Bus Orgs - Fiduciary Duties (Owed by Corp. Officers, Directors, and Controlling SHs); Indemnification and Insurance
What are the exceptions to the business judgment rule (when are directors/officers denied the presumption that they satisfied their duty of care)?
(1) Conflict of interest (director or officer had a personal interest in the corporate decision) (2) Decision constitutes illegal/wrongful conduct (3) Acted in bad faith (fraud, actual intent to do harm, not acting to advance corp's interests, conscious disregard) (4) Unintellingent, uninformed decisions - failing to consult with experts as necessary (Van Gorkum) (5) Waste of corp. assets (decision lacked a rational business purpose) --> TOUGH STD TO PROVE! (6) No decision made at all ("dummy director" scenario - Francis v. United Jersey Bank)
How do you analyze a corporate opportunity fact pattern?
(1) Determine if "corporate opportunity" - Use "Line of Business Test" - If NO -> fiduciary can nab the opp (but disclosure is still recommended - safe bet) (2) If corp. opportunity - was the opportunity DISCLOSED (i.e. to the board)? - If NO disclosure -> breached duty of loyalty. - If disclosure and opp rejected -> no breach as long as full disclosure and vote. (Broz v. Cellular Information Systems)
What are the duties of CONTROLLING SHAREHOLDERS?
(1) Duty of LOYALTY and (2) Duty of CARE - Plaintiffs/minority SHs can sue them under either or both of these theories. (Sinclair Oil v. Levien)
What does SUBSTANTIVE FAIRNESS and PROCEDURAL FAIRNESS mean in the context of the duty of loyalty?
(1) SUBSTANTIVE FAIRNESS: the merits and terms of the transaction are fair. (2) PROCEDURAL FAIRNESS: entails evaluation of the corporate decision-making process.
What is the purpose of the business judgment rule?
(1) Shield officers and directors from liability partly b/c it is easy to judge decisions as bad in hindsight. (2) Benefits of enabling directors and officers to make risky (but reasoned decisions) often results in a big pay-off; we don't want to hinder that by restricting their entrepreneurial decision-making. (3) Shareholders can always limit their risk by diversifying their stock portfolio. (4) Want to limit litigation and judicial intrusiveness in the realm of private-sector decision- making.
What is the analysis for a duty of care fact pattern?
(1) What are the director's responsibilities? (2) What did the director's fail to do? (3) Was causation satisfied (did the director's failure cause the harm being complained of? • Hardest element to prove. • Particularly hard to show non-action caused damages (4) Defense available to shield the director from liability (i.e. BJR)?
In what two (actually three) situations does a DUTY OF LOYALTY problem present itself?
(1) Where there is a CONFLICT OF INTEREST (2) When a CORPORATE OPPORTUNITY is presented to an officer/director of the corp. (3) Where an OUTSIDE DIRECTOR has been hired to make sure SOX violations don't take place.
What is the distinction b/w the Delaware and Model Act approaches to evaluating interested transactions
-DE: Even if disinterested and informed directors/SHs approved or ratified the TX, the disputing SH(s) can assert the TX was not intrinsically fair (ask the court to look at the merits of the TX) -MODEL ACT: Ct. will NOT look into the merits of the TX once the conflicted director of officer shows disinterested and informed directors or SHS OKd the transaction. **NOTE: Under both approaches, plaintiffs can always attack procedural fairness (i.e. attack the board's/SHs' decision making process, show that the "disinterested" directors were acting under the influence of the interested director, and thus their decision was not independently made).
What is the CORPORATE OPPORTUNITY DOCTRINE?
A fiduciary of the corp. may not take, for personal gain, an opportunity like a business venture, new opportunity or discovery in which the corp. has an (1) interest (preexisting contractual right), (2) expectancy, or (3) necessity and use it for his own advantage without first offering it to the corp. - Analogous to the duties a partner owes to the partnership (SEE: Meinhard v. Salmon) - Applies to board members, officers, controlling SHs (in certain situations) and other fiduciaries of the corp (i.e. Ls, consultants)
When is DE's SAFE-HARBOR statute that serves to protect transactions involving interested directors from judicial review?
ANSWER (DE APPROACH): TX may be shielded from judicial review ("cleansed") if the interested officer/director disclosed the CofI, and: • TX is approved by majority of fully informed and disinterested directors (but no quorum req) OR • TX is ratified by informed and disinterested SHs (under Gantler - sufficient IFF SH ratification was NOT required), OR • TX is shown to have been INTRINSICALLY FAIR (price terms) to corp at the time it was authorized, approved or ratified by the board, a committee or the shareholders.
What is a CORPORATION'S main PURPOSE?
ANSWER - A business corporation is organized and carried on primarily for the profit of the stockholders. A director cannot put this primary goal aside and pursue other objectives. (Dodge v. Ford Motor Co.* - Henry Ford was limiting his company's profits and acting primarily in the interests of consumers' financial welfare. ) *This case has been highly criticized b/c can lead directors/officers to disregard their corporate responsibilities AND ignores long-term goals in favor of short-term profit.
What is the "business judgment rule"
ANSWER - A common-law created safe-harbor provision that shield directors from personal liability and insulates their decisions from judicial review. (1) Rebuttable presumption that a director has not breached his duty of care (acted in good faith, in the best interests of the company, and made an informed and rational decision). (2) Challenging party can rebut by introducing evidence that there was a CofI, director engaged in fraud, acted in bad faith, engaged in self-dealing, etc. (3) If challenging party shows, i.e. a conflict of interest - BJR no longer applies. Director can escape liability by showing: - TX was beneficial to the corporation, - TX was procedurally and substantively FAIR, OR - No damages
What is the common law test of fairness (DUTY OF LOYALTY inquiry)
ANSWER - A tx premised on a CofI will be void unless the conflicted party can affirmatively show that the tx was fair (or procedural safeguards in place - "safe harboring" mechanism). (Lewis v. S.L. & E., Inc.) - IF plaintiff shows CofI existed, conflicted directors are NOT shielded by the BJR. - Upon proof of a CofI, the directors bear the burden of showing the overall tx was intrinsically fair OR show procedural safeguards in place (safe-harboring mechanism).
What is a strategy plaintiff's attorneys will often take in order to reach deep-pocket insurers to satisfy obligations owed by a corporation's directors or officers?
ANSWER - Avoid claiming fraud/bad faith claims b/c insurance companies typically do NOT insure intentionally wrongful acts. - ALSO - collusion b/w plaintiff's and defendant's attorney is typical here (bootleggers and baptists type scenario)
What is the DE "good faith" requirement for indemnification and can an indemnification agreement trump it.
ANSWER - DE only allows corp. indemnification of officers and directors when they acted in good faith. An indemnification agreement to the contrary will NOT overcome this requirement. (Waltuch v. Conticommodity Services) -If "good faith" absent, D/O not entitled to indemnification.
What is the standard duty of care for directors
ANSWER - Directors have a duty to: (1) act in "good faith" ( = act honestly, do not have a CofI, and do not approve or condone wrongful/illegal activity) AND (2) in a manner he reasonably believes to be in the corporation's best interests AND (3) act on an informed basis (necessitates monitoring and supervising corp. activities; cannot be a dummy director) (Francis v. United Jersey Bank - director's children misappropriating corp. funds -> failure to monitor = breach of duty of care)
Can a shareholder derivative suit be premised solely on the fact that the Board of Directors is not taking certain actions that might serve to increase the corporation's revenue?
ANSWER - Generally, No. Cts generally will not interfere w/directors's business judgment unless the disputing SHs show their business decision borders on fraud, illegality or a conlfict of interest. (Shlensky v. Wrigley - minority SH lost suit against Cubs directors following their refusal to allow night games at Wrigley Field - their social/community concerns were respected.
How does the corporation's impending insolvency affect a director's duty of care?
ANSWER - If a director knows the corp. is getting close to insolvency, duty of care expands to require his consideration of CREDITOR'S INTERESTS.
Absent procedural fairness (protection via DE's safe harbor statute), are interested transactions per se voidable?
ANSWER - NO. Even if the transaction did not receive approval by the board (i.e. deadlock b/w two groups of directors on the board), a TX involving an interestes SH will not be voided so long as it is deemed INTRINSICALLY FAIR. (Marciano v. Nakash) -Can prove intrinsic fairness by showing, i.e. terms of loan similar to what banks offering, K desirable from the corp's perspective (i.e. banks won't lend and tx necessary's to corp's continued existence/well-being).
What is a director's duty when he obtains notice that violations may or have been taking place within the corporation?
ANSWER - The director must make good faith effort to detect illegal behavior (monitor) and prevent/stop the violations by setting in place corporate monitoring and reporting systems. (In re Caremark - employees were taking "kick-backs") - Adjustment to the Graham v. Allis-Chalmers rule.
When has a director breached the duty of GOOD FAITH where oversight of company activities is at issue?
ANSWER - The duty of acting in good faith is breached where there is a "sustained or systematic failure to exercise oversight." (Stone v. Ritter) - Requires utter failure to attempt to assure a reasonable information and reporting system exists to monitor activities and ensure legal compliance. - If have a system in place (in accordance w/Caremark), ct. likely to find you satisfied duty of food faith even if the system is not very good.
When does a director breach their duty of acting in GOOD FAITH?
ANSWER - When he consciously and intentionally disregards his responsibilities to the company. (In re Walt Disney Derivative Litigation) - Good faith is tied to both the director's duty of care AND his duty of loyalty. - The fact that the board's conduct falls significantly short of corporate governance best practices does not necessarily constitute a breach (but this seems to be changing). - Gross negligence w/out more does not constitute bad faith (but generally qualifies as a breach of care violation). - LARGER IMPLICATIONS - Directors can be indemnified by the corp's insurer for breaching duty of care but NOT for breaching duty of duty of loyalty.
When does the BJR protect directors from personal liability?
ANSWER - When they make and INFORMED business decision. (Smith v. Van Gorkum) - Director must be (specifically) INFORMED about the PARTICULAR TX at issue, not just about the company's financial status and the market in general. - This may require the director to CONSULT with qualified EXPERTS (both inside and outside his company to make sure the TX is good for the company and its SHs). - The reliance on experts consulted must also be REASONABLE (judged from the particular director/officer's perspective, which is based on his education and position w/the company)
What falls w/in a corp's "line of business" warranting disclosure under the corporate opportunity doctrine
Activities as to which the corp has fundamental knowledge, practical experience, and ability to pursue. Req. consideration of corp's INTEREST, EXPECTATIONS/ASPIRATIONS, and its NEEDS. (Northeast Harbor v. Harris) - Do NOT limit analysis to what the corp. is doing now - ask "what does the corp. EXPECT?"
When have directors breached their duty of loyalty/good faith in the context of executive compensation agreements?
Bad faith in this context typically arises only where the directors engaged in fraudulent/illegal conduct. (Ryan v. Gifford - employee stock backdating case)
What is the standard DUTY OF LOYALTY?
Directors have a duty to exercise their powers in the corps' interests and not in the directors' own interest or in the interest of another person (including a family member) or organization. -CANNOT use their corp. position to make a personal profit or for other personal advantage.
What is the GENERAL RULE regarding a controlling SH's ability to sell his share?
If someone offers controlling SH a a premium for his controlling shares, he can accept it, and does NOT need to share premium with minority SHs
What is the EXCEPTION to the general rule that a controlling SH does not need to share the premium he received for his shares in the corp. with minority SHs?
If the sale gives the purchaser more than just control of the Co → something else that really belongs to the Co (i.e. ability to determine who can purchase a commodity the co. manufacturers) → premium must be shared w/minority SHs. (Perlman v. Feldmann)
What is the Iowa Approach to safe-harboring interested TXs?
MINORITY APPROACH - Directors must still prove fairness of transaction: • Approval by "disinterested" directors does not imply they exercised independent judgment. • Ct. Will not stop once safe harbor established - ct will still look into the merits of the TX to determine if made in good faith, honesty, and fairness. (Cookies Food Products v. Lakes Warehouse)
What is the Graham v. Allis-Chalmers rule w/respect to directors' duty of care and what is the major criticism of its rule?
THE RULE: Directors are not required to put in place monitoring systems unless they know of or suspect illegal conduct by corporate employees, officers, etc. THE CRITICISM: Motivates directors to prevent information from flowing to them in order to protect themselves from liability.
