Corporations - DIRECTORS AND OFFICERS (Fiduciary Duties to shareholders)

Question 1

DUTY OF CARE standard

Answer 1

A director must discharge her duties in GOOD FAITH and with that degree of diligence, care and skill that an “ordinarily prudent person would exercise under similar circumstances in like position.”

Question 2

Nonfeasance

Answer 2

Breach of duty of care by virtue of doing nothing at all (aka lazy director)

However, director will be held liable only if it can be shown that his breach of duty CAUSED a loss to the corporation

e. g. Justin, director of C Corp fails to attend any board meetings or keep up with business in any way.
- always state above the standard first - an ordinarily prudent person would attend some meetings, BUT he is only liable if his breach caused a LOSS to the corporation (must show breach AND causation - ie his laziness CAUSED the loss)
- e.g. where this might be satisfied is if board member is antitrust expert and board decided to take an action that violates antitrust laws - you would have stopped them if youd shown up

Question 3

Misfeasance

Answer 3

breach of DUTY OF CARE where Board member affirmatively does something that hurts the corporation

here, causation is easily established, the question is whether or not his decision fell under the “Business Judgment Rule” (BJR) - aka if directors did their homework (deliberated and analyzed) they will not be held liable

E.g. directors of a hot tub co. vote to start a new product line of hot tubs with built-in wine coolers and video cameras. Idea ends up being a disaster and company loses money. are directors liable for breach of “duty of care” ? depends, if they deliberated and anaylzed its prospects and it simply didn’t work out, they won’t be held liable (not judged by results in hindsight)

Question 4

Business Judgment Rule

Answer 4

Courts will not second-guess the business judgment of directors if exercised in good faith, was reasonably informed, and had a rational basis

i.e. if directors did their homework before making the decision, deliberated and analyzed - then won’t be held liable when the decision turns out badly

(a director is NOT a guarantor of success - don’t have to be right, just prudent)

Question 5

DUTY OF LOYALTY

Answer 5

A director must act in good faith and with the conscientiousness, fairness, morality and honesty that the law requires of fiduciaries

these cases deal with

(1) CONFLICTS OF INTEREST
(2) SELF-DEALING

why does Bus Judgment rule not apply in “duty of loyalty” cases? bc it cannot apply when there is a CONFLICT OF INTEREST - so whenever see conflict of interest, you know it is a “duty of loyalty” problem

Question 6

INTERESTED DIRECTOR TRANSACTIONS (ie conflicts of interest)

DUTY OF LOYALTY

Answer 6

This is any deal between the corporation and one of its directors (or business of which its director is also a director or officer or in which he has a substantial financial interest) - CONFLICT OF INTEREST

INTERESTED DIRECTOR TRANSACTIONS will be SET ASIDE UNLESS the director shows either

(1) the deal was FAIR AND REASONABLE to the corporation when approved OR
(2) the material facts and her interest were disclosed or known AND the deal was approved by any of these:
- -(i) SHAREHOLDER ACTION
- -(ii) BOARD APPROVAL by a sufficient vote NOT counting votes of interested directors
- -(iii) UNANIMOUS VOTE of DISINTERESTED DIRECTORS if disinterested directors are insufficient to take a board act

NOTE: Interested directors COUNT TOWARDS A QUORUM and they can participate in the meeting, but as stated before, their vote doesn’t count

e.g. Martha is director of XYZ, inc. If she sells wreaths to the corp, it is an interested director transaction. is she in trouble? depends on if she satisfies the test

Question 7

Duty of Loyalty Standard - Interested director transactions will be set aside UNLESS the director shows:

(DUTY OF LOYALTY)

Answer 7

either

(1) the deal was fair and reasonable to the corporation when approved OR
(2) the material facts and her interest were disclosed or known AND the deal was approved by any of the following:
- –(a) Shareholder action
- –(b) Board approval by a sufficient vote NOT counting votes of interested directors
- –(c) Unanimous vote of disinterested directors if disinterested directors are insufficient to take a board action

Question 8

Do interested directors count toward a QUORUM of the board?

DUTY OF LOYALTY

Answer 8

Yes, and they can participate in the meeting but their votes do not count

e.g. X corp has 9 directors. 5 are interested in an interested director transaction. All 9 attend the meeting to consider approving the deal. After appropriate disclosure, what vote can approve the deal?

you need ALL 4 disinterested directors bc if 9 are at meeting would need 5 to take a a valid board action, but can’t here because only 4 are disinterested, therefore, need it to be unanimous

Question 9

Who sets compensation for DIRECTORS?

Answer 9

The board can set compensation of directors BUT the compensation must be REASONABLE and in GOOD FAITH. If excessive, it is WASTE of corporate assets

Question 10

COMPETING VENTURES

DUTY OF LOYALTY

Answer 10

A director CANNOT compete with his corporation. He owes a duty of loyalty as a fiduciary.

If he DOES compete with the corporation, his profits will be placed in CONSTRUCTIVE TRUST for the benefit of the corporation and the corporation MAY get damages if the competition hurt it.

e.g. Sharon is director of Ozzie Corp. She can also serve as director of Home Depot bc Home Depot does not compete with Ozzie corp. BUT if Sharon starts her own music business Ozzie Corp. will get a CONSTRUCTIVE TRUST on Sharon’s profit and ozzie corp may sue and get damages if the competition hurt it.

Question 11

CORPORATE OPPORTUNITY DOCTRINE

DUTY OF LOYALTY

Answer 11

A Director cannot USURP a corporate opportunity. This means it cannot take until

(1) he tells the board about it and
(2) he waits for the board to reject it

What qualifies as a “Corporate Opportunity?”
something the corporation NEEDS, or has an interest or tangible expectancy in, or that is logically related to its business

USUAL REMEDY FOR USURPATION: property acquired in violation of this duty may be impressed with a CONSTRUCTIVE TRUST for the benefit of the corporation
-conceivably damages as well if harmed corp by diverting opportunity or assets, but relatively rare

Corporate opportunity doctrine DOES NOT APPLY to acquisitions that the corporation has refused, or opportunities that it would not have been able to take advantage of, or that are not appropriate or logically related to the corporation’s business

HOWEVER, if corpration cannot AFFORD the opportunity is this a defense? probably not, he is a fiduciary so arguably he should help the co. get financing

Alternatively stated: (from NY Book)
Directors (nor officers, nor controlling shareholders) may acquire or divert to themselves property or opportunities that the corporation needs or is seeking, or as to which the corporation as a “tangible expectancy” or that the directors, officers, or controlling shareholders were otherwise under a duty to acquire for the corporation

Question 12

Corporate Opportunity Doctrine example

Answer 12

Cheatem is a director of C Realty Corp. which develops condo projects. Cheatem learns of some land that has been zoned for condos and buys it for himself as an investment. What are C’s rights against Cheatem?

step 1: state the duty of loyalty standard.
then say: a director cannot USURP a corporate opportunity unless he (1) tells the board and (2) waits for the board to reject it

Cheatem has to account for it. If he still has it, he must sell it to the corporation AT HIS COST. If Cheatem has sold it for a profit, the corporation gets the profit.

Question 13

Other Bases of Director Liability: IMPROPER LOANS OF CORPORATE FUNDS

Answer 13

e. g. board of directors votes to lend a director $100k of corporate funds or to guarantee a director’s personal obligation - this is allowed ONLY IF
(1) APPROVED BY SHAREHOLDERS - OR
(2) if the board finds it will benefit the corporation (e.g. lending $$ to director so director can afford to take courses at a business college to make him a better director)

Question 14

Sarbanes-Oxley Act (federal)

Answer 14

restricts loans to executives in REGISTERED (ie publicly-traded) corporations. It requires the board of such a large corporation to

(1) establish an audit committee and oversee work of registered public accounting firm.
(2) Chief executive and financial officers must certify accuracy and completeness of financial reports

Question 15

Improper distrubutions

Answer 15

covered later - but basically

corporation can make distributions even though it lost money last year; BUT corporation CANNOT make distributions if it is INSOLVENT or if the distribution would RENDER IT INSOLVENT (.ie. company unable to pay its debts)

DIrectors are personally liable for unlawful distributions (so are SHs who knew i was unlawful when they received it)

Question 16

For any of these violations of duties, exactly what are DIRECTORS liable for?

Answer 16

GENERAL RULE: A director is presumed to have concurred with board action UNLESS her dissent is noted IN WRITING in corporate records

Question 17

How does a director get his DISSENT in WRITING?

Answer 17

a director who is present at the meeting where prohibited action is taken is PRESUMED to have concurred in the action UNLESS

(1) Dissent is entered in the minutes of the meeting; or
(2) Written dissent is presented to the corporate secretary at the meeting; or
(3) dissent is delivered or sent by registered mail to the secretary of the corporation promptly after adjournment

An ORAL DISSENT is never effective by itself, have to get it in writing

ALSO, a director cannot dissent if he VOTED FOR the resolution at the meeting

Question 18

ABSENT DIRECTORS: What if a Director MISSED the meeting?

Answer 18

EXCEPTION to the GENERAL RULE: if director missed the meeting (e.g. bc he was sick) he is NOT liable if the board approved something wrongful that day if he registers written dissent within a REASONABLE TIME after learning of the action
either by
(1) by delivering the dissent or sending it by registered mail to the corporate secretary [(iii) above], or
(2) ensuring that the dissent is filed with the minutes for the meeting

Question 19

Good Faith Reliance

DIRECTOR LIABILITY FOR UNLAWFUL BOARD ACTION

Answer 19

No director is LIABLE who has discharged her duties in good faith and with the degree of diligence, care and skill that ordinarily prudent persons would exercise under similar circumstances in like positions.

Under this standard it IS ALLOWABLE in determining the lawfulness of a proposed action to Rely in “Good Faith” on information, opinions, reports, or statements by

(1) officers or employees of the corporation whom the director or officer believes competent and reliable,
(2) lawyers or public accountants whom the director or officer believes are acting within their competence, or
(2) a committee of which the person relying is not a member, as to matters within its designated authority

This EXCEPTION for “Good Faith Reliance” is most likely in a case of “Improper Distributions”

Question 20

OFFICERS: What duties do OFFICERS owe to the corporation?

Answer 20

The same fiduciary duties of Care and Loyalty owed by directors

Question 21

Can Officers BIND the corporation to acts that they take in the corporation’s behalf?

Answer 21

YES, OFFICERS are AGENTS of the corporation. IF they have the authority to do so, they can BIND the corporation to acts they take in the corporation’s behalf

e.g. President that has inherent authority to sue on behalf of the corporation and to bind the corporation to contracts entered in the “ordinary course of business”

Question 22

The board may select a president, one or more vice-presidents, a secretary, a treasurer, and any others the Board may determine or for which the bylaws provide

Can one person hold multiple offices simultaneously?

Answer 22

YES

Question 23

Who selects and removes OFFICERS?

Answer 23

the BOARD OF DIRECTORS, unless the Certificate allows the shareholders to elect them

(on BAR EXAM certificate is usually silent, so BOARD DOES IT - BAR must tell you if shareholders can elect them, BUT if they do tell you that SHs can elect them, then only shareholders can fire them. Even then, for cause, directors can suspend and officer’s authority to act)

General rule: Shareholders hire and fire directors, and the BOARD hires and fires OFFICERS

NOTE: POTENTIAL CROSS-OVER with CONTRACTS in this area
–e.g. the board of Hair Care Inc. appoints John Stamos as President. What if the board fires John from the presidency? the corporation may be liable for contract damages

Question 24

Removal by Judicial Action

Answer 24

The attorney general or holders of 10% of all shares may sue for a judgment removing an officer FOR CAUSE. Court can bar reappointment of a person so removed from office

Question 25

Who sets compensation of OFFICERS?

Answer 25

The BOARD

Question 26

Reimbursement of Directors and Officers

Answer 26

Situation: A person is sued in her capacity as OFFICER or DIRECTOR by or on behalf of the corporation. She incurs costs, attorneys’ fees, maybe even fines, a judgment or settlement; she seeks reimbursement (indemnification) from the corporation.

THREE CATEGORIES:
(1) Reimbursement PROHIBITED - if she was HELD LIABLE to the corporation

(2) The corporation MUST REIMBURSE director or officer if she WON a judgment on the merits or otherwise
(but note, oddly if D or O is successful in defending a suit against her and is qualified to reimbursement of right from the corp, but corp refuses and she sues corp to force reimbursement and wins, she cannot recover attys fees for this subsequent enforcement action against the corp)

(3) PERMISSIVE reimbursement in cases not in the first 2 categories
- - e.g. case against O or D that SETTLES - in such cases she must show that:
(i) she acted in GOOD FAITH; and
(ii) for a purpose reasonably believed to be in the company’s best interests

(note: reimbursement in this 3rd “permissive” category can include settlement amount, expenses and attorney’s fees (not any JUDGMENT though)

for PERMISSIVE category, who determines eligibility for reimbursement?

(a) the BOARD (with a quorum of directors being non-parties); or if there is no such quorum
(b) shareholders or a quorum of those directors who are disinterested; or
(c) the BOARD pursuant to report from independent legal counsel

Nothwithstanding the categories above, a court (in which O or D was sued) can ORDER the corp to reimburse her for litigation expenses and atty’s fees if it finds she is “REASONABLY ENTITLED” to it

Question 27

Can a corporation ADVANCE litigation expenses to a director or officer?

Answer 27

YES, but they must be repaid if it turns out she is NOT entitled to reimbursement

Question 28

Insurance

Answer 28

The corporation can buy insurance to cover director and officer liability

Question 29

Indemnification by resolution

Answer 29

The Certificate or Bylaws can provide for indemnification by resolution of board or shareholders or by agreement, unless the director or officer acted in

(1) BAD FAITH,
(2) was deliberate and dishonest in a way material to the case or
(3) wrongfully profited

SUGGESTION FOR BAR: Any time you see a director arguably breaching a duty, say this:
“the certificate may eliminate Director Liability to the corporation or shareholders for damages for breach of duty EXCEPT if she acted in BAD FAITH or with INTENTIONAL MISCONDUCT or received an IMPROPER FINANCIAL BENEFIT OR approved an unlawful distribution or loan

Bottom Line: basically, certificate can exculpate for liability for “breach of DUTY OF CARE”