FACT PATTERN THREE: Directors and Officers

Question 1

Qualification of Directors

Answer 1

Directors must be human beings with legal capacity

Directors do not need to be shareholders in the corporation or residents of any particular state (absent a provision in the articles or bylaws)

Any qualifications for directors prescribed by the articles or bylaws must be reasonable and lawful

No qualification may limit the ability of a director to discharge their duties.

Question 2

How Many Directors are allowed

Answer 2

We must have one or more directors.

The number can be set in the articles or bylaws.

Question 3

Election of Directors

Answer 3

Initial directors are usually named in the articles. If not, they are elected by the incorporator(s) at the organizational meeting.

After that, the shareholders elect the directors at each annual shareholders’ meeting, subject to contrary provisions in the articles.

Question 4

How to Remove Directors

Answer 4

A director is removed if the votes cast in favor of removal exceed the votes cast against.

Shareholders may remove a director with or without cause, and can remove directors before their terms expire.

In some states, if there is a staggered board, shareholders can remove a director only with cause.

A director elected by cumulative voting cannot be removed if the votes cast against removal would be sufficient to elect her if cumulatively voted at an election of directors.

A director elected by a voting group of shares can be removed only by that class.

Question 5

Vacancies

Answer 5

When a vacancy arises, the board or the shareholders will select the replacement.

If the shareholders created the vacancy by removing a director, the shareholders generally must select the replacement.

Question 6

When the Board takes Action

Answer 6

The board of directors must act as a group. Individual directors have no authority to speak for or bind the corporation.

They may take an act only in one of the following ways:
* Unanimous agreement in writing (email is OK, and separate documents are also OK), or
* At a meeting, which must satisfy the quorum and voting requirements

Question 7

How can a Corporation Ratify Defective Corporate Actions?

Answer 7

Directors, incorporators, and officers may ratify defective corporate actions (i.e., actions that are void or voidable due to a failure of authorization).

To ratify, the board of directors must state the action to be ratified and the nature of the failure of authorization, approve the ratification, and seek shareholder approval if necessary.

Question 8

Types of Notice Required for Board Meetings

Answer 8

If there is a board meeting, the method for giving notice is usually set in the bylaws.

For regular meetings notice is not required.

For special meetings at least two days’ written notice of date, time, and place is required. The notice need not state the purpose of the meeting.

Failure to give required notice means that whatever happened at the meeting is void or voidable UNLESS the directors who were not notified waive the notice defect either (1) in writing anytime, or (2) by attending the meeting without objecting at the outset of the meeting.

Question 9

Use of Proxies and Voting Agreements

Answer 9

Directors cannot give proxies or enter voting agreements for how they will vote as directors. Any efforts to do so are void.

Question 10

When must a Shareholder’s ANNUAL meeting take place?

Answer 10

As the board of directors or president directs, but must be within 18 months of prior annual meeting

Question 11

When must a Shareholder’s SPECIAL meeting take place?

Answer 11

As board of directors or president directs

Question 12

When must a Director’s SPECIAL meeting take place?

Answer 12

As board of directors or president directs

Question 13

When must a Director’s REGULAR meeting take place?

Answer 13

As board of directors or president directs

Question 14

What are the Notice Requirements for Shareholder Meetings

Answer 14

Annual Meeting:
Can be by mail between 10 and 60 days before meeting. Notice must include time and place.

Special Meeting:
Can be by mail between 10 and 60 days before meeting; must include time, place, and purpose

Question 15

What are the Notice Requirements for Board Meetings

Answer 15

Regular: No notice needed

Special: Notice required

Question 16

What is a Quorum

Answer 16

A quorum is a majority of all directors, unless the bylaws say otherwise. HOWEVER, a quorum can be no fewer than one-third of the board members.

Without a quorum, the board cannot act.

Question 17

Approval of an Action when a Quorum is Present

Answer 17

If a quorum is present at a meeting, passing a resolution requires only a majority vote of those present.

Example: If there are nine directors, at least five directors must attend the meeting to constitute a quorum. If five directors attend, at least three must vote for a resolution for it to pass

Question 18

Director’s ability to bind a corporation to contract

Answer 18

A director does not have the power to bind the corporation in contract UNLESS there is actual authority to act.

Actual authority generally can arise only if:
(1) proper notice was given for a directors’ meeting, a quorum was present, and a majority of the directors approved the action, or
(2) there was unanimous written consent of the directors.

Question 19

Committees

Answer 19

Unless the articles or bylaws provide otherwise, the board may create committees.

The board can delegate actions to a committee, but a committee CANNOT:
* Declare a distribution
* Fill a board vacancy
* Recommend a fundamental change to shareholders (but can recommend such actions to the full board for its action)

Question 20

Director’s Duty of Care

Answer 20

A director owes the corporation a duty of care.

Directors have a duty to manage to the best of their ability. They must discharge their duties:
1. In good faith AND
2. With the care that a person in a like position would exercise under similar circumstances

Question 21

Two Common Duty of Care scenarios

Answer 21

Nonfeasance: Director does nothing when a person acting with care would have taken action. This director is liable only if his breach causes a loss to the corporation.

Misfeasance: When the board makes a decision that hurts the corporation. Still requires causation but it is clear here.

Question 22

Business Judgement Rule

Answer 22

A court will not second-guess a business decision if it (1) was informed, (2) was made in good faith, (3) was made without conflicts of interest, and (4) had a rational basis.

USE WHEN: A director has harmed the corporation (i.e., breached their duty of care) by making corporate decisions that in hindsight turn out to be erroneous.

Question 23

Directors Relying on Other Information when Making Decisions

Answer 23

A director is entitled to rely on information if prepared or presented by:
(1) Officers or employees whom the director reasonably believes to be reliable and competent
(2) Persons whom the director reasonably believes are acting within their professional competence (e.g., legal counsel, accountants), or
(3) A committee of which the director is not a member, if the director reasonably believes the committee merits confidence.

Question 24

Duty of Loyalty

Answer 24

A director owes the corporation a duty of loyalty, which prohibits the director from competing with their corporation, and bars the director from usurping corporate opportunities

Question 25

What Constitutes a Conflicting Interest Transaction?

Answer 25

Any transaction between the corporation and one of its directors, that director’s close relative, or another business of the director’s.

Question 26

Upholding Conflicting Interest Transactions

Answer 26

A conflicting interest transaction will not be enjoined, set aside, or give rise to an award of damages because of director’s interest if:

(1) It was approved by a majority (at least two) of disinterested directors who were either (i) informed of all material facts, or (ii) knew of the facts when the transaction was approved.

(2) It was approved by a majority of votes entitled to be cast by disinterested shareholders (Notice of the shareholders’ meeting must describe the transaction), OR

(3) Judged by the circumstances at the time the corporation entered into the transaction, it was fair to the corporation.

Question 27

Special Quorum Requirements when Voting on CoI Transactions

Answer 27

Directors’ meeting: A quorum is a majority (at least two) of disinterested directors. NOTE: In many states, interested directors count toward a quorum.

Shareholder’s Meeting: A quorum consists of a majority of the votes entitled to be cast, not including shares owned or controlled directly or beneficially by the director with the conflicting interest.

Question 28

Fairness Requirement for Upholding CoI transactions

Answer 28

SAY THIS: “Some courts also require a showing of fairness. In determining whether a transaction is fair, courts look to factors such as adequacy of the consideration, corporate need to enter into the transaction, financial position of the corporation, and available alternatives.”

Question 29

Remedies for a CoI Transaction

Answer 29

(1) Enjoining the transaction
(2) Setting the transaction aside
(3) Damages (and similar remedies)

Question 30

Is it a conflict of interest for directors to set their own compensation?

Answer 30

NO. The board can set director compensation so long as it is reasonable and in good faith.

If the level of compensation is excessive, the board is wasting corporate assets and breaching the duty of loyalty.

Question 31

Corporate Opportunity Doctrine

Answer 31

A director owes their corporation a duty of loyalty, which prohibits the director from competing with his corporation and bars the director from usurping corporate opportunities.

A director cannot take for themselves a business opportunity in which the corporation might have an interest unless they first offer the opportunity to the corporation and the corporation rejects the opportunity.

A corporation’s interest does not extend to every conceivable business opportunity, but the closer the opportunity is the corporation’s line of business, the more likely a court will find it to be a corporate opportunity. The corporations lack of financial ability to take advantage of the opportunity is typically not a defense, and the director should still present the opportunity to the corporation to decide whether it can take advantage of the opportunity.

If a director does not give the corporation an opportunity to act and usurps the opportunity, the corporation can (i) recover the profits from the transaction, (ii) force the director to convey the opportunity to the corporation under a constructive trust theory for whatever consideration the director purchased the opportunity.

Question 32

Which Directors are Liable?

Answer 32

A director is presumed to concur with board action unless their dissent or abstention is noted in writing in the corporate records. In writing means (1) in the minutes, (2) delivered in writing to the presiding officer at the meeting, or (3) written dissent to the corporation immediately after the meeting.

NOTE: An oral dissent by itself is not effective.
NOTE: A director cannot dissent if they voted for the resolution at the meeting.

A director is NOT liable if (1) they were absent from the board meeting, (2) they relied in good faith on information presented by an officer, employee, committee (of which the relying director was not a member), or professional they reasonably believed was competent.

NOTE: The reliance must be in good faith. Director is still liable if they knew the person giving the information wasn’t reliable.

Question 33

Duty to Disclose

Answer 33

The directors have a duty to disclose material corporate information to other members of the board.

Question 34

Power and Status of an Officer

Answer 34

Officers are agents of the corporation.

Whether the officer can bind the corporation is determined by whether they have actual or apparent authority to do so.

Unauthorized actions may become binding on the corporation because of ratification, adoption, or estoppel.

The corporation is liable for actions by its officers within the scope of their authority, even if the particular act in question was not specifically authorized.

Question 35

Duties of Officers

Answer 35

Officers owe the same duties of care and loyalty to the corporation as directors.

Question 36

Selection and Removal of Officers

Answer 36

Officers are selected and removed by the board.

Despite any contractual term to the contrary, an officer has the power to resign at any time by delivering notice to the corporation, and the corporation has the power to remove an officer at any time, with or without cause.

Question 37

When can Officers and Directors NOT be indemnified?

Answer 37

A corporation CANNOT indemnify a director who is (1) held liable to the corporation or (2) held to have received an improper benefit

Question 38

When MUST Officers and Directors be Indemnified?

Answer 38

A corporation MUST indemnify a director or officer who was successful in defending a proceeding on the merits for reasonable expenses incurred in connection with the proceeding. In some states, the director or officer must win the entire case.

Question 39

When MAY Officers and Directors be Indemnified?

Answer 39

A corporation MAY indemnify a director in situations not satisfying the two categories above (e.g., the case against a director or officer settled, the director unsuccessfully defended a suit against them.) The director must show: (1) they acted in good faith; and (2) believed that their conduct was: (a) in the best interests of the corporation, (b) not opposed to the best interests of the corporation, or (c) not unlawful (in criminal proceedings).

The decision to indemnify can be made by a disinterested majority of the board, a majority of a disinterested committee, independent legal counsel, or the shareholders

NOTE: A court can order indemnification