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Bylaws

What Are Bylaws?

Bylaws are a set of formal rules and regulations adopted by an organization, typically a corporation or other entity, that govern its internal operations and management. They fall under the broad category of corporate governance, defining the fundamental procedures and principles by which the entity functions. Bylaws outline how the board of directors is elected, how corporate officers are selected, how shareholder meetings are called, and other essential corporate functions. In most jurisdictions, including the state of Delaware, corporations are legally required to establish and maintain bylaws51, 52.

History and Origin

The concept of organizational bylaws has ancient roots, with their use traceable to Roman statutes as early as the 5th century B.C.E.50. Throughout history, various organizations, from guilds to English municipalities, required rules to define membership, purpose, and leadership selection. This fundamental need for internal governance mechanisms led to the widespread adoption and evolution of bylaws49.

In the United States, early corporate laws were often restrictive, with the formation of corporations typically requiring a special legislative act. However, states began enacting more general incorporation laws in the 19th century, allowing companies to form without individual legislative charters. New York enacted the first such statute in 1811, followed by New Jersey in 1816 and Connecticut in 1837, which permitted the incorporation of any lawful business. Delaware enacted its first corporation law in 1883 and later became a leading state for corporate incorporation by adopting an "enabling" corporate statute in 1899, which provided greater flexibility in corporate governance, including the provisions within bylaws. This historical progression underscores the enduring importance of bylaws in structuring and regulating corporate entities.

Key Takeaways

  • Bylaws are internal governing documents that define an organization's operational rules and procedures.
  • They cover aspects such as the election of the board of directors, appointment of officers, and conduct of meetings.
  • Bylaws are legally required for corporations in most U.S. states and must comply with state law and the articles of incorporation.
  • They provide a framework for corporate governance, ensuring consistent and agreed-upon decision-making.
  • Bylaws can be amended by shareholders and often by the board of directors, although shareholder approval is typically required for significant changes.

Interpreting the Bylaws

Bylaws are crucial for interpreting how a corporation operates in the real world, providing the practical framework for its corporate structure and daily activities. They detail the roles and responsibilities of the board of directors, officers, and shareholders. For instance, bylaws specify quorum requirements for meetings, voting procedures, and methods for passing resolutions47, 48.

They also outline the process for appointing and removing officers, defining their authority and duties45, 46. Understanding the bylaws is essential for stakeholders to comprehend their rights and obligations within the company. For example, shareholders typically have voting rights defined within the bylaws for matters like the election of directors or approval of corporate actions43, 44. Any challenge to a board's or officer's actions often relies heavily on the specific provisions set forth in the bylaws42.

Hypothetical Example

Imagine "GreenTech Innovations Inc." is a startup corporation. Their bylaws, drafted during the incorporation process, include specific provisions for their annual meeting. Section 3.2 of GreenTech's bylaws states that the annual shareholder meeting must be held on the second Tuesday of April each year, with at least 30 days' written notice to all shareholders of record. It also stipulates that a quorum for any shareholder meeting requires the presence, in person or by proxy, of holders of a majority of the outstanding voting shares.

During the board meeting in February, the board of directors reviews these bylaws and ensures that the notice for the upcoming April 11th annual meeting is prepared and dispatched by March 10th. This notice will include the agenda, which, as per the bylaws, must cover the election of new directors and approval of the previous year's financial statements. On the day of the meeting, the corporate secretary verifies that shareholders representing 55% of the voting shares are present, confirming that a quorum has been met, and the meeting can proceed according to the rules set out in the bylaws.

Practical Applications

Bylaws are fundamental to the practical functioning of any corporation, dictating how decisions are made and conflicts are resolved. In investing, bylaws ensure transparency and structure in corporate decision-making, affecting everything from dividend policy to the issuance of new shares. For example, bylaws specify how dividends are declared and distributed, influencing investor returns and the overall attractiveness of a company's equity.

In the context of market regulation, entities like the Securities and Exchange Commission (SEC) often require public companies to file their bylaws as part of their public disclosures, providing investors with insight into the company's internal governance39, 40, 41. This allows for greater scrutiny of the corporation's rules regarding its capital structure, stock issuance, and general management. Moreover, bylaws play a critical role in addressing potential shareholder disputes, outlining procedures for resolving disagreements over voting rights, director appointments, or even significant corporate actions like a sale of assets37, 38. Well-defined bylaws can prevent costly litigation by providing clear pathways for dispute resolution, often specifying mediation or arbitration as preferred methods35, 36.

Limitations and Criticisms

While bylaws are essential for corporate governance, they are not without limitations or potential criticisms. One major limitation is that bylaws are subordinate to the corporation's articles of incorporation and state laws34. This means that if a bylaw provision conflicts with either the articles or the governing state statute, the bylaw may be deemed invalid33. For example, the Delaware General Corporation Law (DGCL) grants considerable flexibility but still requires bylaws to be consistent with state law31, 32.

Another critique arises in the context of shareholder litigation. Historically, some corporations have attempted to use bylaws to restrict shareholders' rights to bring lawsuits against the company or its directors. While some provisions, such as forum selection clauses that designate a specific jurisdiction for internal disputes, have been upheld, others aiming to shift litigation expenses onto shareholders who challenge corporate actions have faced legal challenges and, in some cases, have been banned by legislative amendments30. Such attempts highlight the tension between a board's desire for operational efficiency and shareholder rights. Additionally, poorly drafted or overly complex bylaws can lead to ambiguity and internal conflicts, making it difficult to interpret procedures for board appointments, voting rights, or major corporate actions29. This can result in costly and time-consuming shareholder disputes, potentially leading to derivative lawsuits or demands for buyouts26, 27, 28.

Bylaws vs. Shareholder Agreement

Bylaws and a shareholder agreement are both critical documents that govern a corporation, but they serve distinct purposes and have different scopes. Bylaws are the internal operating rules of the corporation, established by the board of directors and outlining the procedures for the corporation's day-to-day management24, 25. They typically define the roles of the board of directors and officers, the conduct of meetings (including quorum requirements and voting procedures), and general administrative functions22, 23. Bylaws are generally accessible to shareholders upon request but are not filed publicly with the state21.

In contrast, a shareholder agreement is a contract between some or all shareholders of a company. It addresses specific rights and obligations of the shareholders that may go beyond what is covered in the bylaws or the articles of incorporation20. Shareholder agreements often include provisions regarding share transfer restrictions, dividend policies, buy-sell arrangements, and dispute resolution mechanisms among shareholders18, 19. While bylaws primarily govern the relationship between the corporation and its directors and officers, a shareholder agreement focuses on the relationships and rights among the shareholders themselves. In cases of conflict, jurisdictional laws typically prioritize bylaws due to their statutory authority, though a well-drafted shareholder agreement may contractually assert precedence in specific areas17.

FAQs

Are bylaws legally required?

Yes, most state laws in the U.S. require corporations to establish bylaws16. These documents are crucial for defining the internal operations and governance structure of the company.

Who creates and can amend bylaws?

Bylaws are typically drafted by the initial board of directors during the incorporation process14, 15. They can generally be amended by a majority vote of both the board of directors and the shareholders, although specifics on amendments may vary by state law and the bylaws themselves11, 12, 13.

What happens if a company doesn't follow its bylaws?

Failure to follow bylaws can lead to serious consequences, including legal challenges to corporate actions, internal disputes among stakeholders, and potential liabilities for directors and officers10. Courts may invalidate actions taken in violation of the bylaws, and shareholders might pursue derivative lawsuits9.

Are bylaws public documents?

No, unlike articles of incorporation, bylaws are generally not filed with the state and are not public documents7, 8. However, they must be kept by the corporation and provided to any shareholder upon request6. External parties like investors, lenders, and banks may also request them5.

How do bylaws differ from articles of incorporation?

Articles of incorporation are filed with the state to legally create the corporation and contain basic information like the company name, registered agent, and authorized shares3, 4. Bylaws, on the other hand, provide the detailed internal rules for how the corporation will be governed and operated on a day-to-day basis, expanding on the framework established by the articles1, 2.