Debt Securities

Debt securities represent money loaned to the corporation and a person holding debt securities is a creditor of the corporation.

These rights are fixed by the instrument creating the debt; usually, the creditor is entitled to repayment of his principal at a specified time with a return on the principal in the form of interest.

Holders of debt securities have priority over equity security holders upon liquidation of the corporation, but do not ordinarily have the right to vote.

Debentures are unsecured obligations of the corporation.  Holders of these debt securities are general creditors.

Bonds usually are secured by a mortgage or a security interest in specific assets of the corporation; thus, holders are secured creditors.

Notes are long-term debt securities which may be secured or unsecured.

Equity Securities

Equity securities represent the capital of the corporation which is at risk in the business.  Equity security holders have no right to repayment of the amount invested or to return on the investment. 

Upon liquidation, once the creditors are satisfied, all the remaining corporate assets belong to the shareholders.

Shareholders usually have:

• dividend rights
• liquidation rights - the right to a share of the corporate assets at the end of the corporation's existence; and
• voting rights - the right to a voice in management.

All shares have equal rights unless otherwise provided in the articles of incorporation .  The articles may create several classes of shares and delineate the different rights of each.

The articles may provide that any preferred or special class is to be divided into series.  This allows variations in the rights and preferences of the different series within a class.  Common stock represents the residual ownership interest in the corporation.

The articles - if they do not establish series - may vest in the directors the authority to divide classes into series and to fix the relative rights and preferences of the shares in each series. 

Usually, common stockholders have the right to vote, but common stock may be divided into classes, some of which may be nonvoting or may be limited in the election of directors.

Holders of common stock have no right to a dividend unless declared by the directors after payment of preferred stock dividends.

Preferred stockholders are generally entitled to receive fixed dividends before any dividends are paid to common stockholders.

Preferred stock is usually nonvoting stock

Usually, preferred shares receive no more than their stipulated dividend.  However, the articles may provide a right to participate with the common in distributions after the stipulated preferred dividend is paid (participating preferred).

With cumulative preferred, the shareholders have the right to receive the stated amount each year, regardless of earnings.  If not paid in one year, the amount is added to the preference of the next, and the dividend preferences cumulate until paid.

If the preferred dividend right is noncumulative, the shareholder is entitled to a dividend only if and when declared by the board.

Preferred stock is usually redeemable at a stated price at the corporation’s option; the articles may state that it is redeemable at the option of the shareholder.

The Revised Model Business Corporation Act does away with the traditional designations of "common" and "preferred" stock. Under the Revised Act, shares may be divided into classes of shares, and classes may be further divided into series; each class and each series is to have distinct designations, preferences, limitations and rights.

Securities Issuance and Related Issues

A corporation is empowered to issue the number of shares authorized by its articles of incorporation.

Once issued, shares are outstanding; if the corporation redeems - i.e., buys back - the shares, they are treasury shares.  Treasury shares, although no longer outstanding, are still considered issued stock.

A stock subscription is an agreement to purchase stock. Upon acceptance of the offer by the corporation or the other subscribers, an enforceable contract is formed, and, under the Model Act, is irrevocable for a period of six months.

The shares of a corporation are represented by certificates.  One's status as a shareholder is not dependent upon issuance of a certificate, which is merely tangible evidence of stock ownership.

The face of each certificate must state the number of shares, and the class and series, if any, which the certificate represents.

Any restriction on the transferability of stock or any agreement to which the corporation is a party must be noted conspicuously on the share certificate, or it will be ineffective, except against a person with actual knowledge of it at the time he acquired the shares.

Par value shares may not be issued for a consideration worth less than the par value.  No-par shares may not be issued for a consideration less than their stated value.

Under the Revised Model Act, there is no provision relating to the concept of "par value," and therefore no minimum price at which specific shares must be issued.

Valid consideration for shares may be:

• money;
• property, tangible or intangible, actually received by the corporation; or
• services actually performed for the corporation.

A promise to perform future services does not furnish consideration for issuance or reissuance of shares.

A debt or note of the purchaser, whether secured or unsecured, is unacceptable as consideration.

If "fully paid" stock is issued for property or services the fair value of which is less than the value of the shares, it is watered stock.

Shareholders' Preemptive Rights

Preemptive rights are the rights of existing shareholders to acquire unissued or treasury shares in the corporation, or options or rights in proportion to their holdings of the original shares. 

Under the Model Act, shareholders have no preemptive rights except to the extent provided in the articles of incorporation.

Dividends and Distributions

A dividend is a distribution by a corporation to its shareholders of cash or property of the corporation.

A shareholder has no inherent right to be paid a dividend.  Generally, the board of directors has discretion to decide whether and when to declare a dividend.

The directors may not declare a dividend if the corporation is insolvent or if payment of the dividend would render it insolvent, or if a declaration or payment would contravene any restrictions in the articles.

If the directors' refusal to declare a dividend amounted to fraud, bad faith, or an abuse of discretion, a court of equity can intervene to compel declaration.

When a dividend has been declared, a debtor-creditor relationship arises between the corporation and the shareholders, and the funds to pay the dividend are considered segregated from other corporate funds.

A valid declaration of a lawful dividend generally cannot be revoked without the shareholders' consent. If funds are not legally available to pay the dividend, the declaration may be revoked.

Liability for Improper Dividends

Directors who vote to authorize a dividend that is in violation of statute will be jointly and severally liable for the amount of the dividend payment in excess of the amount which could legally have been paid, to the extent that it has not been repaid to the corporation.

Directors are not liable if the dividend could properly have been paid at the time of authorization, even though circumstances later made it improper.

The director will not be liable if he relied and acted reasonably and in good faith upon corporate financial records.

Any director against whom a claim is successfully asserted is entitled to contribution from the other directors who voted for the dividend, and who are not entitled to the good-faith defense.

A stockholder who receives a dividend when the corporation is insolvent or is rendered insolvent by its payment is liable to the corporation for the amount of the dividend, or for the amount of the dividend in excess of what could lawfully have been paid.

Redemption And Repurchase Of Shares

Redemption occurs when a corporation has the right to compel a shareholder to sell his shares back to it.  This right must be stated in the articles.

A repurchase is a voluntary agreement by the corporation to buy its own shares of either common or preferred.  Authorization in the articles is not required, and repurchase is governed by the agreement.

A corporation may purchase or otherwise acquire its own shares to:

• eliminate fractional shares;
• collect or compromise indebtedness to the corporation;
• pay dissenting shareholders entitled to payment for their shares; or
• effect the retirement of its redeemable shares by redemption or by purchase at not to exceed the redemption price.

A corporation cannot repurchase shares if it is insolvent or if repurchase of common stock would impair the rights of preferred stockholders.