Stock in a Corporation

Business Judgment Rule in Texas


What is stock in a corporation?


Capital Stock

The defining characteristic of a corporate legal structure is that its ownership is in the form of stock. The “capital stock” collectively refers to everything in which that entity has an interest, which the courts analogize to a trust fund made up of the assets, opportunities, and business operations of the corporate enterprise. See, e.g., Turner v. Cattleman's Trust Co. of Ft. Worth, 215 S.W. 831, 832 (Tex. Comm'n App. 1919) (“The term ‘capital” is used to designate that portion of the assets of a corporation, regardless of their source, which is utilized for the conduct of the corporate business and for the purposes of deriving therefrom the gains and profits.”); Dewing v. Perdicaries, 96 U.S. 193, 196 (1877) (“The capital stock and all the other property and effects of a corporation are a trust fund.”). The capital stock is divided into shares, which are owned by shareholders or stockholders. Turner v. Cattleman's Trust Co. of Ft. Worth, 215 S.W. at 832 (“The shares of stock are the intangible interests in the corporate business owned by the individual shareholders.”).


Shares of Stock

“‘Share’ means a unit into which the ownership interest in a for-profit corporation, professional corporation, real estate investment trust, or professional association is divided, regardless of whether the share is certificated or uncertificated.” Tex. Bus. Orgs. Code § BOC § 1.002 (80). “In order to bring into existence the relationship of stockholder to a corporation there must be some sort of contract in which the subscriber obtains the right to demand and exercise the privileges of a shareholder.” Turner v. Cattleman's Trust Co. of Ft. Worth, 215 S.W. at 832.

Each share of stock is an undivided, proportional ownership interest in the common fund. Id. (each share represents a “definite interest in the common fund existing in the individual”); Dewing v. Perdicaries, 96 U.S. at 196 (shares represent “aliquot parts of the trust fund”); Farrington v. State of Tennessee, 95 U.S. 679, 687 (1877) (“Each share represents an aliquot part of the capital stock.”). See also Auto. Mortg. Co., 266 S.W. at 135 (“It is generally agreed that shares in an incorporated company are the aliquot parts of the capital stock, and merely give to the owner a right to his share of the profits of the corporation, while it is a going concern, and to a share of the proceeds of its assets, when sold for distribution in case of its dissolution and winding up.”) (quoting Presnall v. Stockyards Nat’l Bank, 151 S. W. 873, 876 (Tex. Civ. App.—Texarkana 1912), aff’d, 194 S. W. 384 (Tex. 1917)). However, ownership of the fund itself and ownership of the partial interest in that fund are completely different things. Auto. Mortg. Co., 266 S.W. at 135 (“Shares of stock in a corporation are a species of personal property, belonging to the holder thereof, entirely separate and distinct from the property of the corporation itself.”); Farrington, 95 U.S. at 686 (“The capital stock [i.e., the corpus of the trust fund] and the shares of the capital stock are distinct things.”). The “possession of the stock evidenced by the certificate does not pass from, but is retained by, the corporation.” Turner v. Cattleman's Trust Co. of Ft. Worth, 215 S.W. at 832. The corporation owns the capital stock collectively. Tenneco Inc. v. Enter. Prods. Co., 925 S.W.2d 640, 645 (Tex. 1996); see also McAlister v. Eclipse Oil Co., 98 S.W.2d 171, 176 (Tex. 1936) (“Under our authorities the corporation is a legal entity, distinct from its stockholders. In this regard, strictly speaking, the ownership of the corporate assets is vested in the corporation itself and not in its stockholders.”); Hicks v. State, 419 S.W.3d 555, 558 (Tex. App.—Amarillo 2013, no pet.) (“It has long been the law that a stockholder owns an interest in the company but not the assets of the company. Rather, the assets, including the cash residing in corporate bank accounts, are owned by the corporation, and the latter is a separate legal entity from its shareholders.”). But the corporation owns the stock as a trustee for the benefit of the shareholders. Dewing, 96 U.S. at 196 (“The corporation owns and holds [the trust fund] as a trustee.”); Farrington, 95 U.S. at 686 (“It is a trust fund, held by the corporation as a trustee.”); Farrington, 95 U.S. at 687 (“Every [stock]holder is a cestui que trust to the extent of his ownership.”); McAlister, 98 S.W.2d at 176 (“Also, strictly speaking, the ownership of the stock does not carry with it the equitable title to the corporate property. This simply means, however, that the stockholders have no right to require the corporation to convey to them the legal title to the corporate property. In a larger or real sense the stockholders of a corporation are the beneficial owners of its corporate properties.”).


Personal Property

Shares of stock are personal property, and the stockholder is a property owner. TEX. BUS. ORGS. CODE ANN. § 21.801 (West 2006) (“Except as otherwise provided by this code, the shares and other securities of a corporation are personal property.”); Engel v. Teleprompter Corp., 703 F.2d 127, 131 (5th Cir. 1983) (“Under Texas law, shares of corporate stock are personal property.”); Capital Parks, Inc. v. Se. Advert. & Sales Sys., Inc., 864 F. Supp. 14, 16 (W.D. Tex. 1993) (“The shares of corporate stock, on the other hand, are the personal property of the shareholders.”), aff’d sub nom., 30 F.3d 627 (5th Cir. 1994); Barnhill v. Automated Shrimp Corp., 222 S.W.3d 756, 764 (Tex. App.—Waco 2007, no pet.) (“By virtue of owning shares of stock in a Texas corporation, Barnhill maintains personal property in Texas.”); Brosseau v. Ranzau, 81 S.W.3d 381, 387 (Tex. App.—Beaumont 2002, pet. denied) (“In Texas, stock is considered personal property, even when the underlying corporation itself owns real property.”); Evans v. Prufrock Rests., Inc., 757 S.W.2d 804, 805–806 (Tex. App.—Dallas 1988, writ denied) (“[T]he transaction was the sale of a personalty rather than realty. . . . It is a well established fact that the sale of stock is personalty not real estate.”); Griffith v. Jones, 518 S.W.2d 435, 437 (Tex. Civ. App.—Tyler 1974, writ ref’d n.r.e.) (“Shares of corporate stock are personal property in the nature of choses in action.”); Benson v. Greenville Nat’l Exch. Bank, 253 S.W.2d 918, 928 (Tex. Civ. App.—Texarkana 1952, writ ref’d n.r.e.) (“Without any attempt at historical review, we think it is now well settled that shares of corporate stock are personal property in the nature of choses in action”); Auto. Mortgage Co. v. Ayub, 266 S.W. 134, 135 (Tex. Comm. App. 1924) (“While not negotiable, shares are freely assignable, and in this respect resemble negotiable choses in action and tangible property rather than other nonnegotiable choses in action.”); Bergin v. Bergin, 312 S.W.2d 409, 412 (Tex. Civ. App.—Texarkana 1958), rev’d on other grounds, 315 S.W.2d 943 (Tex. 1958) (“Corporate stock, which is personalty, is involved.”). Shares of stock in a corporation are a species of personal property, belonging to the holder thereof, entirely separate and distinct from the property of the corporation itself. They are the subject of barter and sale the same as other personal property. Under our laws they are subject to taxation, may be impounded by garnishment proceedings, and may be sold under execution as other personal property. They are the intangible interests of the individual shareholders in the corporate business, while the tangible property belongs to the corporation. Auto. Mortg. Co., 266 S.W. at 135.


Types of Stock

Authorized, outstanding shares and treasury shares

An ‘“authorized share” means a share of any class that the corporation is authorized to issue. BOC Sec. 21.002(1). Shares are issued by the corporation when authorized by the board of directors. Sec. 21.157(a) (“(a) Except as provided by Section 21.158, a corporation may issue shares for consideration if authorized by the board of directors of the corporation.”). The board may issue as many shares as are authorized in the certificate of formation. Sec. 21.151 (“A corporation may issue the number of authorized shares stated in the corporation's certificate of formation.”). A corporation’s “authorized shares” are not really shares at all but merely the total allowable number that might ultimately be issued.

Shares only “count” once they have been issued to and are owned by shareholders. The corporation cannot own its own shares in the sense of paying itself dividends or voting. Issued shares are termed “outstanding” unless they are treasury shares.” Sec. 21.171(a) (“Shares that are issued are outstanding shares unless the shares are treasury shares or are canceled.”). Treasury shares are shares that the corporation has issued and subsequently acquired and not cancelled. Sec. 21.002(13) (“Treasury shares” means shares of a corporation that have been issued, and subsequently acquired by the corporation, that belong to the corporation and that have not been canceled. The term does not include shares held by a corporation in a fiduciary capacity, whether directly or through a trust or similar arrangement.).

Treasury shares are owned by the corporation, Sec. 21.002(13), and are not considered outstanding shares, Sec. 21.171(c), and are not voted and do not receive distributions. See § 6.152(a) (“Except as provided by Subsection (b), an ownership interest owned by the domestic entity that is the issuer of the interest, or by its direct or indirect subsidiary, may not be: (1) directly or indirectly voted at a meeting; or (2) included in determining at any time the total number of outstanding ownership interests of the domestic entity.”). The value of the treasury shares are not considered in determining net assets of the corporation. Sec. 21.171(d). The corporation may sell treasury shares for consideration determined by the board of directors. The board of directors may cancel all or part of the corporation’s treasury shares. Sec. 21.252(a) (“(a) A corporation, by resolution of the board of directors of the corporation, may cancel all or part of the corporation's treasury shares at any time.”). Cancelled treasury shares become authorized but unissued shares, and the corporation’s stated capital is reduced by the amount represented by the treasury shares. Sec. 21.252(b) (“(b) Upon the cancellation of treasury shares, the stated capital of the corporation shall be reduced by that part of the stated capital that was, at the time of the cancellation, represented by the canceled shares, and the canceled shares shall be restored to the status of authorized but unissued shares. (c) This section does not prohibit a cancellation of shares or a reduction of stated capital in any other manner permitted by law.”).


Common and Preferred—Classes and Series of Shares

Basically, there are only two kinds of corporate stock, common and preferred. Weaver v. Bowers, 173 Ohio St. 1, 3, 179 N.E.2d 50, 52 (1962). What is commonly referred to as “common stock” has unlimited voting rights and the right to receive distribution of net assets at winding up. Sec 21.152 (d) (“A corporation's certificate of formation must authorize: (1) one or more classes or series of shares that together have unlimited voting rights; and (2) one or more classes or series of shares, which may be the same class or series of shares as those with voting rights, that together are entitled to receive the net assets of the corporation on winding up and termination.”). Among a corporation’s outstanding shares must always be one or more shares whose voting rights are not limited and which are entitled to receive net assets at termination. Sec. 21.171(b) (“(b) If there are outstanding shares, one or more shares that together have unlimited voting rights and one or more shares that together are entitled to receive the net assets of the corporation on the winding up and termination of the corporation must be outstanding shares.”).

A corporation may divide its shares into one or more classes of stock and may divide classes into one or more series. Sec. 21.152(a) (“A corporation's certificate of formation may divide the corporation's authorized shares into one or more classes and may divide one or more classes into one or more series. If more than one class or series of shares is authorized, the certificate of formation must designate each class and series of authorized shares to distinguish that class and series from any other class or series.”) Each class and series may have different attributes; however, the certificate of formation must state the differences exactly and distinguish among classes and series. Sec. 21.153(a) (“If more than one class or series of shares is authorized under Section 21.152(d), the certificate of formation must state the designations, preferences, limitations, and relative rights, including voting rights, of each class or series.”). Stock with different attributes from common shares are usually termed “preferred shares.”


Preferred shares

The certificate of formation may limit or deny voting rights to a class or series or provide special voting rights. BOC Sec. 21.153 (b) (“The certificate of formation may limit or deny the voting rights of, or provide special voting rights for, the shares of a class or series or the shares of a class or series held by a person or class of persons to the extent the limitation, denial, or provision is not inconsistent with this code.”) For example, one class of shares may be entitled to elect a specific director. The permitted limitations, preference and special rights are as follows: Shares may be (1) redeemable, at the option of the corporation, the shareholder or other person, or on the occurrence of a designated event, (2) entitled to receive cumulative, noncumulative, or partially cumulative distributions, (3) entitled to preferences over other classes or series with respect to distributions, (4) entitled to preferences over other classes or series with respect to distributions in a liquidation or winding up, (5) exchangeable, at the option of the corporation, the shareholder or other person, or on the occurrence of a designated event for other shares, obligations, indebtedness, or other rights in the corporation or one or more other entities, or any combination, and/or convertible into shares of any other class or series at the option of the corporation, the shareholder or other person, or on the occurrence of a designated event. Sec. 21.154. Shares without par value may not be converted into shares with par value unless the stated capital of the corporation is adequate at the time of conversion or the amount of the deficiency is transferred from surplus to stated capital. Sec. 21.154 (b). A limitation, preference, or special right may depend on conditions that may arise in the future, such as a future act of the corporation, so long as the condition is clearly stated in the certificate of formation. Sec. 21.153 (c).

Within a class (if not subdivided into series) or otherwise within a series, all shares must have the same (or no) par value, Sec. 21.152(b), and must be in all other respects identical. Sec. 21.152 (c). At least one class or series must have unlimited voting rights, and at least one class or series (not necessarily the same one) must be entitled to receive the net assets on winding up and termination of the corporation. Sec. 21.152(d).

Separate classes of shares may only be created in the certificate of formation; however, the certificate may provide authority to the board of directors to establish new series of shares within a class. See sec 21.155.


Voting limitations and preferences

The certificate of formation may limit or deny the voting rights of, or provide special voting rights for, the shares of a class or series or the shares held by a person or class of persons. Sec. 21.153(b) (“The certificate of formation may limit or deny the voting rights of, or provide special voting rights for, the shares of a class or series or the shares of a class or series held by a person or class of persons to the extent the limitation, denial, or provision is not inconsistent with this code.”). A designation, preference, limitation, or relative right, including a voting right, of a class or series of shares of a corporation may be made dependent on facts not contained in the certificate of formation, including future acts of the corporation, if the manner in which those facts will operate on the designation, preference, limitation, or right is clearly and expressly stated in the certificate of formation. Sec. 21.153(c) (“A designation, preference, limitation, or relative right, including a voting right, of a class or series of shares of a corporation may be made dependent on facts not contained in the certificate of formation, including future acts of the corporation, if the manner in which those facts will operate on the designation, preference, limitation, or right is clearly and expressly stated in the certificate of formation.”).


Action by the board of directors with respect to series

A series is a subdivision of a class of stock. With respect to series within a class, the Code permits a corporation to grant additional power and flexibility to the board of directors to establish different series among the unissued shares within a class and to establish or change the designations, preferences, limitations, or relative rights of the various series and to increase or decrease the number of unissued shares in a series, all by means of board resolution without the need to amend the certificate of formation. Sec. 21.155(a). However, this power must be affirmatively stated in the certificate of formation and may be limited by the terms of the provision in the certificate. If the power is granted, then the board exercises that power by adopting a resolution specifying the designations, preferences, limitations, and relative rights, including voting rights, of the series to be established or specifying any designation, preference, limitation, or relative right that is not set and determined by the certificate of formation. Sec. 21.155(b).

The board may also increase or decrease the number of shares in a series from the authorized but unissued shares in a class, although the board may not reduce the number of shares in a series below the number that have been issued. Sec. 21.155(c). An increase or decrease in the number of shares in a series is accomplished by board resolution setting the number for the series. Sec. 21.155(d). When the board decreases the number of shares in a series, the excess shares simply become unissued shares in the class.

If there are no outstanding shares of a particular series, the board may adopt a resolution deleting that series, resulting in those shares becoming unissued shares in the class. Sec. 21.155(e). If no shares in a series are outstanding, the board may also amend the designations, preferences, limitations, and relative rights, including voting rights, of the series or amend any designation, preference, limitation, or relative rights of that series. Sec. 21.155(f). To effect a board resolution with respect to a series, the corporation must file a statement with the secretary of state containing the name of the corporation; a copy of the resolution, the date of adoption, and a statement that the resolution was adopted by all necessary action on the part of the corporation. Sec. 21.156(a). The filing of the statement with a copy of the resolution has the effect of amending the certificate of formation. Sec. 21.156(b).


Fractional Shares and Scrip

A corporation may issue fractions of a share either through a share certificate or in uncertificated form. Sec. 21.163(1)(a). Holders of fractional shares are real shareholders and may vote, receive distributions, and receive net assets in a termination. Sec. 21.164(a).

The corporation may “arrange for the disposition of fractional shares by persons entitled to the interests,” Sec. 21.163(a)(2), meaning that the corporation may eliminate any fractional shares but must pay cash for the fair value of the fractional shares to the shareholders. Sec. 21.163(a)(3)

A corporation is not required to recognize fractions of a share and may deal with situations in which a person is entitled to receive a fraction of a share by issuing that person scrip. Scrip is a written contract between the corporation and the scrip holder dealing with the scrip holder’s right to a fraction of a share. A holder of scrip is not a shareholder and is not entitled to vote or to receive distributions or a share of net assets in a termination, unless the scrip certificate provides those rights. Sec. 21.164(b). The corporation may provide that the scrip may be exchanged for a full share if the holder surrenders scrip aggregating to a full share. Sec. 21.163(a)(4). The board may also issue the scrip on the condition that it becomes void if not exchanged by a certain date, Sec. 21.163(b)(1), that the shares for which the scrip is exchangeable may be sold to the corporation and the cash distributed to the scrip holders, Sec. 21.163(b)(2), or any other condition that the board may deem advisable. Sec. 21.163(b)(3).


Stock Rights, Options and Convertible Debt

Stock rights and options

A corporation may create and issue rights or options to purchase or receive shares or any class or series or any other security. Sec. 21.168(a)(1). A stock right or option is evidenced in a written instrument approved by the board, Sec. 21.168(b), which must state the terms, timing, and consideration (including any formula for determining consideration) of the purchase or receipt of shares upon exercise of the right or option. Sec. 21.168(c).


Convertible debt

A corporation may create and issue debt that is convertible into shares of any class or series or other securities. Sec. 21.168 (a)(2). The conversion right is evidenced in a written instrument approved by the board, Sec. 21.168(b), which must state the terms and conditions, the timing, and the conversion ratio by which the debt will be converted into shares. Sec. 21.168(d)


Par value, stated capital, and surplus

A corporation’s “stated capital” is the total par value of all shares that have been issued if the corporation’s shares have a par value. Sec. 21.002(11)(A). If the corporation’s shares have no par value, then the stated capital is the total amount of consideration received by the corporation for the shares. Sec. 21.002(11)(B). Stated capital is also increased in the event of a share dividend or by resolution of the board directing that part of the surplus be transferred to stated capital. Sec. 21.002(11)(C). The “surplus” of the corporation means the amount by which the net assets exceed the stated capital. Sec. 21.002(12)


Reducing stated capital for no par value shares

If all or part of the stated capital is based on consideration received for no par value shares, the board of directors may reduce the stated capital in one of two ways. First, within 60 days after issuance, the board may by resolution transfer a portion (not all) of the consideration paid to surplus. Sec. 21.002(11)(B). After 60 days, the corporation may reduce the stated capital associated with no par value stock as follows: (1) the board adopts a resolution stating the amount of the proposed reduction and the manner in which the reduction will be effected and directs a vote of the shareholders at an annual or special meeting; (2) the corporation gives written notice to the shareholders; (3) a majority of the shareholders vote in favor of the resolution. Sec. 21.253. The stated capital may not be reduced below the amount of the aggregate amounts payable to preferred stock holders in a termination plus the total amount of par value shares. Sec. 21.254.