Corporations and Agency Flashcards
Is a corporation bound when its board of directors ratifies a transaction previously entered into by the corporation’s agent acting without authority?
The land-sale agreement signed by Carol is binding on the corporation. Although Carol (agent) originally lacked actual or apparent authority to bind the corporation (principal) to the land-sale agreement, the corporation became bound by the board’s subsequent ratification of the agreement at a properly called meeting at which a majority of the directors approved the transaction after full disclosure.
Agency
Agency is the fiduciary relationship that arises when one person (a “principal”) manifests assent to another person (an “agent”) that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent consents so to act. Restatement (Third) of Agency § 1.01; Restatement (Second) of Agency § 1.
Actual vs Apparent Authority
If an agency relationship exists, an agent who makes a contract with a third party on behalf of a disclosed principal binds the principal to the contract if the agent acted with actual or apparent authority. Actual authority may be express or implied. Actual express authority arises where a principal expressly causes an agent to believe that she has been empowered to act on the principal’s behalf. Actual implied authority is the authority that an agent has to take actions that are reasonably necessary to carry out the principal’s express instructions. Both types of authority focus on communications between the principal and the agent. By contrast, apparent authority exists when a principal’s communications to a third party cause the third party to reasonably believe that an agent is authorized to act, even if the principal and the purported agent never so agreed.
Ratification
Even when an agent lacks actual or apparent authority to bind the principal, ratification can cure this lack of authority. Ratification is the affirmance of a prior, nonbinding act done by another, whereby the act is given effect as if done by an agent acting with actual authority. § 4.01; Restatement (Second) of Agency § 82. A person ratifies an act by accepting the results of the act with an intent to ratify, and with full knowledge of all the material circumstances surrounding the act.
Application
Here, because Carol lacked actual or apparent authority to enter into the land-sale agreement, the agreement was not binding on the corporation at the time it was entered into. However, after Carol fully disclosed all material terms of the agreement to the directors, a majority of the corporation’s directors (Danielle and the third director) at a properly called special meeting expressly accepted the agreement and thus ratified it. See MBCA § 8.22 (special meetings of the board must be preceded by two days’ notice). There is no indication that the corporation’s articles, bylaws, or shareholders’ agreement required unanimous agreement for such a sale. Thus, the action by the majority of the corporation’s directors is binding on the corporation. See MBCA § 8.24(a) (board quorum generally consists of a majority of directors); § 8.24(c) (if quorum is present, “affirmative vote of a majority of directors present is the act of the board”). Accordingly, through this board action, the corporation became bound by the agreement to sell the land to the bank pursuant to the terms negotiated by Carol.
Was the bonus payment made to Danielle, which was approved by a majority of the board of directors, proper? Explain
The bonus payment to Danielle was not proper. The payment, a director’s conflicting interest transaction, was not properly approved by a majority of qualified directors because Danielle was financially interested in the transaction and thus was not qualified to approve the transaction. Nor is there any indication Danielle would be able to show that the payment was fair to the corporation. Thus, the bonus payment constituted a breach of Danielle’s fiduciary duty of loyalty.
Director’s conflicting interest transaction (DCIT)
The MBCA defines a “director’s conflicting interest transaction” (DCIT) as a transaction effected by the corporation to which a director is a party. MBCA § 8.60(i). Although the common law treated such director self-dealing transactions as null and void, modern courts and statutes will uphold such a transaction if it is properly approved by informed, disinterested directors or shareholders. See MBCA § 8.62(a) (safe harbor for DCIT approved by qualified directors), § 8.63(a) (safe harbor for DCIT approved by qualified shareholders). Absent such approval, the transaction may nonetheless be upheld “if the [conflicted] director shoulders the burden of showing the transaction was fair” to the corporation. See Introductory Note, MBCA Subchapter F: Directors’ Conflicting Interest Transactions. Fairness can be shown if the director’s self-dealing transaction was “beneficial” to the corporation and “on terms comparable to what might have been obtained in an arm’s length transaction.” Official Comment, Fair to the Corporation, MBCA Subchapter F. The normal presumption under the “business judgment rule” that directors act in the best interests of the corporation does not apply to cases of director self-dealing. See Official Comment, Note on Directors’ Liability, MBCA § 8.31.
Application
Here, the bonus payment by the corporation only to Danielle constituted a “director’s conflicting interest transaction” or a DCIT. See MBCA § 8.60(i) (defining DCIT to include any transaction “effected by the corporation . . . to which . . . the director is a party”). The transaction, which was approved only by Danielle and the third director, does not fit the safe harbor for approval by a majority vote (no less than two) of “qualified” directors. MBCA § 8.62(a). Even if the third director was qualified, Danielle was not qualified because of her financial interest in the bonus payment. See MBCA § 1.43 (defining “qualified” director as one having no conflicting interest in the transaction and no “material relationship” with a director having such an interest). Thus, the payment was not approved by a majority of qualified directors.
Furthermore, there is no indication that the corporation was benefited by making a bonus payment to only Danielle or that such payment was made on terms comparable to those that would have been obtained in a market transaction. There is no indication that Danielle provided any services that warranted a bonus payment. Nor is there any indication that such bonus payments normally occur in other corporations. In effect, the bonus payment here was undeserved, excessive compensation to the corporation’s controlling shareholder. Therefore, Danielle cannot show that the bonus payment was fair to the corporation. MBCA § 8.61(b)(3).
As a result, Danielle violated her fiduciary duty of loyalty both by receiving from the corporation a financial benefit to which she was not entitled and by dealing unfairly with the corporation. See MBCA § 8.31(a)(2)(v) (director liable for “receipt of a financial benefit to which the director was not entitled or any other breach of the director’s duties to deal fairly with the corporation”); see also Official Comment to MBCA § 8.31 (as amended in 2005) [Note on Business Judgment Rule] (“A director is expected to observe an obligation of undivided loyalty to the corporation [as to any] financial benefit to which a director is not properly entitled”). Further, Brian will likely be able to show that the bonus payment, for which the corporation apparently received nothing in return, caused harm to the corporation. See MBCA § 8.31(b).
Does a minority shareholder in a close corporation have sufficient grounds to seek judicial dissolution of the corporation when the corporation’s majority shareholder (a) takes actions that contravene the corporation’s purpose, (b) engages in unfair self-dealing, and (c) refuses to allow the minority shareholder to inspect the corporation’s accounting records?
It is likely that Brian has sufficient grounds to seek judicial dissolution of the corporation. In this close corporation, the actions by the majority shareholder in disposing of the corporation’s primary asset in apparent contravention of the corporation’s purpose, in approving the payment of a bonus only to herself, and in voting to deny Brian’s access to the corporation’s accounting records likely constitute “oppression” under the MBCA. Thus, Brian likely has sufficient grounds to seek judicial dissolution of the corporation.
Oppression
The MBCA, consistent with the approach in most states, gives courts discretion to order the judicial dissolution of a corporation if a shareholder can demonstrate that the majority (or controlling) shareholder is acting in a manner that is “oppressive.” MBCA § 14.30(a)(2)(ii). In applying the oppression test, many courts have looked to whether the conduct of the majority shareholders defeats the “reasonable expectations” that the majority knew, or reasonably should have known, were held by the minority shareholders. See O’Brien v. Pearson, 868 N.E.2d 118, 126 (Mass. 2007); Matter of Kemp & Beatley, Inc., 473 N.E.2d 1173, 1179 (N.Y. 1984); accord California Corp. Code § 1800(b)(5) (court may dissolve corporation when “reasonably necessary” to protect minority shareholders). Courts have justified judicial dissolution because of the reality that there is generally no available market for the sale of shares in a closely held corporation. Without the ability to petition for dissolution, a minority shareholder may be unable to protect his legitimate interests in the corporation.
Application
Here, there were a number of “oppressive” actions by the majority shareholder. First, the ratification (by Danielle and the third director) of the sale of the corporation’s only property to the bank frustrated Brian’s reasonable expectation of participating in the corporation’s development and sale of residential properties. This expectation was based on the board’s unanimous decision that the corporation would purchase land for the purpose of residential development, assign Brian the task of building homes on the land, have Brian paid an annual salary for building homes for the corporation, and have Danielle secure financing to build these homes. In short, Brian expected to build homes and to be paid a salary for building the homes, on property acquired by the corporation. There is no indication that Brian expected the corporation to engage in real estate speculation, as happened when Danielle accepted the sale to the bank of the corporation’s only property.
Second, Danielle’s acceptance of a bonus payment—from which Brian was excluded—constituted unfair self-dealing. See Point Two. Courts have regularly cited “freeze outs” (where minority shareholders are excluded from the benefits of the business) as oppressive conduct that justifies judicial dissolution of the corporation. In addition, the MBCA permits judicial dissolution when corporate assets are being “misapplied or wasted,” as happened here with the bonus payment to Danielle. See MBCA § 14.30(2)(iv).
Third, Danielle’s vote (joined in by the third director) refusing to give Brian access to corporate records was in contravention of Brian’s right to inspect the corporation’s accounting records. See MBCA § 16.02(b) (“A shareholder . . . is entitled to inspect . . . accounting records of the corporation . . . .”). Courts have also cited the refusal of majority shareholders to provide information to minority shareholders as grounds for granting a petition for judicial dissolution.
Thus, Brian likely has sufficient grounds to seek judicial dissolution of the corporation. Together, the actions by Danielle—that is, the sale of the property, the unfair bonus payment, and the refusal to allow inspection of corporate records—likely would be seen as “genuine abuse” by a controlling shareholder. See Official Comment, MBCA § 14.30 (as amended in 2005) (cautioning courts to exercise discretion to grant petition for judicial dissolution on grounds of oppression only in cases of “genuine abuse rather than instances of acceptable tactics in a power struggle for control of a corporation”).
[NOTE: An examinee might point out that in a proceeding to dissolve the corporation, one or more of the corporation’s shareholders may elect to purchase all the shares owned by the complaining shareholder for their fair value, and if that happens, the court will dismiss the petition to dissolve. MBCA § 14.34. This point should not receive any credit, as the question is not whether the court will dissolve the corporation but whether there are grounds for judicial dissolution.]
