Fiduciary Duty of Care – The Business Judgment Rule

Question 1

Business Judgment

Answer 1

BJ is a presumption that is rebuttable

Question 2

Triad of Fiduciary Duty

Answer 2

Care
Loyalty
Good faith

Question 3

Duty of Care

Answer 3

The business judgment rule applies to the duty of care. Care is assumed unless the person who is alleging a breach of this duty can present clear and convincing evidence that the duty was not upheld. The duty of care applies to situations in which a member of the corporation makes a binding decision for the corporation (usually a officer or director). The person making the decision has a duty of care which has been defined by case law, but can generally be stated as a duty to undertake a diligent investigation and consider viable options before making a decision.

Question 4

Duty of Loyalty

Answer 4

one has a duty to bring any opportunity for making money, or that would otherwise be of benefit to the corporation, to the attention of the corporation, and to act on it in a personal capacity only after the corporation has had an opportunity turn it down.

Question 5

Duty of Goodfaith

Answer 5

a duty of one to act in good faith and evenhandedly when dealing with the corporation.

Question 6

Business Judgement Rule

Answer 6

A court will not interfere with the decision of a company’s directors unless there is evidence of fraud or dishonest practice.

Question 7

BJR Presumpton & Shielding

Answer 7

• Under the business judgment rule, a business judgment is presumed to be an informed judgment, but the judgment will not be shielded under the rule if the decision was unadvised.

Question 8

Duty of Care Standard for BJR

Answer 8

Gross negligence is the proper standard for determining whether the business judgment was an informed one.

Question 9

WHAT TO DO TO PREVENT VAN GORKUM LIABILITY:

Answer 9

1. Do research,
2. Get an outside opinion, a “fairness certificate,” and
3. Provide adequate documentation of the decision-making process (of course skewed in the board’s favor).

Question 10

Reliance on Uninformed Officers

Answer 10

• Other officers not personally liable because they relied in good faith on reports of another officer
• The implication is they don’t need to question the accuracy of an uninformed officer

Question 11

Shareholder Ratification

Answer 11

• Valid ratification cures duty of care violation by board
• No Ratification where SH were not informed of all material facts that a reasonable SH would consider important

Question 12

Standard of Care for Directors

Answer 12

• Reasonably prudent director in similar circumstances in like positions
• A director has a fiduciary duty to support the corporation’s interest over his or her own conflicting interests, and any competing interests renders the business judgment rule inapplicable.

Question 13

When can a Director be held personally liable?

Answer 13

A director can be personally liable, even to third parties, if they neglect to provide the ordinary care of staying current with corporate affairs as one would normally do in that position, and that neglect is the proximate cause of the damages.

Question 14

Minimum Duties of Director

Answer 14

• Rudimentary understanding of business
• Cannot shut eyes to misconduct
• Read financial statements
• Reliance on professionals is ok
• Resignation protects them sometimes
• Duty to SH or Creditors?
  
  • Depends on whether company is solvent
    
    • If solvent - SH
    • If insolvent - creditors
  • Solvent = assets worth more than liabilities

Question 15

BJR Summarized

Answer 15

• Evidentiary presumption that directors acted with good faith and in the best interest of their shareholders.
• The business judgment rule will not be used to second guess admittedly bad decisions of directors.
• However, the business judgment rule will not be observed if it is proved that the directors did not act with the requisite duty of care.
• In Van Gorkum this meant that they must consider all available information when making decision. Directors are able to rely on reports given to them by experts or other directors without examining the due diligence of the parties giving the report.
• After Van Gorkum the law was amended in every state to allow provisions to be put into a corporate charter to exempt executives for money damages for the breach of due care, however a breach of good faith will leave executives open to liability.

Question 16

Duty of Loyalty

Answer 16

• The duty of loyalty trumps the business judgment rule.
  
  • Directors have no power to act outside of meeting
• Test: entire fairness, not BJ

Question 17

Corporate Opportunity Doctrine

Answer 17

The corporate opportunity doctrine is the legal principle providing that directors, officers, and controlling shareholders of a corporation must not take for themselves any business opportunity that could benefit the corporation.

Question 18

WHEN IS AN OPPORTUNITY IN THE CORP’S LINE OF BUSINESS:

Answer 18

An opportunity is within the corporation’s line of business when it is an activity as to which the corporation has fundamental knowledge, practical experience, and the ability to pursue

Question 19

SH Loyalty

Answer 19

• Unlike a director, a shareholder, majority or otherwise, is entitled to vote in a manner that is most beneficial to their interests.
• Majority SH can be selfish, but the minority SH deserve to gain from it

Question 20

Ratification

Answer 20

not voidable if approved on full disclosure by indep board members

Question 21

Taint of Vote

Answer 21

• For proper ratification, director w conflict of int would have to leave the room
• Its not void just because there is taint
  
  • Still requires Ratified by a majority of SH who are independent
    
    • This eliminates taint as well

Question 22

Duty of Loyalty Summarized

Answer 22

• The essence of the duty of loyalty is a conflict of interest. There is a presumption of good faith, care, and loyalty. The courts will not second guess business judgment decisions unless gift or waste can be proved.
• If there is a violation of good faith, care, or conflict of interest they must show entire fairness. The fiduciary can seek ratification from the non-conflicted shareholders, but full disclosure must be provided for ratification to be valid.
• The same goes with conflicted directors. The ratification is not tainted by the participation of the conflicted board members.
• If ratified gift or waste must be proved to challenge it, the burden is shifted to the shareholder to show complete unfairness.

Question 23

Preferred Stock

Answer 23

• Preferred in dividends:
  
  • entitled to mandatory dividends before dividends paid on common
• Preferred in liquidation:
  
  • has face value in liquidation, paid in preference to common

Question 24

Participating Preferred

Answer 24

Get % of common divs

Question 25

Cumulative Preferred

Answer 25

If no divs paid, preferred divs accumulates

Question 26

Stock redemption

Answer 26

Corp can buy back stock for fixed price

Question 27

Conversion Rights

Answer 27

Can convert stocks to different type

Question 28

Care:

1. Whats BJR of no violation?
2. If there is a violation and it is ratified?
3. If there is a violation and it is not ratified?

Answer 28

1. Whats BJR of no violation?
   
   • BJR applies and P loses - can only win if show gift/waste
2. If there is a violation and it is ratified?
   
   • director shows entire fairness
3. If there is a violation and it is not ratified?
   • extinguished

Question 29

Conflict:

1. Whats BJR of no violation?
2. If there is a violation and it is ratified?
3. If there is a violation and it is not ratified?

Answer 29

1. Whats BJR of no violation?
   
   • BJR applies and P loses - can only win if show gift/waste
2. If there is a violation and it is ratified?
   
   • director shows entire fairness
3. If there is a violation and it is not ratified?
   
   • BJR - Gift/Waste

Question 30

Controlling SH Conflict of Int:

1. Whats BJR of no violation?
2. If there is a violation and it is ratified?
3. If there is a violation and it is not ratified?

Answer 30

1. Whats BJR of no violation?
   
   • BJR applies and P loses - can only win if show gift/waste
2. If there is a violation and it is ratified?
   
   • SH shows entire fairness
3. If there is a violation and it is not ratified?
   
   • P shows entire unfairness

Question 31

Good Faith (decisions)

Answer 31

Directors of a corporation must use that amount of care which ordinarily careful and prudent men would use in similar circumstances, and consider all material information reasonably available’ in making business decisions.

Question 32

Bad Faith

Answer 32

Intentional Dereliction of duty, Conscious Disregard for One’s Responsibilities, deliberate and indifference and inaction in the face of a duty to act, conduct that is clearly disloyal to the corporation, is the epitome of faithless conduct.

Question 33

3 kinds of bad faith and the one we mean is bad faith

Answer 33

1. SUBJECTIVE BAD FAITH:
   
   • Fiduciary conduct motivated by an actual intent to cause harm.
2. LACK OF DUE CARE:
   
   • Fiduciary conduct undertaken in gross negligence without any malevolent intent. Failing to inform oneself with clearly available facts may be gross negligence, but cannot be, considered alone, bad faith.
3. INTERMEDIATE THEORY: This is What we Mean by Bad Faith
   
   • Something between lack of due care and intent to cause harm
     • Could be a knowing violation of law
     • Conduct that may constitute gross negligence, but not subjective bad faith. DGCL 102(b)(7)(ii) exculpates executives for this kind of behavior.

Question 34

Corporate Waste

Answer 34

To recover on a claim of corporate waste, the plaintiffs must prove that the exchange was “so one-sided that no business person of ordinary sound judgment could conclude that the corporation has received adequate consideration. Such a case will only arise in the rare case where directors irrationally squander or give away corporate assets.

Question 35

No Exculpation for bad faith and Liability

Answer 35

• There is no exculpation under Delaware Corporate law DGCL 102(b)(7)(ii) as there is for failure to exercise care, directors are personally liable for acting in bad faith.
• imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.
• directors are not responsible for ensuring the legality of every act by the corporation’s personnel, even if the illegal conduct would have been discovered if there hadn’t been a failure of the corporate compliance program.

Question 36

The standard for determining whether directors can be liable for failure to exercise oversight of employees who fail to comply with their duties is

Answer 36

• a “lack of good faith as evidenced by a sustained or systematic failure of a director to exercise reasonable oversight.”
  
  • Good faith is a branch of loyalty - not independent duty
  • Fiduciary duties do not constitute rate regulation - all that is needed is full disclosure