Chapter 10: Director's Duties and Liabilities

Delaware Law on Duty of Care

MCA §2.02(b)(4) and §102(b)(7) (Delware) Removes directors from liability for certain acts by including the above-cited provision in the AOI. Typically creates a removal from violation of Duty of Care, but not Duty of Loyalty. Delaware says "not in good faith", MBCA says "an intentional infliction of harm on the corporation".

What must a Directory do at the Least?

• A director must at least: o Have a rudimentary understanding of the business. o Keep informed as to the business's activities o Generally monitor corporate affairs and policies (attend board meetings) o Maintain familiarity with the financial status of the corporation by regular review of financial statements. o Seek assistance of counsel when needed.

4 Tranches of Duty of Care

1. Complete dereliction 2. Failure to inform 3. Bad Oversight 4. Bad Disclosures

Questions to ask during Corporate Opportunity Test

1. Is this a corporate opportunity? 2. Was there full disclosure to the board of the deal and the director's intention? Remember: EVEN IF THERE IS A CORPORATE OPPORTUNITY (see above) IF THE BOARD RATIFIES THAT THEY DON'T WANT IT, you can take advantage of it.

Cede v. Technicolor

A breach of the duty of care does not require that the plaintiff prove causation (that the breach-failure to inform- was the actual cause of the damages they claim) in order to sue for damages.

Orman v. Cullman: Delaware Independent Director standard:

Apply a subjective actual person standard to determine whether a particular director's interest Is material and debilitating or that he lacks independence because he is controlled by another. In order to find that a board decision was not independently made, the plaintiff must show that a majority of the board involved in the decision was conflicted, and thus, breached their duty of loyalty in voting

Lewis v. Vogelstein

Board is approving options to itself, and did not reveal the lucrative amount to the shareholders. They, however, unanimously approved the dealings they were doing. FOUR POSSIBLE EFFECTS OF SHAREHOLDER RATIFICATION OF AN INSIDER DEAL: 1. Complete defense to any charge of breach of duty 2. Shift substantive test on judicial review of the act from one of fairness that would otherwise be obtained to one of waste. 3. Shifts the burden of proof of unfairness to the plaintiff, but leaves the shareholder- protective test in place. 4. Shareholder ratification offers no assurance of assent of a character that deserves judicial recognition. THEY GO WITH THE WASTE THEORY. If a qualified group, majority of shareholders, freely approves a conflicting interest transaction then the director is off the hook. The only way to upset this is to prove that the shareholders were 1. lied to or deceived or 2. that there was corporate waste.

Duty of Loyalty: State Ex. Rel Hayes Oyster Co. v. Keypoint Oyster Co.

Cited for the proposition that if you take the benefit of a self-dealing transaction and don't disclose it, you must give it back. It does not necessarily void the deal, but if the failure to disclose was sufficiently unfasair, you need to return the benefit.

Remillard Brick (self-dealing transactions)

Corporation tried to sell bricks to another corporation owned by the same directs. Court Found for Shareholders • After this decision, California amended their laws to disqualify shares voted by interested directors. That meant that in the future if people like Stanley and Sturgis wanted the corporation to contract with another business they owned, they would have to get a majority of the minority shareholders to agree that was a good deal.

Duty of Loyalty

Duty of Loyalty: The duty of loyalty stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act without personal economic conflict. The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity.

In Re: Caremark Internal Inc. Derivative Litigation

Failing to monitor a decision/ provide oversight resulted in a significant loss to the company. Under Caremark, the court found that "it is important that the board exercise a good faith judgment that the corporation's information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations." If not, they may be responsible for a breach fo the duty of care.

Duty of Care Francis v. United States

Francis v United States (bad faith, waste, dereliction) • This is the Mrs. Pritchard, Complete Derelict Standard • "A director is not an ornament, but an essential component of corporate governance." • Failing to act at all is dereliction of duty, and a breach of the duty of care.

Farber v. Servan Land Company Co.

Individuals discussed buying land, bought land on their own, Shareholder sued for breach of loyalty. 4 things to consider Was there an opportunity Ratification of purchase Whether it was declined The effect of the benefit Court says that there was a breach of duty of loyalty.

MCBA Independence Standard

MCBA Independence Standard (stricter than Delaware) Under MBCA 8.61: If the majority of qualified directors approved the transaction with required disclosures, the D does not have to prove fairness to the corporation due to conflicting interest. If do not get the majority of qualified directors, P may proceed. MBCA 8.62 defines "qualified director" : any director who des not have either a conflicting interest respecting the transaction or a familial, financial, professional, r employment relationship with a second director who does have a conflicting interest respecting the transaction which would...exert an influence on the first director's judgment when voting.

McPadden v. Sidhu

The Board of Directors was grossly negligent, but gross negligence alone does not constitute bad faith. Thus, you can't get to their personal effects. Intentionally neglect or intentionally disregard duties = bad faith. In this case, the board had a meeting and talked about it. In the AOI Duty of Care removes liability

Corporate Opportunities Doctrine

The COD represents the idea that a person occupying a fiduciary position in relation to a company cannot legitimately acquire, in opposition to the corporation, property in which "the corporation has an interest or tangible expectancy." (Farber v Servan Land Co., pg 552). The rationale behind the COD is to avoid having Directors, or other fiduciaries, void their duty of loyalty to the company by sniping deals that would otherwise belong to the entity.

Gantler v. Stephens

The Company represented that there had been careful deliberations regarding the "first place merger proposal" when there were not. If you state you "carefully deliberated" you need to give the details. The shareholders need to know how the vote split etc. so that when they decide to ratify etc., they have an idea of the background. In the context of an action when you're seeking approval you must disclose all material facts. Material facts are defined as those that a reasonable investor would want to know in making the vote.

Malone v. Brincat

The company was not seeking shareholder action when they made a materially false disclosure/ filing. The shareholders sue because they were damaged by the resulting 2 million dollar loss. They would have gotten out had they known the status of the co. Do the directors have a duty to disclosure if they're not asking for any shareholder action? Are the liable under duty of care if they don't ask? Under Delaware law, there is no corporate law duty upon board to keep shareholders informed if they not asking for action. That comes from federal securities law. However, ONCE YOU MAKE A DISCLOSURE, it must be ACCURATE (this true under state law too). Shareholder duty to investigate

Duty of Care

The duty of care stands for the principle that directors and officers of a corporation in making all decisions in their capacities as corporate fiduciaries, must act in the same manner as a reasonably prudent person in their position would. Courts will generally adjudge lawsuits against director and officer actions to meet the duty of care, under the business judgment rule. The business judgment rule stands for the principle that courts will not second guess the business judgment of corporate managers and will find the duty of care has been met so long as the fiduciary executed a reasonably informed, good faith, rational judgment without the presence of a conflict of interest. The burden of proof lies with the plaintiff to prove that this standard has not been met. If the the plaintiff meets the burden, the defendant fiduciary can still meet the duty of care by showing entire fairness, meaning that both a fair process was used to reach the decision and that the decision produced a substantively fair outcome for the corporation's shareholders.

Second Half of Test

The second Guth test is a corollary of the first. It address when a director CAN take a potential corporate business opportunity for his or her own benefit. A director may take an opportunity for his own if: 1. Opportunity is presented to the director in his individual and not his corporate capacity. 2. The opportunity is not essential to the corporation 3. The corporation holds an interest or expectancy in the opportunity 4. The director or officer has not wrongfully employed the resources of the corporation in pursing or exploiting the opportunity

Two Prong Tests: Under the First Guth Test

Under the first Guth test, a fiduciary may not take a business opportunity if: 1. The corporation is financially able to exploit the opportunity 2. The opportunity is w/in the corporation's line of businesses 3. The corporation has an interest or expectancy in the opportunity 4. By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimical to his duties to the corporation.

Smith v. VanGorkom

VanGorkom attempted to buy stock that wasn't worth its cost. The board of Directors filled a lawsuit auguring breach of fiduciary duty of care o The Appellate Court found that the directors were grossly negligent because they approved the merger without substantial inquiry or any expert advice. Therefore they breached their duty to care. • The Court found that the directors breached their fiduciary duty by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the merger, and • The Court found that there was a failure to disclose all material information such as a reasonable stockholder would consider important in deciding whether to approve the merger. • The Court found that Van Gorkom breached his duty to care by offering $55 a share because, "the record is devoid of any competent evidence that $55 represented the per share intrinsic value of the Company." o The Court found that the business judgment rule was not a defense because the directors and Van Gorkom didn't use any "business judgment" when they came to their decision.

Standard for the Business Judgement Rule:

a. What is the standard to get to business judgment rule? -Aaronson Test -Caremark -Breach of typical duties of honesty re: disclosures b. Can I get damages or injunction (§2.02(b)(4))? Both, either. c. What burden of proof does ea party have? Does it shift? Initially, Plaintiff has the burden of proof. It moves to the Defendant once the business Judgment rule is rebutted. Typically must prove "entire fairness"

When you grant indemnification rights, must define them how?

o How long do they continue (through trial, through appeal?) o Who has the right to settle the case o Fee on fee dispute. Dispute as to whether you are entitled to be indemnified for fighting for your right to be indemnified. o Scope of the players indemnified--- BE SPECIFIC. o General indemnification in the Articles, large specific ones in the contract.

Insurance Styles Side A

o Side A coverage (protects the executive- co isn't indemnifying me, you need to)

Side B Insurance

o Side B coverage (we have to indemnify our employee, take care of it). o Usually need special KINDS of coverage (sexual harassment, securities law violations). o Coverage will never extend to professional liability/ malpractice. Designed to protect you in the fiduciary role as officer and director.

In Re Walt Disney Co. Derivative Litigation (II)

• In order to rebut the business judgment rule , must meet the Aaronson Standard: o Particularized facts that show reasonable doubt that the action was taken in good faith o Reason to doubt that the board was adequately informed. o This creates a beach of the duty of care that removes the business judgment protection • The court finds that this board is not merely uninformed- They consciously and intentionally disregarded their responsibilities, showing they did not care about the potential risk.. • This seems tor rise to the level of bad faith. • If it rises to the level of bad faith, the Duty of Loyalty is also implicated, which means the action would not be exempted under §2.20(b)(4) (see below)

Director Protections

• The Schoon Issue—can't amend bylaws to exclude indemnification w/ relation to employees who, before they left the co, understood themselves to be indemnified. (see page 567)

Stone v. Ritter (Poor oversight and monitoring)

• The directors utterly failed to implement any reporting or information system or controls; or • Having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. • In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations. o The Court found that there is no duty of good faith that forms a basis, independent of the duties of care and loyalty, for director liability. • The Court found that just because there was a bad outcome in this case, that was not evidence of bad faith on the part of the directors. • Basically, this case said that directors are not responsible for ensuring the legality of every act by the corporation's personnel, even if the illegal conduct would have been discovered if there hadn't been a failure of the corporate compliance program.

In Re: Walt Disney

• The plaintiff has not proven that Eisner is a conflicted interest party. Consequently, the board is not "per-se" disqualified by their connection to Eisner (financial or familial). • Are the directors independently disqualified? o Plaintiff must prove (under prong 1 of Aronson test) that the majority of the disinterested directors approved the transaction. o Go through the board, figure out who is independent (b/c Eisner is not conflicted, this analysis must operate off of connections to Ovitz). • Essentially, by failing to prove that Eisner was a conflicted party, there was NOTHING in this case. • The case was dismissed. Brought back to counsel. o Forget independence theory- the claim must be DERELECTION OF DUTY. o Board gave no substantive attention to the contract (see above) (2nd prong of Aronson). This made it through. o Dereliction--- if found to be liable they are JOINT AND SEVERALLY LIABLE (go after the deep pockets).

What to ask before joining a board?

• WHAT TO ASK BEFORE YOU JOIN A BOARD o Are there good ppl on the board o Do you have indemnification rights? For what? o How financially strong is the company? If not strong- make sure the indemnification rights are secured by a larger pocket. o How is the company going to use your name or status to raise money?