Management & Control — Business Associations

Dana is president of Columbia Robotics, and she just signed a $150,000 supply contract. The bylaws are clear. Any single contract over $100,000 needs prior board approval. She never got it. The supplier had no idea the cap existed. Is Columbia bound?

Very likely yes. Which is a strange result for a topic that is mostly about reading documents, so hold on to it. This episode is about who holds which power in a corporation and in an LLC, and almost every question runs the same two steps. State the default rule. Then find the document that changes it.

Here is the route. First the three corporate actors. Then shareholders, their votes, and their meetings. Then directors and how a board actually acts. Then officers and the authority to bind. And finally LLCs, where the operating agreement does the work.

Corporate governance is a representative democracy, and lawyers call the design the separation of ownership and control. Shareholders own the company but do not run it. They elect directors. The board sets policy and oversees the business, and under the Model Business Corporation Act, the MBCA, all corporate powers are exercised by or under the authority of the board. The board appoints officers, who run day-to-day operations as agents.

Keep that chain straight, because two corollaries get tested. A shareholder acting as a shareholder cannot manage or bind the corporation. And a single director acting alone has no power either, because the board acts only as a body. This is an unstarred topic, so the exam may hand you the articles, the bylaws, or the operating agreement and ask you to apply it.

Start with shareholders, whose ownership is mostly about control and money rather than management. Their power comes in three flavors. Voting rights choose the board and approve big changes. Economic rights bring dividends if and when the board declares them, plus a share of what is left on dissolution. And informational rights allow inspection of the books.

Ownership is sliced into shares, and the articles define the classes. Common stock is the residual owner. It carries the vote, takes dividends if declared, and gets whatever remains after creditors and preferred holders. Last in line, unlimited upside. Preferred trades that upside for priority on dividends or on liquidation, often with no vote.

Four preferred labels recur. Cumulative, where skipped dividends accrue and must be cleared before common gets anything. Participating, which takes its preference and then shares again with common. Convertible into common. And redeemable, meaning the corporation can buy it back. Blank check preferred lets the board set the terms of a new series without a shareholder vote, if the articles allow.

One old trap deserves a word. Watered stock. Historically shares carried a par value, and issuing below it left the shareholder personally liable for the gap. The modern MBCA abolishes mandatory par and makes the board's judgment on the adequacy of consideration conclusive. But Delaware still uses par, so if a problem gives you par and an issue below it, watered stock is live.

Now the first big opt-in. Preemptive rights are a right of first refusal to buy a proportional part of a new issuance, so your slice does not shrink. Here is the exam-critical default. Under the MBCA there are no preemptive rights unless the articles provide for them. Delaware is the same. The default is no protection at all.

Even when granted, the right has holes. It commonly does not reach shares issued for property or services rather than cash, shares issued within six months of incorporation, or shares under compensation plans. So Maya, who owns 20%, must be offered her 20% of a cash issuance. But when the board pays a supplier in shares for equipment, the exception applies.

Shareholders act mainly at meetings. An annual meeting is required, chiefly to elect directors, and a shareholder can ask a court to order one if it is skipped. Special meetings can be called by the board or, under the MBCA, by holders of at least 10% of the votes. Delaware gives shareholders no statutory right to call one.

Notice must be written, 10 to 60 days ahead, stating date, time, and place. Special-meeting notice must also state the purpose, and business is limited to it. And a record date set no more than 70 days before the meeting fixes who votes, so you vote the shares you owned that day.

Then two numbers decide every shareholder vote. Quorum defaults to a majority of the voting power. Once a quorum is present, ordinary matters pass if the votes cast in favor exceed the votes cast against. Test that. A company has 1,000 shares. Holders of 520 attend. A proposal draws 260 for, 200 against, and 60 abstaining. Does it pass?

It passes. Only votes cast count, so 260 beats 200 and the abstentions are ignored. Notice it carried with 260 of 1,000 shares, about 26% of the company. Electing directors is the exception, by plurality. The articles can raise these thresholds with a supermajority, which then locks itself in, since only that supermajority can change it.

Fundamental changes are different again. A merger, selling substantially all assets, amending the articles, or dissolving all need a separate shareholder vote on top of board approval. And because most shareholders never show up, the law lets them send a stand-in. A proxy is valid for 11 months unless it says otherwise, and freely revocable, unless coupled with an interest.

Shareholders can also act with no meeting at all, by written consent, and the MBCA default is strict. It must be unanimous. The articles can loosen that to the minimum votes that would have passed the matter at a meeting. Delaware flips the default. Directors, as we will see, get no such flexibility.

Three tools let shareholders pool power. A voting agreement is a contract to vote a set way, specifically enforceable and with no time limit. A voting trust transfers legal title to a trustee who votes the bloc, and cannot exceed 10 years unless renewed. And in a close corporation a shareholder agreement can rewrite governance almost entirely.

On to directors. The board is the corporation's governing brain. It sets strategy, declares distributions, appoints and removes officers, and initiates the fundamental changes shareholders then approve. Two structural rules matter most. The board acts as a body, so a lone director purporting to approve a deal is a nullity. And directors owe their duties to the corporation itself.

Board mechanics are tighter than shareholder mechanics. Regular meetings need no notice. Special meetings need at least 2 days notice, but need not state a purpose. Quorum is a majority of the directors in office unless the bylaws say otherwise, and never fewer than one-third. With a quorum present, the board acts by a majority of the directors present.

Three more director rules. No proxies, because directors must use their own judgment. A director present is presumed to assent unless she objects at the outset, votes no, or abstains with her dissent noted. And written consent must be unanimous, always. Shareholder consent can be made non-unanimous. Director consent cannot. Directors may join by phone or video if all can hear one another.

Cumulative voting is the second big opt-in. Ordinarily each share casts one vote per open seat, so a bare majority elects the entire board. Cumulative voting lets a shareholder multiply her shares by the number of seats and pour all those votes onto one candidate. Like preemptive rights, it applies only if the articles provide for it.

The formula is worth memorizing. Shares voting, divided by directors to be elected plus one, then add one. With 900 shares voting and 3 directors up, that is 900 divided by 4, which is 225, plus one. So 226 shares guarantee one seat, even against a hostile 674-share majority.

Then structure and removal. A classified board splits directors into two or three groups with staggered terms, a takeover defense, because an acquirer needs two election cycles. The MBCA default is removal with or without cause unless the articles limit it, and a classified board typically shifts to for cause only. Under cumulative voting, a director cannot be removed if the votes against removal would have elected her.

A vacancy from removal, resignation, or death can be filled by the shareholders or the remaining directors, even if fewer than a quorum. Boards also delegate through committees, which bind the corporation as if the full board had acted. But four powers cannot be delegated. Authorizing distributions, except by a board-set formula. Approving anything needing shareholder approval. Filling vacancies. And amending bylaws.

Last for directors, indemnification, in three buckets. Mandatory, where a director wholly successful in defending a proceeding must be indemnified for reasonable expenses. Permissive, where she acted in good faith and reasonably believed her conduct served the corporation. And prohibited, where she was adjudged liable to the corporation or found to have received an improper personal benefit.

Officers next, and legally they are agents of the corporation. The MBCA is deliberately hands-off. A corporation has the officers described in its bylaws or appointed by the board, with the authority those documents give them. There is no required slate of titles. The board appoints officers and can remove any officer at any time.

An officer can bind the corporation four ways. Actual express authority from the bylaws or a board resolution. Actual implied authority, whatever is reasonably necessary to carry out those duties. Apparent authority, where the corporation's own conduct leads an outsider reasonably to believe the officer has power. And ratification, where the board later adopts an unauthorized act.

Apparent authority is the one that decides cases. A president has apparent authority to bind the corporation within the ordinary course of business, while extraordinary matters require specific board authorization. Which brings us back to Dana and her $150,000 contract, signed against a bylaw capping her at $100,000.

Columbia is very likely bound. A president has apparent authority for ordinary-course contracts, and the supplier reasonably believed she could sign. The bylaw limit binds Dana internally, and she may answer to her board for it, but it does not defeat an innocent third party. Flip one fact. If the supplier knew about the cap, or the deal were plainly extraordinary, the result changes.

Is Dana personally on the hook? Generally no. An officer who signs as agent for a disclosed principal binds the corporation, not herself. She is personally liable only in specific situations. She guarantees the obligation. She signs for an undisclosed principal. She acts with no authority at all. Or she personally commits a tort.

Finally, LLCs, which throw out the three-tier structure entirely. Members get the same liability shield shareholders get, but instead of a rigid statute they write an operating agreement that can design control almost any way they like. The governing uniform statute dates from 2013, and its rules are mostly defaults that yield to that agreement.

So the single most important idea in LLC law is this. The operating agreement controls, and the statute only fills the gaps. And that agreement can be written, oral, or even implied from how the members actually behave.

Every LLC lands in one of two structures. In a member-managed LLC the members run the business directly, like partners. In a manager-managed LLC they delegate to managers, who may be members or outsiders. Ordinary-course decisions go by a majority, of the members or of the managers. But acts outside the ordinary course, and any amendment to the agreement, require the consent of all members.

Now the point most likely to separate a right answer from a wrong one. Under older partnership-style thinking, a member of a member-managed LLC was automatically an agent who could bind the company just by being a member. Test yourself. A member signs a contract for the LLC. Is the company bound simply because they are a member?

No. The 2013 act deliberately abolished agency by status. A person is not an agent of the LLC solely by reason of being a member. So how does an LLC get bound? By ordinary means. Actual authority from the operating agreement or a member vote. Apparent authority created by the company's own conduct. Or a filed statement of authority.

One more default that surprises people. Absent contrary agreement, votes and distributions are allocated per capita. One member, one vote, and equal shares of the money, not in proportion to what each invested. So three members who put in $90,000, $9,000, and $1,000 each get one equal vote and an equal third. That is the opposite of the corporate norm.

Private ordering has limits. An operating agreement cannot eliminate the duty of loyalty or the duty of care outright, though it may reasonably tailor them. It cannot eliminate the implied covenant of good faith and fair dealing. It cannot unreasonably restrict a member's access to information. And it cannot vary third parties' rights.

Watch it all work at once. Olympia Ventures is manager-managed, with Priya as sole manager, voting allocated by capital contribution, and a two-thirds requirement for borrowing over $250,000. Priya holds 60%. She can sign an ordinary $50,000 lease alone. But to borrow $300,000 she needs two-thirds, and her 60% is not enough.

A word on authorities. This episode named no cases, and for a governance topic that is right. Everything here lives in a statute and in private documents, and the exam tests whether you can read them. The MBCA is the corporate template most states follow, with Delaware standing as the recurring contrast.

If you keep only three things, keep these. The chain of command, because shareholders elect, directors govern as a body, and officers bind. The short list of opt-in features, preemptive rights, cumulative voting, a staggered board, and non-unanimous shareholder consent. And the two-step habit. Default rule first, then the document that changes it.

Now the traps, straight from the examiners' favorites. One. Counting abstentions as no votes. Only votes cast for or against count, so a matter can pass with far less than a majority of the outstanding shares. Two. Thinking a lone director can act. The board acts only as a body, at a meeting or by unanimous written consent.

Three. Assuming preemptive rights or cumulative voting exist automatically. Both are opt-in under the MBCA, so no articles provision, no right. Four. Letting an internal bylaw limit defeat a third party. Apparent authority can still bind the corporation to an innocent outsider. Five. Forgetting that directors' written consent must be unanimous, even though the articles can make shareholders' consent non-unanimous.

And the two LLC traps. Six. Assuming a member can bind the LLC just by being a member. The 2013 act abolished agency by status. Seven. Applying corporate voting to an LLC. Power and payout track shares in a corporation, but the LLC default is per capita, one member one vote.

Time for the quick check, and this one comes straight from the BARGO question bank. A corporation with 25 shareholders is governed by the MBCA, and its articles contain no special provision about shareholder action without a meeting. Holders of 70% of the voting shares want to approve an ordinary measure by signing a written consent. They circulate it, 70% sign, and the remaining 30% refuse.

Is the measure validly approved? Option one. No, because under the MBCA shareholder action by written consent must be unanimous. Option two. Yes, because 70% exceeds the majority needed to approve an ordinary measure. Option three. Yes, because more than two-thirds of the voting shares signed. Pause here if you want a moment.

The answer is option one. The MBCA default is strict. Shareholders may act without a meeting only by unanimous written consent, so with 30% refusing the measure fails. The articles could have relaxed that to the minimum votes needed at a meeting, but these do not. Options two and three make the same mistake. They apply the meeting threshold to a no-meeting consent. Skipping the meeting costs you unanimity.

That is the whole two-step in one question. Default first, then the document. There are thirty plus more questions on this topic alone, each with every option explained like that.

Five things to take away. One. Shareholders elect, the board governs as a body, and officers bind the corporation as agents. Two. Quorum plus a majority of votes cast carries an ordinary matter, abstentions are not no votes, and directors are elected by plurality. Three. Preemptive rights and cumulative voting are opt-in, and director consent is always unanimous.

Four. An officer binds the corporation through apparent authority, and an internal limit the third party never saw usually will not save the company. Five. In an LLC the operating agreement controls, the default is member-managed and per capita, and nobody binds the company merely by being a member.

Which is why Dana's signature stuck. The bylaws told her what she could do. They never told the supplier. Next time, Fiduciary Duties.

Practice this topic with more than 2,900 exam-style questions, free to start, at nextgenbargo.com. This episode is for education and exam preparation only, not legal advice, and we are not affiliated with or endorsed by the NCBE or any bar examining authority.