978-0134004006 Chapter 37 Lecture Note Part 1

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responsibility.”

Ambrose Bierce

I. Teacher to Teacher Dialogue

allows for many distinct advantages to the corporate entity; but what the law gives with one hand,

it can take away with the other. How to protect those corporation-based prerequisites is really

1. A diagram of the corporate lines of authority.

2. The respective rights and duties of the various parties in that line of authority.

3. A listing of responsibilities and liabilities of these parties not only to each other, but also to

key third parties such as shareholders and parties having a contract or tort nexus with the

corporation.

In all three scenarios try to give case examples that illustrate the rule of law being discussed.

There are two basic theories under which most of the limitations to corporate entity and/or

corporate participants’ liability are restricted or eliminated. First, public policy never has allowed

the corporate form to act as a total shield from liability to third parties. From the very inception of

corporate law, courts and legislators have clung to the back door option of holding someone

The second theory is found in the intracorporate workings of the organization itself. Just as

the corporate form should not be allowed to defraud creditors and the like, so too should it not be

allowed to be used by various members of corporate organizations to harm each other. The

cornerstone of relationships among shareholders, directors, and officers is founded in the law of

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Finally, Congress acted quickly in 2002 when passing the Sarbanes-Oxley Act to help restore

II. Chapter Objectives

corporation.

2. Describe a director’s and an officer’s duty of care and the business judgment rule.

III. Key Question Checklist

 What are the fiduciary duties of a director?

IV. Text Materials

Introduction to Corporate Governance and the Sarbanes-Oxley Act

Following decades of financial frauds and scandals involving directors and officers at some of the

largest companies in the United States, Congress enacted the Sarbanes-Oxley Act of 2002. This

Shareholders – The corporation shareholders are the owners of the corporation, and have the

Shareholders’ Meetings – Annual meetings are held to elect the board and appoint auditors at

the time prescribed by the bylaws. If a meeting is not held within 15 months of the last annual

Proxies – Shareholders may appoint another person to act as their agent to vote at the meeting.

Voting Requirements – Every corporation has at least one class of shares which has voting

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Quorum and Vote Required – Unless otherwise provided in the articles of incorporation, if a

majority of shares entitled to vote are represented at a meeting in person or by proxy, there is a

Straight (Noncumulative) Voting – Unless otherwise stated in the articles or bylaws, votes for

Cumulative Voting – A corporation’s articles of incorporation may provide for cumulative

voting for the election of directors. This means that each shareholder is entitled to multiply the

Supramajority Voting Requirement – Either the articles or the bylaws may call for greater than

the simple majority of shares to fulfill a quorum or vote requirement. Such votes are often

duration and filed with the corporation.

 Shareholder Voting Agreements – Shareholder voting agreements are agreements

methods are:

 Right of First Refusal – This is an agreement that grants certain shareholders the right of

 Buy-and-Sell Agreement – This agreement requires that shareholders sell their shares to

be offered elsewhere.

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shareholders at a set record date.

Stock Dividends – These are distributions of additional stock shares in proportion to the existing

ownership interests of shareholders.

is not in the best interests of the corporation. If successful, the plaintiff (shareholder) may recover

reasonable expenses and attorneys’ fees, with the remainder of the money going to the

corporation.

Critical Legal Thinking – Piercing the corporate veil enables a plaintiff to obtain personal assets

of a defendant, officer, or director who has been sued as a result of liability in a corporation. The

corporate veil doctrine permits plaintiffs to obtain personal assets of officers and directors when

fraudulent.

Case 37.1 Piercing the Corporate Veil: Northeast Iowa Ethanol, LLC v. Drizin

2006 US Dist Lexis 4828 (2006), United States District Court for the Northern District of Iowa

Facts: Local farmers in Manchester, Iowa, decided to build an ethanol plant in the Manchester

million, for which financing needed to be secured. Jerry Drizin formed Global Syndicate

International, Inc. (GSI), a Nevada corporation with $250 capital. GSI was formed for the

purpose of assisting Northeast Iowa raise the additional financing for the project. Traditional

financing from banks was not available for such a project, so Drizin looked for other sources of

a shareholder of GSI. The plaintiffs alleged that the doctrine of piercing the corporate veil applied

and that Drizin was therefore personally liable for the funds.

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fraud?

Decision: The U.S. District Court held that the corporate veil of GSI could be pierced to reach its

shareholder Drizin. The Court awarded the plaintiff compensatory damage of $3.8 million and

punitive damages of $7.6 million against Drizin. Generally a corporation is a distinct entity from

its shareholders. This distinction usually insulates shareholders from personal liability for

risk of loss, this is a ground for denying the separate entity privilege. Secondly, if corporate funds

are not segregated, there is a strong inference that they are being used by the shareholders for

their individual purposes.

Ethics Questions: Civil fraud is the intentional misrepresentation of a material fact, knowing

Board of Directors

The board of directors of a corporation is elected by the shareholders of the corporation. The

board of directors is responsible for formulating policy decisions that affect the management,

Resolutions of the Board of Directors – The board of directors acts by adopting resolutions.

Digital Law: Corporate E-Communications

efficient.

Selecting Directors – The board consists of both inside directors, who are also officers of the

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Quorum and Voting Requirement – The articles usually require that a simple majority of the

board members be present to constitute a quorum.

Ethics: Sarbanes-Oxley Act Imposes Responsibilities on Audit Committee

officers will engage in some kind of fraud because they have total control over a corporation. To

deter such wrongful acts we need laws such as the Sarbanes-Oxley Act. The requirement of

Corporate Officers

offices simultaneously.

Agency Authority of Officers – Because they are agents, officers have the express authority

Fiduciary Duty: Duty of Obedience

shareholders.

Fiduciary Duty: Duty of Care

Directors and officers must use care and diligence, discharging their duties in good faith and

corporation and its shareholders.

Critical Legal Thinking – The business judgment rule is an affirmative defense which officers