Liability of Directors and Officers

Question 1

What are the powers of the board of directors?

Answer 1

• exercise all corporate powers;
• make tactical decisions;
• manage the officers to ensure long-term success and profitability

Question 2

What are the limitations on board members?

Answer 2

Individual board members are NOT authorized to act on behalf of the corporations, unless specifically stated in the articles of incorporation.

Question 3

What does Sarbanes-Oxley require?

Answer 3

Publicly-traded corporations must have a majority of independent directors. The audit, compensation, and nominating committees must also be independent.

Question 4

What does it mean for a director to be independent?

Answer 4

The director:

• has no pecuniary relationship with the company, its promoters, senior management or affiliate companies (other than sitting fees)
• is not related to senior management
• has not recently been an executive with the company

Question 5

What is cumulative voting?

Answer 5

when a minority shareholder can cumulate his total votes (shares times open board seats) and cast them for one director

Question 6

When is cumulative voting allowed?

Answer 6

When (1) permitted by the articles and (2) prior notice of intent to cumulate is given.

Question 7

When is the board not permitted to declare dividends and distributions?

Answer 7

If it would render the company insolvent and unable to pay its liabilities as they become due.

Question 8

What happens if distributions or dividends are declared and the company is rendered insolvent?

Answer 8

Directors who approve such a distribution will become personally liable.

Question 9

What is a quorum of the board of directors?

Answer 9

a simple majority (not to be reduced by the bylaws to less than 1/3)

Question 10

What is the notice requirement for a special meeting?

Answer 10

• two days

- written, unless the bylaws allow oral notice

Question 11

Who are the fiduciaries of a corporation?

Answer 11

All corporations:

• directors
• officers
• senior executives
• promoters
• In a close corporation: shareholders (“members”) to one another

Question 12

What are the fiduciary duties owed to a corporation?

Answer 12

• duty of care
• duty of loyalty
• duty of confidentiality
• duty to stay informed about the company’s financial condition

Question 13

What is the duty of care owed to a corporation?

Answer 13

to devote attention and diligence to corporate affairs and make decisions in a reasonably prudent manner

Question 14

What is the duty of loyalty owed to a corporation?

Answer 14

to put the corporation’s best interests ahead of their own

Question 15

What are the three important categories of conflicts of interest?

Answer 15

• competing with the corporation
• usurping a corporate opportunity
• appropriating trade secrets

Question 16

What is insider trading?

Answer 16

The federal Securities and Exchange Act prohibits insider trading. Insider trading occurs when:

(1) a corporate fiduciary duty discloses confidential information to a tippee
(2) in exchange for a personal benefit
(3) the tippee knows the information is confidential and divulged for personal benefit; and
(4) the tippee uses the information to trade in a security

Question 17

What are the consequences of insider trading?

Answer 17

• profits from the trade are disgorged

- the SEC can enforce in criminal prosecution or by civil fines

Question 18

When is a corporate opportunity not usurped?

Answer 18

When (1) the fiduciary fully discloses the opportunity and his intent to pursue it personally and (2) the corporation then rejects the opportunity

Question 19

Can a fiduciary having knowledge of trade secrets subsequently work for a competitor?

Answer 19

Some courts apply the “inevitable disclosure” doctrine and will enjoin the fiduciary from working for a competitor if he has such intimate knowledge of confidential or proprietary information of his former company that the job cannot be performed without making tortious disclosures.

Question 20

What remedies are available for breach of loyalty claims?

Answer 20

• set aside the act
• disgorge profits
• damages
• removal of the fiduciary

Question 21

What is required for transactions in which a director has a personal interest (“interested transactions”) to be entered?

Answer 21

the interest must be:

• disclosed
• recorded in the minutes
• the price at market value
• fair and reasonable terms
• approved by a majority of non-interested directors and/or shareholders, with full notice

Question 22

When may the board of directors dismiss an officer of the corporation?

Answer 22

Generally, officers are at-will employees and can be dismissed with or without cause.

Question 23

What defense can an officer or director make if charged with violating the duty of care?

Answer 23

the “business judgement rule”

Question 24

What does the business judgment rule provide?

Answer 24

Honest, good faith errors of judgment made after reasonable investigation are do not give rise to personal liability.

Question 25

What if directors and officers made business decisions based on indirect information from others in the business?

Answer 25

Officers and directors are entitled to rely on information and assurances from other officers, employees, committees, legal counsel, and public accountants, unless they know that the reliance is unwarranted.

Question 26

In applying the business judgment rule, what standard does the court apply?

Answer 26

(1) Business judgments presumed valid absent fraud, self-dealing, or criminal conduct.
(2) Was there a rational basis for the judgment at the time made?
(3) Was there a reasonable investigation, analysis, and deliberation.

Question 27

What rights do directors, officers, or employees personally named as defendants have against the corporation?

Answer 27

They have right to be indemnified by the corporation if:

(a) successful on the merits,
(b) otherwise provided in articles of incorporation and not for breach of fiduciary duty, intentional or criminal wrongdoing, or excess distributions, or
(c) as the court may allow in view of all relevant circumstances.