d)Provisional Directors--some
statutes allow them to be appointed by court if the board is deadlocked and
corporate business is endangered. a provisional dir serves until the deadlock
is broken or until removed by a court order or by majority of shs.
e)Voting Agreements--an
agreement in advance among dirs as to how they will vote is void as contrary to
public policy. There are certain exceptions for statutory close corps.
4.COMPENSATION--dirs are NOT entitled
to compensation unless they render extraordinary services or such compensation
is otherwise provided for. Officers are entitled to reasonable compensation for
services.
5.DIRECTORS’ RIGHTS, DUTIES, AND
LIABILITIES
a)Right to Inspect Corporate Records--if done in good faith for purposes germane to
his position as dir, this right is absolute.
b)Duty of Care--dirs must
exercise the care of an ordinarily prudent and diligent person in a like
position, under similar circumstances. There is no liability (absent a conflict
of interest, bad faith, illegality, or gross negligence) for errors of judgment
(business judgment rule--the rebuttable presumption that action was
taken on an informed basis, in good faith and exercising reasonable care), but
the dir must have been reasonably diligent before the rule can be invoked (Shlensky)
1)The duty of care requires:
I)Education--a dir should
acquire at least a rudimentary understanding of the business of the
corporation;
ii)Information--a dir is
under a continuing obligation to keep informed about the activities of the
corp;
iii)Participation--dirs
must “generally monitor” corporate affairs, but need NOT involve themselves in
the day-to-day operations; (i.e. they should attend board of dirs meetings with
reasonable regularity).
iiii)Inquiry--a dir has a
duty to inquire when circumstances would alert a reasonable person for the need
of inquiry.
iiiii)Action--where
wrongdoing is revealed, a dir should object, correct, or resign. Object to the
course of conduct, steer toward correction, and resign if it isn’t corrected.
2)Extent of liability--dirs
are personally liable for corporate losses directly resulting from their breach
of duty or negligence in falling to discover wrongdoing. a director may seek to
avoid being held personally liable for acts of the board by recording his dissent.
I)Many statutes permit the
articles to abolish or limit dir’s liability for breach of the duty of care
absent bad faith, intentional misconduct, or knowing violation of law.
3)Defenses to liability--these
include good faith reliance on management or expert’s reports. Disabilities may
be considered in determining whether the dir has met the standard of care.
c)Duty of Loyalty--a
catch-all duty designed to prevent unfairness--the duty to act in good faith
(BJR applies). Application:
1)Self-dealing transactions
I)Common Law:
(1)early absolute prohibition
against self-dealing renders transactions void
or voidable;
(2)permissive self-dealing:
dirs and officers may contract with the corp if (a)done
in “strictest good faith.”; (b)with full disclosure; and (c)consent of “all
concerned.”
[1]--burden of proof is
on the dir to establish good faith, honesty & fairness;
[2]--courts weigh
self-dealing transactions with “closest scrutiny”
(3)self-dealing prohibition
also applies to intercorporate transactions where
dirs are common.
ii)Statutory (example):
(1)quasi-safe harbor approach
(Iowa statute)--transaction is not void or
voidable because of dirs’ interest, if either:
[1]--interest is
disclosed and approval is made without counting the vote of
the interested dir.
[2]--interest is
disclosed to shs and shs authorize
[3]--transaction is fair
and reasonable
(2)Note--dir must still
establish that he acted in good faith, honesty, and fairness
2)Domination of subsidiary by
parent--courts look at the transaction to see if self-dealing has occurred.
Example (Sinclair Oil):
I)declaration of dividends shared
pro rata was NOT self-dealing; BJR applies
ii)contract between parent and
sub was self-dealing; apply intrinsic fairness test
3)Manager’s compensation:
I)Ordinary corporations--conflicts
are inevitable but all firms need to set compensation. The burden of proof is
placed on challengers as a matter of convenience.
ii)Close corporations--the
income generated by the firm may be diverted to salaries, so there is an option
for self-dealing by the parties in control to take tax-advantaged compensation
in the form of salaries (taxed once) as opposed to dividends (taxed twice).
d)Statutory Duties and Liabilities--in
addition to general duty of care, federal and state laws also impose certain
duties and liabilities, e.g., registration requirements under the Securities
Act of 1933, liability for rule 10b-5 violations, liability for illegal
dividends. Some statutes also impose criminal liability on corporate managers
for unlawful corporate actions.
C.OFFICERS
1.ELECTION--officers are usually
elected by the board of dirs. Some statutes permit election of officers by shs.
2.AUTHORITY OF CORPORATE OFFICERS
(liability of corp to outsiders)--only authorized officers can bind the corp.
Authority may be: actual (expressed in bylaws or by valid board
resolution), apparent (corp gives third parties reason to believe
authority exists), or power of position (inherent to position). If ratified
by the board, even unauthorized acts can bind the corp.
a)Authority of President--the
majority rule is that the president has the power to bind the corp in
transactions arising in regular course of business.
3.DUTIES OF CORPORATE OFFICERS--the
duty of care owed by a officer is similar to that owed by dirs ( and sometimes
higher).
D.CONFLICTS OF INTEREST IN CORPORATE
TRANSACTIONS.
1.DUTY OF LOYALTY--because of their
fiduciary relationship with the corp, officers and dirs have the duty to
promote the interests of the corp without regard for personal gain.
2.BUSINESS DEALINGS WITH THE CORPORATION--conflict
of interest issues arise when a corp transacts business with one of its
officers or dirs, or with a company in which an officer or dir is financially
interested.
a)Effect of Self-Interest on Right
to Participate in Meeting--most statutes permit an “interested” dir to
be counted toward quorum, and interested dir’s transactions are NOT
automatically voidable by the corp because the interested dir’s vote was
necessary for approval.
b)Voidability Because of Director’s
Self-Interest--today, such transactions are voidable only if unfair
to the corporation. The burden of establishing fairness is on the interested
director. Note that a dir’s failure to fully disclose material facts may
be per se unfair.
1)Unanimous shareholder
ratification--if, after full disclosure, shareholder ratification is
unanimous, the corp will be estopped from challenging the transaction with the
interested dir (except at to creditors).
I)Less-than-unanimous
ratification--courts then will look at whether the majority shares were
owned or controlled by the interested director. Courts are more likely to
uphold ratification by a disinterested majority so as to preclude the
transaction from being attacked by the corp or by a sh in a derivative suit.
2)Statutes--most statutes
provide that such transactions are NOT voidable if: (1)approved, after full
disclosure, by a disinterested board majority or by majority of shs, or (2)the
transaction is fair to the corp notwithstanding disclosure.
I)”Interested”--an
“interested” dir or officer is one who has a business, financial, or familial
relationship with a party to the transaction that would reasonably affect the
person’s judgment so as to adversely affect the corp.
c)Remedies--the corp may
rescind, or affirm and sue for damages.
3.INTERLOCKING DIRECTORATES--generally,
transactions between corps with common dirs are subject to the same rules of
interested director transactions. There is no conflict of interest if one corp
is the wholly owned subsidiary of the other. However, a question of fairness
arises where the parent owns only a majority of the subsidiary’s shares.
4.CORPORATE OPPORTUNITY DOCTRINE
(Also see duty of loyalty)
a)Definition--COD bars
dirs from taking any business opportunity belonging to the corp without first
offering it to the corp.. If the corp is unwilling to pursue an
opportunity (after an independent board is fully informed of the opportunity),
then the dir may pursue it.
b)Defenses (available in
most, but not all jurisdictions):
1)Inability--If the corp is
legally or financially unable to take the opportunity, then the dir
generally may take advantage of it. (But the question of who caused the
financial inability is quite relevant. Example: Irving Trust Co--the
defense of inability was rejected).
2)Rejection, abandonment, or
approval--then the fiduciary has a valid defense.
c)Remedies--constructive
trust or damages--the fiduciary must account to the firm for all the profits he
has made as a result of usurpation.
d)Definition of a Corporate
Opportunity:
1)Line of business test--does
the firm have fundamental knowledge, practical experience, and ability to
pursue the opportunity? If yes, then it is within the firm’s line of business.
It should be a natural fit, and not a mere desire by a firm to pursue the
opportunity.
2)Interest/expectancy test
e)Application--Guth Rule and
Corollary:
1)Guth rule (offered in corporate
capacity)--if there is presented to O/D a business opportunity which
the corp is (1)financially able to undertake, which is from its nature (2a) in
the line of business and is of practical advantage to it OR (2b)is one in which
the corp has an interest or reasonable expectancy (under an established
corporate policy or plan), and, (3)by embracing the opportunity the
self-interest of the dir will be brought into conflict with that of his corp,
then officer or dir may NOT take the opportunity.
2)Guth corollary (a safe
harbor; satisfy all provisions and dir can take)--if a business opportunity
(1)comes to O/D in his individual capacity and (2) is not essential
to the corp and is (3)one in which corp has no interest or expectancy, then the
O/D can treat it as his own, IF he has not taken corporate resources to pursue
the opportunity.
I)”Essential”--indispensably
necessary to the continued viability of the firm;
ii)Individual or corporate?
Look at O/D capacity to determine how offer was made
5.COMPETING WITH CORPORATION--such
competition by a dir or officer may be a breach of fiduciary duty even when the
competing business is not a corporate opportunity
6.COMPENSATION FOR SERVICES TO THE
CORPORATION--the compensation plan must be duly authorized by the board,
and its terms must be reasonable. Good faith and the BJR ordinarily protect disinterested
dirs from liability to the corp for approving compensation.
a)Publicly Held Corporations--The
SEC has authorized shs to make proposals about executive pay in management’s
proxy statements. Further, the tax code now limits expense deductions for
executive pay over $1mln, unless it is tied to the corp’s performance.
b)Past and Future Services--compensation
for past services is generally invalid. Compensation for future
services is proper if there is reasonable assurance that the corp will
receive the benefit of the services.
VI.INSIDER TRADING--purchase or sale of securities by someone with access to material
nonpublic information. It may be illegal. It affects
corps with more than $1 mln in total assets and with at least 500/750 shs.
a)Who may be hurt by insider
trading:
1)Target shareholders--they
sell too early;
2)Other arbitrageurs--they
lose a portion of the gain that they make from honest effort
3)Other issuers--they lose
confidence in the stock market
4)The acquiring company--insider
trading drives up their cost of acquisition, since the target may adopt
defensive measures otherwise not in place.
b)Possible Sources of Liability:
1)Common Law;
2)10b-5 traditional;
3)10b-5 misappropriation theory (O’Hagan);
4)Mail or wire fraud;
5)14e-3;
6)Statutory liability under
16(b)--insiders are forced to give their profits to the corp, if the y buy and
sell securities within a 6-month period regardless of whether they are
using insider info. (Need to know 2, 3, 6)
c)O’Hagan--insider trading
violation where a partner in law firm took info rom his firm regarding the
firm’s client’s plans for acquisition of Pillsbury and used that info to buy
shares in Pillsbury
d)Penalties For Insider Trading--ITSA
(Insider Trading Sanctions Act)--3 measures:
1)Out-of-pocket measure--if a
sh buys a share for $10, while in fact it costs $9, his out-of-pocket expense
is $1.
2)Causation-in-fact--because
an insider engaged in insider trading, it caused a loss
3)Disgorgement--we look at D’s
profit. ITSA measures the damage to sh by the amount of profit that D received
from the transaction.
2)SEC civil penalties--treble
damages; SEC may seek penalty capped by three times profit gained or loss
avoided.
A.COMMON LAW--under the majority rule,
there was no duty to disclose to the shs inside info affecting the value
of shares. Therefore, the protection of investors was very weak.
a)For lability to exist there
should be:
1)At least fraud or deceit upon
purchasers;
2)May also be a device or scheme;
3)May also be an implied
misrepresentation.
b)Two Elements (relationship and
unfairness):
1)Relationship--existence of a
relationship giving access, directly or indirectly, to
information intended to be available for a corporate purpose and no other.
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