Litigating the Business Divorce
By: Robert A. Royal
This series of articles continues to now examine unique statutory claims that may exist when a business divorce cannot be avoided and the squeeze out actions reviewed in the last article leads to possible legal actions.Claims exist under the Arizona Corporation Code and arise from common law duties.Claims arising out of the Corporation Code are similar to those that may exist in limited liability company and partnership statutes.When your client has been wronged because of an intra-corporate dispute, you may want to examine the following statutes to see if a claim may be brought against the wrongdoers.
- Liability for Non-Corporate Transactions, A.R.S. S 10-204.A person(s) who purports to act as or on behalf of a corporation with actual knowledge that the corporation does not exist is jointly and severally liable for all liabilities created.
- Validity of Corporate Actions, A.R.S. S 10-304.A corporate action may not be challenged on the grounds that the corporation lacks power to act except at a proceeding by a shareholder to enjoin the act, in a proceeding by the corporation directly or derivatively against directors, officers, or agents, or in a proceeding by the Attorney General to dissolve the corporation.This statute must be considered when you are prosecuting unauthorized actions.
- Liability of Subscribers and Shareholders, A.R.S. S 10-622.A director or officer who is a shareholder is not liable to the corporation's creditors except for payment of his or her full consideration for the shares that are purchased.Further, shareholders are not personally liable for acts of the corporation or its debts.Exceptions to this statute are when a party attempts to pierce the corporate veil or in certain "trust fund" situations where an insider has paid themselves over a creditor.
- Director Removal by Judicial Proceeding, A.R.S. S 10-809.A director can be removed from office if the director engages in fraudulent conduct or intentional criminal conduct with respect to the corporation and removal is in the best interest of the corporation.
- Liability of Committee Members, A.R.S. S 10-825.A committee exercising the authority of the Board of Directors creates liability for committee members if the committee authorizes distributions, approves action which requires shareholders' approval, fills Board vacancies, amends Articles and Bylaws, approves a merger or share reacquisition plan or a plan for issuance of shares of the corporation.Liability may also exist for determining rights of stockholders or director compensation.
- Breach of the General Standards of Conduct for Directors and Officers, A.R.S. SS 10-830, 10-842. A director or officer may be liable for action or inaction which is not done in good faith with the care of an ordinarily prudent person under similar circumstances and in a manner the director or officer reasonably believes is in the best interest of the corporation.This statutory duty parallels the fiduciary duty which will be discussed in a future column.
- Liability for Unlawful Distributions, A.R.S. S 10-833(A).A director who votes or assents to a distribution made in violation of the Arizona statutes has personal liability, generally in the amount of the distribution that exceeds what could have been distributed without violating Arizona law.If the director establishes that his or her action was done in compliance with the statutory standards of conduct set forth above, liability may be discharged.
- The Director's Conflict of Interest Transaction, A.R.S. SS 10-860 to 863.A director may be liable because a director or related person has a personal, economic, or other interest in a transaction with the corporation if the director's action does not meet one of the safe harbors.These statutes require careful reading in their application.
- Liability for False Statements, Reports, Certificates or Statements, A.R.S. S 10-1631.Directors and officers of a corporation may be jointly and severally liable to persons who have become a creditor or shareholder of a corporation on the faith of false, material representations in or alterations to any report, certificate, or other statement made or public notice given or if any book, record, or account of the corporation is knowingly or wrongfully altered.Such officers or directors or even their agents must knowingly or wrongfully authorize, sign or make the false report, certificate, other statement or notice.
- Felony Liability for Interrogatory and Signature Violations, A.R.S. S 10-1632.Any person who knowingly fails or refuses within the time prescribed by statute to answer truthfully any interrogatories propounded by the Arizona Corporation Commission or signs any Articles, statement, report, application or other document filed with the Commission that is known by the person to be false is guilty of a Class 4 felony.A person who with intent to defraud or deceive knowingly falsifies, alters, steals, destroys, mutilates, defaces, removes or secretes the books, records or accounts of a corporation is guilty of a Class 5 felony.While this statute may not be a basis of a direct claim by a shareholder, it may be useful in negotiating a settlement of disputed litigation, but only in an ethical manner.
These primary areas of potential liability for directors and officers in a closely held corporation provide statutory bases of causes of action that may be filed in a business divorce.These statutory based claims are in addition to the more common tort claims that are likely present in a litigation between owners of a closely held corporation going through a business divorce.