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Posted by on Nov 9, 2015 in Uncategorized | 0 comments

A Stockholder’s (Non-Existent) Right to Receive Dividends

By Ryan Vince

A dividend is a special type of distribution made by a corporation to its shareholders—the owners. These payments (dividends) are typically taken out of the corporation’s current or retained earnings and given to shareholders in proportion to the number of shares that each shareholder owns. However, contrary to common belief, a shareholder will probably never see a return on his or her investment through a receipt of corporate dividends.

A corporation’s board of directors normally has the sole authority to decide whether to issue dividends to the shareholders. Unless the articles of incorporation or a certain statute says otherwise, payment of dividends will not be required. Regardless of the wisdom or fairness in the decision to pay dividends, the board will usually be protected by the business judgment rule. The business judgment rule is the presumption that the board of directors acted under sound business judgment and in good faith. In the absence of fraud, bad faith, or other misconduct, courts will decline to interfere with a decision made by the board of directors.

Courts have recognized that the board of directors owes fiduciary duties of good faith and fair dealing toward minority shareholders. When it comes to the initial payment of dividends, the board of director’s only duty is to make a good-faith decision that reflects legitimate business purposes rather than the private interests of the directors. In other words, a board of directors can always choose not to pay dividends to the owners of the corporation as long as the board does not act in bad faith or abuse its discretion. This provides the board with a wide range of discretionary power in regards to issuing dividends. Generally, the board of directors must act in the best interests of the corporation, but in most instances, this precludes the shareholders’ ability to receive or compel the payment of dividends.

When a person invests in a corporation by purchasing stock, that person becomes a “part-owner.” This investor has a general expectancy to receive a return on his or her investments, and as a new owner, may want his or her fair share of corporate profits. Unfortunately, the board of directors decides on whether to issue dividends, and most times, will not do so. The board of directors’ desire for company growth is often contrary to the shareholder’s interest in receiving corporate profits, and the business judgment rule provides almost infinite protection to the board’s dividend policy. Because of the extreme difficulty in proving a fraudulent dividend policy, self-interest in the decision by the board, or some other breached duty, a shareholder’s legal action to compel payment of dividends is virtually designed to fail.

The desired benefit of bringing a direct suit against a corporation for its dividend policy will rarely outweigh the costs of bringing the action. Thus, in most cases, the shareholder will bring a derivative suit for the purpose of enforcing a corporate right. Because of the supposed “harm” to the corporation, the corporation will bring the action and bear the costs of litigation, making this type of action more suitable to the complaining shareholder. However, a derivative suit has several strict procedural limitations, one being the act of making a demand on the board. In some jurisdictions, a demand may be excused when the demand would have been “futile,” or useless, because directors were actually self-interested or there is evidence clearly showing misconduct by the board. Nevertheless, a high degree of self-interest is required to excuse demand, and in most cases, the board of directors will request that the derivative suit be dismissed based on the findings of a special litigation committee. The members of this committee are typically disinterested, and if so, the court will give deference to the committee’s decision not to bring the derivative suit because doing so would not be in the best interests of the corporation.

As a result, a shareholder with a legitimate complaint may be denied the opportunity to compel dividends. Not only is an attempt to compel the declaration of dividends very burdensome, gaining access to the courts may be just as difficult. The strict procedural requirements of a derivative suit, the business judgment rule, and the special litigation committees, have all been effective in precluding the consideration of shareholders’ actions for payment of dividends. It is important that the board of directors be given free-reign when making managerial decisions. Conversely, the power of the owners to enforce the corporation’s and their own rights should become more flexible. The business judgment rule provides a nearly impenetrable wall of protection to the decisions of the board, but the strict procedures of a derivative suit seek to thwart any shareholder’s chances in receiving a share of the corporation’s profits.

 

 

References

  1. http://www.hofstralawreview.org/wp-content/uploads/2013/08/09_4HofstraLRev731975-1976.pdf
  2. https://www.sdcba.org/index.cfm?pg=BusinessandCorporateArtice7142014
  3. http://digitalcommons.pace.edu/cgi/viewcontent.cgi?article=1589&context=plr
  4. Textbook: Business Structures (4th Edition) by David G. Epstein, Richard D. Freer, Michael J. Roberts, and George B. Shepherd