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CHAPTER 43
MANAGEMENT OF CORPORATIONS
I. OBJECTIVES
This chapter is intended to acquaint students with the management structure of corporations and
the duties and liabilities of those who manage corporations. A student should know:
A. The objectives and powers of corporations.
B. The functions of boards of directors.
C. The process by which directors are elected.
D. The formalities of valid board actions.
E. The various proposals for changing corporate governance.
F. The corporate governance rules imposed by the Sarbanes-Oxley Act of 2002 and Dodd-Frank
Act of 2010.
G. The authority of officers.
H. The special rules for managing close corporations.
I. The fiduciary duties of directors and officers.
J. The operation of the business judgment rule and how directors can comply with it.
K. The tactics directors can adopt to fight hostile takeovers of the corporation and the legality of
the directors’ tactics.
L. The rules that apply to decisions of the board of directors when a director has a conflict of
interest.
M. The reasons corporations freeze-out minority shareholders, the freeze-out methods, and the
legal rules that apply to freeze-out transactions.
N. The liability of the corporation for its agents’ torts and crimes.
O. The rules for insurance and indemnification of directors and officers.
II. ANSWER TO INTRODUCTORY PROBLEM
A. The board of directors should comply with the business judgment rule. The board must
oral presentation and take questions from the directors. KRNP should advice the board to
and not grossly negligent.
B. The board should comply with the intrinsic fairness standard because one of Clestra’s
one that would be made by reasonable persons acting at arm’s length. KRNP’s role in this
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a reasonable investigation and informing the board of the facts. In addition, KRNP should
strategy that the decision to acquire naming rights is fair to the corporation.
C. The board should adopt the tactics in Figure 1 on page 1131 that deter a hostile bid. These
include putting shares in the hands of friendly shareholders, incorporating in a state with a
control share law, having a stock trading surveillance program, and perhaps having a poison
oppose an acquisition by a company that threatens that strategy. Having an acquisition
strategy, like Time, Inc. did in the Paramount v. Time case (page 1132), will help Clestra’s
III. SUGGESTIONS FOR LECTURE PREPARATION
A. Introduction
Preview the material in this area by explaining that a corporation is managed by its board of
directors, which often delegates much authority to board committees and the officers. Next,
B. Objectives of the Corporation
1. Compare the profit motive and the other motives of corporations. Note that a
corporation may be acting socially responsibly yet be maximizing profits simultaneously.
2. Note that the courts have allowed corporations to act socially responsibly for many
years. Dodge v. Ford (which appears on page 1165 in Chapter 44), a 1919 case,
objective dominated.
3. Ethics in Action: Corporate Constituency Statutes (p. 1114): Discuss the corporate
constituency statutes that were passed in response to the Revlon, Inc. v. MacAndrews &
Forbes Holdings, Inc., 506 A.2d 173 (Del. S. Ct. 1986). Check whether your state has
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we studied in Chapter 4 require consideration of many constituencies. A profit
A justice theorist has to consider which of many constituents is most needy.
4. Mention Section 2.01 of the ALI’s Principles of Corporate Governance: Analysis and
Recommendations. The ALI Corporate Governance Project recommends that during the
conduct of business a corporation may take ethical considerations into account and may
and has appeared to have potential to impact significantly the development of corporate
law in the area of social responsibility. However, the Revlon case and the state
legislatures’ reaction to that case have stolen much of the limelight from the Corporate
Governance Project.
C. Corporate Powers
incorporation.
3. Tell students that few limitations exist on a corporation’s powers today. Modern statutes
empower a corporation to do anything legal. The articles of incorporation rarely limit a
corporation’s powers.
1) Modern statutes do not permit a party to a contract to use ultra vires as a defense
2) Nearly every corporation has a purpose clause that allows it to engage in any
lawful act. For example, a coal mining corporation’s articles may have a
corporation is not limited by its purpose clause.
b. Explain the situations in which ultra vires may be asserted. Note the reasons for
allowing ultra vires to be asserted in these situations.
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1) Shareholder suit to enjoin an executory ultra vires contract, when the party
dealing with the corporation knew the contract was ultra vires. This rule allows
a shareholder to force the corporation to comply with its purpose clause.
2) A corporate suit against management for causing damages to the corporation by
committing an ultra vires act.
management’s ultra vires act.
3) Action by the attorney general. You may want to mention this. We let the
students cover this material themselves during their reading of the book.
corporation may not use the ultra vires defense to avoid liability on a contract exceeding
its purpose clause.
D. The Board of Directors
1. Function of board
a. Note that boards in large publicly held corporations mostly only oversee
management by officers.
independent directors for public companies.
2. Election and removal of directors. You may wish to assign or to refer to Chapter 44’s
discussion on this subject at pages 1151-1153.
b. State that directors are elected and removed by shareholders.
1) Distinguish between straight voting and cumulative voting. Refer to the
board of directors.
2) Discuss class voting. Refer to the discussion on classes of shares in Chapter 44
at page 1152.
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3) Note that shareholders may remove directors with or without cause at any time,
remove a director.
Example: Problem Case # 1.
Chapter 44.
d. Proxy solicitation process
of the term proxy.
2) Explain why a corporation and its management will solicit proxies: to ensure that
a quorum of the shares are present and to ensure that management will obtain
shareholder approval of management’s slate of directors.
3) Note the practical effect of management’s solicitation of proxies: it ensures
directors.
4) Note that sometimes shareholders opposed to management will solicit proxies,
Management nearly always wins a proxy fight, because most shareholders
5) Improving Corporate Governance.
a) Review the proposals for changing (improving) corporate governance on
proposals to change corporate governance.
b) Attempt to define the goals of corporate governance rules. Ask students
whether corporate governance rules should increase the efficient
some corporate governance rules increase shareholder participation and
c) Ask students why they think the traditional corporate governance model
than in the philosophic: investors recognized that they could realize larger
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profits by investing in the most profitable businesses and selling unprofitable
2012. We’ll watch that closely.
d) Log On (p. 1118): This website is a good source of best practices in
corporate governance.
e) The Global Business Environment: Corporate Governance in Germany (p.
1120): Some critics laud Germany’s corporate governance structure as a
f) Grimes v. Donald (p. 1119). The court held that the board of directors had
not illegally delegated the board’s duties and responsibilities to Donald, the
CEO, by agreeing to make a high severance payment to Donald if the board
interfered with his management of the corporation.
Points for Discussion: What reasons did the court give to support its
holding? First, the contract did not foreclose the board from exercising its
pursue his course of action or to pursue the action desired by the board. The
court concluded that the cost was not so high in relation to the size of DSC
that the board would be unlikely to interfere or terminate Donald if it wished
to do so.
e. Vacancies on the board. Note the power given to the board here. There is no need to
3. Meetings
director consents in writing to the action taken.
b. Notice of Meetings
invalid.
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adjourned.)
c. Quorum requirement. Usually, a quorum is a majority of the directors.
E. Officers of the Corporation
1. Appointment of officers. Note that officers are selected by the directors. List the
officers of the usual corporation; note that the MBCA permits flexibility in determining
the officers a corporate may have.
inherent authority as a subset of implied authority.]
F. Managing Close Corporations
Compare the roles of shareholders in close corporations with shareholders’ roles in publicly
held corporations. Note that many close corporations are essentially incorporated
shareholder to dominate the corporation to the detriment of minority shareholders. Although
domination or oppression may sometimes provide a legal right of action for the dominated
legal planning.
1. Reducing Management Formalities. Many statutes now permit close corporations to
corporations are merely incorporated partnerships. Note that dispensing with the board
directors: restricting board discretion and requiring supermajority votes for board
actions.
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a. Restricting board discretion. Explain that modern statutes grant shareholders
unlimited power to limit board discretion. Give a few examples of restrictions:
1) Requiring mandatory annual dividends.
2) Prohibiting the termination of a shareholder’s employment.
3) Requiring shareholder approval to hire employees.
2) Unanimous approval to terminate a shareholder’s employment.
3) Unanimous approval to hire new employees.
c. Log On (p. 1121): California’s secretary of state provides assistance to those
forming close corporations. Does your state?
G. Managing Nonprofit Corporations
ordinary and fully inform the directors prior to or during to their consideration of a matter.
Note the purpose of the MBCA’s optional provision requiring that no more than 49% of the
directors of a public service corporation may be financially interested in the business of the
corporation: to reduce the risk that the directors win run the corporation for their personal
benefit, not the public benefit.
a. To act within their authority.
b. To exercise due care.
c. To be loyal to the corporation.
Expand upon each of these, especially the last two.
2. Duty of care
Examples: Problem Cases # 2 and 3.
Note that managers will not be judged in light of the 20-20 vision of hindsight.
Everyone knows what to do after history reveals one’s mistakes. A manager need
merely consider the information available at the time the decision was made.
b. Good faith and reasonable belief
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line, an extensive investigation is required. Note that management is permitted
accountants and valuations of investment bankers.
2) Best interests of the corporation. The good faith standard requires the managers
accordance with the firm’s strategies.
c. The Business Judgment Rule.
the judgment of management.
2) Indicate the difficulty courts have judging the wisdom of business decisions
corporation is based upon evidence presented in court, which is sketchy and
profits even though there is a small risk that project may generate large losses.
The result is that the law would encourage managerial decision-making that
would not maximize the total wealth of society.
3) Review the elements of the business judgment rule. Note that the rule is
prior to making a decision.
b) No conflicts of interest. There should be no self-interest. For example,
self-interest exists if there is self-dealing. There must be no doubt that the
manager is acting only with his corporation’s interest in mind.
c) Rational basis. Note the apparent contradiction in the business judgment
reasonableness is required by the rule.
d) Because many of our students will be consultants, we spend most of class
time covering how to help clients comply with the business judgment rule.
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The material on page 1124 matches what we tell our students to do when
advising corporate clients.
e) Brehm v. Eisner (p. 1125). Disney CEO Michael Eisner and other Disney
directors were found to have complied with the business judgment rule both
when hiring new COO Michael Ovitz and when firing him a year later.
Points for Discussion: This is a high profile and highly interesting case with
judgment rule.
Ask students what is the greatest learning from this case? It is that the
business judgment rule protects about any decision that is honestly
motivated when there is no conflict of interest. While Eisner’s domineering
led to flaws in the process of getting board approval to hire Ovitz, and while
Case # 4.
Additional Points for Discussion: This litigation was part of an effort by
Walt Disney nephew Roy Disney to oust Eisner from Disney, a battle that
went on for years, motivated by Disney’s stagnant stock price and Eisner’s
management style, which chased away a number of very talented executives.
f) Additional Examples: Problem Cases ## 4, 5, and 6.
4) Criticism of the business judgment rule
Critics of management argue that the business judgment rule unduly isolates
management from liability for their bad decisions. It is true that very few
directors are held liable in the absence of self-dealing. This explains why the
value of the corporation. Should a board always be required to look at such
information? Clearly it should if there is no regular market for the corporation’s
accepted by lawyers and judges.
5) Changes in the Duty of Care