CHAPTER 40
CORPORATE DIRECTORS,
OFFICERS, AND SHAREHOLDERS
ANSWER TO CRITICAL THINKING QUESTION
IN THE FEATURE
GLOBAL INSIGHT—CRITICAL THINKING
Why do you think officers and directors of accused companies accept dissent decrees
rather than contest accusations at trial? In the last few years, those companies accused of
violating anti-bribery laws, particularly the FCPA, believe that it is most cost effective to
CASE 40.1—CRITICAL THINKING
LEGAL ENVIRONMENT
In a letter to the Oliveiras, the board explained that it saw “no upside—and much
downside—to the action and lawsuit proposed in the Demand.” What would the
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4. Failing to honor the awards, after they had been promised, would likely lead to
litigation with key members of management, who would likely win.
WHAT IF THE FACTS WERE DIFFERENT?
Only one member of the iStar board—Sugarman—received an award as an employee.
The others who made the decision to change the award were, like Ridings, outside
directors. Suppose that the opposite had been true. Would the result have been the
same? It is possible that the result in this case would have been the same, even under the
facts given in the question—if only one member of the board had been an outside, non-
management director and the others had received awards.
iStar promised awards of company stock to employees if the shares averaged a certain
target price over a specific sustained period before a stated date. The stock’s value rose 300
percent, but the conditions for the awards were not met. The board changed those conditions to
base an award on service—an employee with a certain period of service was entitled to an
award—and issued additional shares to pay the awards. Shareholders (the Oliveiras) demanded
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 3
CASE 40.2—CRITICAL THINKING
WHAT IF THE FACTS WERE DIFFERENT?
Suppose that Loft’s board of directors had approved Pepsi-Cola’s use of its personnel
CASE 40.3—LEGAL REASONING QUESTIONS
1A. How many shareholders were present at the shareholders’ meeting that gave rise
to the dispute in this case? During the shareholders’ meeting of Sink & Rise, Inc., that give
rise to the dispute in the Case case, James (Cale) Case was the only shareholder present in
person. According to the introduction to the case, another shareholder was present by proxy.
Sink & Rise had eighty-four shares of voting common stock outstanding. Cale owned twenty
shares, he and his spouse Shirley jointly held another sixteen shares, and three different
individuals owned sixteen shares each.
At the meeting, Cale concluded that a quorum existed and voted on and passed several
resolutions. He also elected himself and another shareholder to be directors, replacing Shirley,
with whom Cale was estranged, as the corporation's secretary. Shirley filed a complaint in a
Wyoming state district court against Sink & Rise and Cale to set aside these actions.
2A. How did the court “characterize” and “classify” the shares of stock that Cale and
Shirley Case held jointly? The lower court “characterized” the sixteen shares of stock held
jointly by Cale and Shirley as owned with rights of survivorship. The court further “classified” the
ownership as creating a presumption of tenancy by the entirety. As tenants by the entirety, each
spouse owned an undivided entire interest in the shares.
The state supreme court agreed with the lower court’s interpretation, explaining that “in
an estate of the entirety, the husband and the wife during their joint lives each owns, not a part,
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or a separate or a separable interest, but the whole.” Thus, for example, the death of one
spouse would leave the survivor still holding title to the whole sixteen shares as before, but of
course with no one to share it.
3A. According to the court, how many shares were represented at the shareholders’
meeting? Was a quorum present? Explain. Both the lower court and the state supreme court
agreed that a majority of the outstanding voting shares of Sink & Rise were represented at the
shareholders’ meeting. Under the corporation’s bylaws, this majority constituted a quorum.
According to those bylaws, “A majority of the outstanding shares entitled to vote,
represented in person or by proxy, shall constitute a quorum at a meeting of Shareholders. If a
quorum is present, the affirmative vote of the majority of shares entitled to vote at the meeting
shall be the act of the Shareholders.” In other words, according to the bylaws, for the shares to
count in determining a quorum, they must be (1) entitled to vote, and (2) represented in person
or by proxy.
Here, all of the shares were entitled to vote. Represented in person at the meeting were
the twenty shares that Cale owned and, according to the courts’ interpretation, the sixteen
shares that he owned jointly with Shirley. Represented by proxy were another sixteen shares
held by a different individual. Thus, of the eighty-four outstanding shares of Sink & Rise stock,
fifty-two were represented at the shareholders’ meeting at the center of this case. This number
constituted a majority and hence a quorum. And a majority vote of those shares could take
action “with requisite authority.”
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Duties of directors
As a director, Brock is in a fiduciary relationship with the corporation, which means that he owes
to Firm Body the duty of care and the duty of loyalty.
2A. Conflict of interest
The duty of loyalty requires officers and directors to disclose fully to the board of directors any
possible conflict of interest that might occur in conducting corporate transactions. Because
Brock failed to disclose his interest in Sunglow and continued to encourage Firm Body to
purchase tanning equipment from Sunglow, he has a conflict of interest that violates his duty of
loyalty to Firm Body.
3A. Breach of loyalty
The business judgment rule immunizes decisions that are made in good faith as long as the
decision complies with the manager’s fiduciary duties and was within the manager’s power to
make. Here, Brock breached his duty of loyalty by not informing the other director’s of his
interest in Sunglow, so he cannot claim the business judgment rule immunizes him from liability.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 5
4A. Shareholder’s suit
If the corporation does not bring suit against Brock for breaching his duty of loyalty, then Peñada
could file a shareholder’s derivative suit to redress a wrong suffered by the corporation. In other
words, Peñada could file a suit on behalf of the corporation claiming that Brock’s breach of his
fiduciary duties caused harm to the corporation. If the suit was successful, any damages
recovered would go to the corporation, not Peñada.
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
Because most shareholders never bother to vote for directors, shareholders have
no real control over corporations. The statistics are indeed shocking—almost no
shareholders of corporations ever bother to vote for directors. Most shareholders don’t know
who the directors are and clearly don’t know how publicly held companies are gov-
erned. Therefore, even though on paper shareholders control corporations because they can
vote out bad directors, they really never do.
When a corporation is badly managed, that corporation’s stock price drops. That is
because shareholders vote with their “wallets” by selling the shares in that company, thereby
lowering the price of the stock. When the price of the stock gets low enough, outside groups
attempt a takeover in order to put in place their preferred group of directors. That’s how the
market for corporate control works.
ANSWERS TO ISSUE SPOTTERS
AT THE END OF THE CHAPTER
1A. Wonder Corporation has an opportunity to buy stock in XL, Inc. The directors
decide that, instead of Wonder buying the stock, the directors will buy it. Yvon, a Wonder
shareholder, learns of the purchase and wants to sue the directors on Wonder’s behalf.
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ANSWERS TO BUSINESS SCENARIOS
AT THE END OF THE CHAPTER
40-1A. Conflicts of interest
Various state statutes contain different standards for contracts made between two corporations
when a director of one corporation has a material interest in the other. In general, however, the
courts will uphold these contracts providing that:
(a) The contract was fair and reasonable to the corporation at the time the contract
40-2A. Liability of directors
Directors are personally answerable to the corporation and the shareholders for breach of their
duty to exercise reasonable care in conducting the affairs of the corporation. Reasonable care
is defined as being the degree of care that a reasonably prudent person would use in the
conduct of personal business affairs. When directors delegate the running of the corporate
affairs to officers, the directors are expected to use reasonable care in the selection and
supervision of such officers. Failure to do so will make the directors liable for negligence or
40–3A. Fiduciary duty of officers
Arizona Tile supplied materials to Designer Surfaces. The statute regarding the suppliers of
materials created an obligation on Designer’s part to treat funds it obtained for the sale of
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 7
40–4A. BUSINESS CASE PROBLEM WITH SAMPLE ANSWER—Rights of shareholders
Yes. Woods has a right to inspect Biolustre’s books and records. Every shareholder is entitled to
examine corporate records. A shareholder can inspect the books in person or through an agent
such as an attorney, accountant, or other authorized assistant.
The right of inspection is limited to the inspection and copying of corporate books and
40–5A. Duty of loyalty
Dweck breached the fiduciary duty of loyalty that a director and officer owes to his or her
corporation—in this case, Kids. The essence of the duty of loyalty is the subordination of self-
interest to the interest of the entity to which the duty is owed. The duty presumes constant
loyalty to the corporation on the part of the directors and officers. The duty prohibits directors
40–6A. Duties of majority shareholders
Ron may arguably have been the victim of a freeze out by Bill and Gertrude. A majority
shareholder is sometimes regarded as having a fiduciary duty to the corporation and the
minority shareholders. This occurs when a few shareholders acting together own enough shares
to exercise control over the corporation. A breach of fiduciary duty by those who control a close
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corporation can constitute oppressive conduct when the majority shareholders “freeze out” the
minority shareholders and exclude them from the benefits of participating in the firm. When a
majority shareholder breaches his or her fiduciary duty to a minority shareholder, the minority
shareholder can sue for damages.
40–7A. Business judgment rule
No, the Songers are not personally liable for Country’s failure to complete its contract with A
Westside Storage. A hallmark of the corporate form of business organization is that
shareholders are not personally liable for the debts of the corporation. If the corporation fails, the
shareholders can lose their investments, but that is generally the limit of their liability. A court
may pierce the corporate veil to hold the shareholders personally liable in certain instances of
fraud, undercapitalization, or a failure to observe corporate formalities. But these situations are
40–8A. Rights of shareholders
Clifford can pursue his action on the companies’ behalf against Frederick. When a corporation is
harmed by the actions of a director or officer, the other directors can bring a suit in the name of
the company against that party. If the directors do not bring a suit, the shareholders can do so
filing what is known as a shareholder’s derivative suit.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 9
Any damages recovered in Clifford’s action will go into the appropriate company treasury.
When shareholders bring a derivative suit, they are not pursuing rights or benefits for
themselves personally but are acting as guardians of the corporate entity. Thus, if the suit is
successful, any damages recovered go into the corporate treasury, not to the shareholders
personally.
Here, two firms—one a limited liability company (LLC), the other a corporation—are
40-9A. A QUESTION OF ETHICS—Duties of directors and officers
(a) Reuther, as a director, was entitled to full access to all financial information. As a
shareholder, Reuther could also have access to the information. The court extrapolated that “[t]o
hold otherwise would put directors in the untenable position of being legally and personally
responsible to shareholders for malfeasance while denying them the tools necessary to
determine if malfeasance has occurred. The directors are not required to accept blindly, the
attestations of the president. Particularly with regard to financial information, they must be
allowed to examine the underlying documents which support the financial statements . . . . If
not, their ability to independently evaluate the performance of the president or the accuracy of
the information he [or she] presents to them is severely hampered. If questions of performance
or honesty arise, it would be a breach of duty to not inquire further. Directors have an absolute
and unqualified right to all corporate books and records. JES' continued refusal to honor
requests by directors for financial information . . . is indicative of his inability to grasp the
hierarchy of authority within a corporation. That the board has the responsibility to manage the
affairs of the company, supervise its officers, and holds a fiduciary responsibility to its
shareholders, seems to have escaped JES' understanding.
“The lack of respect for this simple principle of corporate governance by JES is evident in
his exchanges with the board. On many occasions he is heard to complain that board meetings
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40–10A. Shareholders’ duties
(a) These parties owed fiduciary duties to each other, which they breached by
withholding cash from each other. Weintraub misappropriated corporate cash and Griffith kept
all of the proceeds from the sale of the casino.