Business Organizations - Quiz 4

Question 1

What are the rules for directors’ qualifications?

Answer 1

1. Directors must be natural persons; they cannot be artificial entities
2. Default Rule: No other qualifications exist, but the articles of incorporation or bylaws may impose reasonable qualifications that do not limit the ability of a nominee or director to discharge his or her duties as a director

Question 2

What document fixes the number of directors in a corporation?

Answer 2

The fundamental documents. The number of directors can also be changed in the manner set forth in those documents.

Question 3

What is the default rule for election of board members?

Answer 3

all board members are elected annually and serve until their successors are elected and qualify

Question 4

What is an inside director?

Answer 4

A director who is employed by the corporation

Question 5

What is an outside director?

Answer 5

A director who is not employed by the corporation

Question 6

What is an independent director?

Answer 6

A director who is independent of management

Question 7

What is the default rule for binding corporations?

Answer 7

the directors of a corporation may bind a corporation only when they act at a legal meeting of the board. If they purport to act at a meeting which is not a legal meeting, their action is not that of the corporation and the corporation is not bound.

Question 8

Who has the power to call special meetings in a corporation?

Answer 8

In the absence of any governing provision, some courts have held that the corporation president has the power to call a special meeting.

Question 9

Who has the power to set the time and place of a meeting in a corporation?

Answer 9

In the absence of any controlling provision, the person calling the meeting has the authority to choose the time and the place.

Question 10

What is the default rule for notice for meetings in corporations?

Answer 10

Regular meetings of the board of directors may be held without notice to the directors. Additionally:
a. Every director must be given reasonable notice of a special meeting.
b. Notice must be given at least two days before the special meeting and need not state the purpose of the meeting.

Question 11

T/F: Action taken at a meeting without notice to all directors is still valid.

Answer 11

FALSE. Action taken at a meeting without notice to all directors is INVALID.

Question 12

T/F: A director’s participation in a meeting without objection waives that director’s objection to lack of notice

Answer 12

True

Question 13

What is the default rule for director voting in corporations?

Answer 13

directors may not vote by proxy and that each board member has one vote.

Question 14

What is the default rule for quorum of directors in corporations?

Answer 14

a quorum of the board of directors is a majority of the number of directors fixed in the fundamental documents or elsewhere.

Question 15

Do corporations need to maintain minutes for meetings of directors?

Answer 15

Yes; however, the failure to record minutes does not invalidate action taken at the meeting.
If minutes are recorded, they are considered the best evidence of what occurred at the meeting.

Question 16

What is the exception to holding a meeting of directors in corporations?

Answer 16

Directors may take action without meeting if they do so unanimously and in writing.
1. The records of actions taken without a meeting are kept in the same manner as minutes of meetings

Question 17

T/F: Boards of directors may delegate nearly all of their functions to board committees

Answer 17

True

Question 18

What functions may not be delegated by boards of directors to board committees

Answer 18

changes to bylaws and fundamental decisions that require the approval of shareholders

Question 19

T/F: Shareholders may serve on board committees.

Answer 19

FALSE. Only board members may serve on board committees.

Question 20

T/F: If an LLC’s operating agreement so provides, the LLC will be manager-managed (ULLCA § 407(a))

Answer 20

True

Question 21

T/F: The manager or managers do not have the power to decide any matter relating to the activity and affairs of the company.

Answer 21

FALSE. They DO have the power to decide any matter relating to the activity and affairs of the company.

Question 22

What is required to undertake an act outside the ordinary course of an LLC’s activities and affairs.

Answer 22

The affirmative vote or consent of ALL members.

Question 23

T/F: If more than one manager is chosen in an LLC, each manager has equal rights in the management and conduct of the company’s activities and affairs.

Answer 23

True

Question 24

What is the default rule for general partner decision making in LPs?

Answer 24

the general partner’s decision making scope includes any matter relating to the activities and affairs of the entity

Question 25

T/F: General partners have authority to decide matters outside the ordinary course of the limited partnership’s activities and affairs.

Answer 25

True

Question 26

What three matters require a vote of all the partners in a partnership?

Answer 26

i. Amending the partnership agreement;
ii. Converting between the status of LP and LLLP; and
iii. Selling all, or substantially all, of the LP’s property outside the usual and regular course of the LP’s activities and affairs.

Question 27

T/F: A majority vote of the partners is required for mergers, conversions, and share exchanges.

Answer 27

FALSE. Unanimous consent is required for mergers, conversions, and share exchanges.

Question 28

What is the rule for a director’s right to examine the corporation’s records?

Answer 28

1. Any director shall have the right to examine the corporation’s books and records for a purpose reasonably related to the director’s position as a director.
2. The defendant corporation bears the burden of proving that any such inspection is for an improper purpose

Question 29

Any request for communications among corporation directors and officers must:

Answer 29

1. State a proper purpose;
2. Encompass communications constituting books and records of the corporation, i.e., those that affect the corporation’s rights, duties, and obligations; and
3. Be sufficiently tailored to direct the Court to the specific books and records relevant to the director’s proper purpose.

Question 30

T/F: Directors are entitled to inspect the books and records of subsidiaries

Answer 30

True.

Question 31

What must directors disclose to other board members?

Answer 31

information known by the director to be material to the discharge of their decision-making or oversight functions

Question 32

In manager-managed LLCs, managers have the same information rights that members have in member-managed LLCs, including the right to:

Answer 32

“inspect and copy any record maintained by the company regarding the company’s activities, affairs, financial condition and other circumstances” but only to the extent the information is material to the [manager’s] rights and duties under the operating agreement

Question 33

LLCs are required to furnish to managers, without demand, any information concerning the company’s:

Answer 33

a. Activities
b. Affairs
c. Financial conditions
d. And other circumstances which the company knows and is material to the proper exercise of the member’s rights and duties

Question 34

T/F: LLCs managers’ rights extend to information, not merely records.

Answer 34

True

Question 35

T/F: A general partner’s rights to inspect and copy and to receive information are virtually identical to those of LLC managers

Answer 35

True

Question 36

Does a limited partnership have to maintain a set of required information including tax returns and financial statements?

Answer 36

Yes. General partners are entitled to inspect and copy this required information without having any particular purpose for seeking the information.

Question 37

What are the standards for each entity for a breaching the duty of care?

Answer 37

1. Delaware standard for liability is gross negligence.
2. MBCA standard for liability is ordinary negligence.
3. LLC standard for liability is gross negligence.
4. Partnership standard for liability is gross negligence.
5. Limited partnership standard for liability is gross negligence.

Question 38

What does the fiduciary duty of care require for Delaware directors?

Answer 38

the fiduciary duty of due care requires that directors of a Delaware corporation use that amount of care which ordinarily careful and prudent men would use in similar circumstances, and consider all material information reasonably available in making business decisions.

Question 39

What does the duty of care require for directors?

Answer 39

directors sufficiently inform themselves before reaching decisions

Question 40

What is the focus of the analysis of the duty of care for directors?

Answer 40

The “focus of a duty of care analysis is not the substance of the decision the directors made but rather the process they undertook in making it. Due care in the decision making context is process due care only.”

Question 41

What does the MBCA require of directors when becoming informed in connection with their decision-making function?

Answer 41

discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.

Question 42

What are the elements of the business judgement rule?

Answer 42

1. A business judgment;
2. the judgment’s rationality;
3. the decision maker’s belief that the decision is in the entity’s best interests (loyalty);
4. the decision maker’s good faith; and
5. the decision maker’s compliance with the duty of care.

Question 43

T/F: if any of the five elements of the business judgement rule are not present, entire fairness is the standard of review.

Answer 43

True

Question 44

T/F: the business judgement rule protects every decision a director makes.

Answer 44

FALSE. The business judgement rule only protects business decisions.

Question 45

When does the business judgement rule apply to corporation’s decisions to make charitable contributions?

Answer 45

The business judgement rule applies if the contributions are “reasonable.”

Question 46

T/F: Under the business judgement rule, the rationality standard requires only that the board’s decision not constitute waste.

Answer 46

True

Question 47

What does waste entail under the business judgement rule?

Answer 47

Waste entails an exchange of corporate assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade.

Question 48

Under the business judgement rule, the intent to act in the entity’s best interest requires directors:

Answer 48

directors to believe their decision to be in the best interests of the entity

Question 49

T/F: Under the business judgement rule, proof that the directors did not take the action in the honest belief that it was in the best interests of the corporation rebuts the presumption and removes the decision from business judgment rule protection.

Answer 49

True

Question 50

What is the Delaware standard for a director’s intent to act in the entity’s best interest under the business judgement rule?

Answer 50

the business judgment rule is “a presumption that in making a business decision, the directors of a corporation acted . . . in the honest belief that the action taken was in the best interest of the company.”

Question 51

What is the MBCA standard for a director’s intent to act in the entity’s best interest under the business judgement rule?

Answer 51

“each member of the board of directors, when discharging the duties of a director” to “act . . . in a manner the director reasonably believes to be in the best interests of the corporation.”

Question 52

Under the business judgement rule, what does good faith mean?

Answer 52

a. Good faith is the absence of bad faith, which has been characterized as conduct “which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence.”

Question 53

What is exculpation?

Answer 53

a Delaware corporation could excuse its directors from all liability for breach of the duty of care—even liability for gross negligence in the process employed for making decisions

Question 54

T/F: An exculpation provision is effective even when the entire fairness test, rather than the business judgment rule, applies

Answer 54

True

Question 55

T/F: Exculpation protects officers and directors

Answer 55

FALSE. Exculpation only protects directors.

Question 56

T/F: Exculpation does not apply to equitable relief.

Answer 56

True

Question 57

Who can directors rely on in decision making?

Answer 57

the corporation’s officers and employees and other persons with “professional or expert competence” who were “selected with reasonable care.”

Question 58

How can you survive a Rule 32.1 motion to dismiss in a due care case where an expert has advised the board in its decision-making process?

Answer 58

the complaint must allege particularized facts (not conclusions) that, if proved, would show, for example, that:
1. the directors did not in fact rely on the expert;
2. their reliance was not in good faith;
3. they did not reasonably believe that the expert’s advice was within the expert’s professional competence;
4. the expert was not selected with reasonable care by or on behalf of the corporation, and the faulty selection process was attributable to the directors;
5. the subject matter that was material and reasonably available was so obvious that the board’s failure to consider it was grossly negligent regardless of the expert’s advice or lack of advice; or
6. that the decision of the Board was so unconscionable as to constitute waste or fraud.

Question 59

T/F: RUPA, ULLCA, and ULPA impose no duty of care on managers, but contain provisions entitling managers to rely on anyone or anything

Answer 59

FALSE. RUPA, ULLCA, and ULPA impose a duty of care on managers, but contain no provisions entitling managers to rely on anyone or anything

Question 60

What fiduciary duty does conflicted decision making implicate?

Answer 60

The duty of loyalty

Question 61

What is a conflict of interest?

Answer 61

A conflict of interest is an interest in the decision or underlying transaction that differs from the interest of the entity and its investors

Question 62

What is a conflicted transaction/interested transaction?

Answer 62

If a manager has a conflict of interest with respect to a transaction, the transaction is a conflicted transaction or interested transaction

Question 63

T/F: Managers must disclose their conflicts

Answer 63

True

Question 64

What is a disabling conflict?

Answer 64

A conflict is disabling if the court considers it sufficiently severe to prevent the particular director from deciding what is in the best interests of the entity.
1. Such a conflict renders the manager not “fit” to make the particular decision.
2. Generally, only a material conflict of interest is disabling.

Question 65

What three kinds of relationships constitute conflicts of interest for directors?

Answer 65

1. In a transaction directly between the director and the corporation,
2. As a party with an interest in a transaction between the corporation and a third party, and
3. As a party with an interest in or material relationship with, a party to the transaction.

Question 66

T/F: Courts have chosen to ignore structural bias in board decision making that results from the structure of the corporation.

Answer 66

True. However, courts hold directors conflicted when bias-inducing facts not common to most directors are shown.

Question 67

How does Delaware refer to unconflicted directors?

Answer 67

as “disinterested and independent” directors while the MBCA refers to them as “qualified” directors

Question 68

In what two instances does a “disabling interest” exist in Delaware?

Answer 68

1. The first is when (1) a director personally receives a benefit (or suffers a detriment), (2) as a result of, or from, the challenged transaction, (3) which is not generally shared with (or suffered by) the other shareholders of his corporation, and (4) that benefit (or detriment) is of such subjective material significance to that particular director that it is reasonable to question whether that director objectively considered the advisability of the challenged transaction to the corporation and its shareholders.
2. The second instance is when a director stands on both sides of the challenged transaction. This latter situation frequently involves the first three elements listed above. As for the fourth element, whenever a director stands on both sides of the challenged transaction he is deemed interested and allegations of materiality have not been required.

Question 69

What three kinds of conflicts does a director have in a conflicting interest transaction in an MBCA jurisdiction?

Answer 69

1. In a transaction directly between the director and the corporation,
2. As a party with an interest in a transaction between the corporation and a third party, and
3. As a party with an interest in or material relationship with, a party to the transaction.

Question 70

What is a qualified director in an MBCA jurisdiction?

Answer 70

A qualified director is a director for whom the transaction is not a director’s conflicting interest transaction and who has no material relationship to a director for which the transaction is a director’s conflicting interest transaction

Question 71

What are Uniform Act Conflicts?

Answer 71

The fiduciary duty of loyalty of the decision maker includes the duties to refrain from dealing with the entity in the conduct of the entity’s affairs as or on behalf of a person having an interest adverse to the entity.

Question 72

What is the standard for director approval in conflicted decisions under the MBCA?

Answer 72

qualified directors must deliberate and vote outside the presence of, and without the participation of, the other directors

Question 73

What is the standard for director approval in conflicted decisions under Delaware law?

Answer 73

the conflicted and beholden directors may deliberate and vote together with the disinterested and independent directors.

Question 74

How can a violation of a fiduciary duty be excused in director approvals of conflicted decisions?

Answer 74

the voting managers or investors must be fully informed of all material facts.

Question 75

T/F: A manager’s failure to disclose material information is itself a breach of the duty of loyalty.

Answer 75

True

Question 76

What is the standard of review under Delaware law for judicial approval of conflicted decisions?

Answer 76

the standard of review depends initially on whether the corporate fiduciaries (i) were disinterested and independent (the business judgment rule), (ii) faced potential conflicts of interest because of the decisional dynamics present in a particular recurring and recognizable situation (enhanced scrutiny), or (iii) confronted actual conflicts of interest such that the directors making the decision did not comprise a disinterested and independent board majority (entire fairness).

Question 77

When will courts apply the business judgement rule to conflicted decisions?

Answer 77

when the challengers have not proven any conflict or where any conflicted transaction received disinterested approval.

Question 78

When will courts apply enhanced scrutiny in a conflicted transaction?

Answer 78

Enhanced scrutiny, the intermediate standard of review, is applicable when an investor seeks to buy a controlling stake or more in the entity.

Question 79

When will courts apply the entire fairness standard in a conflicted transaction?

Answer 79

Entire fairness is the standard of review for a conflicted transaction that has not been approved by disinterested directors or shareholders

Question 80

In conflicted transactions, what are the elements of the entire fairness standard?

Answer 80

1. Fair dealing
2. Fair price

Question 81

What is fair price?

Answer 81

A fair price is one that a reasonable seller, under all of the circumstances, would regard as within a range of fair value; one that such a seller could reasonably accept.

Question 82

What is the burden of proof for partnerships, LPs, and LLCs to prove fair price under the entire fairness standard?

Answer 82

the burden is on the conflicted partners or members to prove the fairness of the transaction.

Question 83

What is the burden of proof for partnerships, LPs, and LLCs to prove fair price under the entire fairness standard?

Question 84

What is the burden of proof for Delaware corporations to prove fair price under the entire fairness standard?

Answer 84

the burden is on the conflicted directors, but shifts to the persons challenging the transaction upon proof that after full disclosure, the transaction was approved by a majority of disinterested directors that did not constitute a majority of the board.

Question 85

What is the burden of proof for MBCA corporations to prove fair price under the entire fairness standard?

Answer 85

the burden is on the conflicted directors and does not shift with proof of disinterested approval.

Question 86

What is the default rule for partnerships, LLCs, and LPs for approval of conflicted transactions?

Answer 86

Under the default rules, partnerships, LLCs, and limited partnerships may authorize or ratify acts or transactions that would otherwise violate the fiduciary duty of loyalty. However, they can do so only by a unanimous vote of the partners or members

Question 87

T/F: RUPA, ULLCA, and ULPA do not recognize fairness to the entity as a defense in conflicted transactions

Answer 87

FALSE. They DO recognize fairness to the entity as a defense

Question 88

T/F: Corporations cannot limit or eliminate the liability of directors for breaches of the duty of loyalty.

Answer 88

True

Question 89

T/F: Partnerships, LLCs, and limited partnerships can alter or eliminate aspects of the duty of loyalty if not manifestly unreasonable.

Answer 89

True

Question 90

What four elements must an otherwise valid transaction meet to be considered valid?

Answer 90

The transaction (1) is unconflicted, (2) has been approved by a majority of the unconflicted directors on the board or a committee, (3) has been approved by the unconflicted shareholders, or (4) is entirely fair to the corporation
(if the conflicted transaction satisfies none of these tests, the transaction is avoidable and the court can invalidate it)

Question 91

When are courts reluctant to order rescission?

Answer 91

Courts are reluctant to order rescission against a party who had no notice of the breach of duty that would justify it or where the rights of third parties would be affected.

Question 92

What is laches?

Answer 92

an equitable doctrine by which courts deny relief to claimants who have unreasonably delayed in asserting their claims.

Question 93

What circumstances trigger laches?

Answer 93

a. When did the parties know about the conflict? (If one party didn’t know something material about the conflict (it was hidden from them), the court may allow the case to proceed)
b. Did the party affected do their due diligence to uncover the material facts of the case?

Question 94

T/F: If the statute of limitations has not run, laches do not apply.

Answer 94

FALSE. Laches may apply even if the statute of limitations has not yet run.

Question 95

T/F: A court may not grant any remedy against a director for conflict if the transaction has been approved by disinterested directors or shareholders or if the court has determined that the transaction is fair to the corporation—even if the director acted in bad faith

Answer 95

True

Question 96

Under the MBCA, when is a director not liable for conflicted decisions?

Answer 96

a director is not liable if he or she established that the challenged conduct was reasonably believed by the director to be in the best interests of the corporation

Question 97

In Delaware, when is a director liable in conflicted decisions?

Answer 97

self-dealing fiduciaries are liable because they breached their duty of loyalty if the transaction was unfair, regardless of whether they acted in subjective good faith.

Question 98

T/F: Managers who abstained from voting and deliberation are generally not liable for an invalid action

Answer 98

True. However, a manager who knowingly accepts a personal benefit flowing from a self-interested transaction and refuses to return it upon demand, can be thought to have ratified the action taken by the board in his absence and, thus, share in the full liability of his fellow directors

Question 99

What three remedies are available against managers who breached their duties of loyalty?

Answer 99

1. The corporate officer forfeits all rights to compensation
2. Attorneys’ fees
3. Rescission. If rescission is impractical, the court may aware rescissory damages.

Question 100

What are rescissory damages?

Answer 100

monetary damages equal to the value a plaintiff would have received from rescission of the transaction

Question 101

What is the opportunity doctrine?

Answer 101

The doctrine prohibits fiduciaries from taking their entity’s opportunities without the entity’s consent.

Question 102

The corporate opportunity doctrine, as delineated by Guth holds that a corporate officer or director may not take a business opportunity for his own if (4 things):

Answer 102

1. the corporation is financially able to exploit the opportunity;
2. the opportunity is within the corporation’s line of business;
3. the corporation has an interest or expectancy in the opportunity; and
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.

Question 103

Guth also states that a director or officer may take a corporate opportunity if (4 things):

Answer 103

1. the opportunity is presented to the director or officer in his individual and not his corporate capacity;
2. the opportunity is not essential to the corporation;
3. the corporation holds no interest or expectancy in the opportunity; and
4. the director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity

Question 104

Under Guth, what seven factors should courts take into account in evaluating an opportunity case?

Answer 104

1. the entity’s financial ability to exploit the opportunity,
2. whether the opportunity is in the entity’s line-of-business,
3. whether the entity has an interest or expectancy in the opportunity,
4. whether taking the opportunity will bring the fiduciary in conflict with the entity,
5. whether the opportunity came to the fiduciary in the fiduciary’s personal or fiduciary capacity,
6. whether the opportunity is essential to the entity, and
7. whether the fiduciary used entity resources to pursue the opportunity.

Question 105

Under the seven Guth factors, what is an entity’s line-of-business.

Answer 105

An entity’s line-of-business is the type of business it conducts or could plausibly come to conduct.

Question 106

Under the seven Guth factors, what is an entity’s interest?

Answer 106

Two Definitions:
i. Interest may mean that the entity is interested in the opportunity, or that the opportunity is the object of the entity’s plans.
ii. Interest may mean that the entity has a contract or property right to the opportunity

Question 107

Under the seven Guth factors, what does “conflict with the entity” mean?

Answer 107

If taking the opportunity would bring the fiduciary into conflict with the entity, this is a factor that is taken into account.

Question 108

Under the seven Guth factors, what does “personal or fiduciary capacity” entail?

Answer 108

Whether the fiduciary learned of the opportunity in the fiduciary’s personal capacity or its fiduciary capacity is a factor taken into account.
a. Controlling shareholders owe fiduciary duties, and are thus subject to the opportunity doctrine.
b. Non-controlling shareholders are sometimes subject to the opportunity doctrine on the basis of the small number of shareholders in the corporation, the active participation by these shareholders in management decisions, and their close and intimate working relations.

Question 109

Under the seven Guth factors, what does “essential to the entity” mean?

Answer 109

That an opportunity is necessary or essential for an entity’s survival or success strengthens the entity’s claim to the opportunity.

Question 110

Under the seven Guth factors, what does “use of entity resources” mean?

Answer 110

Whether the fiduciary used the entity’s resources to develop the opportunity is a factor the courts consider.

Question 111

T/F: A fiduciary may lawfully take a specific opportunity if the fiduciary properly discloses the opportunity to the entity and the entity authorizes the taking

Answer 111

True.

Question 112

If an entity grants authorization before the fiduciary takes the opportunity, the entity is said to reject or renounce the opportunity. What do rejection and renunciation entail?

Answer 112

a. Rejection occurs if an entity deliberately declines a specified opportunity.
b. Renunciation occurs if an entity announces, before the particular opportunities are specified, that it is not interested in opportunities within some class or category.

Question 113

How can an entity ratify a fiduciary’s taking of an opportunity under the corporate opportunity doctrine?

Answer 113

If the entity grants authorization after the fiduciary takes the opportunity, the entity is said to ratify the taking.

Question 114

T/F: the opportunity doctrine is within the duty of care

Answer 114

FALSE. It is within the duty of LOYALTY.

Question 115

T/F: Some states allow a corporation to renounce, in its certificate of incorporation or by action of its board of directors, any interest or expectancy of the corporation in, or in being offered an opportunity to participate in, specified business opportunities or specified classes or categories of business opportunities that are presented to the corporation or 1 or more of its officers, directors or stockholders

Answer 115

True

Question 116

What remedies may entities recover for opportunities who usurped their opportunities?

Answer 116

Compensatory, and in appropriate cases punitive, damages from the fiduciary.
- Fiduciaries who breach their duties of loyalty may also be required to surrender the profits earned from the opportunity.

Question 117

How can entities prevent usurpation of corporation opportunities?

Answer 117

to restrict the flow of sensitive information to directors the board has reason to distrust

Question 118

What are the elements of aiding and abetting liability?

Answer 118

Aiding and Abetting liability may be imposed on one who aids and abets the commission of an intentional tort if the person
(a) knows the other’s conduct constitutes a breach of duty and gives substantial assistance or encouragement to the other to so act or
(b) gives substantial assistance to the other in accomplishing a tortious result and the person’s own conduct, separately considered, constitutes a breach of duty to the third person.

Question 119

What does the oversight duty require?

Answer 119

every corporate board must at least attempt to put in place a reasonable information and reporting system and to monitor the corporation’s central compliance risks
i. It also requires that the board take action when a majority of the directors is aware of evidence of corporate misconduct (red flag).

Question 120

What does Section 302(a)(4) of the Sarbanes-Oxley Act of 2002 require?

Answer 120

that the company’s chief executive officer and chief financial officer review each quarterly or annual report and certify that, “based on the officer’s knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition of operations.”

Question 121

What are internal controls?

Answer 121

policies or procedures put in place to safeguard assets, provide reliable financial information, promote efficient operations, and ensure compliance with more basic policies and procedures

Question 122

What are preventative controls?

Answer 122

They seek to discourage errors from occurring. An example would be a policy that the chief financial officer must approve the hiring of an employee at a salary in excess of a certain dollar amount.

Question 123

What are detective controls?

Answer 123

They seek to discover errors after they occur. An example would be a requirement that each department head review a list of expenditures charged to the department each month

Question 124

What are directive controls?

Answer 124

They seek to encourage positive actions or outcomes. An example would be a requirement that employees complete a training seminar.

Question 125

With respect to public companies, Sarbanes-Oxley Section 404 requires that:

Answer 125

[E]ach annual report . . . contain an internal control report, which shall—
1. (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and
2. (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.

Question 126

Sarbanes-Oxley Section 302(a)(4) requires:

Answer 126

that each report state that the signing officers—the CEO and CFO—“are responsible for establishing and maintaining internal controls.”
1. For large companies, the Certified Public Accounting firm that prepares the report must “attest to, and report on” the manager’s assessment

Question 127

What four kinds of failures do directors who make decisions have liability for?

Answer 127

i. The first is failure to act in good faith.
ii. The second is failure to act in a manner the director reasonably believes is in the corporation’s best interests.
iii. The third is failure to inform themselves to the extent they reasonably believed appropriate.
iv. The fourth is acting while lacking objectivity because of a conflict of interest.

Question 128

What two standards for oversight liability are purported in Caremark?

Answer 128

We hold that Caremark articulates the necessary conditions predicate for director oversight liability:
1. (a) the directors utterly failed to implement any reporting or information system or controls; or
2. (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations…

Question 129

To establish demand futility under Caremark’s second prong, what must the complaint plead?

Answer 129

the Complaint must plead [particularized facts] that the board knew of evidence of corporate misconduct—the proverbial “red flag”—yet acted in bad faith by consciously disregarding its duty to address that misconduct.

Question 130

To establish demand futility under Caremark’s second prong, what must a Delaware plaintiff plead?

Answer 130

Under Delaware law the plaintiff must even more particularly plead facts specific to each director, demonstrating that at least half of them could not have exercised disinterested business judgment in responding to a demand.

Question 131

What two tests are available to determine whether a demand is futile?

Answer 131

i. The test established in Aronson v. Lewis applies to claims involving a contested transaction, i.e., where it is alleged that the directors made a conscious business decision in breach of their fiduciary duties.
ii. The second test established in Rales v. Blasband applies where the subject of a derivative suit is not a business decision of the Board but rather a violation of the Board’s oversight duties.

Question 132

T/F: Dodd-Frank’s whistleblower protections cover individuals only when they report a violation to the SEC before they are fired.

Answer 132

True.

Question 133

T/F: Delaware law does not allow a shareholder to sue directors only if a majority of the board has disabling conflicts of interest.

Answer 133

FALSE. Delaware law DOES allow a shareholder to sue directors only if a majority of the board has disabling conflicts of interest

Question 133

T/F: Delaware law does not allow a shareholder to sue directors only if a majority of the board has disabling conflicts of interest.

Answer 133

FALSE. Delaware law DOES allow a shareholder to sue directors only if a majority of the board has disabling conflicts of interest