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Protecting Your Rights as a Shareholder
If you are considering purchasing shares in a company, do you understand the potential risks as well as the perks? What are the rights and privileges of a shareholder? And how do you protect these rights once you have them?
Before becoming a shareholder, review the certificate of formation, bylaws, and any shareholders’ agreement carefully with the help of a lawyer. A closely held company should have a written shareholder’s agreement in addition to bylaws.
These documents typically provide several essential details on the following topics:
- Mission or purpose of the company and how it will be run
- Duties the company has to its shareholders
- Duties the shareholder has to the company
- Roles and rights (including voting rights) of each shareholder
- Process for resolving disputes among shareholders
- Process for buying and selling shares of the company
- Impact and process for handling the incapacity, death, or divorce of a shareholder
Because a shareholders’ agreement impacts your rights and obligations as a shareholder and how you can exit the company, you must review the terms carefully and ask questions about anything you do not understand.
Reading and understanding the bylaws and shareholders’ agreement is just the beginning of your work. Protecting your rights as a shareholder involves staying informed, communicating effectively, and knowing when to take action. The following is a list of things you can do to protect and preserve your rights as a shareholder.
Know the Company’s Purpose & Who is on the Board
Make sure you understand the overall purpose of the company and identify its short- and long-term goals. Because shareholders rely on the officers and directors to make day-to-day decisions for the company and propose major decisions, it is important to know who is leading the company. What are the names and backgrounds of the officers and directors? What experiences do they bring to the company? What potential problems could they bring with them?
Understand the Duties of the Board, Officers, & Directors
The primary duties of a board of directors to its shareholders are the duty of care, the duty of loyalty, and the duty of obedience. The duty of care means that the persons in charge of the company owe a duty to the shareholders to ensure good and prudent use of the company’s assets, people, and goodwill. The duty of loyalty means that the governing board must make decisions that are in the best interests of the company, rather than the best interests of an individual board member. The duty of obedience is the duty to abide by the company’s bylaws, as well as applicable laws and regulations.
Understand Your Rights as a Shareholder
Shareholders retain certain rights within the company (although they can often be limited or modified by contract). First, shareholders have the right to vote (except for non-voting shares) and to attend meetings. Shareholders are usually allowed to vote on major decisions affecting the company such as the board of director positions and other changes in leadership and potential buyouts or mergers. Second, shareholders have a right to pro-rata ownership of company assets and the right to dividends, or the right to a portion of the profit that the company pays out. Third, shareholders have a right to transfer their ownership to another person or entity. Fourth, shareholders have a right to inspect the books, records, and other corporate documents of the business. This is an important right, and shareholders should assert this right by asking to see the bylaws, the minutes from board meetings, and the annual reports. Fifth, shareholders have a right to sue when the company has done something illegal or contrary to its bylaws. Usually, the right to sue will involve a class action suit.
Communicate & Attend Meetings
Shareholder meetings are held annually and often periodically throughout the year. Notice of meetings is provided to inform shareholders of the place, time, and manner of the meeting. Attend the meeting and review any agendas and action items. Review any proposals to amend the bylaws, as well as the company budget, balance sheet, or annual plan. Ask questions and understand not only the purpose of proposed changes but also the potential risks and rewards. If something raises a red flag at the meeting or you suspect decisions are being made that are not in the company’s best interests or are illegal, seek legal advice.
Know When to Take Action
When should a shareholder consider filing a class action suit? Since the board of directors owes duties of care, loyalty, and obedience to its shareholders, a breach of any of these duties is grounds for a lawsuit. Some common examples that could be grounds for seeking legal counsel to assert the shareholder’s rights are the improper withholding of dividends, excessive compensation paid to directors, unfair business dealings with others at the expense of the company, and interference with shareholders’ voting rights.
Becoming a shareholder in a company comes with certain rights and responsibilities. Being an informed shareholder will help you spot potential risks in advance and minimize your exposure. If you need help understanding corporate documents or are concerned about the actions of your board of directors, we have a team of lawyers able to assist you—from contract interpretation to litigation.