts to be totally extinguished by its dissolution. The effects of dis-
solution on the corporate franchise are simply to prevent the further continuance of its exercise.
Corporate Suit
At common law, a corporation’s suits or actions abated on its dissolution. This is now prevented
by statute. The defunct corporation’s representatives can continue the actions in its place. At com-
mon law, no valid judgment could be rendered against a dissolved corporation, and attachment and
garnishment proceedings were terminated by a dissolution. Statutes now usually provide that dis-
solution won’t abate pending suits or prevent the defunct corporation from being sued. Regardless of
whether dissolution is voluntary, or made by charter repeal, it usually provides that the corporation
can continue to exist for a period of time to wind up its affairs or that a receiver be appointed for
such purposes.
58
Voluntary Dissolution
The discussion in this chapter about the protection of creditors and others, in the case of dissolu-
tion, apply just as strongly in the case of a voluntary dissolution, which is the most common method
of dissolution. Statutes in every state provide for voluntary dissolution according to prescribed pro-
cedures. These aren’t always the same, but in general they give a majority of shareholders entitled to
a vote the right to determine whether the corporation should continue its business, even if it’s been
prosperous. If the necessary requirements are met and provision made for protecting creditors and
others, filing a certification of dissolution with the secretary of state will ordinarily suffice as a dis-
solution de jure.
59
CHAPTER 15
FOREIGN CORPORATIONS
Status of National Corporations

National corporations shouldn’t be regarded as foreign corporations in any state, unless they’re
created to operate in one of the territories or in the District of Columbia. In this case they’re regarded
substantially the same way as if they were created by one of the state legislatures, with Congress
merely acting as the local legislature. Corporations created by the federal government to perform its
national functions aren’t foreign corporations in any state. In very much a similar way, a national
bank located in any particular state is, for most purposes, treated as a citizen or inhabitant of that
state. However, it can’t be taxed in such state or have the exercise of its powers restricted by the state
where it’s located in any other way than expressly authorized by national laws.
Status of Foreign Corporations

Earlier in this program, you learned that a corporation isn’t a citizen within the meaning of
Article IV, Sec. 2, of the U.S. Constitution, which declares that “the citizens of each state shall be
entitled to all the immunities and privileges of citizens in the several states.” It has been held ac-
cordingly that a corporation created by one state can’t exercise any of the privileges or functions
conferred by its charter in any other U.S. state, except by the state’s courtesy and consent. A corpora-
tion organized in New York to manufacture and sell agricultural machinery has no vested or constitu-
tional right to transact business in Ohio.
Strictly speaking, U.S. states are foreign to each other in most matters relating to corporate laws.
The ownership of property in any state by a corporation organized in another state is protected under
the provisions of the Federal Constitution as long as it’s legal, just like an individual’s property.
However, a foreign corporation’s right to do business in any state is based upon mere courtesy, and
can’t be claimed as a legal right. If it’s charter doesn’t limit it, it has the power to do business any-
where. But its right to do business in a state other than the one creating it depends on the consent of
the state where it seeks to do business.
Even after the foreign state has granted the corporation of another state a license to do business
there, the license may be revoked at any time without violating any constitutional provision. This is
true even if valuable consideration was paid for the license. As said by the U.S. Supreme Court:
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“A license to a foreign corporation to enter a state does not involve a permanent right to remain.
Subject to the laws and Constitution of the United States, full power and control over its territo-
ries, its citizens, and its business belongs to the state. If the state has the power to do an act, its
intention or the reason by which it is influenced in doing it cannot be inquired into.”
For example, suppose the state of Wisconsin grants a license to a foreign insurance company.
It can require, as a condition to do business there, that the insurance company not move any suit
against it from state court to federal court. It may compel the foreign company to abstain from the
federal courts or cease to do business in the state. This is justifiable, because the corporation has no
constitutional right to do business in the state. The state has authority at any time to forbid the corpo-
ration from doing business within its borders.
The Rule of Comity

It doesn’t follow that because a corporation doesn’t have a constitutional right to do business
in a state other than the state creating it, it can’t do business in other states. It’s permitted to do so
under the principles of comity. In this case, comity means friendship between sovereign states. Under
this rule of comity, a foreign corporation can do business, subject only to certain restrictions. The
foremost of these restrictions is that it can’t act in a way that it isn’t authorized by the charter of its
home state. The second is that it can’t do any act that’s contrary to any prohibitory law or the general
public policy of the foreign state.
In other words, comity permits a corporation to enter another state and do business therein,
provided that it conforms with its own charter and with the public policy of that state. The matter is
summed up clearly in the following excerpt from a court decision:
“It is very true that a corporation can have no legal existence out of the boundaries of the sover-
eignty by which it is created. But although it must live and have its being in that state only, yet it
does not by any means follow that its existence there will not be recognized in other places; and
its residence in one state creates no insuperable objection to its power of contracting in another.
Natural person, through the intervention of agents, are continually making contracts in countries
in which they do not reside, and where they are not personally present when the contract is made,
and nobody has ever doubted the validity of these agreements. And what greater objection can
there be to the capacity of an artificial person, by its agents, to make a contract within the scope
of its limited powers in a sovereignty in which it does not reside, provided such contracts are
permitted to be made by them by the laws of the place?”
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Methods of Exclusion
In order to regulate and restrict foreign corporations doing business within their boundaries,
states usually provide the following:
1. Before doing business in a state, a foreign corporation should appoint someone within
the state to serve summons.
2. When the corporations of one state are excluded by a second state, the first state will
exclude the corporations of the second state. This is called the retaliatory law.
3. Suits against such corporations can’t be removed by the corporations to the federal
courts. While a provision of this kind can’t prevent the removal of a suit to the federal
courts, the state may exclude the offending foreign corporation from doing business
within the state.
Certain penalties are usually imposed for violating these provisions. Much controversy has arisen
as to the validity of contracts made with the corporation that has failed to comply with them. The
weight of authority is that if a penalty is imposed either on the offending corporation or its agent, this
is the exclusive remedy, and the contract’s validity isn’t affected and may be enforced. This is partic-
ularly true when the complaining party seeking performance of the contract is the person contracting
with the corporation, since such a provision is specially designed for his protection. Many cases hold
that if the corporation is compliant, it can enforce a contract made by it before it complies with the
provisions of the state law in reference to its doing business within the state. Other cases hold that if
there’s no penalty and the corporation hasn’t complied with the provisions, its contracts are void and
unenforceable by either party until compliance has been made. This rule doesn’t seem reasonable, as
far as it applies to a contract enforced against the offending corporation. In either case, the state may
exclude the corporation for failure to comply.
The usual restrictions are imposed either (1) to serve the corporation within the foreign state,
such as by compelling it to appoint an agent there to receive service of process; or (2) to compel the
foreign corporation to place information on file that will enable people within a jurisdiction to as-
certain the powers of foreign corporations. In the second method, information must be filed with the
secretary of state or another public officer.
These restrictions only apply where the foreign corporations are actually doing business within
the state. To be within the rule, the corporation must transact some substantial part of its ordinary
business within the state. It must be a continuous transaction of business, not merely casual or oc-
casional.
Right to Engage in Interstate Commerce

The general rule you just read about prevents a foreign corporation from entering and establish-
ing a place of business and exercising its corporate franchises in another state without its consent.
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Yet any corporation, just as a natural person, has the right to engage in interstate commerce without
being excluded or controlled by any state. It’s difficult to determine just what constitutes interstate
or foreign commerce. But, in general, it includes buying, selling, and transporting any commodity
across state or national lines, as well as any person traveling or transmitting intelligence across state
lines. These constituents of interstate commerce can’t be prevented, hampered, or regulated by the
states. A foreign corporation may make purchases through the mail, or it may send its sales people
into other states to make sales or purchases. If the corporation sends goods to fill an order or receives
goods to fill a purchase made across states lines, this is interstate commerce. The Federal Constitu-
tion gives interstate commerce federal control through congress. The state can’t interfere in any way
that would unfairly restrict interstate commerce.
You’ve now finished Lesson 23. When you’re sure you understand the material in this les-
son, complete the examination that follows through the Online Student Center
63
64
Blackstone paralegal studies
P.O. Box 3717

Allentown, PA 18106
EXAMINATION 0123A
LESSON 23
Complete the following examination when you’re sure you understand the material in
this lesson. Then, submit your exam electronically through the Online Student Center at www.
blackstone.edu.
1. Stock that has once been issued but that was surrendered or forfeited is called ______
stock.
A. unissued
B. deferred
C. guaranteed
D. treasury
2. Suppose a corporation has a clause in its charter that it must earn a certain amount of
money within ten years. The corporation doesn’t earn a profit within this time, so it
ceases to exist. This is an example of a(n)-
A. quo warranto.
B. ultra vires act.
C. submission.
D. forfeiture.
3. A rule adopted to govern the internal management of a corporation is called a-

A. proxy.
B. quorum.
C. bylaw.
D. tenure.
65
4. Shares of stock are usually evidenced by a(n)-
A. transfer.
B. certificate.
C. assignment.
D. purchase.
5. A corporation’s profit earned through the use of its capital stock is called a(n)-
A. dividend.
B. trust.
C. interest.
D. aggregate.
6. Which of the following concerning corporate creditors is true?

A. They often control the use of corporate property.
B. They generally possess the same rights as creditors of individuals.
C. They often interfere with the management of the corporation.
D. They can’t object to corporate funds being wasted or misused.
7. A fine or punishment for something wrong that’s recoverable by the state is called
a(n)-
A. enforcement.
B. over-valuation.
C. statutory liability.
D. penalty.
8. Which of the following was not a way that a corporation could be dissolved at com-
mon law?
A. an act of Parliament
B. the forfeiture of its charter
C. the natural death of its members
D. a lack of qualified stockholders
9. A corporation can often do business in a state other than the one it was created in
under the principle of-
A. retaliation.
B. comity.
C. forfeiture.
D. exclusion.
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10. Which of the following is true regarding the ownership of a dividend?
A. The owner of the stock at the time the dividend was declared owns the dividend.
B. The owner of the greatest amount of stock owns the dividend.
C. The corporation’s board of directors owns the dividend.
D. The corporation’s general creditors own the dividend.
11. To join a non-stock corporation, you need to-

A. purchase stock in the corporation.
B. obtain the approval of the existing members.
C. demonstrate a working knowledge of the corporation’s bylaws.
D. have prior experience working in a corporation.
12. Stock issued in excess of the amount authorized is called _______ stock.
A. watered
B. deferred
C. treasury
D. spurious
13. Which of the following is not a type of corporate property?

A. surplus
B. capital stock
C. credit
D. franchise
14. If a corporation enters into an ultra vires contract, this contract-

A. must be executed within a limited period of time.
B. can be interpreted several different ways.
C. is beyond the powers of the corporation.
D. applies to two separate corporations.
15. The number of shares of stock that must be present to conduct business is called a-
A. proxy.
B. quorum.
C. variation.
D. bylaw.
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16. If a stockholder can’t attend a stockholders’ meeting and has someone else attend the
meeting for her, this person is called a-
A. proxy.
B. substitute.
C. stand-in.
D. dilectus personarum.
17. Who ultimately controls the actions of a corporation?

A. the president
B. upper management
C. the secretary
D. the shareholders
18. If the director of a solvent corporation wants to make a personal loan of money to the
corporation, the director should discuss the situation with the corporation’s-
A. creditors.
B. stockholders.
C. president.
D. founder.
19. A corporation’s directors may be removed because of-

A. a difference in opinion.
B. misconduct.
C. inadequate compensation.
D. a change in public policy.
20. “Watered stock” is stock-

A. that has no real value.
B. that extends beyond a fixed limit.
C. for which no payment has been received.
D. owned by more than one stockholder.
68

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LESSON 23

PRIVATE CORPORATIONS – PART II

Program Reviewer: John DeLeo

Editorial Manager: Tracey Vasil Biscontini

Blackstone Editorial/Layout Staff: Moira Fleming, Valerie Behrle B.S., M.E.d.

Copyright © 1988 by Direct Learning Systems, Inc., 2018 Edition

When you finish this lesson, you’ll be able to:

• Tell how a stockholder in a corporation relates to contracts

ULTRA VIRES TRANSACTIONS

Definition of Ultra Vires

Ultra Vires Distinguished From Illegality

Development of the Doctrine

Rescission of Ultra Vires Contract

CORPORATE CRIMES AND TORTS

Development of Corporate Liability

Liability for Torts

Torts Involving Malice

Crimes Involving Malicious Intent

DIRECTORS, OFFICERS, AND AGENTS

Relation Between Corporation and Its Directors

Liability for Unauthorized or Illegal Acts

Effect of Good Faith

Dealings of Directors With Their Corporations

Contracts Between Corporations With Interlocking Directors

Duty Toward the Individual Stockholder

Functions of Corporate Officers

CORPORATE MEMBERSHIP, CAPITAL STOCK, AND

The One‑Person Company

Capital Stock and Capital

Capital Stock Distinguished From Shares of Stock

Nature of Shares of Corporate Stock

Transfer of Shares of Stock

This would be especially true of a corporation operating a cooperative apartment building, in

Effect of Executed Transfer

Provisions of the Uniform Commercial Code

THE RIGHTS OF STOCKHOLDERS

Right to Perform Extraordinary Corporate Acts

Right to Make Bylaws

When Equity Will Decree Declaration

Setting Apart of Specific Fund

Right to Subscribe to New Issue of Stock

Right to Inspect Corporate Books and Records

Right of Stockholder to Sue on Own Behalf

Right of Stockholder to Sue on Behalf of the Corporation

“We understand the doctrine to be that to enable a stockholder in a corporation to sustain in a

Or such a fraudulent transaction completed or contemplated by the acting managers,

Who Can Sue

Relation Between Creditor and Corporations

The Trust Fund Theory

Relation Between Creditor and Director

Relation Between Creditor and Stockholder

Stock Issued for Property

Effect of Transfer of Shares

Forfeiture Clauses in Charters

Abuse or Misuse of Franchise

Effect on Corporate Property

Status of National Corporations

Status of Foreign Corporations

The Rule of Comity

Right to Engage in Interstate Commerce

P.O. Box 3717

3. A rule adopted to govern the internal management of a corporation is called a-

6. Which of the following concerning corporate creditors is true?

11. To join a non-stock corporation, you need to-