Fiduciary Duties of Directors

Question 1

What are a directors two fiduciary duties?

Answer 1

1. Duty of loyalty

2. Duty of care

Question 2

To whom does a director owe fiduciary duties?

Answer 2

Generally, a director owes FDs to a the corporation, not individual shareholders

Question 3

What is the justification for imposing fiduciary duties?

Answer 3

Directors should have FDs to the ultimate owners of the corporation

Question 4

What are the two types of suits for fiduciary duty claims?

Answer 4

1. Directors sue on behalf of the company

2. Derivative actions where shareholders sue on behalf of the company

Question 5

What is the duty care?

Answer 5

Corporate directors must carry out their duties with responsible care and diligence

Question 6

What is the Business Judgment Rule?

Answer 6

The judicial presumption that directors have acted in accordance with their fiduciary duties of care, loyalty, and in good faith

Question 7

What must a plaintiff plead with particularity to rebut the Business Judgment Rule?

Answer 7

Plaintiff must plead that the board failed to act:

1. In good faith
2. In an informed manner (gross negligence)
3. Without a conflict of interest
4. In the honest belief that its actions are in the best interest of the company

Question 8

What happens if the plaintiff rebuts the Business Judgment Rule?

Answer 8

The burden shifts to the directors to show their decision was fair or reasonable

Question 9

What are the policy justifications for the Business Judgement Rule?

Answer 9

1. Courts are not equipped to second guess board decisions because they aren’t experts in the field
2. Deters frivolous lawsuits
3. Encourages boards to take risks by shielding directors from personal liability for their business decisions
4. Encourages individuals to serve on boards
5. Promotes the board’s full exercise of its power under DGCL § 141

Question 10

What factors did the court consider in Smith v. Van Gorkom to evaluate the plaintiff’s claim that the board did not properly inform itself?

Answer 10

1. Length of the deliberation - depends on magnitude
2. Use of outside experts - helps to show proper process
3. Reliance on officers - must be reasonable [see § 141(e)]
4. Significance of the decision - more imp = more process
5. Review of documentation - helps to show proper process
6. Bargaining/negotiation - shows corp is getting best deal
7. Prior notice of decision before meeting

Question 11

What is the exculpatory provision of § 102(b)(7)?

Answer 11

Eliminates or limits liability for money damages if director breaches FDs EXCEPT for:

1. Breach of the duty of loyalty
2. Acts or omissions not in good faith or involving intentional misconduct

Question 12

What is the procedural effect of the exculpatory provision of § 102(b)(7)?

Answer 12

1. Corporations can include exculpatory provision in C/I
2. Serves as an affirmative defense
3. Best protection for directors since case is dismissed even if P can show duty of care has been breached
4. Makes sure there will never be another Van Gorkom

Question 13

What is the duty of loyalty?

Answer 13

Requires that a director favor the corporation’s interests over their own whenever they conflict

Question 14

How do courts evaluate a breach of the duty of loyalty?

Answer 14

Evaluate the entire substance of the transaction (no BJR-type rule)

Question 15

What are recurring fact patterns in the duty of loyalty?

Answer 15

1. Director competing with corporation
2. Usurpation of a business opportunity
3. Self-dealing/conflict of interest
4. Lack of good faith

Question 16

What are the factors courts have used in evaluating whether an opportunity properly belongs to the corporation?

Answer 16

1. Whether it was presented to the director in her capacity as a director
2. Whether the opportunity is in the corporation’s line of business
3. Whether the corporation had the financial means to take advantage of the opportunity (only in DE)
4. Whether the company had an interest or expectancy in the opportunity
5. Whether taking the opportunity would put the director in an adverse position to the corporation

Question 17

What defenses can be raised by a director accused of taking a corporate opportunity?

Answer 17

1. Director presented the opportunity to the corporation and they rejected it
2. Corporation was financially unable to take the opportunity
3. Third party would refuse deal with the corporation

Question 18

What is the Delaware Approach to corporate opportunities?

Answer 18

1. No formal presentation required, but formal presentation serves as a safe harbor
2. Rejection of a formal presentation by the board is determinative

Question 19

What is the ALI Approach to corporate opportunities?

Answer 19

1. Applies to “any opportunity to engage in a business activity of which a director becomes aware in connection with the performance as a director”
2. Requires a formal presentation to the corp
3. When the board rejects a formal presentation, courts will stills scrutinize the transaction (worried about quid pro quo and intimidation)

Question 20

What are the two types of self-dealing transactions?

Answer 20

1. Direct self-dealing – individual on both sides of transaction
2. Indirect self-dealing – individual is on both sides of the transaction but through the form of a biz org on one or both sides

Question 21

What is the entire fairness review of self-dealing transactions?

Answer 21

1. Fair price – equivalency of value between what the corporation gave up and what it received; and
2. Fair dealing - includes candor
3. Fiduciary has the burden of showing the transaction was entirely fair

Question 22

What is a disinterested director?

Answer 22

One who, for the purposes of voting on a specific transaction, does not have an employment, family, or other significant personal or financial connection to that specific transaction

Question 23

What are the provisions of DGCL § 144 regarding disinterested directors?

Answer 23

No contract or transaction between a corporation and one or more of its directors is voidable for self-dealing if:

1. Approved by a fully informed vote of disinterested directors
2. Approved by a fully informed vote of disinterested shareholders; or
3. The contract or transaction is fair to the corporation (passes entire fairness test)

Question 24

When is disinterested director or shareholder approval effective?

Answer 24

If all material facts are disclosed and they are fully informed

Question 25

What things cast doubt on a director’s disinterested status?

Answer 25

1. Financial interest
2. Suspect types of relationships
3. Control exerted by an interested director

Question 26

When do courts conduct an entire fair review of a transaction?

Answer 26

If there is adequate approval by disinterested directors, the court will not engage in entire fairness review; if approval is inadequate, the court will conduct review

Question 27

What is indemnification?

Answer 27

An agreement between a director and the corporation that the corporation will pay legal fees, settlements, and judgments against a director

Question 28

Why do directors want indemnification agreements?

Answer 28

1. Unlike C/Is, indemnification agreements are a contract and can’t be changed w/o the director’s approval
2. If the corp doesn’t follow through, director can sue for breach of contract

Question 29

What are the two types of indemnification agreements under § 145?

Answer 29

Permissive and mandatory indemnification

Question 30

What is permissive indemnification under § 145?

Answer 30

1. If the director loses on the merits of the case, the corporation can choose to indemnify the director if she acted in good faith (i.e. reasonably acted in the best interest of the corporation)
2. “Good faith” is determined by the corporation - 145(d)
3. Can contract to make the indemnification mandatory but indemnification is never permitted if bad faith

Question 31

What is mandatory indemnification under § 145?

Answer 31

1. Corp must indemnify the director if “successful on the merits or otherwise”
2. Success =
   - no payments by D; or
   - payment of a nuisance value

Question 32

What are the two types of liability insurance?

Answer 32

1. Corporate reimbursement liability - covers corporation’s liability to indemnify employees
2. Director and officer liability – insures named officers against insurable acts for which the corporation does not indemnify