Corporations and LLC's Flashcards
Controlling Shareholder
Under the common law, controlling shareholders owe fiduciary duties to minority shareholders. See generally James D. Cox & Thomas Lee Hazen, Business Organizations Law § 11:11 (5th ed. 2020). A controlling shareholder is a shareholder that has sufficient voting power to elect the majority of the board. Because controlling shareholders can exercise their power in ways that prove detrimental to minority shareholders, courts impose a fiduciary duty of loyalty on controlling shareholders that parallels the duty owed by corporate directors. Id. In some states, this duty is described as one to refrain from deriving an improper personal benefit at the expense of the minority shareholder. See, e.g., Data Key Partners v. Permira Advisers LLC, 849 N.W.2d 693, 706 (Wis. 2014). Even if the duty were characterized in that way, it would cover the type of action engaged in here.
When a parent exercises its control in a way that prefers its own interests to the detriment of a subsidiary, the courts often place the burden on the parent to prove that the transaction was entirely fair to the subsidiary.
Good Faith Discretion
Whether dividends will be paid, and in what amount, is to be determined in the good-faith discretion of the corporation’s board of directors. Cox & Hazen, supra, § 20.2 (describing directors’ general discretion over the declaration of dividends as “well-settled doctrine”). This approach means that directors “are given a great deal of discretion to use corporate resources to expand the business . . . and to establish various reserves if they consider it to be in the interests of the corporation to do so.” Id.
This hands-off approach to judicial interference in board decisions, including the decision whether to pay dividends, is known as the “business judgment rule.” The rule creates a rebuttable presumption that directors’ decisions are made in good faith and in the best interests of the corporation. Unless a shareholder rebuts the business judgment rule presumption, courts will not second-guess a board’s decision. See Cox & Hazen, supra, § 10.1. Shareholders can rebut the business judgment rule presumption by showing that directors breached their fiduciary duty of care or loyalty in connection with a challenged transaction. The primary way in which directors might breach their duty of care is by failing to become adequately informed during their decision-making process. See id.; MBCA § 8.31(a). Directors breach their duty of loyalty through self-dealing.
Where a shareholder challenges the nonpayment of a dividend to which it is allegedly entitled, that shareholder generally makes a direct claim against the board rather than a derivative claim. That is because the failure to declare a dividend would be a harm suffered only by the shareholder, not the corporation. Moreover, the recovery would go only to the shareholder, not the corporation. See Strougo v. Bassini, 282 F.3d 162, 171 (2nd Cir. 2002) (“[W]hen the shareholders of a corporation suffer an injury that is distinct from that of the corporation, the shareholders may bring direct suit for redress of that injury; there is shareholder standing. When the corporation is injured and the injury to its shareholders derives from that injury, however, only the corporation may bring suit; there is no shareholder standing.”). As such, the shareholder does not need to comply with the various formalities (such as making a demand on the board to bring the lawsuit or show why demand would be futile) associated with bringing a derivative claim.
Business Judgment Rule
The corporation’s board of directors is responsible for corporate decision-making. See MBCA § 8.01(b) (“Except as provided in a [shareholder agreement], and subject to any limitation in the articles of incorporation . . . , all corporate powers shall be exercised by . . . the board of directors.”); see also Delaware Gen. Corp. Law § 141(a) (“The business and affairs of every corporation . . . shall be managed by or under the direction of a board of directors, except as may be otherwise provided . . . in its certificate of incorporation.”). Judicial review of board decision-making is governed by a doctrine known as the “business judgment rule.” The business judgment rule embodies a “hands off” approach to judicial interference in corporate decisions. The rule creates a rebuttable presumption that directors’ decisions are made in good faith and in the best interests of the corporation. Unless a shareholder rebuts the business judgment rule presumption, courts will not second-guess a board’s decision. Cox & Hazen, supra § 10.1.
Shareholders can rebut the presumption created by the business judgment rule by, among other things, showing that directors breached their duty of care in connection with a challenged transaction. See id., § 10.2; MBCA § 8.31(a)(2)(ii)(B). The primary way in which directors might breach their duty of care is by failing to become adequately informed during their decision-making process. MBCA § 8.31(a)(2)(ii)(B). To be adequately informed when making decisions, directors must become informed to the degree that “a person in a like position would reasonably believe appropriate under similar circumstances.” MBCA § 8.30(b). The MBCA’s reference to “similar circumstances” allows courts to consider the complexity or the exigency of the circumstances surrounding a challenged transaction. The overall focus in this context is on the quality of the deliberations, diligence, and research that go into board decisions. If the corporation’s directors became informed to an extent reasonable under the circumstances, then courts will not interfere with their business judgment.
