Putnam's Handy Law Book for the Layman

Corporations. - There are many kinds of corporations. Those most generally known are business corporations; and though many of them are very large, legally they are private corporations. A railroad corporation, though performing a public service, nevertheless is a private corporation.

Public corporations are formed for governing the people and are often called municipal corporations. They are created or chartered by the legislatures of the states wherein they exist. Formerly, all private corporations in this country were granted charters by the legislative power, and many corporations are doing business by virtue of the authority thus granted to them. More recently general statutes have been enacted whereby individuals may form such corporations without the aid of a legislature. Authority has been conferred on the courts, secretary of state, or other official to grant to individuals, who may apply for them, charters on complying with the requirements of these statutes. There are other kinds of corporations, religious, charitable and the like; only one other need be mentioned, to which the term quasi has been applied. These resemble corporations in some ways, and this is the reason for calling them quasi corporations. A county or school district is such a corporation. The supervisors of a county, or the trustees of a school district, can make contracts, own and manage real estate for their respective bodies, sue and be sued like the officers of other corporations.

By the general comity [courtesy and considerate behavior toward others] existing between the states, corporations created in one state are permitted to carry on any lawful business in another, and to acquire, hold and transfer property there like individuals.

Formerly charters were granted to corporations for a long term of years, or forever. The policy of the law has changed in this regard, and the duration of their existence is limited to a comparatively short period. The life of a national bank is only for twenty years; at the end of that period the charter is renewed, and the charters of the older national banks have been renewed several times. Perpetual charters are infrequently granted, and some of the older ones have been limited by legislative or judicial action. A private corporation had perpetual authority to build and maintain a bridge across the Susquehanna River at Harrisburg, nor could any other company build one within the distance of ten miles above or below. Notwithstanding this clear and exclusive grant, another company was formed which attempted to build a bridge within a mile of the other. The old company tried to prevent by law the new company from building the bridge. The court said that "perpetual" did not mean literally perpetual, but a long time, that the old company had enjoyed its exclusive grant a long time, long enough, and that the new company was justified in its undertaking.

A corporation has no heirs like an individual; it continues through succession, one sells his interest or stock to another, and thus it lives to the end of its charter unless it fails or, through some other event, comes to an end. Suppose a stockholder buys all the stock of the other members, does the corporation still exist? It does for a limited time.

How long?

No court has answered this question. It depends on the particular case. The courts also say, that he can sell his stock to other individuals and thus practically revive a dying corporation. A stockholder who had bought all the stock of a corporation claimed that he should be taxed as a corporation, which was at a lower or favored rate than that paid by individuals. The court said the game would not work, that for the purposes of taxation the concern must be regarded as an individual. So the stockholder knew more after that decision than he did before.


Every private corporation has a capital composed usually of money, which is advanced or [75]paid by its members or shareholders.

Among the reasons for forming corporations two may be stated. It is a way for collecting money from many sources needful for an enterprise; the many contributors are like the small streams that unite and create a great reservoir. The other reason is, the contributors are free from the liabilities that attach to every member of a partnership for its entire indebtedness. A stockholder may indeed, if his corporation does not succeed, lose a part or all of the capital he has contributed, but no more or only a fixed amount, as will be hereafter explained.

Almost anyone can subscribe for stock, with a few limitations. A minor cannot subscribe for stock, nor can his guardian act for him. Doubtless they do subscribe in some cases; the practical difficulties will be shown in another connection. A married woman cannot always subscribe, unless by virtue of a statute. What usually happens when she wishes to subscribe is to act through a friend, who, after the corporation is fully formed, transfers the stock to her. There is no legal stone in the way of such a course.

Sometimes fictitious subscriptions are made to induce others to subscribe for stock. Whenever the fraud is found out an innocent subscriber can do one of three things. If he has paid for his stock, he can bring an action to recover it; if he has not paid, he can refuse to do so, and set up the fraud as a defense. He can do another thing, accept the stock and sue for the damage he has sustained by the deceit that has been practiced on him. The discovery of a fictitious subscriber among the number, after all have subscribed, where his action in subscribing did not affect their action, will not justify them in not fulfilling their obligation to pay for their shares.

The issuing of a share certificate is not an essential condition of ownership. It is merely evidence of it, like the deed of a piece of real estate. All the shareholders of a corporation are the owners whether any certificates are issued to them or not. Of course a stockholder desires to have his certificate for obvious reasons.

Whenever the capital stock of a company is increased, each shareholder has a right to his proportionate number of the new shares on fulfilling the terms on which they are issued before they can be offered to the public. Occasionally a clique seeks to get control of a corporation by the issue of new stock and taking it among themselves. They can be defeated for the courts carefully guard the rights of all stockholders to take their shares of new stock before it can be offered to, and taken by others.

Of late years private corporations have been issuing a kind of stock, called preferred, that must be explained. Formerly such stock was more like a loan of money to a company, and was issued primarily as the most feasible way of getting a fresh supply of money capital. The lenders or takers of the stock received a fixed per cent. on their money, which was paid before the common shareholders received anything. His preference or dividend was not guaranteed, but the probability of regular payment was so strong in most cases that his shares usually possessed a real value. Preferred shareholders are not liable for the debts of their corporations, and the right to vote at any meeting of the shareholders is sometimes given to them, though not always. The tendency of the day is to confer this right on them. Whether, when the amount of [77]the preferred stock is increased, the preferred shareholders are entitled to subscribe for their proportionate amount, like common shareholders, is an open question.

The authority of agents or commissioners to receive subscriptions is strictly regarded. They cannot refuse to receive a subscription made by a competent person, nor release a subscriber, nor vary the terms of subscription to anyone.

A subscription for shares is a contract in writing and cannot be proved by oral evidence unless the original subscription paper has been lost. As the contract is an open one, any subscriber must inform himself of the legal consequences of subscribing, and cannot therefore refuse to execute it on the ground of ignorance or misunderstanding. Suppose an agent who was soliciting subscriptions, in reply to questions concerning the laws relating to the proposed company, should give incorrect answers to a subscriber, these would furnish no ground for refusing to pay, as he has promised to do, for he could have found out what the laws were without inquiring of the agent. This may seem a hard rule, yet it has a wide application. In one sense it is true that every person can find out the law for himself, the books are open, the statutes especially may be easily found, but how many know enough to find the laws in which they are interested?

Of course if a person has been deceived by an agent, if a fraud has been practised on him, he can avoid his contract. Thus a person who, unable to read a subscription paper, was induced to subscribe through misrepresentation of its contents, was not bound by it. If he wishes to act, he must lose no time after discovering the fraud that has been practiced on him. He cannot say, "I will abide by [78]a company if successful, and will leave it if it fails." He must therefore decide at once either to continue his membership or withdraw.

A company cannot purchase its own shares unless by charter or statute such action is clearly authorized. For, to do this is to reduce its assets or fund for paying its indebtedness, which the law will not permit to be done. If a company has no debts, a reduction in its capital made in an open manner in accordance with law, is legal. The tendency of the times everywhere is to increase the capitals of private corporations; reductions though are sometimes made to lessen especially the burden of taxation.

A corporation has no lien on its stock for the indebtedness of the owner unless conferred by charter or statute. Once such a lien could be established by usage or by-law under authority given to a corporation to regulate the transfer of its stock. The national banking law prohibits the creation of such liens, and the strong current of the law runs in this direction. But a bank can retain a dividend that has been declared to reduce the indebtedness of the owner to the bank for his stock.


The liability of the shareholders of a corporation is very unlike that of members of a partnership. It was the liability of each partner for all the debts of a concern that kept many persons from forming that relation. The shareholders of many corporations are liable only for the amount they have contributed and paid, or have agreed to pay. National bank shareholders are liable for another sum, equal to the par value of their [79]stock, provided as much may be needed to pay its debts should the bank fail. Thus if a shareholder owned ten shares, having a par value of $100 a share, he might be required to pay, should the bank fail, $1,000 more provided as much was needed to pay its debts. In a few states shareholders are required to pay twice the amount of the par value of the stock if as much may be needed to pay its indebtedness.

If a corporation fail, one or more persons are usually appointed by a court to settle its affairs, who are called receivers. Several years are sometimes required to settle the affairs of a corporation. First an inventory is made of its property, names of the debtors and creditors, and the amounts due from and to them, and as soon as its property can be converted into cash, dividends are declared and paid to the creditors; and this work is continued until there has been a disposition of all the property, and the amount received therefrom less the expense of the receivership, has been paid to the creditors. When the shareholders are required to pay more, as above explained, on the failure of their corporation, they are notified by the receiver how much and when they must pay. This requirement is based on an order from the court that appointed him, which, in turn, is based on information which he has furnished to the court of the amount that may be needed to pay the debts of the corporation. Several assessments may be ordered, but they never exceed in the aggregate more than the amount of liability fixed by law, the amount or twice the amount of the par value of the stock subscribed. Should shareholders decline to pay these assessments as ordered, the receiver sues them and obtains judgments, the proceeds of which are paid to the creditors.


The power of a corporation vests or rests in its members. The charter and statutes provide that they shall meet, organize, elect officers, and adopt by-laws for the more detailed governing of the corporation. One of the most general principles pertaining to them is, the majority shall rule. This however may be modified by charter or statute. There are a few ancient charters which provide that, notwithstanding the quantity of stock a shareholder may own, he is entitled to only one vote. The writer knows of a case in which a shareholder bought nearly all the stock of a corporation and went to the annual meeting supposing that he could and would do as he pleased. On learning the unwelcome truth that he had only one vote like the others he quickly put on his hat and walked out.

The statutes usually prescribe how notice of the joint meeting shall be given. They are not mandatory, but directory, hence if all the persons in a corporation should come together without any notice or call whatever, and accept the charter, and do any other thing needful to form the corporation, their action would be valid. Where the regulations of a corporation definitely fix the place, the day, and hour of the annual meeting at which the directors are to be elected, no further notice of the meeting to the stockholders is needed unless required by its charter or by-laws.

A case may arise in which other persons than those designated by statute may call a meeting. Suppose a statute prescribes that the persons named in the certificate of incorporation, or any three of them, may call a meeting of the shareholders, and before giving notice all of them had died? Then [81]the meeting could be called by others. Again, authority to create a corporation may fail through long delay in calling a meeting and organizing. Should the notices for the first meeting not be given as the law requires, it is nevertheless valid if the shareholders have notice and join in waiving the mailing of the required notices. Likewise a subscriber waives his notice of the first meeting when he afterwards offers to pay for his shares.

If the by-laws require that an annual meeting shall be held at a particular time, and those whose duty it is to call it, forget to do so, it may be held afterwards, and the officers elected and other business transacted would be as valid as if the meeting had been held at the proper time.

Should the officer who ought to call a meeting refuse to do so he may be compelled by law to call it. This proceeding is called a mandamus, and is issued at the instance or request of the shareholders.

"Besides annual meetings, corporations hold many stated or regular meetings at monthly or other times. Thus if a meeting of proprietors must be called by twelve of them, a call signed by eleven is defective. If a statute requires a committee of a society to sign the call, it cannot be signed by the clerk, nor by him for them. If the trustees of a corporation must issue the call, this cannot be done by the president. If exclusive authority to issue the call is vested in the directors, it cannot be exercised by the president and secretary. If the articles of association provide that meetings of shareholders may be called by the board of directors, or by any three shareholders, the president and cashier cannot issue a valid call. But if a board consists of three members and there is a vacancy, the other two may act and give the notice."

[82]A well understood distinction exists between the calling of regular and special meetings. Regular meetings are held in the way set forth in the charter and by-laws of a corporation; special meetings are called at irregular times on proper authority. A notice for a special meeting must state the object of it, and no other business can be transacted. On the other hand unless the regular meeting is of great importance no mention need be made of its object in the notice.

An authorized meeting may be adjourned from time to time without giving further notice, for it is only a continuation of the original meeting. Says an eminent judge: whether a meeting is continued without interruption for many days, or is adjourned from day to day, or from time to time, many days intervening, it is evident that it must be considered the same meeting.

A meeting may be legally held though one of its members is incapable, physically or mentally, from receiving notice. "The law cannot look into the capacity of the stockholders to transact business, but can only regard the capacity of the aggregate body when duly assembled." On the death of a stockholder, the purchaser, if the stock has been sold, should have it transferred, or give distinct notice to the company how notices of its meetings should be sent to him; if neglecting to do this, he cannot charge the corporation with neglect should it continue to send notices to the former address.

Two other points may be mentioned concerning notices. One is, they may be waived and this is often done. Many a question though arises, what action amounts to a waiver of notice. If each shareholder attends in person or by proxy and participates in the meeting, he cannot afterward question [83]its legality because he received no notice of it. An improper notice may also be cured by ratification. Thus if a secretary calls a meeting instead of the directors, and his action is properly ratified by them, the call is effective. More generally, the action of a meeting will be declared valid where it appears that every stockholder who did not participate in the meeting ratified its action afterwards. An election of trustees of a church may be valid even though the notice lacked the proper length of time and the names of the trustees whose seats became vacant at the election, if it was fairly conducted and all who had the right to vote were present. Likewise a stockholder who knows of the sale of his railroad, though not legally notified of the meeting which authorized its sale, and was not present, may be bound by its action through acquiescence. And a stockholder who, after receiving notice of a meeting called by the directors to consider their neglect of duty and who decides not to go, is not thereby prevented from taking action against them by the stockholders who did attend and authorized their unauthorized action. Lastly a stockholder who was present cannot complain that notice was not given to others; the objection is personal.

Next we may inquire, who can vote at such meetings? Unless prevented by charter, statute or by-law a stockholder may vote at any corporate meeting even though no certificate of stock has been issued to him. Nor does his indebtedness for his stock prevent him from voting. On the other hand if inspectors were not bound by the record of ownership in the company's books and went behind them to find out the real ownership of the company's stock, they would often have a grave task before them. Consequently in many, perhaps all of the [84]states, only stockholders or those holding proxies for them can vote at a general election. By statute the stock record of ownership is usually made the conclusive test of the right to vote. Stockholders who thus appear on the stock books at the date of a meeting are entitled to vote the stock.

A trustee is the legal owner of stock standing in his name and may vote the stock for all purposes; but a testator may impose limitations on his voting power. Should trustees under a will holding a majority of the stock of a corporation disagree, and one of them should be enjoined from voting it, a minority stockholder would be entitled to an injunction to restrain the other trustee from holding an election or voting the stock alone until the right to vote the stock had been legally decided.

A different rule applies to a naked trustee who holds the title to the stock without any real interest in it. He can indeed vote, but in the way directed by the beneficiary or real owner. In Colorado, by statute, perhaps in some other states, a person to whom stock has been issued as trustee without the knowledge of the owner, is not a bona fide stockholder and cannot vote.

An executor has the power to vote the stock of his testator. And if one of joint executors issues a proxy authorizing the vote of the stock belonging to the estate, and the other executor is present at the stockholders' meeting, the vote of the stock by the executor who is present is deemed a revocation of the proxy given by his co-executor. And if a will gives to one of three executors the power to vote the stock, and directs the other two to give him a proxy for that purpose, which they decline to do, a court will order the proxy to be given. And whenever stock is held by executors who are not united in [85]voting it, they cannot vote at all. A foreign executor should present to the inspectors of election an exemplified copy of his letters of administration, and having done so may vote on the stock standing in the testator's name. An administrator has the right to vote stock belonging to the estate, even though it has not been transferred to him in the corporation's books.

A partner of a firm who owns stock in a corporation may represent the stock in all meetings. He may therefore receive and waive notice of them, vote when attending them, in short, participate in all matters. And on the death of a partner the surviving partner has the right to represent the partnership and vote on its stock.

Two other kinds of stockholders still require mention, sellers and purchasers of stock and pledgors and pledgees. Until a transfer is entered on the books of a corporation, "the transferee, as between himself and the company, has no right beyond that of having the transfer properly entered. Until that is done, the person in whose name the stock is entered on the books of the company is, as between himself and the company, the owner to all intents and purposes, and particularly for the purpose of an election."

Many questions have arisen between pledgors and pledgees about their rights to vote the pledged stock. Of course, whenever an agreement has been made by them this must be respected. In other cases, if the record remains unchanged, the pledgor can vote the stock. But if the pledgor has transferred his right to vote the stock, he cannot ask a court to restore his right to vote it until the purpose for which it was pledged has been satisfied. Again a pledgor who pledges his stock not in good faith as [86]security for a loan, but to enable the pledgee to vote it and effect an unlawful purpose, cannot do this and so defeat a statute which provides that the real owner, the pledgor, may vote his stock.

Passing to the pledgee, whenever he is registered as owner of the stock on the company's books, its officers will not look behind these to ascertain whether he is the real owner or not when he is voting his stock. A court of equity though may do this, and enjoin a pledgee from voting the stock whenever the pledgor's rights would be affected. Should the pledgor acquiesce for years in the control of the stock by the pledgee, who is the record owner, and not inform the company of his ownership until the holding of a contested election, he would be too late to claim the right to vote. Finally when a certificate of stock has been assigned in blank as collateral security, which is often done, and never transferred to the pledgee on the books of the corporation, a memorandum only having been made on the stub of the certificate in the stock book, the pledgee is not a stockholder and cannot vote the stock. It may be added that notices of meetings should be sent to whoever has the right to vote the stock, to the pledgor if the stock still stands in his name, to the pledgee if the stock has been transferred to him and stands in his name.


Shareholders manage their corporations through directors or trustees elected for that purpose. The business of some corporations is managed by trustees who are named in the charter and who fill vacancies in their number by electing others themselves, a self-perpetuating body. Many [87]savings banks especially are thus organized and continued. From their number they usually select a smaller number to manage or direct its affairs.

The directors are always shareholders, unless the charter of a corporation permits the election of outsiders, a thing that rarely happens. The national banking act requires that every director shall own at least ten shares of stock, and many other corporations have similar requirements. The charter or statutes prescribe at least the minimum number that must be elected, but the maximum number is left to the stockholders themselves. A national bank must have five directors, not infrequently the board is composed of ten, fifteen, or even more. A director is chosen for some real service that he is likely or willing to perform. An individual may be chosen a bank director who may not be able to do much in directing the affairs of the bank, yet by reason of his wealth or business relations he may be able to attract business to the bank and thus greatly promote its prosperity.

He is elected by a majority of the votes of the shareholders. More recently the cumulative system of voting has come into general favor. By this system a voter may cast as many votes for each of the candidates as he holds shares of stock, or he may distribute or cumulate his votes on a smaller number. "Where the votes under such a system are cast and counted, the validity of the election must be determined precisely as in all other cases." Where the shareholders have failed, whether voting cumulatively or otherwise, to elect a quorum of the new board, at an annual meeting of stockholders, it is the privilege of the shareholders to ask for successive voting for directors to fill the board. The ruling of a chairman on one occasion, that because [88]of a tie further balloting could not proceed, and that the old board held over was arbitrary and illegal. A stockholder who has votes enough to elect himself and other directors by cumulating his shares in voting, but refrains from doing so in consequence of a verbal agreement among the stockholders that he shall be chosen president, which they fail to carry out, cannot obtain any satisfaction from a court. A court says in effect stockholders should not be trusted to make such agreements, and will not aid the tricked stockholder by ordering a new election. Probably he will be fooled only once.

Having elected directors, the management of a corporation is confided to them. What authority do they possess? This is defined by charter, statute, by-law, and custom. Says Morawetz: "The rule limiting the authority of the power of the majority to the general supervision of the affairs of the corporation is established for the protection of the individual shareholders, as well as for reasons of practical consequence." Directors also have wide discretion in delegating their authority. Their rights and limitations in this regard are also bounded by charter, by-laws and usage. Formerly bank directors loaned the money of their bank; this was their most important duty. Of late years, especially in the larger cities, this business has been largely delegated to a committee, chosen from their number, or to two or three officials of the bank. The directors continue to meet, very much as before and at their meetings the action of those who have been entrusted with power to lend the bank's money is ratified. More and more authority to direct or do the greater things in a corporation are concentrated in the hands of a smaller number of individuals. Time is ever becoming a more important element, a [89]smaller number of men can act more quickly than a larger number, and so business must be more and more concentrated to be done efficiently.

A director has no authority to act separately and independently. Only as a board, properly convened, does he represent his corporation. While this is the law, he can and does in fact often act singly, and his action becomes effective to bind his corporation by ratification. Such action plays a great part in the modern corporation.

Though a principal may at any time, as a general rule, revoke the authority he has given to an agent, this does not apply to the directors of corporations. Says Morawetz: "The majority of the board clearly have no power to expel an individual director, or to exclude him from inspecting the company's books and participating in its management, although they may believe him to be hostile to the interests of the association." A president or other official is chosen pursuant to the charter to serve for a year or other period, and is simply an agent in serving the corporation, he cannot be turned away like an ordinary agent. If he conducts fraudulently, he may be removed, but this is not an easy process as corporations long ago found out.

Directors in most cases receive no compensation though the practice is growing of rewarding them. Unless this is fixed by charter or by the stockholders they can get nothing, for they cannot legally vote salaries to themselves. A director who performs a different service, serves as an attorney, for example, may receive compensation for it. This is a salutary rule of the law, which the courts everywhere do not hesitate to enforce. By another rule, hardly less important, directors cannot bind their corporation by any contract made with themselves, or represent [90]their corporation in transactions wherein they have an interest. This is only another application of a rule of agency, that an agent cannot act at the same time for both parties. Yet there is increasing difficulty in applying this rule because the business of corporations has become so intermingled, and also the business of directors, directly or indirectly, with that of the corporations they represent. From this state of things has come another rule, that the transactions between directors and their corporations are not actually void but voidable, in other words if they are tainted with fraud, they can be set aside provided proper action is taken as soon as the fraud is discovered.

Suppose directors had defrauded their corporation, but the fraud was not discovered until several years afterward. Once it was held that they could shield themselves behind the Statute of Limitations (see Statute of Limitations) if the discovery of the fraud did not occur until after the Statute had become effective to protect them. This is no longer the law. Action however must be begun against them within the proper time after discovering the fraud, otherwise the Statute may be interposed as a bar to proceeding against them.

The complication of business has led to the adoption of another principle in managing corporations. A majority of the directors may lawfully act as opposed to the minority; in other words if a majority are not interested in a matter that concerns one or more of the minority directors, the interests of the corporation are supposed to be properly safeguarded. Yet an illustration discloses the dangerous character of this method of doing business. Suppose each director of a bank wished to obtain a loan of money from it. They could not legally make such loans, [91]for no one would represent the bank. Suppose a single director made such an application, that would be a proper thing for him to do and for them to grant, for the bank would be represented by all the directors except the applicant. Suppose it were agreed in advance that each would make an application at different meetings that should be favorably regarded, the series of loans would be in fact only a single transaction in which the bank was not represented.

The knowledge of a director or other officer is imputed to, or regarded in the law as known by the bank on all matters relating to it. Thus if a director knew that a note was signed by a minor which was afterwards presented for discount at a directors' meeting at which this director was present, and he forgot to tell the directors what he knew and it was discounted, the bank would be regarded as having knowledge that the maker was a minor, who of course could not be held on the note. This principle has a very wide application, yet is very difficult to apply. The tendency of the law is to narrow the application of the rule, for directors do not in many cases impart their knowledge, either through forgetfulness or other cause, and it is not just to hold their corporation always for their unintentional neglect. Often they are busy men, have greater interests of their own, and do not remember the things they learn about matters relating to their corporation, and if it were always held as knowing as much as they do on all occasions, the way of a corporation would be fraught with a grave peril.

A proper distinction is made in the imputation of knowledge between that of a bank director for example who is engaged chiefly in some other business, and that of its president whose chief [92]employment is the management of his bank. Suppose he should learn about a defective note before it was presented for discount, the bank would be very properly charged with his knowledge, because it would be his clear duty to remember what he had learned and impart it to his fellow directors.

Directors sometimes go astray and cases are constantly arising to determine their liability. When a corporation has failed or passed a dividend nothing is more common than to accuse its directors of negligence, incompetence or fraud. The legal rule of liability is quite a different thing. Let us try to give this in the fewest words possible. The charters of corporations, or statutes that apply to directors, prescribe some definite things which they must do or not do, and if these are violated they are clearly liable. The directors of a bank are required to make a statement of its affairs to a government official at a stated period, and if they neglect to do it, or intentionally make a wrong and deceptive one, they are liable. By many statutes they are forbidden to make loans above a certain amount, or a fixed proportion of their bank's capital, and if they violate this plain law they are liable. In all other cases where by charter or statute a plain rule of duty is prescribed for directors, they are liable, should they disregard it.

Besides these clearly defined lines of duty are other lines of duty in which the proper course of action is not so clearly defined, indeed is largely discretionary. From the nature of the business of almost any kind of corporation, it is impossible to prescribe in detail the course of action directors must follow. Much must be left to their judgment. They must on all occasions be honest and free from fraud. This is one limitation. If they are guilty [93]of doing things tainted or marked with fraud, they are liable. Fraud may be of two kinds, omission and commission. If a director knew that his fellow directors were doing fraudulent things, and he kept away from directors' meetings because he did not wish to participate in their wrongdoing, or dared not go and try to stop them, or kept silent when he should have exposed them, he must suffer in the end as one of the number though entirely innocent of actual participation in the fraud. Many a director knowing or suspecting with good reason that his fellow directors were running the corporation in an illegal manner, has quietly sold out leaving the stockholders to find out afterwards and from some other source about the wrongdoing of their agents. In all such cases of omission of duty a director is held responsible for the wrongs of his associates.

Recently a court has declared that a director who desires to escape further responsibility by resigning his position must make sure that his resignation reaches the board. If therefore he should send it to the secretary, who failed to deliver it to the board, his resignation would not be effective and he would still be responsible like the other directors for whatever the board might do.

What acts are fraudulent are sometimes difficult to determine. Different courts interpret the same act sometimes in different ways. They do not differ so much on the application of the principle—for all acts of fraud, whether of omission or commission, directors are liable.

There is another series of acts for which they are liable, those of gross negligence. How gross must the act be? If it is so gross as to amount to a fraud, they are liable; if not so gross, if no fraud is found of any kind, nothing but negligence pure and simple, [94]they are not liable at all. Most courts though go further and declare that if they are guilty of gross negligence, even though the smell or taint of fraud is not perceptible, they are liable. What, then, is the nature of the acts that constitute gross negligence? These cannot be easily defined, they differ in each case; so each case stands by itself. This is the conclusion of the highest court in the land and which is followed by many others. The same case therefore may be regarded differently by different tribunals. Thus some directors were tried not long since for wrecking a national bank. The lower court decided that all the directors were guilty of gross negligence, on appeal the reviewing court decided that the president only was guilty of fraud and acquitted the others.


One of the most cheerful things a corporation can do is to declare a dividend, especially if it be a large one. Until a dividend is declared the profits of a corporation are simply its assets, do not belong to the stockholders, and should it become insolvent must be used to pay creditors. But if a dividend has been declared and the corporation afterwards becomes insolvent before paying it, the stockholders may insist on its payment to them instead of paying it to the creditors.

Dividends must be paid from net profits. They can never be taken from the capital, for this would impair it and, if continued, result in the insolvency of the corporation. The laws everywhere forbid this, and, if violated, the directors are usually penalized. It is not an infrequent thing to declare a dividend that has not been earned in order to keep [95]up the value of the stock, and enable the directors and their friends to sell out before the true condition of things has become public. Such action is a palpable fraud which the law recognizes and for which the guilty ones must answer.

Nor can dividends be declared out of borrowed money, for this is no profit, though money may be temporarily borrowed for this purpose. A profit may have been actually made, which may not have been reduced to money, that will justify a corporation in borrowing to pay a dividend, assured that the loan will soon be repaid. But the rule or practice is hedged about with limitations. Thus the premiums received by an insurance company and interest on its capital stock constitute the fund from which dividends are paid. Unearned premiums that have been paid do not form a part of that fund, for, while the risk is still running, the company may be obliged to pay them out in settling losses.

The profits of coal and other mining corporations may be divided without making any deduction for decrease in the value of the mine from extracting minerals. The same principle applies to all corporations organized to operate wasting property like a mine or patent, though in thus dividing all its net profits and accumulating no surplus the value of the property is lessened. Except such cases, before a corporation can lawfully set apart its profit as a dividend, a sufficient sum must be set aside to represent the wear and tear for the purpose of creating a fund to renew and improve the property of the corporation.

Dividends illegally declared and paid, not based on profits may be recovered either by the corporation or by its representative for the benefit of creditors. The fact, says Clark, that the directors [96]acted in good faith under a misconception of the amount of profits possessed by the company or that were available for that purpose is immaterial. And if the capital stock of a company has been wrongfully paid away by the directors as dividends, it may be recovered by the creditors from anyone who is not an innocent receiver.

Whether a dividend shall be declared, and also the amount, are questions lying largely within the discretion of the directors. A company may earn a large net profit, yet the directors may think it should be used for improvements or kept for a future contingency in business, perhaps a time of business depression. Courts will not interfere in such cases. Corporations are sometimes organized with the well understood intention that the earnings shall be kept until a large surplus has been accumulated. On the other hand directors are not permitted to abuse their power; they must act in good faith. They cannot withhold dividends in order to depress the value of the property and buy its stock at a lower price.

Dividends must be distributed among the stockholders without unjust discrimination. "The dividends," said a court, "must be general on all the stock so that each stockholder will receive his proportionate share. The directors have no right to declare a dividend on any other principle. They cannot exclude any portion of the stockholders from an equal participation of the profits of the company." A stockholder cannot be deprived of his dividend because he purchased his stock a very short time before the action of the directors in declaring a dividend. On one occasion a person held bonds convertible into stock. Shortly after the conversion a dividend was declared. He was as [97]much entitled to his dividend as any other stockholder.

To whom should the dividend be paid? To the person whose name appears as owner on the books of the company. But if a company has notice of a transfer of stock, a dividend subsequently declared should be paid to the purchaser even though the transfer was not registered. In pledging stock it is a common practice to declare that the pledgee shall be entitled to the dividends that are declared. If nothing is said, and the stock has been transferred on the books of the company, the pledgee is entitled to the dividends following the general rule above mentioned.

A dividend may be payable in cash or property or a stock dividend may be made. Such a dividend, if the stock is issued only to the extent of the surplus profits, is not a violation of the prohibition against reducing or withdrawing the capital stock by distribution among the stockholders.

During recent years some important questions have arisen about dividends or income on stock given by will to the legatees or friends of the testator. Dividends that are declared after a grant or bequest, though earned before, go to the legatee as income. This is not the rule everywhere. In some states the surplus profits accumulated during the testator's life, though not divided until after his death, belong to the estate, while the dividends or income earned and declared after his death are paid to the legatee or beneficiary mentioned in the will. Again, a somewhat different rule applies to stock dividends. In some states these are regarded as an increase of capital and must be kept as a part of the estate; in other states such stock is regarded simply as another form of income and goes to the legatee [98]like any other income flowing from the investment. The highest federal court has declared that when a distribution of earnings is made by a corporation among its stockholders, the question whether such distribution is an apportionment of additional stock representing capital, or a division of profits and income, depends upon the substance and intent of the action of the corporation, as manifested by its vote or resolution; and ordinarily a dividend declared in stock is to be deemed capital, and a dividend in money is to be deemed income of each share.

A will bequeathed stock in a corporation in trust to pay the dividends as they accrued to a daughter of the testator during her lifetime. Stock dividends were declared by the corporation from time to time and after the death of the testator, and these accumulated earnings were invested by the company in permanent works. After the testator's death the corporation was authorized by statute to increase its capital stock. The dividends were held to be accretions to the capital, and the income only was payable to the daughter for life.


Passing from the action of directors in declaring dividends, the wrongs done by corporations may be stated. As it is an impersonal, artificial thing, a corporation cannot possibly commit a wrong or tort like a natural person. For many years this conception of a corporation, that it could not commit many of the well-known wrongs, could not slander a person for example, led to perplexing consequences. Finally the principle was established that through its agents or servants a corporation could do wrong quite like an individual. Thus a [99]corporation may be guilty of malice, and may be punished for slander or libel, for a malicious prosecution, false representation, for trespass should its agents unlawfully enter on the land of another, for maintaining a nuisance and the like. A national bank is forbidden to certify the check of a depositor unless he has the amount of money stated in the check in the bank. And if this is done the certifying official and all others who participated with him in disregarding the law are made criminally liable, and on several occasions the law has been enforced.

Again, a corporation is liable for the negligence of its servants in performing their duties, and are constantly sued for their failures. A railroad company is sued for injuries to its passengers caused by the improper running of its trains; for its failure to carry and deliver freight in accordance with its obligations or agreements. Street railways are constantly sued by passengers who are injured through the negligence of its officials.

By statutes corporations are required to do many things and, if they fail, are liable for the consequences. These duties may be divided into two classes, those toward the public and those that affect their stockholders. Their public duties may again be divided into those that are imposed on them by statute, and a still larger number by the common law. As we have seen, stockholders confide necessarily the management of their corporation to directors, who in most cases must necessarily have a largely discretionary power, and who, in turn, must appoint other agents to execute the details of the corporate business. These not infrequently fail through incompetence or neglect to perform their duties properly, and consequently corporations are subjected to lawsuits in which [100]redress is sought by the injured parties. Some of these wrongs for which they are liable to the public have been mentioned, it would require too much space to mention all.

The injuries done to stockholders by their directors remain for consideration. Unless directors are restricted by action of the stockholders at a stockholders' meeting, they have the authority prescribed by charter and statute; outside these, their authority is largely discretionary, and must be so. If, therefore, stockholders are dissatisfied with their directors, as they often are, their remedy is to elect others at the end of their term of service. If at the time of choosing them, the annual meeting, none are chosen, the directors hold over until they are again elected, or others are chosen in their places. After they have been chosen, no stockholder can interfere in any way with their discretionary authority unless he has a clear case calling for judicial action. "Until a mistake," says Morawetz, "on the part of the directors, individual stockholders have no right to appeal to the courts to define the line of policy to be pursued by the company. The courts therefore are quite unanimous in sustaining the action of directors so long as they act within the discretionary authority given them."

Occasions happen when the removal of directors is essential to the welfare of a corporation. Suppose they are pursuing a course clearly ruinous to the company? In such a case the court will grant relief on the request of the stockholders whenever the corporation itself is unable or unwilling to do so. Primarily the corporation should proceed against the directors, for the wrong is a corporate one. In many cases the corporation is so completely in their control that the stockholders are unable to do [101]anything through it. In such case they must act in the name of, and in behalf of the company. And if they succeed in establishing their case, the courts will order the removal of the directors.

Sometimes the courts, instead of going so far, will enjoin them from doing wrongs that are feared. Suppose it is feared that directors will declare a dividend that has not been earned, the courts on proper proof would enjoin them from making it. Suppose it is feared they will issue more stock and divide all the shares among themselves instead of proportionately among all the stockholders as the law requires, in order to get control of the company, a court would not hesitate to restrain them.

Lastly may be considered a stockholder's rights to inspect the books of his company. This he may do at all proper times and for reasonable purposes. And if the right is refused the courts will aid him in making an inspection. What then is a proper purpose that justifies him in making the request? He cannot do so to satisfy some freak, or to annoy an official with whom he may be on bad terms. Nor can he do it to obtain information to be used for stock-jobbing purposes. Suppose he has reason for supposing that the books were falsified, that the stockholders were not receiving correct accounts of the expenditures and earnings of the company, a stockholder would certainly have a right to make an examination, and could also employ an agent, attorney, or expert accountant to do this for him, for his ignorance of bookkeeping methods might debar him from making an efficient examination were the right confined exclusively to himself.


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Do It Yourself Legal Forms
Law for the Laymen - Corporations
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