(2) Fiduciary Duties of Corporate Directors

3 Rationales Behind Business Judgment Rule

--Boardroom not courtroom --Entice outside directors to serve --Entice directors to take risks/encourage innovation Cons: No accountability/liability for bad acts.

Duty of Loyalty and Special Problem of Controlling Shareholders

SHs owning so much of a company that they essentially control the business's conduct are imputed the fiduciary duty of loyalty (Sinclair Oil).

Three Ways of Failing to Establish Good Faith

(1) Intentionally acting against the interests of the corporation (2) Intentionally causing the corporation to violate a law (3) Intentionally failing to act in the fact of a known duty to act (becomes modern duty to monitor)

Three Fiduciary Duties

-Duty of Care (easiest to find liability) -Duty of Good Faith (closer to loyalty) -Duty of Loyalty (hardest to find liability)

What is Self Dealing?

Self dealing is where an officer or director stands on both sides of a transaction, using one's position for personal gain, at the expense of the corporation. E.g. using corporate funds as a personal loan; purchasing company stock based on inside information received through being in the position of a fiduciary.

Superloyalty Test*

(1) Fair Dealing? like 144(a)(1) and (a)(2) (a) disclosure to minority all relevant facts (b) No misuse of proprietary info (~#1) (c) sufficient time for board and SHs to consider. (d) arms length processes (Board & SHs) --- Board will usually create special negotiating committee --- Need informed decision and affirmative vote of the majority of the minority of SHs AND (2) Fair Price? like 144(a)(3) If one prong is not met, it is a breach of fiduciary duty. Thus, involves both procedural and substantive fairness. Applies in cash out merger situations (when a company owns 50-90% of another company's stock and tries to buy the rest).

Duty of Good Faith

D/Os owe a duty of good faith to the corporation.

Two ways to cleanse usurping transactions

(1) Disclosure & approval (RARE) (2) Was the transaction fair? (looking at substance)(USUALLY USE THIS TEST)

Duty of Care Test

(1) Grossly negligent process on an (2) Extremely important matter (3) What remedy is being sought? -if seek personal liability, P will lose based on 102(b)(7), which permits corporations to include provisions eliminating monetary damages for directors' breach of fiduciary duty. -if seeking injunctive relief, director might be found liable.

What are the three types of disloyalty/breach of duty of loyalty?

(1) Self-dealing (classic) (2) Usurping corporate opportunities (3) Cashout mergers (Super loyalty)

Who is a "disinterested director" under section 144(a)(1)?

3 ways to determine independence: -Anyone with NO financial ties to the transaction - Inside vs. outside directors (most common) - No one is independent (structural bias theory - the professional and social relationships that naturally develop among members of a board impede independent decision making)

Duty of Loyalty

A director owes the corporation a duty of loyalty. She must act in good faith and with a reasonable belief that what she does is in the corporation's best interest.

102(b)(7)

A provision of the Delaware General Corporation Law that permits corporations to shield directors from personal liability for their breaches of fiduciary duty (unless found that it was done in bad faith)

Rationale behind Superloyalty

Delaware law allows the majority SH to cash-out with the minority SHs solely for the purpose of increasing its [the majority's] control, provided that the majority SH treats the minority SH with ENTIRE FAIRNESS. Think of it involving both procedural (fair dealing) and substantive fairness (fair deal/price).

Cleansing usurping transactions using the second prong (fairness of substance of transaction) (2 Factors & 3 Tests)

Factors: (1) Did the director learn of the opportunity in her individual or corporate capacity? (2) Is the Corporation financially able to undertake the opportunity? Tests: (1) Line of Business Test (narrow or broad) (2) Interest or Expectancy Test (does corp have an I/E in the opportunity -- meaning contractual option to purchase) (3) Fairness Test (ad hoc decision - minnesota)

Business Judgment Rule

Presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company -D/Os are best positioned to make business decisions -BJR can be rebutted by showing grossly negligent process on extremely important matter (duty of care analysis)

Duty of Care

The Directors and Officers owe the corporation a duty of care. This imposes on the director an obligation to act reasonably when making corporate decisions. - Be reasonably informed - Exercise independent judgment - Attend and participate in Board meetings - Analyze information, consider alternatives - Fulfill these obligations honestly, in good faith

Line of Business Test

This is one of the tests used to determine whether a director usurped a corporate opportunity Can be applied -NARROWLY (existing LOB), or -BROADLY (potential LOB) Note - where a court finds that the director learned of the opportunity in his INDIVIDUAL capacity, likely to apply NARROW LOB test. If learn of opp. b/c of position on board, likely to construe LOB test BROADLY.

Classic Disloyalty Test ("Self Dealing")

Under section 144 of the DGCL, a self dealing transaction can be saved if: -144(a)(1) Disclosure + disinterested dir'r approval (maj.), -144(a)(2) Disclosure + SH approval, or -144(a)(3) If self-dealing transaction is fair to the corp.

Duty of Loyalty and Special Problem of Majority Freezeouts

When a company owns 50-90% of another company's stock and tries to buy the rest ("cash out merger"), we apply the SUPERLOYALTY ("entire fairness") test (Weinberger).

Duty of Loyalty: Usurping Corporate Opportunities

Where directors or officers take advantage, in their individual capacity, of business opportunities that rightfully belong to the corporation.