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Corporate Bylaws: Use Them or Lose Them

Despite the proliferation of limited liability companies and the various benefits of that structure, many businesses today still operate as corporations. As you know, a corporation is owned by its shareholders, who elect the directors who run the company. The directors, in turn, elect the officers, including the president, to oversee day-to-day operations. The directors are generally elected once a year either at a shareholders' meeting or by written consent according to the rules and procedures set forth in the corporate bylaws. Thus, the bylaws establish where and when the annual meeting will take place, how many directors will be elected, when the directors will meet, who can call special meetings, how those meetings will be called, what powers the directors and officers have, and so on.

While virtually every corporation has bylaws, many of the provisions are regarded as boilerplate and are often ignored or not even read at all. Treating bylaws this way, however, is never good corporate practice, and two provisions in particular should be afforded more respect since they are often pivotal when disputes arise over control of a company: (1) the number of directors and (2) whether and how the bylaws can be amended.

Ignoring these provisions can have negative consequences, as a shareholder learned in a recent Illinois Appellate Court case, Kern v. Arlington Ridge Pathology S.C. When a dispute arose between shareholders over control of a corporation, one of the shareholders filed suit to prevent the directors from amending the corporate bylaws, claiming that the directors did not have a quorum. The bylaws required four to nine directors, yet only three had been in place for the prior six years. The bylaws also stated that three directors were not sufficient to constitute a quorum or to amend the bylaws. Despite these straightforward provisions, the Illinois Appellate Court denied the plaintiff's petition, allowing the directors to proceed with the meeting and amend the bylaws.

How did this happen?

The answer is simple. The court ruled that, since the corporation had for six continuous years operated with only three directors, it had in effect waived or abrogated the provision that required four to nine directors. In other words, since the corporation did not "use" or act on that provision for an extended period of time, the court treated that bylaw as if it had already been amended to require only three directors. "Non-use," the court said, resulted in the removal of the requirement for four to nine directors.

Implications for Corporations

What are the implications for anyone who is operating a business as a corporation? For starters, you should not take your bylaws for granted, especially if you are not the sole shareholder in your company. If you are not operating with the required number of directors and you attempt to hold an election to fill the vacancies in an effort to resolve a dispute, you may not be able to do so. At the very least, such a situation can create confusion, if not litigation.

But there are other common provisions that should be followed as well, such as how your bylaws are amended. If you fail to amend them as required, then it is possible that the bylaws themselves—the governing document of your organization—will be rendered absolutely meaningless in the eyes of the courts.

Therefore, every business operating as a corporation should take the time to review its bylaws and make sure that this important document accurately states your organization’s intended policies. If not, the bylaws should be properly amended—now, not later. But having the bylaws say what you want is only half the battle. The second half is to follow them. As the Kern court made very clear to the plaintiff, with corporate bylaws, you have to use them or lose them.

© 2010 Much Shelist Denenberg Ament & Rubenstein, P.C.National Law Review, Volume , Number 146
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