DIRECTORS & OFFICERS: FIDUCIARY DUTIES, LIABILITY, AND INDEMNIFICATION

Question 1

FIDUCIARY DUTIES OWED TO THE
CORPORATION
6.1.1 The Standard

Answer 1

• Director must perform duties in good faith & w/ reasonable belief that her actions are in the best interest of corp.
• She must also use care a person in similar position would reasonably believe appropriate under
  the circumstances.
• The 1st sentence of this standard is duty of loyalty.
• The 2nd sentence of this standard is duty of care.
• Every time you see a director arguably in breach of either duty, state the entire standard.

Question 2

Duty of Care

Answer 2

The standard (stated above) includes the duty of care. A
director owes this duty to the corporation.

Question 3

Burden on Challenger/Plaintiff

Answer 3

• Person challenging directors’ action on basis of a BOD of care has burden of proving that statutory standard above was not met.

Question 4

Two Common Scenarios

Answer 4

• On exam, you’ll typically see the duty of care come up in two ways: (1) nonfeasance or (2) misfeasance

Question 5

Nonfeasance

Answer 5

Nonfeasance : director basically does nothing.

Question 6

Misfeasance

Answer 6

• Misfeasance: board makes a decision that hurts the business.
• Here, in contrast to cases of nonfeasance, causation is clear.
• This means that directors who meet the standard will not be liable for corporate decisions that turn out to be poor/erroneous.
• We expect a person in a like position to do appropriate homework.
• If she did, she is not liable for bad results.
• Think of the business judgment rule as a presumption that when the board took an act, it did
  appropriate homework.
• That’s why burden is on P to show that board either did not do appropriate homework/did something galactically stupid.
• The ct will not second-guess a business decision if it
  was made in good faith, was informed, & had a rational basis.
• A director is not a guarantor of success.

Question 7

Director May Rely on Reports or Other Information

Answer 7

• In performing her duties, director is entitled to rely on info, opinions, reports, or statements (including
  financial statements), if prepared or presented by:
  (1) corporate officers/employees whom the director reasonably believes to be reliable & competent;
  (2) legal counsel, accountants, or other persons as to matters the director reasonably believes are within such person’s professional competence; or
  (3) a committee of the board of which director is not a member, if director reasonably believes committee merits confidence

Question 8

Duty of Loyalty

Answer 8

The standard (see 6.1.1) includes the duty of loyalty. A director
owes this duty to the corporation.

Question 9

Burden on Defendant

Answer 9

• Duty of loyalty cases are about conflicts of interest
• The business judgment rule does not apply in duty of loyalty cases.
• Why? Because it can never apply when the fiduciary
  has a conflict of interest.
• So the burden in these cases is on D

Question 10

Common Scenarios
z Conflicting Transactions (“Self-Dealing”)
— What Constitutes a Conflicting Transaction?

Answer 10

• This is any transaction between corp (on one
  side) & (1) one of its directors, or (2) that director’s close relative, or (3) another business of director’s (on other side).
• A classic example: XYZ Corp. enters into K w/ LMN Corp., which is owned (wholly/in part) or run by one of XYZ Corp.’s directors. We worry that the director has divided loyalties. The same is true if LMN Corp. is owned by director’s spouse/child/other relative close enough to affect one’s judgment.

Question 11

Standards for Upholding Conflicting Interest
Transactions

Answer 11

• A conflicting interest transaction will not be enjoined, set aside, or give rise to an award of damages b/c of director’s interest if:
  (1) It was approved by a majority (but at least two)
  of disinterested directors (those w/o a conflicting interest).
• All material facts must be known to board when board approved transaction. OR
  (2) It was approved by a majority of votes to be case by disinterested shareholders (those w/o
  a conflicting interest)—again, after disclosure/facts were known.
• Notice of shareholders’ meeting must describe the transaction. OR
  (3) Judged by the circumstances at time corp entered into transaction, it was fair to corp.

Question 12

Interested Director’s Presence at Meeting Irrelevant

Answer 12

• Presence of interested director(s) at meeting at which directors/shareholders voted to approve conflicting interest transaction does not affect the action

Question 13

Special Quorum Requirements

Answer 13

• For purposes of the vote on a conflicting interest transaction, at a directors’ meeting, a quorum is a majority (at least two) of disinterested directors.
• Note that at a shareholders’ meeting, a quorum consists of a majority of the votes entitled to be cast, not including shares owned/controlled directly/beneficially by director w/ the conflicting interest.

Question 14

Factors to Be Considered in Determining Fairness

Answer 14

• Despite statute’s absolute terms, a transaction approved by board/shareholders might still be set aside if party challenging transaction can prove that it constitutes a waste of corporate assets.
• So, even if deal is approved, remember on exam to say:
• “Some cts also require transaction to be fair. For fairness, cts look at adequacy of consideration, corporate need to enter into transaction, financial position of corp, & available alternatives”

Question 15

Remedies

Answer 15

• Possible remedies for an improper conflicting interest transaction include enjoining transaction, setting transaction aside, damages, & similar remedies

Question 16

Directors May Set Own Compensation

Answer 16

• Despite apparent conflict of interest, unless articles /bylaws provide otherwise, board can set director compensation.
• Must be reasonable & in good faith.
• If it’s excessive, board is wasting corporate assets & breaching duty of loyalty

Question 17

Competing Ventures

Answer 17

• Directors may engage in unrelated businesses, but
  engaging in a directly competing business raises serious duty of loyalty problems.

Question 18

Corporate Opportunity Doctrine

Answer 18

• Directors’ fiduciary duties prohibit them from usurping a corporate opportunity from their corporation w/o first giving their corp an opportunity to act.
• This is known as “usurpation of a corporate opportunity.”

Question 19

Corporation Must Have Interest or Expectancy

Answer 19

• So what is a corporate opportunity?
• Some say it’s something in corp’s business line.
• Other tests include whether it’s something the company has an interest/expectancy in/something D found on company time/ w/ company resources.
• Remember, then, that a usurpation problem
  arises only if a director takes advantage of a business
  opportunity in which corp would have an interest/ expectancy.
• A corp’s interest does not extend to every conceivable business opportunity, but neither are opportunities limited to those necessary to corp’s current business.
• The closer the opportunity is to corp’s line of business, the more likely a ct will find it to be a corporate opportunity.

Question 20

Lack of Financial Ability Not a Defense

Answer 20

• Corp’s lack of financial ability to take advantage
  of the opportunity probably is not a defense.
• Director should still present opportunity to corp & allow it to decide whether it can take advantage of the opportunity.

Question 21

Board Generally Decides

Answer 21

• Board must decide whether to accept/reject an opportunity

Question 22

Remedies

Answer 22

• If director usurps a corporate opportunity, corp can sue to recover under a constructive trust theory.
• If director still owns the property, she can be compelled to transfer it to corp at price she paid.
• If she has sold property at a profit, corp may recover that profit.

Question 23

Tip

Answer 23

Usurpation of a corporate opportunity is a very
common Corporations exam issue. Whenever the
facts of a question mention that a director learns
of a business opportunity, be sure to consider whether her corp would be interested. If so, she must present opportunity to her corporation, disclosing all material facts, & can take advantage of opportunity personally only if corp decides not to pursue it.

Question 24

Common Law Insider Trading—Special
Circumstances Rule

Answer 24

• Director has no CL duty to disclose all facts relevant to a securities transaction between director & other party to transaction.
• However, cts have found a duty to disclose where a director knows of special circumstances (ex. an upcoming extraordinary dividend/planned merger).

Question 25

Duty to Disclose

Answer 25

• Directors also have a duty to disclose material corporate info to other board members

Question 26

Loans

Answer 26

• Corp can make a loan to a director if it is reasonably
  expected to benefit corp

Question 27

Personal Liability of Directors May Be Limited

Answer 27

• Articles may limit/eliminate directors’ personal liability for money damages to corp/shareholders for actions taken/not taken.
• However, articles may not limit/eliminate liability for financial benefits received by director to which she is not entitled, an intentionally inflicted harm on the corp/shareholders, unlawful corporate distributions, or an intentional violation of criminal law.

Question 28

WHICH DIRECTORS MAY BE LIABLE?
6.2.1 Determining Director Liability

Answer 28

• Directors may be liable to corp for improper distributions, improper loans, “ultra vires” acts (making company do things it has no power to do), & for breaches of fiduciary duties.
• But how do we know exactly which directors are liable for these actions?
• A director is presumed to concur w/ board action unless her dissent/abstention is noted in writing in corporate records.
• In writing means (1) in the minutes, (2) delivered in writing to presiding officer at the meeting, or (3) written dissent to corp immediately after meeting.
• So an oral dissent, by itself, is not effective.
• Note also that a director cannot dissent if she voted for the resolution at the meeting.

Question 29

Exception

Answer 29

• Director is not liable under the rule above if she was absent from the board meeting (she was sick that day).

Question 30

OFFICERS
6.3.1 Powers and Status

Answer 30

• Officers are agents of corp.
• Agency law determines authority & powers of officers.
• Corp: principal & officer: agent.
• Whether officer can bind corp is determined by whether she has agency authority to do so (actual/ apparent authority).
• Unauthorized actions may become binding on the corp b/c of ratification, adoption, or estoppel.
• Corp is liable for actions by its officers w/in scope of
  their authority, even if particular act was not specifically authorized.

Question 31

Roles

Answer 31

• Traditionally, corps were required to have a president, secretary, & treasurer.
• Now, corp need not have any particular officers.
• It may have those specified/permitted by its bylaw
• One officer may appoint assistant officers if permitted by bylaws.
• May one person can simultaneously serve in more than one office

Question 32

Duties

Answer 32

• Officers’ general duties are determined by the bylaws or, to the extent consistent w/ bylaws, by the board/officer so authorized by the board.
• Officers owe the same duties of care & loyalty to corp as directors

Question 33

Selection and Removal of Officers

Answer 33

• Officers are selected & removed by the board, which also sets officer compensation.
• Despite any contractual term to the contrary, an officer has power to resign at any time by delivering notice to corp, & corp has power to remove an officer at any time, with/without cause.
• If resignation/removal is a breach of K, nonbreaching party may have a right to damages, but
  note that mere appointment to office itself does not create any contractual right to remain in office.
• Remember that shareholders hire & fire directors.
• Shareholders do not hire & fire officers.

Question 34

INDEMNIFICATION OF DIRECTORS,
OFFICERS, AND EMPLOYEES
6.4.1 Categories of Indemnification

Answer 34

• Someone has been sued by (or on behalf of) the corp in her capacity as an officer/director.
• Director has incurred costs, attorneys’ fees, maybe even fines, & a judgment/settlement in that litigation.
• Now, she seeks indemnification (reimbursement) from the corp.
• There are 3 categories of indemnification.

Question 35

Category 1: No Indemnification

Answer 35

• Corp cannot indemnify a director who is
  (1) held liable to corp or
  (2) held to have received an improper benefit.

Question 36

Category 2: Mandatory Indemnification

Answer 36

• Unless limited by articles, a corp must indemnify
  a director/officer who was successful in defending a
  proceeding on the merits/otherwise against officer/ director for reasonable expenses, including attorneys’ fees, incurred in connection w/ the proceeding.
• In some states, director/officer must win entire case; in others, they are entitled to indemnification “to the extent” that they win the case.

Question 37

Category 3: Permissive Indemnification

Answer 37

• Corp may indemnify a director for reasonable
  litigation expenses incurred in unsuccessfully defending a suit brought against director on account of director’s position if director:
  (1) acted in good faith; and
  (2) believed that her conduct was in the best interests of corp (when conduct at issue was within director’s official capacity).
• This standard sounds familiar. Why? It’s the duty of loyalty part of the standard from earlier.

Question 38

Who Makes Determination

Answer 38

• Generally, determination whether to indemnify is
  to be made by a disinterested majority of the board,
  or if there is not a disinterested quorum, by a majority of a disinterested committee or by independent legal counsel.
• The shareholders may also make determination
  (shares of director seeking indemnification are not counted).

Question 39

Officers

Answer 39

Officers generally may be indemnified to the same
extent as a director

Question 40

Court-Ordered Indemnification

Answer 40

• Notwithstanding the above rules, a ct in which a director/officer was sued may order indemnification if it is justified in view of all circumstances.
• If director/officer was held liable to corp, reimbursement is limited to costs & attorneys’ fees (it cannot include the judgment).

Question 41

Limitations of Liability

Answer 41

• Articles can eliminate director (&, in some states,
  officer) liability to corp for damages, but not for
  intentional misconduct, usurping corporate opportunities, unlawful distributions, or improper personal benefit.
• So, these provisions can eliminate liability only for duty of care cases.

Question 42

Advances

Answer 42

• Corp may advance expenses to a director defending
  an action if director givess corp a statement that director believes he met the appropriate standard of conduct & that he will repay the advance if he is later found to have not met the appropriate standard.

Question 43

Liability Insurance

Answer 43

• Corp may purchase liability insurance to indemnify
  directors/officers for actions against them even if directors/officers would not have been entitled to indemnification under the above standards.

Question 44

Agents and Employees

Answer 44

• MBCA does not limit a corp’s power to indemnify,
  advance expenses to, or maintain insurance on agents & employees.