How Corporations Are Governed

A corporation is a separate legal entity that acts through people. Shareholders own it, the board of directors oversees it, and officers run it day to day. Corporate governance describes the rules and relationships that keep these groups accountable to one another. Paralegals who assist with corporate law prepare minutes, resolutions, annual reports, and shareholder notices, so exam questions on this topic reflect real tasks you will perform.

What Is the Role of the Board of Directors?

The board manages or directs the management of the corporation's business and affairs. Directors set strategy, select and oversee officers, declare dividends, approve major transactions, and ensure compliance with law. Directors typically act as a body at a properly noticed meeting with a quorum, or through unanimous written consent where the statute allows. An individual director generally has no authority to bind the corporation acting alone.

Shareholders elect directors, usually at the annual meeting. Many statutes allow cumulative voting, which helps minority shareholders gain board representation, and staggered boards in which only a portion of directors are elected each year.

What Fiduciary Duties Do Directors Owe?

Directors owe fiduciary duties to the corporation and its shareholders. The two central duties are:

Duty of care: Directors must act in good faith, with the care an ordinarily prudent person would use in a similar position, and in a manner reasonably believed to be in the corporation's best interest. This includes attending meetings, reading materials, asking questions, and relying reasonably on experts and officers.
Duty of loyalty: Directors must put the corporation's interests ahead of their own. This duty addresses conflicts of interest, self-dealing transactions, and usurping corporate opportunities.

Many jurisdictions also recognize a duty of good faith and a duty of oversight, requiring directors to make a good-faith effort to put a reasonable reporting system in place and to respond to red flags.

What Is the Business Judgment Rule?

The business judgment rule is a presumption that directors acted on an informed basis, in good faith, and in the honest belief that the action served the corporation. Courts will not second-guess a decision that turned out badly if the process was sound. A plaintiff can overcome the presumption by showing fraud, illegality, conflict of interest, bad faith, or gross negligence in the decision making process.

The rule protects honest mistakes but not self-dealing. If a director has a conflict, the burden shifts to the director to prove the transaction was fair to the corporation, or that it was approved by disinterested directors or shareholders after full disclosure.

What Are Common Loyalty Issues?

Exam questions often feature the following:

Interested director transactions: A contract between the corporation and a director is not automatically void. It can stand if approved by disinterested directors with knowledge of the conflict, approved by shareholders, or shown to be fair.
Corporate opportunity doctrine: A director may not take for personal gain a business opportunity that the corporation has an interest or expectancy in and is financially able to pursue, unless the corporation first rejects it after disclosure.
Competition with the corporation: Directors and officers generally may not compete with the company while serving.

What Do Officers Owe the Corporation?

Officers owe duties of care and loyalty similar to those of directors and also act as agents of the corporation. Their authority is actual (express or implied) or apparent. Officers such as the president, secretary, and treasurer carry out board policies and sign contracts, and the secretary typically maintains minutes and records.

What Rights Do Shareholders Have?

Shareholders do not manage the business, but they hold important rights, including:

Voting rights: To elect and remove directors and approve fundamental changes such as mergers, sales of substantially all assets, amendments to the articles, and dissolution.
Right to inspect books and records: Shareholders may inspect certain records for a proper purpose, such as investigating mismanagement, after written demand.
Right to receive dividends when declared by the board. Shareholders cannot compel a dividend unless the board abuses its discretion.
Preemptive rights: In some states, the right to purchase new shares to preserve proportionate ownership, if the articles provide for it.
Appraisal rights: The right to demand a court-determined fair value for shares and exit when the corporation undergoes certain fundamental changes over the shareholder's dissent.
Right to sue: Directly for harm to the shareholder personally, or derivatively on behalf of the corporation.

What Is a Derivative Suit?

A derivative suit allows a shareholder to enforce a corporate claim when the board refuses to act. Because the corporation is the real party in interest, any recovery goes to the corporation. Requirements generally include that the plaintiff was a shareholder at the time of the wrong, makes a pre-suit demand on the board (or shows demand would be futile), and fairly and adequately represents the corporation's interests. Courts typically require court approval for settlement or dismissal. A direct suit, by contrast, addresses harm to the shareholder individually, such as denial of voting rights.

How Does Limited Liability Fit In?

Shareholders are generally not personally liable for corporate debts beyond their investment. Courts may pierce the corporate veil when the corporation is an alter ego of its owners, undercapitalized, or used to commit fraud, and when formalities such as separate records and meetings are ignored. Maintaining proper corporate formalities is a core part of a paralegal's job for that reason.

What Do Corporate Paralegals Actually Do?

Typical tasks include preparing notices of meetings, drafting board and shareholder resolutions, maintaining minute books and stock ledgers, tracking annual report deadlines with the Secretary of State, and assisting in due diligence for mergers and financings. Accuracy and timing matter, since defective notice can invalidate an action.

Study Notes

Create pairs when you study: care versus loyalty, direct versus derivative, interested director versus disinterested approval. Our corporate law flashcards help you memorize these distinctions. Sign up for free to try practice questions, and visit the pricing page to see what the full exam prep package includes.

Corporate Governance: Board Duties and Shareholder Rights