BLTC 11e IM-Ch34 - NACMnacm.org/docs/cap_acap_materials/CL11/BLTC-11e-I… · Web viewChapter 34: Corporate Directors, Officers, and. Shareholders. Introduction

Chapter 34

Corporate Directors, Officers,and Shareholders

INTRODUCTION

Sometimes, actions that benefit a corporation as a whole do not coincide with the separate interests of the individuals making up the corporation. In considering those situations, it is important for your students to be aware of the rights and duties of the participants in the corporate enterprise.

This chapter focuses on the rights and duties of directors, managers, and shareholders and the ways in which conflicts between and among them are resolved. The duty of care and duty of loyalty owed by directors, the business judgment rule and the immunity it provides directors from honest mistakes, and the duty owed by majority share-holders to the corporation and minority shareholders are among the topics.

CHAPTER OUTLINE

I. Directors and Officers• Directors are the ultimate authority in a corporation with responsibility for corporate policy. Each director

has one vote. The board—

Selects and removes corporate officers.Determines the firm’s capital structure.Declares dividends.

• Directors act for and on behalf of their corporation, but no individual director can act as an agent to bind the corporation, and directors collectively control a corporation in a way that no agent can control a principal.

• A corporation may require a director to be a shareholder. Otherwise, there are few, if any, qualifications.

A. ELECTION OF DIRECTORS

• The number of directors is stated in the articles or bylaws. Close corporations may eliminate the board altogether. The incorporators appoint the first board, which serves until the first shareholders’

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meeting. A majority vote of the shareholders elects subsequent directors. Directors typically serve for a year or more.

• A director can be removed for cause (and usually not without cause).

B. COMPENSATION OF DIRECTORSThere is no inherent right to compensation, but many states permit the articles or bylaws to authorize it, and in some cases the board can set its own. Directors may set their own compensation [RMBCA 8.11]. A director who is also a corporate officer is an inside director. A director who does not hold a management position is an outside director.

C. BOARD OF DIRECTORS’ MEETINGSThe dates for regular board meetings are set in the articles and bylaws or by board resolution, without further notice.

• A quorum is generally a majority of the number of authorized directors [RMBCA 8.24].

• Ordinary matters require majority approval—certain extraordinary matters may require more.

ENHANCING YOUR LECTURE—

THE TIMING OF DIRECTORS’ ACTIONS

IN AN ELECTRONIC AGE Corporate directors can hold special board meetings to deal with extraordinary matters, provided that they

give proper notice to all members of the board. If a special meeting is called without giving sufficient notice to all of the directors, are the resolutions made at that meeting invalid? If so, can the directors validate these resolutions by holding a second special board meeting with proper notice? In today’s electronic age, matters of timing can be complicated and can affect a variety of other issues, including the effective date of a director’s resignation and the validity of a resolution appointing a new director. These were the central issues presented by In re Piranha, Inc.a

THE ISSUE OF PROPER NOTICE

In May 2001, Edward Sample, the chairman of the board of directors of Piranha, Inc., called a special meeting for May 25 to consider restructuring Piranha’s management in response to serious financial problems. The four members of the board of directors at that time were Sample, Richard Berger, Larry Greybill, and Michael Steele. Berger objected to the lack of notice of the May 25 meet ing and refused to attend, claiming that the meeting was invalid. The other directors held the meeting without him and, among other things, voted to accept the resignations of two of the directors, Greybill and Steele, and appoint a new director, Mike Churchill.

After the meeting, Greybill submitted his written resignation, but Steele did not, fearing that Berger might be correct about the lack of notice rendering the meeting invalid. Nonetheless, the corporation’s legal counsel filed a form with the Securities and Exchange Commission (SEC) on May 25 indicating the changes made to the board of directors. The SEC form stated that Steele had resigned as director and contained Steele’s


CHAPTER 34: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 3

electronic signature.

THE SECOND MEETING

By early June, Piranha’s legal counsel concluded that insufficient notice had probably rendered the May 25 meeting—and the resolutions made at that meeting—invalid. The attorneys informed the directors that, to effect the changes to the board, they would need to call another special meeting and provide sufficient notice. A second special meeting was held on June 15 with proper notice (to Berger, Sample, and Steele), and Churchill was voted in as a director. Steele, now confident that Churchill was validly appointed as a director, submitted his written resignation the following day.

Berger, however, contended that Churchill was not truly a corporate director because Steele had no right to vote at the second board meeting. At issue was whether the SEC filing of May 25 bearing Steele’s electronic signature meant that Steele had effectively resigned on that date. If Churchill was not a valid director, then his subsequent vote that the corporation should file for bankruptcy would be invalid.b

THE COURT’S CONCLUSION

Ultimately, a federal appellate court held that Steele’s electronic signature on the SEC filing did not operate as his formal resignation. Under the Uniform Electronic Transactions Act (UETA), a signature may not be denied legal effect solely because it is in an electronic form. Section 107(a) of the UETA, however, also allows a person to disavow the signature. Here, Steele claimed that he did not authorize his signature on the form submitted to the SEC. Therefore, the court found that Steele had not resigned until he submitted his written resignation following the second meeting. Thus, Churchill was a corporate director and could vote for the corporation to file bankruptcy.

FOR CRITICAL ANALYSIS

What would the legal consequences have been if Berger had attended the first special board meeting despite the lack of sufficient notice?

a. 2003 WL 22922263 (5th Cir. 2003).b. After the June 15 meeting, the directors voted that the corporation should file a petition for bankruptcy. Berger originally filed an action requesting that the court dismiss the bankruptcy petition because Churchill was not a valid director at the time of the vote. The bankruptcy court rejected this contention and Berger appealed, resulting in the decision discussed here.

D. COMMITTEES OF THE BOARD OF DIRECTORS

• Most states permit a board to elect an executive committee from among the directors to handle management between board meetings. The committee is limited to ordinary business matters.

• The audit committee selects, compensates, and oversees independent public accountants who audit the firm’s financial records under the Sarbanes-Oxley Act of 2002.

E. RIGHTS OF DIRECTORS

• Directors’ basic right is to participate in management, which includes a right to be notified of board meetings.

• Directors have access to all corporate books and records.



• Most states (and RMBCA 8.51) permit a corporation to indemnify a director for costs, fees, and judgments in defending corporation-related suits.

F. CORPORATE OFFICERS AND EXECUTIVESThe board normally hires officers. Qualifications are set in the articles or bylaws. Rights are defined by employment contracts. One person can hold more than one office and be both an officer and a director. Officers’ duties are the same as those of directors.

II. Duties and Liabilities of Directors and OfficersDirectors and officers are corporate fiduciaries.

A. DUTY OF CAREThe duty of care includes acting in good faith and in the best interests of the corporation, and exercising the care that an ordinarily prudent person would use in similar circumstances [RMBCA 8.30(a), 8.32(a)]. Breach of the duty may result in liability for negligence.

1. Duty to Make Informed and Reasonable DecisionsDirectors must be informed on corporate matters and act in accord with their knowledge and train ing. A director can rely on information furnished by competent officers, or others, without being accused of acting in bad faith or failing to exercise due care.

2. Duty to Exercise Reasonable SupervisionDirectors must exercise reasonable supervision when work is delegated.

3. Dissenting DirectorsDirectors must attend board meetings; if not, he or she should register a dissent to actions taken (to avoid liability for mismanagement).

4. The Business Judgment RuleDirectors and officers are immune from liability for a bad business decision as long as—

• The decision is within managerial authority.• The decision complies with management’s fiduciary duties.• Acting on the decision is within the powers of the corporation.• There is no evidence of bad faith, fraud, or a clear breach of fiduciary duties.

The rule applies when—

• The director took reasonable steps to become informed about the matter.• The director had a rational basis for the decision.• There was no conflict of interest between the director’s personal interest and the interest of the

corporation.

B. DUTY OF LOYALTYDirectors and officers must subordinate their self-interest to the interest of the corporation.

1. Situations Involving Duty of LoyaltyDirectors should not—



• Compete with the corporation.• Usurp a corporate opportunity. • Have an interest that conflicts with an interest of the corporation.• Use information that is not public to make a profit trading securities.• Authorize a corporate transactions that is detrimental to minority shareholders.• Sell control over the corporation.

CASE SYNOPSIS—

Case 34.1: Guth v. Loft, Inc.

Loft, Inc., made and sold candies, syrups, beverages, and food in Long Island City, New York. Loft operated 115 retail outlets in several states and also sold its products wholesale. Charles Guth was Loft’s president. Guth and his family owned Grace Co., which made syrups for soft drinks. Guth acquired the trademark and formula for Pepsi-Cola and formed Pepsi-Cola Corp. but neither Guth nor Grace could finance the venture. Without the knowledge of Loft’s board, Guth used Loft’s capital, credit, facilities, and employees to further the Pepsi enterprise. Guth also made Loft a Pepsi customer. Eventually, losing profits at its stores as a result of switching from Coca-Cola, Loft filed a suit in a Delaware state court against Guth and others, seeking their Pepsi stock and an accounting. The court entered a judgment in the plaintiff’s favor. The defendants appealed.

The Delaware Supreme Court upheld the judgment. The state supreme court was “convinced that the opportunity to acquire the Pepsi-Cola trademark and formula, goodwill and business belonged to [Loft], and that Guth, as its President, had no right to appropriate the opportunity to himself.” The court cited the principle that a corporate officer owes “the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation.” Thus “if there is * * * a business opportunity which the corporation is financially able to undertake [that] is * * * in the line of the corporation's business and is of practical advantage to it * * * and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself.”

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Notes and Questions

How could this case have been brought before courts in Delaware? Grace and Pepsi were both incorporated in Delaware.

After the decision in the Guth case, the rule applied with respect to corporate transactions involving interested directors was that, when a matter in which they had an interest came before their board for a vote, their vote was not counted. Courts could therefore hold the transactions voidable. (Under that rule, of course, Guth’s vote on Pepsi’s use of Loft’s resources could have voided the deal even if he had proposed it to Loft’s board.

Is this still the rule? No, at least not in Delaware, where Guth was decided. In 1967, Delaware altered this rule with the enactment of Section 144 of the Delaware General Corporation Law:”



(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because his or their votes are counted for such purpose, if:

(1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or

(2) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in good faith by vote of the shareholders; or

(3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by the board of directors, a committee or the shareholders..

(b) Common or interested directors may be counted in determining the presence of a quorum at a meeting of the board of directors or of a committee which authorizes the contract or transaction..

Under the more recent rule, with full disclosure, an interested director might even vote on a matter without that vote effectively voiding a board’s approval. In that situation, had Guth set out in full detail a proposal for Pepsi’s use of Loft’s facilities, and Loft’s board had approved, there might have been no case.:”

In taking advantage of Loft’s capital and facilities, Pepsi-Cola was utilizing resources that arguably might otherwise have gone unused. Why did the court rule against this “resourcefulness”? The principal reason that the court would not accept this argument is that Loft’s resources belonged to Loft, not Guth, who used them without Loft’s permission. Guth referred to it as “borrowings.” The court was “certain it is that borrowing is not descriptive of them. A borrower presumes a lender acting freely. Guth took without limit or stint from a helpless corporation . . . without the knowledge or authority of the corporation's Board.”. He “commandeered for his own benefit and advantage the money, resources and facilities of his corporation and the services of its officials. He thrust upon Loft the hazard, while he reaped the benefit. . . . A genius in his line he may be, but the law makes no distinction between the wrong doing genius and the one less endowed.”

ADDITIONAL CASES ADDRESSING THIS ISSUE —

Duty of Loyalty

Cases conflicts between a corporate official’s personal interest and his or her duty of loyalty include the following.

• NCMIC Finance Corp. v. Artino, 638 F.Supp.2d 1042 (S.D. Iowa 2009) (a company vice president violated his fiduciary duty to the company when, without his employer’s knowledge, he entered into an agreement with his employer's competitor to divert business to the competitor and expended time and effort to establish a competing business).



• Gundaker/Jordan American Holdings, Inc. v. Clark, __ F.Supp.2d __ (E.D.Ky. 2009) (corporate directors who attempted to remove their president to preserve their employment after they learned the president intended to downsize the company to save money acted in wanton disregard for the best interests of their firm and in breach of their fiduciary duty).

• Auburn Chevrolet-Oldsmobile-Cadillac, Inc. v. Branch, __ F.Supp.2d __ (N.D.N.Y. 2009) (a company president breached his fiduciary duty by issuing a check to himself without advising the company's board, particularly absent evidence the check was payment for a purported loan).

• Brewer v. Insight Technology, Inc., __ Ga.App. __, __ S.E.2d __ (2009) (the president of a company breached his fiduciary duties toward his corporate employer by establishing, with the owner of a competitor, a firm that competed with one of his employer’s divisions, making the president liable for misappropriation of a corporate opportunity).

• Patmon v. Hobbs, 280 S.W.3d 589 (Ky.App. 2009) (the managing member of a limited liability company (LLC) that was having difficulty securing financing for its projects breached his fiduciary duty to the other members of the LLC by diverting the projects to his own company without informing the other members).

• Yates v. Holt-Smith, 319 Wis.2d 756, 768 N.W.2d 213 (App. 2009) (a director of a corporation was motivated by self-dealing in pressuring a shareholder to sell her shares and was not entitled to the protection of the business judgment rule on the shareholder's claim of a breach of the director’s fiduciary duty).

2. Disclosure of Conflicts of InterestDirectors and officers must fully disclose any potential conflict of interest. After full disclosure, the individual may go ahead if the other directors or shareholders approve (assuming the cir -cumstances are otherwise fair and reasonable).

C. LIABILITY OF DIRECTORS AND OFFICERSDirectors and officers are personally liable for their torts and crimes, and may be liable for those of subordinates (under the “responsible corporate officer” doctrine or the “pervasiveness of control” theory). The corporation is liable for acts done within the scope of employment.

III. ShareholdersAs a general rule, shareholders have no responsibility for daily management, and there is no legal relationship between shareholders and creditors of the corporation (unless, of course, a shareholder is a creditor of the corporation).

A. SHAREHOLDERS’ POWERSShareholders—

• Approve fundamental changes to the corporation before the changes are effected.• Elect the board.• May remove a director (in some cases, without cause).

B. SHAREHOLDERS’ MEETINGSShareholders must be notified of shareholders’ meetings [RMBCA 7.05]. Special-meeting notices must include a statement of the purpose of the meeting; business transacted at a special meeting is limited to that purpose.



1. ProxiesShares are often voted by proxy.

2. Shareholder ProposalsShareholders that own stock worth at least $1,000 can submit proposals to include with proxy materials.

3. Rules for Proxies and Shareholder ProposalsPublicly held companies must post proxy materials (e-proxy) online. If a company wishes to distribute the materials only online, it must notify shareholders, who can request paper copies.


A SHAREHOLDER ACCESS RULE Shareholders elect the board of directors. Shareholders who have a relatively small percentage of the

outstanding shares of any corporation have little success, though, in proposing candidates to boards of directors.

Enter the possibility of a “shareholder access” rule. Such a rule would make it easier for shareholders to use the proxy process to elect dissident candidates for a board of directors of a publicly held company. The Securities and Exchange Commission (SEC) made a modest attempt to allow such shareholder access in the early part of the 2000s. Such a proposed change was highly controversial and died in 2003.

It has been resurrected in the last few years, however. Until a court challenge in late 2006, the SEC interpreted its own rule as specifically allowing a corporation to exclude any shareholder proposal from its proxy materials “if the proposal relates to an election for membership on the company’s board of directors . . . .” a The Second Circuit Court of Appeals rejected the SEC’s interpretation of that rule.b The court ruled that the American Federal of State, County & Municipal Employees (AFSCME) could include a shareholder proposal in a proxy statement that, if adopted by the majority of shareholders, would amend bylaws to require a corporation to publish the names of shareholder-nominated candidates for director positions, in addition to any candidates nominated by the corporation’s board of directors.

INVESTOR ACTIVISTS AND OTHERS ARE IN FAVOR OF SHAREHOLDER ACCESS

Whatever the decision the SEC takes on interpretation of its own rule, shareholder access will remain a controversial topic. Investor activists have always claimed that without a shareholder access rule, directors have little incentive to pay attention to the concerns of their shareholders. They point out that most shareholders are discouraged by the current system from putting any effort into guiding the corporations. They argue that the lack of corporate dialogue with shareholders promotes frequent litigation. When shareholders attempt to alter what they view as questionable corporate behavior, their only remedy seems to be a lawsuit.

Much of the media have also argued that shareholders in public companies are relatively helpless in the face of managerial greed.



SHAREHOLDER ACCESS MAY LOWER RETURNS TO SHAREHOLDERS

The arguments against shareholder access have a certain amount of empirical data to substantiate them. Opponents of shareholder access point out that, if passed, such a rule would dramatically accelerate “an already dangerous trend: ‘the flight of corporation away from public investors into the arms of private equity.’” These are the words of law professor Lynn A. Stout of the UCLA-Sloan Research Program on Business Organizations. Stout points out that, in any event, today’s shareholders have more influence and power over top management and directors than ever before. They can be part of class-action lawsuits, they benefit from the passage of the Sarbanes-Oxley Act, and they can buy their shares through mutual funds, which wield much more power than individual shareholders.

It is also true that an increasing number of public corporations are going private by being purchased by private equity funds. Public shareholders of companies taken private earn a small premium over the market value of their shares. Once the corporation goes private, though, previous public shareholders are no longer owners. Consequently, in the long run, public shareholders may earn lower returns if a public access rule is put into place. As more public shareholders impose more costs on publicly held companies, more top managers will suggest that the corporation “do without them.” That is to say, more publicly held companies will make it known to private equity funds that they are for sale.


Several dozen managers and directors of foreign-based pension plans and insurance companies—which invest in U.S. securities—wrote a joint letter to the head of the SEC. In that letter, they stated that “experience in the United Kingdom, Australia, and the Netherlands has shown that boards whose members may be removed by shareholders are much more sensitive to shareholder opinion and are much more likely to engage in a meaningful dialogue with the institutions that hold their shares.” How important is such a dialogue? What might be some of the topics of such a dialogue?

a. Rule 14a-8(i)8, 17 C.F.R. Section 240. 14a-8..b. American Federation of State, County, & Municipal Employees v. American International Group, Inc., 462 F.3d 121 (2nd Cir. 2006). Note that the SEC disagreed with the court in this case and has since proposed a change in its rules to clarify as a response. 72 Fed.Reg. 43488-01 (Aug. 03, 2007).


MOVING COMPANY INFORMATION

ONTO THE INTERNET Anyone who has ever owned shares in a public company knows that such companies often are required

to distribute voluminous documents relating to proxies to all shareholders. Traditionally, large packets of paper documents were sent to shareholders, but in 2007 the Securities and Exchange Commission (SEC) permitted publicly held companies to voluntarily distribute electronic proxy (e-proxy) materials. In 2009, the SEC’s e-proxy rules became mandatory. Now all public companies must post their proxy materials on the



Internet, although they may still choose among several options—including paper documents sent by mail—for actually delivering the materials to shareholders.a

Enter the possibility of a “shareholder access” rule. Such a rule would make it easier for shareholders to use the proxy process to elect dissident candidates for a board of directors of a publicly held company. The Securities and Exchange Commission (SEC) made a modest attempt to allow such shareholder access in the early part of the 2000s. Such a proposed change was highly controversial and died in 2003.

NOTICE AND ACCESS E-PROXY RULES

Companies that want to distribute proxy materials only via the Internet can choose the notice and access delivery option. Under this model, the corporation posts the proxy materials on a Web site and notifies the shareholders that the proxy materials are available online.

The notice and access model involves the following steps—

• The company posts the proxy materials on its publicly accessible Web site.

• Subsequently, the company sends a (paper) notice to each shareholder at least forty calendar days before the date of the shareholders’ meeting for which the proxy is being solicited.

• No other materials can be sent along with the initial notice (unless the proxy is being combined with the meeting notice required by state law)..

• The notice must be written in plain English, and it must include a prominent statement of the following: the date, time, and location of the shareholders’ meeting; the specific Web site at which shareholders can access the proxy materials; an explanation of how they can obtain paper copies of the proxy materials at no cost; and a clear and impartial description of each matter to be considered at the shareholders’ meeting.

• Next, the company must wait at least ten days before sending a “paper” proxy card to the shareholders. This ten-day waiting period provides shareholders with sufficient time to access the proxy materials online or to request paper copies.

• If a shareholder requests paper proxy materials, the company must send them within three business days.

• After receiving the initial paper notice, a shareholder can permanently elect to receive all future proxy materials on paper or by e-mail.

OTHER DELIVERY OPTIONS

Rather than using notice and access delivery, public companies can choose to deliver the full set of proxy materials to the shareholders in paper or electronic form, such as on a CD or DVD. They can also use a blend of these two options, as long as they also post the materials on a Web site. Many corporations choose one option for certain shareholders and another option for other shareholders, depending on the number of shares owned or whether the shareholders are domestic or foreign. The shareholder can always choose to receive paper documents rather than accessing materials online.

Some corporate executives want the SEC to go even further and allow corporations to disseminate important information to the public via CEO blogs. Thus far, however, the SEC has not allowed companies to distribute proxy materials (or disclose material information to the public as required before issuing shares) via blogs.




Why might a company or other party choose to solicit proxies the old-fashioned way—by providing paper documents instead of Internet access—despite the added costs?

a. 17 C.F.R. Parts 240, 249, and 274.

ADDITIONAL BACKGROUND—

Shareholders’ MeetingsCorporate articles or bylaws may provide for the conduct of shareholders’ meetings. Typically, the

company president or the chairperson of the board of directors presides, and the corporate secretary records the minutes of the meeting. The agenda may include reports of management, the amendment or repeal of bylaws, resolutions submitted on behalf of management or shareholders, extraordinary corporate matters or decisions that require shareholder approval, and other subjects. Shareholders can offer and respond to proposals and resolutions. For example, shareholders concerned about social and political issues have used shareholders meetings to propose changes in corporate activities that relate to the issues.


Rules for Proxies and Shareholder Proposals

The following is the text of SEC Rule 14a-8, which requires that when a company sends proxy materials to its shareholders, the company must include whatever proposals will be considered at the meeting.

TITLE 17—COMMODITY AND SECURITIES EXCHANGESCHAPTER II—SECURITIES AND EXCHANGE COMMISSION

PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934SUBPART A—RULES AND REGULATIONS UNDER THE SECURITIES EXCHANGE ACT OF 1934

REGULATION 14A: SOLICITATION OF PROXIES

§ 240.14a-8 Proposals of security holders.

(a) If any security holder of a registrant notifies the registrant of his intention to present a proposal for action at a forthcoming meeting of the registrant’s security holders, the registrant shall set forth the proposal in its proxy statement and identify it in its form of proxy and provide means by which security holders can make the specification required by Rule 14a-4(b) [17 CFR 240.14a-4(b) ]. Notwithstanding the foregoing, the registrant shall not be required to include the proposal in its proxy statement or form of proxy unless the security holder (hereinafter, the “proponent”) has complied with the requirements of this paragraph and paragraphs (b) and (c) of this section:

(1) Eligibility. At the time he submits the proposal, the proponent shall be a record or beneficial owner of at least 1% or $1000 in market value of securities entitled to be voted on the proposal at the meeting and have



held such securities for at least one year, and he shall continue to own such securi ties through the date on which the meeting is held. If the registrant requests documentary support for a proponent’s claim that he is the beneficial owner of at least 1% or $1000 in market value of such voting securities of the registrant or that he has been a beneficial owner of the securities for one or more years, the registrant shall make such request within 14 calendar days after receiving the security holder proposal and the proponent shall furnish appropriate documentation within 21 calendar days after receiving the request. Appropriate documentation of the proponent’s claim of beneficial ownership shall include:

(i) A written statement by a record owner or an independent third party, accompanied by the proponent’s written statement that the proponent intends to continue ownership of such securities through the date on which the meeting is held; or

(ii) A copy of a Schedule 13D (s 240.13d-101 of this chapter), Schedule 13G (s 240.13d-102 of this chap ter), Form 13F (s 249.325 of this chapter), Form 3 (s 249.103 of this chapter) and/or Form 4 (s 249.104 of this chapter), or amendments thereto, filed with the Commission and furnished to the registrant by the proponent, provided that such filings indicate the proponent’s beneficial ownership as of or prior to the date on which the relevant one year period commences, and are supported by

(A) A copy of all subsequent amendments reporting a change in ownership level,

(B) The proponent’s affidavit, declaration, affirmation or other similar document provided for under applicable state law attesting that the proponent continued to be the beneficial owner of at least 1% or $1000 in market value of such voting securities of the registrant throughout the required one year period and as of the date of the affidavit, declaration, affirmation or other similar document provided for under applicable state law, and

(C) The proponent’s written statement that the proponent intends to continue ownership of such securities through the date on which the meeting is held. In the event the registrant includes the proponent’s proposal in its proxy soliciting material for the meeting and the proponent fails to comply with the requirement that he continuously hold such securities through the meeting date, the registrant shall not be required to include any proposals submitted by the proponent in its proxy material for any meeting held in the following two calendar years.

(2) Notice and Attendance at the Meeting. At the time he submits a proposal, a proponent shall provide the registrant in writing with his name, address, the number of the registrant’s voting securities that he holds of record or beneficially, the dates upon which he acquired such securities, and documentary support for a claim of beneficial ownership. A proposal may be presented at the meeting ei ther by the proponent or his representative who is qualified under state law to present the proposal on the proponent’s behalf at the meeting. In the event that the proponent or his representative fails, without good cause, to present the proposal for action at the meeting, the registrant shall not be required to include any proposals submitted by the proponent in its proxy soliciting material for any meeting held in the following two calendar years.

(3) Timeliness. The proponent shall submit his proposal sufficiently far in advance of the meeting so that it is received by the registrant within the following time periods:

(i) Annual Meetings. A proposal to be presented at an annual meeting shall be received at the regis trant’s principal executive offices not less than 120 calendar days in advance of the date of the registrant’s proxy statement released to security holders in connection with the previous year’s annual meeting of security holders except that if no annual meeting was held in the previous year or the date of the annual meeting has



been changed by more than 30 calendar days from the date contemplated at the time of the previous year’s proxy statement, a proposal shall be received by the registrant a reasonable time before the solicitation is made.

(ii) Other Meetings. A proposal to be presented at any meeting other than an annual meeting specified in paragraph (a)(3)(i) of this section shall be received a reasonable time before the solicitation is made.

Note.—In order to curtail controversy as to the date on which a proposal was received by the registrant, it is suggested that proponents submit their proposals by Certified Mail-Return Receipt Requested.

(4) Number of Proposals. The proponent may submit no more than one proposal and an accompanying supporting statement for inclusion in the issuer’s proxy materials for a meeting of security holders. If the proponent submits more than one proposal, or if he fails to comply with the 500 word limit mentioned in paragraph (b)(1) of this section, he shall be provided the opportunity to reduce the items submitted by him to the limits required by this rule, within 14 calendar days of notification of such limitations by the registrant.

(b)(1) Supporting Statement. The registrant, at the request of the proponent, shall include in its proxy statement a statement of the proponent in support of the proposal, which statement shall not include the name and address of the proponent. A proposal and its supporting statement in the aggregate shall not exceed 500 words. The supporting statement shall be furnished to the registrant at the time that the proposal is furnished, and the registrant shall not be responsible for such statement and the proposal to which it relates.

(2) Identification of Proponent. The proxy statement shall also include either the name and address of the proponent and the number of shares of the voting security held by the proponent or a statement that such information will be furnished by the registrant to any person, orally or in writing as requested, promptly upon the receipt of any oral or written request therefore.

(c) The registrant may omit a proposal and any statement in support thereof from its proxy statement and form of proxy under any of the following circumstances:

(1) If the proposal is, under the laws of the registrant’s domicile, not a proper subject for action by se curity holders.

Note.—Whether a proposal is a proper subject for action by security holders will depend on the applicable state law. Under certain states’ laws, a proposal that mandates certain action by the registrant’s board of di-rectors may not be a proper subject matter for shareholder action, while a proposal recommending or request -ing such action of the board may be proper under such state laws.

(2) If the proposal, if implemented, would require the registrant to violate any state law or federal law of the United States, or any law of any foreign jurisdiction to which the registrant is subject, except that this provision shall not apply with respect to any foreign law compliance with which would be violative of any state law or federal law of the United States.

(3) If the proposal or the supporting statement is contrary to any of the Commission’s proxy rules and regulations, including Rule 14a-9 [s 240.14a-9 of this chapter], which prohibits false or misleading statements in proxy soliciting materials;

(4) If the proposal relates to the redress of a personal claim or grievance against the registrant or any other person, or if it is designed to result in a benefit to the proponent or to further a personal interest, which benefit or interest is not shared with the other security holders at large;



(5) If the proposal relates to operations which account for less than 5 percent of the registrant’s total as sets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the issuer’s business;

(6) If the proposal deals with a matter beyond the registrant’s power to effectuate;

(7) If the proposal deals with a matter relating to the conduct of the ordinary business operations of the registrant;

(8) If the proposal relates to an election to office;

(9) If the proposal is counter to a proposal to be submitted by the registrant at the meeting;

(10) If the proposal has been rendered moot;

(11) If the proposal is substantially duplicative of a proposal previously submitted to the registrant by another proponent, which proposal will be included in the issuer’s proxy material for the meeting;

(12) If the proposal deals with substantially the same subject matter as a prior proposal submitted to security holders in the registrant’s proxy statement and form of proxy relating to any annual or special meeting of security holders held within the preceding five calendar years, it may be omitted from the registrant’s proxy materials relating to any meeting of security holders held within three calendar years after the latest such previous submission: Provided, That

(i) If the proposal was submitted at only one meeting during such preceding period, it received less than three percent of the total number of votes cast in regard thereto; or

(ii) If the proposal was submitted at only two meetings during such preceding period, it received at the time of its second submission less than six percent of the total number of votes cast in regard thereto; or

(iii) If the prior proposal was submitted at three or more meetings during such preceding period, it received at the time of its latest submission less than 10 percent of the total number of votes cast in regard thereto; or

(13) If the proposal relates to specific amounts of cash or stock dividends.

(d) Whenever the registrant asserts, for any reason, that a proposal and any statement in support thereof received from a proponent may properly be omitted from its proxy statement and form of proxy, it shall file with the Commission, not later than 80 calendar days prior to the date the definitive copies of the proxy statement and form of proxy are filed pursuant to Rule 14a-6 (s 240.14a-6 of this chapter), or such shorter period prior to such date as the Commission or its staff may permit, six copies of the following items:

(1) The proposal;

(2) Any statement in support thereof as received from the proponent;

(3) A statement of the reasons why the registrant deems such omission to be proper in the particular case; and



(4) Where such reasons are based on matters of law, a supporting opinion of counsel. The registrant shall at the same time, if it has not already done so, notify the proponent of its intention to omit the proposal from its proxy statement and form of proxy and shall forward to him a copy of the statement of reasons why the registrant deems the omission of the proposal to be proper and a copy of such supporting opinion of counsel.

(e) If the registrant intends to include in the proxy statement a statement in opposition to a proposal received from a proponent, it shall, not later than 30 calendar days prior to the date the definitive copies of the proxy statement and form of proxy are filed pursuant to Rule 14a-6, or, in the event that the proposal must be revised to be includable, not later than five calendar days after receipt by the registrant of the revised proposal, promptly forward to the proponent a copy of the statement in opposition to the proposal. In the event the proponent believes that the statement in opposition contains materially false or misleading statements within the meaning of Rule 14a-9 and the proponent wishes to bring this matter to the attention of the Commission, the proponent promptly should provide the staff with a letter setting forth the reasons for this view and a copy of the statement in opposition and at the same time promptly provide the registrant with a copy of his letter.

(Authority: Sec. 14(a) and 23(a), 48 Stat. 895 and 901; sec. 12(e) and 20(a), 49 Stat. 823 and 833; sec. 20(a) and 38(a), 54 Stat. 822 and 841; 15 U.S.C. 78n(a); 78w(a), 79(e), 79t(a), 80a-20(a), 80a-37(a) )

C. SHAREHOLDER VOTING

1. Quorum RequirementsA shareholder quorum is generally more than 50 percent. A majority vote of the shares at the meeting is usually required to pass resolutions. Extraordinary corporate matters, require the approval of a higher percentage of shares entitled to vote.

CASE SYNOPSIS—

Case 34.2: Case v. Sink & Rise, Inc.

During a shareholder meeting of Sink & Rise, Inc., James Case was the only shareholder present. He elected himself and another shareholder to be directors, replacing his estranged wife, Shirley Case, as the corporation's secretary. In Shirley’s suit in a Wyoming state court to set aside the election, the court ruled in the corporation’s favor. Shirley appealed.

The Wyoming Supreme Court affirmed. “Shares of stock owned by husband and wife with rights of survivorship were properly counted to establish a quorum at shareholder meeting, * * * where corporate bylaws required that, in determining a quorum, the shares had to be entitled to vote and represented in person or by proxy, and the shares were represented in person by husband.”

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Notes and Questions

How many shareholders were present at the shareholders’ meeting that gave rise to the dispute in this case? During the shareholders’ meeting of Sink & Rise, Inc., that give rise to the dispute in the Case



case, James (Cale) Case was the only shareholder present in person. According to the introduction to the case, another shareholder was present by proxy. Sink & Rise had eighty-four shares of voting common stock outstanding. Cale owned twenty shares, he and his spouse Shirley jointly held another sixteen shares, and three different individuals owned sixteen shares each.

At the meeting, Cale concluded that a quorum existed and voted on and passed several resolutions. He also elected himself and another shareholder to be directors, replacing Shirley, with whom Cale was estranged, as the corporation's secretary. Shirley filed a complaint in a Wyoming state district court against Sink & Rise and Cale to set aside these actions.

How did the court “characterize” and “classify” the shares of stock that Cale and Shirley Case held jointly? The lower court “characterized” the sixteen shares of stock held jointly by Cale and Shirley as owned with rights of survivorship. The court further “classified” the ownership as creating a presumption of tenancy by the entirety. As tenants by the entirety, each spouse owned an undivided entire interest in the shares.

The state supreme court agreed with the lower court’s interpretation, explaining that “in an estate of the entirety, the husband and the wife during their joint lives each owns, not a part, or a separate or a separable interest, but the whole.” Thus, for example, the death of one spouse would leave the survivor still holding title to the whole sixteen shares as before, but of course with no one to share it.

According to the court, how many shares were represented at the shareholders’ meeting? Was a quorum present? Both the lower court and the state supreme court agreed that a majority of the outstanding voting shares of Sink & Rise were represented at the shareholders’ meeting. Under the corporation’s bylaws, this majority constituted a quorum.

According to those bylaws, “A majority of the outstanding shares entitled to vote, represented in person or by proxy, shall constitute a quorum at a meeting of Shareholders. If a quorum is present, the affirmative vote of the majority of shares entitled to vote at the meeting shall be the act of the Shareholders.” In other words, according to the bylaws, for the shares to count in determining a quorum, they must be (1) entitled to vote, and (2) represented in person or by proxy.

Here, all of the shares were entitled to vote. Represented in person at the meeting were the twenty shares that Cale owned and, according to the courts’ interpretation, the sixteen shares that he owned jointly with Shirley. Represented by proxy were another sixteen shares held by a different individual. Thus, of the eighty-four outstanding shares of Sink & Rise stock, fifty-two were represented at the shareholders’ meeting at the center of this case. This number constituted a majority and hence a quorum. And a majority vote of those shares could take action “with requisite authority.”

Were the shares that Cale owned jointly with Shirley voted at the meeting? How did the jointly owned shares affect the business conducted? Cale and Shirley jointly owned sixteen shares of Sink & Rise stock. All of the Sink & Rise shares were common stock with equal voting rights. But the lower court noted, the parties to the suit agreed, and the state supreme court repeated, that the Cases’ jointly owned shares could not be voted without an agreement between the owners. And those owners did not agree to the actions that were voted on during the shareholders’ meeting at the center of this case.

But this lack of agreement did not affect the business that could be conducted. Of the eighty-four outstanding shares of Sink & Rise stock, fifty-two were represented at the meeting. Under the corporation’s bylaws, this constituted a majority and hence a quorum. And a majority vote of those shares could take action “with requisite authority.” And so Cale, who was the only shareholder in attendance at the meeting in person,



and another shareholder represented by proxy, voted on and passed several resolutions. Cale also elected himself and another shareholder to be directors, replacing Shirley as the corporation's secretary. This prompted Shirley to file a complaint in a Wyoming state court to set aside these actions, beginning the litigation that led to with the state supreme court’s opinion.

2. Cumulative Voting

• In most states, shareholders elect directors by cumulative voting; otherwise, the vote is by a majority of shares at the meeting.

• Each shareholder casts a number of votes equal to the number of board members to be elected multiplied by the number of voting shares the shareholder owns. The shareholder casts all votes for one candidate or splits them among nominees.

3. Other Voting TechniquesShares can be voted in accord with a shareholder voting agreement or voting trust.

IV. Rights of Shareholders

A. STOCK CERTIFICATES

• In jurisdictions that require the issuance of stock certificates, shareholders can demand a certificate and that their names and addresses be recorded in the corporate record books.

• In most states, shares can be uncertificated. Notice of shareholder meetings, dividends, and re-ports are distributed according to the ownership listed in the corporation’s books.

B. PREEMPTIVE RIGHTS

• The articles of incorporation determine the existence and scope of preemptive rights. Generally, they apply only to additional, newly issued stock sold for cash and must be exercised within a specified time period.

• Preemptive rights are most significant in a close corporation because of the relatively few number of shares and the substantial interest each shareholder controls.

C. DIVIDENDSDividends can be paid in cash, property, stock of the corporation that is paying the dividends, or stock of other corporations. The sources of funds from which dividends may be paid are—

• Retained earnings.• Current net profits.• Any surplus.

1. Illegal DividendsA dividend paid while a corporation is insolvent is illegal and must be repaid if the shareholders knew that it was illegal when they received it. Directors may be personally liable for paying such a dividend.



2. The Directors’ Failure to Declare a DividendThat corporate earnings or surplus is available to pay a dividend is not enough for a court to compel directors to distribute funds that, in the board’s opinion, should not be paid. Abuse of discretion must be clearly shown.

D. INSPECTION RIGHTS

• The shareholder’s right of inspection is limited to the inspection and copying of corporate books and records for a proper purpose, provided the request is made in advance.

• A shareholder can be denied access to prevent harassment or to protect trade secrets or other confidential corporate information.

E. TRANSFER OF SHARESAlthough stock certificates are negotiable and freely transferable, transfer of stock in closely held corporations is generally restricted by contract, the bylaws, or a restriction stamped on the certificate. Any restrictions on transferability must be noted on the face of the certificate.

F. THE SHAREHOLDER’S DERIVATIVE SUIT

• If directors fail to sue in the corporate name to redress a wrong suffered by the corporation, shareholders can bring a shareholder’s derivative suit.

• This right is especially important when the wrong suffered by the corporation results from the actions of corporate directors or officers.

1. Written Demand RequiredShareholders must first submit a demand in writing to the board to act on the firm’s behalf. The board has ninety days to act, and may oppose a subsequent suit that it believes is not in the best interest of the corporation.

2. Damages Recovered Go into Corporate FundsAny damages recovered by the suit usually go into the corporation’s treasury.


The Shareholder’s Derivative SuitThe right of shareholders to sue derivatively on the behalf of their corporation was indicated as early as

the 1830s. In 1855, the United States Supreme Court upheld a shareholder’s right to sue on behalf of a corporation whose officer had paid a tax that the shareholder claimed was unconstitutional [Dodge v. Woolsey, 59 U.S. 331, 15 L.Ed. 401 (1855)].

The derivative suit developed more fully in the second half of the nineteenth century. Procedural restrictions on derivative suits also developed in the federal courts late in the nineteenth century and in the state courts in the first half of the twentieth century. In 1980, at least one study found that during the 1970s, there was only a slight increase in the amount of shareholder litigation [Jones, “An Empirical Examination of the Incidence of Shareholder Derivative and Class Action Lawsuits, 1971–1978,” 60 Boston University Law Review 306 (1980)].



During the 1980s, however, the amount of shareholder derivative litigation for alleged breaches of management duties was extensive.

V. Duties and Liabilities of ShareholdersShareholders are not usually personally liable for the debts of a corporation.

A. WATERED STOCKA shareholder may be liable personally if he or she receives watered stock without paying the share’s stated value. In that case, the shareholder may be liable not only to the corporation for difference between the price paid and the stock’s stated value, but to creditors for corporate debts.

B. DUTIES OF MAJORITY SHAREHOLDERSA majority shareholder has a fiduciary duty to the corporation and to the minority shareholders when he or she (or a few shareholders acting together) owns enough shares to exercise de facto control over the corporation.


CREATING AN E-DOCUMENT RETENTION POLICY If a corporation becomes the target of a civil lawsuit or criminal investigation, the company may be

required to turn over any documents in its files relating to the matter during the discovery stage of litigation. These documents may include legal documents, contracts, e-mail, faxes, letters, interoffice memorandums, notebooks, diaries, and other materials, even if they are kept in personal files in the homes of directors or officers. Under the current Federal Rules of Civil Procedure, which govern civil litigation procedures, a defendant in a lawsuit must disclose all relevant electronic data compilations and documents, as well as all relevant paper documents.

Although certain documents or data might free a company of any liability arising from a claim, others might serve to substantiate a civil claim or criminal charge. It is also possible that information contained in a document—an interoffice e-mail memo, for example (or even a memo referring to that memo)—could be used to convince a jury that the company or its directors or officers had condoned a certain action that they later denied condoning.

WHICH E-DOCUMENTS SHOULD BE RETAINED?

How does a company decide which e-documents should be retained and which should be destroyed? By law, corporations are required to keep certain types of documents, such as those specified in the Code of Federal Regulations and in regulations issued by government agencies, such as the Occupational Safety and Health Administration. Generally, any records that the company is not legally required to keep or that the company is sure it will have no legal need for should be removed from the files and destroyed. A partnership agreement, for example, should be kept. A memo about last year’s company picnic, however, should be removed from the files and destroyed; obviously, it is just taking up storage space.



MODIFICATIONS MAY BE NECESSARY DURING AN INVESTIGATION

If the company becomes the target of an investigation, it usually must modify its document-retention policy until the investigation has been completed. Company officers, after receiving a subpoena to produce specific types of documents, should instruct the appropriate employees not to destroy relevant papers or e-documents that would otherwise be disposed of as part of the company’s normal document-retention program.

Generally, to avoid being charged with obstruction of justice, company officials must always exercise good faith in deciding which documents should or should not be destroyed when attempting to comply with a subpoena. The specter of criminal prosecution would appear to encourage the retention of even those documents that are only remotely related to the dispute—at least until it has been resolved.

CHECKLIST FOR AN E-DOCUMENT RETENTION POLICY

1. Let employees know not only which e-documents should be retained and deleted but also which types of documents should not be created in the first place.

2. Find out which documents must be retained under the Code of Federal Regulations and under other government agency regulations to which your corporation is subject.

3. Retain other e-documents only if their retention is in the corporation’s interest.

4. If certain corporate documents are subpoenaed, modify your document-retention policy to retain any document that is even remotely related to the dispute until the legal action has been resolved.

TEACHING SUGGESTIONS

1. Ask students to discuss the extent to which a director should be held liable for breaching his or her duty of care if he or she simply neglects to read materials regarding issues to be voted on at board meetings or ne-glects to show up for these meetings. Should such a person be equally or less liable than a director who knowingly votes to approve an illegal or harmful act?

2. Ask students to discuss whether a director’s duty of care is absolute. Should a director always be pre-vented from having an interest in another company? Can any potential conflict of interest problems be avoided by complete disclosure of the conflict to the boards of both companies?

3. Note that companies seeking to prevent a shareholder from exercising his or her right to inspect company records and books will often argue that the inspection will reveal important trade secrets and should thus be barred. How can a company protect itself from having confidential information revealed by shareholder inspections? One way might be to segregate trade secrets (formulas, engineering plans, etc.) from the standard corporate books. Another method would be to ask the court to recognize that some of the information sought might be misused and to issue an order prohibiting the shareholder from misappropriating such information or disseminating it to third parties.



Cyberlaw Link

Could a corporation meet its obligation to hold board of directors meetings and shareholder meetings by conducting those meetings online? Why or why not?

DISCUSSION QUESTIONS

1. Why is it incorrect to characterize a director as either an agent or a trustee of a corporation? Even though directors act for and on behalf of the corporation, no individual director can act as an agent to bind the corpo ration. Moreover, directors, as a group, collectively control the corporation in a way that no agent can control a principal. Directors are also often incorrectly characterized as trustees because they occupy positions of trust and control over the corporation. Unlike trustees, however, directors do not own or hold title to property for the use and benefit of others.

2. What are the most common situations in which directors allegedly violate their duty of loyalty? A director typically breaches his or her duty of loyalty when he or she (1) competes with the corporation; (2) usurps a corporate opportunity; (3) has an interest that conflicts with the interest of the corporation; (4) engages in insider trading; (5) authorizes a corporate transaction that is detrimental to minority shareholders; and (6) sells control over the corporation.

3. What actions must a director or officer take to avoid liability when a corporation enters into a contract or engages in a transaction in which an officer or director has a material interest? The director or officer must make a full disclosure of the interest and must abstain from voting on the proposed transaction. Although standards vary from state to state, a contract will generally not be voidable if it was fair and reasonable to the corporation at the time the contract was made, there was a full disclosure of the interest of the officers or di rectors involved in the transaction, and the contract is approved by a majority of the disinterested directors or shareholders.

4. What sort of legal protection is offered to directors and officers by the business judgment rule? The business judgment rule immunizes directors and officers from liability when a decision is within managerial authority, as long as the decision complies with management’s fiduciary duties and as long as acting on the decision is in the power of the corporation. To benefit from the rule, directors and officers must act in good faith, in what they consider to be the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would exercise in similar circumstances. This requires a rational, informed decision having no conflict between the decision-maker’s personal interest and the interest of the corporation.

5. Are directors entitled to be indemnified for any legal costs they incur in defending suits against the corporation? Because directors are often named as defendants in suits filed against their respective corporations, most states permit corporations to indemnify directors for any reasonable legal costs, fees and judgments involved in defending corporation-related suits. Many states expressly allow a corporation to purchase liability insurance for its directors and officers to indemnify them for any costs or damages. When statutes are silent on this matter, the power to purchase such insurance is usually considered to be part of the corporation’s implied power.

6. What are some of the more important powers that may be exercised by shareholders? Shareholders must approve fundamental changes affecting the corporation before the changes can be effected. Hence, shareholders are empowered to amend the articles of incorporation (charter) and bylaws, approve the merger or dissolution of the



corporation, and approve the sale of all or substantially all of the corporation’s assets. The shareholders also elect and remove the board of directors. Some states require that the removal of directors be for cause but other states will allow a director to be removed without cause.

7. Describe how cumulative voting works. Most states permit or require shareholders to elect directors by cumulative voting—a method of voting designed to allow minority shareholders representation on the board of directors. The number of members of the board to be elected is multiplied by the total number of voting shares held. The result equals the number of votes a shareholder may cast. This total can be cast for one or more nominees for director.

8. What are the limits on the shareholder’s right to inspect corporate records and books? A shareholder is limited to inspecting and copying corporate records and books for a proper purpose if the request is made in advance. The shareholder can properly be denied access to corporate records to prevent harassment or to protect trade secrets or other confidential information. Furthermore, the right of inspection may be conditioned on the shareholder possessing his or her shares for a minimum period of time prior to his making the demand to inspect the records.

9. What are some of the ways in which a corporation or its shareholders can restrict the transferability of shares? A corporation or its shareholders can restrict transferability by reserving the option to purchase any shares offered for resale by a shareholder. This right of first refusal remains with the corporation or the shareholders for only a specified or reasonable time. Alternatively, a shareholder could be required to offer the shares to other shareholders or to the corporation first.

10. Can a shareholder institute an action to dissolve a corporation and liquidate its assets? Yes. In some states, a shareholder has the right to petition a court to appoint a receiver and to liquidate the business assets of the corporation in certain specified situations. A shareholder may institute a dissolution action if (1) the directors are deadlocked in the management of corporate affairs, shareholders are unable to break that deadlock, and irreparable injury to the corporation is being suffered or threatened; (2) the acts of the directors or those in control of the corpora-tion are illegal, oppressive, or fraudulent; (3) corporate assets are being misapplied or wasted; or (4) the shareholders are deadlocked in voting power and have failed to elect successors to directors whose terms have expired or would have expired with the election of successors.

ACTIVITIES AND RESEARCH ASSIGNMENTS

1. Ask each student to write a brief report on a case in which directors or officers of a corporation were ac cused of breaching their duties of care or loyalty. The students should focus on the standards that were used in de termining that these breaches had occurred as well as the critical factors that ultimately resulted in findings of guilt or innocence.

2. Different companies use different styles and levels of detail to inform their shareholders of their equal employment and affirmative action policies. Have students obtain some of the different versions and compare them. For example, in the past, Bristol-Myers Squibb and The Travelers Corporation have produced magazine-style reports. Campbell Soup Company produced a four-page document. General Motors Corporation disclosed its policies in its “Public Interest Report.” J. C. Penney Company produced a one-page analysis as part of its annual report. CIGNA Corporation made available to its shareholders a five-page internal memorandum on the subject. What has Microsoft, Wal-Mart, or any of the “dot com” companies done?



EXPLANATION OF A SELECTED FOOTNOTE IN THE TEXT

Footnote 3: The board of Chugach Alaska Corp. (CAC) split into two factions—one led by Sheri Buretta, who had chaired the board for several years, and the other by director Robert Henrichs. A coalition of directors voted to remove Buretta and install Henrichs. During his term, Henrichs committed a variety of acts of misconduct with respect to CAC’s directors, shareholders, and employees. After six months, the board voted to reinstall Buretta. CAC filed a suit in an Alaska state court against Henrichs, alleging a breach of fiduciary duty. A jury found Henrichs liable. The court banned him from serving on the board for five years. Henrichs appealed. In Henrichs v. Chugach Alaska Corp., the Alaska Supreme Court affirmed. The standard for liability under the business judgment rule was not gross negligence If there is a breach of a fiduciary duty, the rule will not protect a director who makes bad business decisions. In this case, the jury and the lower court found that Henrichs committed a breach of fiduciary duty. The misconduct was serious and egregious. The lower court found “fraudulent or dishonest acts, gross neglect of duty, or gross abuse of authority or discretion.” The business judgment rule did not protect Henrichs.

Do acts such as those in which Henrichs engaged satisfy any of the elements for the application of the business judgment rule? No. The business judgment rule applies to protect a director or officer from liability for a mistake of judgment or a bad business decision as long as (1) the director or officer took reasonable steps to become informed about the matter, (2) there was a rational basis for the decision, and (3) there was no conflict of interest between the director’s or officer’s personal interest and that of the corporation. If there is evidence of bad faith, fraud, or a clear breach of fiduciary duties, the rule will not apply. Among the acts that Henrichs committed, it does not appear that any of them meets any of these requirements. Instead, the conduct seems to evidence bad faith and a breach of fiduciary duties. And, in fact, this is what the jury found.

Why do courts in their application of the business judgment rule give significant deference (weight) to the decisions of corporate directors and officers? Courts give significant deference to the decisions of corporate directors and officers by considering the reasonableness of a decision at the time it was made, without the benefit of hindsight. Corporate decision makers are not subjected to second-guessing. This is because judges are not business experts, and courts do not have access to all of the information and factors that a corporate director or officer may weigh and balance in making a decision.

Does misbehavior such as the conduct at the heart of this case constitute a breach of business ethics? Yes. Business ethics focuses on what is right or wrong in the business world. Henrichs exhibited unethical behavior when he breached his fiduciary duty to his corporation by holding mini-board meetings and making decisions with only his supporters present; refusing to follow bylaws that required a special meeting of shareholders in response to a shareholder petition; acting without board discussion or approval and ignoring board rules in the conduct of meetings; personally mistreating directors, shareholders, and employees; and retaliating against directors who challenged his decisions by excluding them from the board and spending corporate funds to file meritless complaints against them with state authorities. By this conduct, Henrichs took unfair advantage of his position and authority. The actions were not fair to the other directors, the officers, the shareholders, or the employees.


Documents

BLTC 11e IM-Ch34 - NACMnacm.org/docs/cap_acap_materials/CL11/BLTC-11e-I… · Web viewChapter 34: Corporate Directors, Officers, and. Shareholders. Introduction