978-1133019145 Chapter 9 Solution Manual

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CHAPTER 9

The Corporate Organization

THEME

Chapter 9 focuses on the roles of the officers,

directors, and shareholders in the operation of

the corporation. Special attention is given to

the authority and duties of the directors and to

the rights of shareholders.

CHAPTER GOAL

The goal of this chapter is for students to

• Roles of the corporation’s officers,

directors, and shareholders

• Authority and duties of the corporation’s

directors and officers

• Rights and responsibilities of the corp-

oration’s shareholders

• Purpose and requirements for shareholder

meetings

• The role of corporate paralegals when

assisting with board of director and

shareholder meetings and actions

• Resources available to corporate

paralegals who may be assisting with

meetings and actions of the corporation’s

board of directors and shareholders

SUGGESTED APPROACH

Lawsuits and other disputes involving corporate

officers, directors, and shareholders are often the

center of media attention. In addition to your

focus on the chapter material, you may want to

bring in pertinent news stories, or ask students to

do so. Through class discussions, students can

try to analyze the information in the news stories

in light of what they have learned in Chapter 9.

LECTURE NOTES

Introduction

1. Corporations act through their agents,

especially their officers, directors, and

shareholders.

2. Most corporations are required to have a

board of directors. There may be exceptions

for statutory close corporations.

directors that range from one director to

several.

4. The directors of smaller corporations

may also be employees, officers, and

shareholders of the corporation.

Authority and Duties of Directors

5. The corporation’s shareholders elect the

directors, who are given statutory

authority to make most decisions

regarding the operation of the corporation.

6. The board of directors elects the officers

of the corporation and delegates authority

to them.

7. The board of directors may delegate

certain authority to the officers, but the

directors must maintain general

supervision of the activities of the

officers. Directors are generally

responsible for the actions of the officers

they elect.

8. The board of directors may also delegate

authority to committees comprised of

members of the board of directors. The

right to this delegation is usually granted

by state statutes and the bylaws of the

corporation.

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9. The board of directors is responsible for

overseeing the management and affairs of

the corporation. The responsibilities the

board of directors must oversee will vary

depending on the size and business of the

corporation, and whether the stock of the

corporation is publicly traded. Some state

statutes list items representative of those

for which directors of a publicly traded

corporation have oversight

responsibilities.

10. Not all authority may be delegated to

committees. The Model Business

Corporation Act specifies that a

committee may not do the following:

• Authorize dividends or distributions

to the shareholders of the corporation

• Approve or propose to shareholders

action required by law to be approved

by shareholders

• Fill vacancies on the board of

directors or on any of its committees

• Amend the articles of incorporation

• Adopt, amend, or repeal bylaws

• Approve a plan of merger that does

not require shareholder approval

• Authorize or approve reacquisition of

shares, except according to a formula

or method prescribed by the board of

directors

• Under most circumstances, authorize

or approve the issuance, sale, or

contract for sale of shares, or

determine the designation and

relative rights, preferences, and

limitations of a class or series of

11. There are also limitations on the authority

of the board of directors. State statutes

and the corporation’s articles of

incorporation or bylaws may provide that

certain extraordinary actions require the

approval of the corporation’s

shareholders.

12. Under the Model Business Corporation

Act, directors must discharge their duties

(1) in good faith, (2) with the care an

ordinarily prudent person in a like

position would exercise under similar

circumstances, and (3) in a manner they

reasonably believe to be in the best

interests of the corporation.

13. A director who acts contrary to the best

interests of the corporation for his or her

own personal gain is breaching his or her

fiduciary duty to the shareholders of the

corporation.

14. A director’s duty of care can be

measured, in part, by the time and

attention he or she devotes to the affairs

of the corporation and the skill and

judgment he or she uses in business

decisions.

15. The director’s duty of loyalty means that

he or she must at all times remain loyal to

the corporation and act in the best

interests of the corporation and its

shareholders as opposed to the director’s

other business or personal interests.

Personal Liability of Directors

16. The business judgment rule protects

directors from personal liability for

informed decisions made in good faith

where there is no conflict of interest and

the director feels the corporation’s best

interests are being served by the decision.

17. The business judgment rule protects

directors and officers from personal

liability for business decisions made in

the context of the following:

• Good faith

• Where the director or officer has no

personal interest in the subject of the

business judgment

• Where the director or officer is

informed with respect to the subject

of the business judgment to the extent

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the director reasonably believes to be

appropriate under the circumstances

• Where the director or officer

rationally believes that the business

judgment in question is in the best

interests of the corporation

18. Directors will generally not be held

personally liable for any damages caused

to the corporation or its shareholders as a

result of their decisions made in good

faith.

19. Directors may be held personally liable

for the following:

• Breaches of the director’s fiduciary

duty, duty of care, or duty of loyalty

• Unauthorized acts (acts clearly

beyond the scope of their authority)

• Negligence

• Fraud or other illegal acts

• Acts that are controlled by state

statute or the corporation’s articles of

incorporation or bylaws that provide

for personal liability by directors

Compensation and Indemnification of

Directors

20. Directors may or may not receive

compensation specifically for their roles

as directors in the corporation. Director

compensation is usually set by the board

of directors, unless the right to set

director compensation is limited to the

shareholders by state statute or the

corporation’s articles of incorporation or

bylaws.

21. Provisions in the articles of incorporation

and bylaws may provide for

indemnification to reimburse directors

for expenses incurred by them in

defending a lawsuit to which they

become a party due to their position with

the corporation.

22. State statutes may provide for mandatory

director indemnification under certain

circumstances and prohibit indemnification

under other situations, such as when a

director incurs legal expenses due to his or

her own wrongdoing.

Election and Term of Directors

23. Directors are elected by a vote of the

shareholders to serve for the term

specified by the shareholder resolution or

in the corporation’s articles of

incorporation or bylaws.

24. The corporation’s shareholders may

decide to ensure the continuity of

management by staggering the terms of

the directors.

25. Directors may usually resign at any time

and for any reason by giving written

notice to the chairman of the board.

26. Directors may be removed by the

shareholders with or without cause in the

manner provided for by state statute and

the corporation’s articles and bylaws.

27. In some states, board vacancies may be

filled by a vote of the remaining

directors. Other states require a special

meeting of the shareholders to elect a

new director.

Board of Directors Meetings and

Resolutions

28. Actions by the board of directors may be

taken by a resolution passed at a meeting

or by a written consent signed by all

directors (or a majority of the directors if

provided for by state statutes and the

corporation’s articles of incorporation).

29. Annual meetings of the board of directors

are generally held to review important

events that have occurred during the past

year and to take actions on those matters

requiring action for the upcoming year.

30. Proper notice of meetings of the board of

directors must be given in accordance

with state statutes and the articles of

incorporation and bylaws of the

corporation.

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31. The board of directors must have a

quorum to take action at a meeting. A

quorum is the minimum number of

individuals who must be present or

represented at a meeting to take a valid

action. The quorum for the meeting of

the board of directors may be set by the

corporation’s bylaws or articles of

incorporation, or by state statute.

32. The minutes of meetings or written

consents of the board of directors and

shareholders are kept in the corporation’s

corporate minute book, along with other

important corporate documents.

33. Meetings of the board of directors may

also be held via telephone, web

conference, or by any means of

communication by which all directors

participating may simultaneously hear

each other talk during the meeting.

Corporate Officers

34. The board of directors elects the officers

of the corporation. The titles and duties of

officers are usually set forth in the bylaws

of the corporation. State statutes often

require that a corporation elect certain

officers, such as a chief executive officer

and chief financial officer. The

corporation’s officers may include the

following:

• Chief executive officer

• President

• Chairman of the board

• Vice president

• Chief financial officer

• Treasurer

• Secretary

• Assistant secretary

35. Officers are generally held to the same

standards of conduct as directors of the

corporation, and they owe the same

fiduciary duty, duty of care, and duty of

loyalty to the corporation and the

corporation’s shareholders.

White-Collar Crime and Corporate

Compliance Programs

36. White-collar crime is an important issue

to the board of directors, officers, and

shareholders of any corporation.

Financial loss due to white-collar crime is

a concern, as is criminal prosecution of

corporate executives.

37. Corporations are proactively adopting

corporate compliance programs to

prevent and detect criminal conduct

within their organizations.

Shareholders’ Rights and Responsibilities

38. A shareholder or stockholder holds stock

in the corporation. In effect, the

shareholders are the owners of a

corporation.

39. Shareholders may be individuals or other

corporations or entities.

40. Preemptive rights granted to shareholders

allow them to purchase new shares issued

by the corporation before persons who

are not current shareholders may do so.

This allows current shareholders to

preserve their percentage of ownership in

the corporation. Preemptive rights may

be granted by state statute or the

corporation’s articles of incorporation.

Preemptive rights are typically granted

only in smaller corporations.

41. Shareholders have a right to inspect the

records of the corporation.

42. Shareholders are generally protected from

personal liability for the debts and

obligations of the corporation, unless the

corporate veil is pierced, as discussed in

Chapter 7.

Shareholder Meetings

43. Shareholders participate in the

management of the corporation by

electing directors and through their

participation in annual shareholder

meetings. Certain acts of the corporation

must be approved by the shareholders.

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44. Corporations are generally required by

state law to hold annual shareholder

meetings. If the board of directors does

not hold meetings in accordance with its

bylaws, shareholders may move for a

court order to compel the corporation to

hold an annual meeting.

45. In some states, shareholders may be

granted the right to cumulate their votes

for directors of a corporation. Cumulative

voting rights give minority shareholders a

better chance of electing at least one

director to the board of directors.

46. In lieu of meetings, shareholders may

take actions by unanimous written

consents.

47. Special meetings of the shareholders may

be called between the annual meetings to

allow shareholders to vote on

extraordinary matters.

48. Shareholders must be given notice of all

shareholder meetings in accordance with

state statute and the corporation’s

bylaws.

49. Shareholders may vote in person or by

proxy. A proxy is authority given in

writing by one shareholder to another to

exercise the shareholder’s voting rights.

50. A quorum of the shareholders must be

present to take action at a shareholder

meeting.

Restrictions on Transfer of Shares of

Corporate Stock

51. Although the freedom to transfer

corporate stock without restriction is

usually a shareholder right, the transfer of

shares of stock may be restricted by

shareholder agreements.

52. Buy-sell agreements are agreements

among shareholders that provide terms

for the purchase of the shares of a

shareholder who withdraws or dies.

Shareholder Actions

53. Shareholder lawsuits include individual

actions, representative actions, and

derivative actions.

54. An individual shareholder who is injured

by an action of the corporation may bring

an individual (or direct) action against

the corporation.

55. A representative action may be brought

against the corporation by a shareholder

on behalf of that shareholder and his or

her entire class of shareholders.

56. Derivative actions are brought by one or

more shareholders to enforce a corporate

right or remedy a wrong to the corporation

in cases where the corporation, because it

is controlled by the wrongdoers or for

other reasons, fails or refuses to take

appropriate action for its own protection.

The Paralegal’s Role

57. Corporate paralegals are often involved

in preparing for meetings of the board of

directors and of the shareholders and in

preparing minutes of meetings and

written consents.

58. Corporate paralegals are often assigned

the task of reviewing and updating

corporate minute books.

CASE BRIEFS

Grassmueck v. Barnet, et al. 281 F.Supp.2d

1227 (Wash. 2003)

Purpose: This case demonstrates how

directors who act in bad faith can be held

personally accountable, even when the articles

of incorporation of the subject corporation

provide for the maximum amount of liability

protection for directors.

Cause of Action: Breach of duty, negligence,

and bad faith

Facts: In this case, the defendants were

outside directors of Znetix Inc., while Znetix’s

founder and principal stockholder, Kevin

Lawrence, served as director. Mr. Lawrence

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was accused of exerting “unchecked power

and control” over Znetix, and diverting

millions of dollars from the day-to-day

operations for the personal benefit of himself,

his family, friends, and accomplices.

As a result of Lawrence’s acts, the

Securities and Exchange Commission forced

Znetix into receivership and forced

liquidation. The complaint alleges losses to

shareholders exceeding $10,000,000.

The plaintiff and receiver, Michael

Grassmuek, claimed that the defendant

directors and officers should be held

personally liable for damages to the creditors

and investors because they were negligent and

exercised bad faith by failing to act to prevent

or control Lawrence’s wrongful acts. The

complaint alleges that the directors and

officers had knowledge of, or recklessly failed

to learn of, Lawrence’s wrongful acts when

they recklessly and negligently continued to

work for Znetix and/or allowed their names,

services, and work product to be used in

furtherance of Lawrence’s wrongful acts,

without disclosing those acts or taking steps to

prevent them. The complaint alleges that they

acted in bad faith by accepting compensation

for a job they did not intend to properly

perform, acting in their own self-interest at the

expense of the corporation. The defendants in

this case brought this motion to dismiss the

suit against them. They claim that the plaintiff

pleads insufficient facts to elevate the duty of

care claim outside of the maximum protection

provided in the articles of incorporation.

The pertinent state laws protect

duty of care. However, if directors breach the

duty of care intentionally, knowingly, or in

bad faith, the director protection statutes will

not shield them from personal liability.

Further, when directors breach the duty of

loyalty or act in bad faith, they are not

shielded by the director protection statutes.

act in a manner that subjects them to personal

liability, in light of the fact that the

corporation’s articles of incorporation

provided for the maximum protection from

personal liability allowed under law?

Holding: The defendants’ actions were not

protected under the director protection

statutes. The motion to dismiss was denied.

Reasoning: In Washington and Delaware,

directors are protected against general claims

for breach of the duty of care when pursuant to

state law a corporation adopts a director

protection provision into its articles of

incorporation. However, if directors breach the

duty of care intentionally, knowingly, or in bad

faith, the director protection statutes will not

shield them from personal liability. The plaintiff

listed several factors showing that the defendant

officers and directors acted in bad faith, in that

they knew or should have known about Kevin

Lawrence’s wrongful acts. Plaintiff sufficiently

stated claims for negligent or bad faith

performance of duties and breach of duty under

Washington law and Delaware law.

Note for Discussion: On July 28, 2003, Kevin

Lawrence pled guilty to three felony counts of

conspiracy, securities fraud, and wire fraud.

On November 25, 2003, he was sentenced to

20 years of imprisonment, to be followed by 3

years of supervised release, and was ordered

to pay more than $91,000,000 in restitution to

the Receiver.

REVIEW QUESTIONS

1. Where does a committee get its

authority?

Who is ultimately responsible for the acts

of the committee?

2. What are the three types of duties a

director owes to the corporation?

• Fiduciary duty

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personal assets to recover their damages?

No, directors cannot be held personally

What if one director withheld

information from the other directors and

personally benefited from the decision?

Yes, a director who acts contrary to the

best interest of the corporation,

4. Suppose that Albert is on the board of

directors of Acme Sailboard Company,

Inc. As the result of a contract dispute,

Acme Sailboard Company, Inc. and

Albert are both named in a lawsuit

brought by one of the company’s

suppliers. If Albert is found at the trial to

be innocent of any wrongdoing, who is

Acme Sailboard Company, Inc. would

be responsible for Albert’s attorney’s

fees and legal expenses. State statutes

and Section 8.52 of the Model Business

What if it is determined at trial that there

5. Can a corporation incorporated under a

state following the MBCA consist of one

Yes

6. Must all corporations have a board of

directors?

No, in some states statutory close

8. Under the MBCA, what is the minimum

number of votes required to pass a

resolution of the shareholders if 1,000

shares of the corporation’s stock have

been issued?

The vote of 501 shares of stock would

be required to pass most resolutions,

9. If the shareholders of a corporation feel

that their stock has lost its value due to the

mismanagement and/or misconduct of the

corporation’s officers and directors, what,

they may vote the directors out of

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10. Who typically benefits when cumulative

voting for the directors of a corporation is

allowed?

Minority shareholders who would not