The Consequences of Violating Corporate Bylaws

Bylaws are written rules that govern the internal operations of a corporation. Among the matters covered by corporate bylaws are shareholder voting rights, meeting requirements and the extent of the directors’ and officers’ authority to act on behalf of the corporation. Adhering to the bylaws is required for shareholders, directors and officers affected by them. Violating corporate bylaws can lead to various adverse consequences, including removal from office and personal liability.

Directors and officers who violate a corporation's bylaws run the risk of being removed from office. State law authorizes the directors to remove an officer without cause. Even an officer who has an employment contract with the corporation can be removed, although the corporation may be liable for payment to the officer under the contract. State law also generally allows the corporation’s shareholders to remove a director without cause, unless the bylaws require cause for removal. If the shareholders are not removing the entire board, an individual director may be protected from removal depending on state law. For example, under Arizona law, if a director was elected by a specific voting group of shareholders, only those shareholders can participate in a vote to remove the director.

A corporation's directors and officers are generally authorized to act on behalf of a corporation. For example, they can sign contracts with vendors and approve compromises to resolve customer disputes. However, the bylaws can restrict this authority as necessary for the benefit of the corporation, such as requiring board approval for certain types or monetary amounts for contracts. When a director or officer violates these restrictions, it is considered an “ultra vires” act – that is, conduct not authorized by the corporation. A problem usually arises because the corporation may still be liable for the act, such as signing a contract, even though the director or officer exceeded his authority. State laws give the corporation and its shareholders the right to hold the offending director or officer personally liable for any monetary damages caused to the corporation.

Corporate bylaws include provisions setting the rules for valid meetings involving the shareholders or directors. The bylaws set the date, time and location for the corporation's annual meeting of shareholders, as well as the regular meetings for the directors. The bylaws will also specify how to call a special meeting for a time and date different than regular meetings. If the bylaws requirements for meetings are not followed, any action that occurred at the meeting may be invalid if other shareholders or directors object. For example, if the shareholders were not given notice required by the bylaws for a special meeting to remove the entire board and elect new directors, the action taken at the meeting can be challenged and a new meeting required.

For corporations with only a few shareholders, it is common for the shareholders to be board members and participate in the corporation's day-to-day business as officers. In this case, it may not be possible to remove an officer or director, particularly if there are only two shareholders with equal ownership in the corporation. If a violation of the bylaws occurs and the shareholders are unable to work out an amicable solution, an impasse may result that necessitates dissolution of the corporation by the court.