III. ROLE OF DIRECTORS AND OFFICERS
By statute, management of a corporation is vested in the board of directors. The
board determines general corporate policy and appoints offcers to execute the
policy and administer the day-to-day operations of the corporation. Both
directors and offcers owe certain duties to the corporation and to shareholders;
if they breach their duties, they are liable. In some instances, controlling
shareholders also are held to the same duties as directors and offcers. (A
*** Chapter Outcomes***
Explain the role of the board of directors in the management of a corporation.
Explain the role of the offcers in the management of a corporation.
CASE 35-3
DONAHUE v. RODD ELECTROTYPE CO., INC.
Massachusetts Supreme Court, 1974
367 Mass. 578, 328 N.E.2d 505
http://scholar.google.com/scholar_case?case=10488013111081435481 &q=328+N.E.2d+505&hl=en&as_sdt=2,34
Tauro, C. J.
The plaintiff, Euphemia Donahue, a minority stockholder in the Rodd Electrotype Company of
New England, Inc. (Rodd Electrotype), a Massachusetts corporation, brings this suit against the
directors of Rodd Electrotype, Charles H. Rodd, Frederick I. Rodd and Mr. Harold E. Magnuson,
against Harry C. Rodd, a former director, officer, and controlling stockholder of Rodd
Electrotype and against Rodd Electrotype (hereinafter called defendants).
The plaintiff seeks to rescind Rodd Electrotype’s purchase of Harry Rodd’s shares in Rodd
Electrotype and to compel Harry Rodd “to repay to the corporation the purchase price of said
shares, $36,000, together with interest from the date of purchase.” The plaintiff alleges that the
defendants caused the corporation to purchase the shares in violation of their fiduciary duty to
her, a minority stockholder of Rodd Electrotype.
abilities of those stockholders who hold office. Disloyalty and self-seeking conduct on the part of
any stockholder will engender bickering, corporate stalemates, and, perhaps, efforts to achieve
dissolution. * * *
Although the corporate form provides * * * advantages for the stockholders (limited liability,
perpetuity, and so forth), it also supplies an opportunity for the majority stockholders to oppress
or disadvantage minority stockholders. The minority is vulnerable to a variety of oppressive
devices, termed “freeze-outs,” which the majority may employ. [Citation.] An authoritative study
of such “freeze- outs” enumerates some of the possibilities: “The squeezers [those who employ
the freeze-out techniques] may refuse to declare dividends; they may drain off the corporation’s
earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and
perhaps to their relatives, or in the form of high rent by the corporation for property leased from
majority shareholders * * *; they may deprive minority shareholders of corporate offices and of
employment by the company; they may cause the corporation to sell its assets at an inadequate
management of the corporation by its directors, but declare as a general rule that the declaration
of dividends rests within the sound discretion of the directors, refusing to interfere with their
determination unless a plain abuse of discretion is made to appear.” * * *
Thus, when these types of “freeze-outs” are attempted by the majority stockholders, the
minority stockholders, cut off from all corporation-related revenues, must either suffer their
losses or seek a buyer for their shares. Many minority stockholders will be unwilling or unable to
wait for an alteration in majority policy. Typically, the minority stockholder in a close
corporation has a substantial percentage of his personal assets invested in the corporation.
[Citation.] The stockholder may have anticipated that his salary from his position with the
corporation would be his livelihood. Thus, he cannot afford to wait passively. He must liquidate
his investment in the close corporation in order to reinvest the funds in income-producing
enterprises.
* * * In a large public corporation, the oppressed or dissident minority stockholder could sell
his stock in order to extricate some of his invested capital. By definition, this market is not
available for shares in the close corporation. In a partnership, a partner who feels abused by his
fellow partners may cause dissolution by his “express will * * * at any time” [citation] and
definition lacking fifty per cent of the corporate shares, can never “authorize” the corporation to
file a petition for dissolution under [citation], by his own vote. He will seldom have at his
disposal the requisite favorable provision in the articles of organization.
Thus, in a close corporation, the minority stockholders may be trapped in a disadvantageous
situation. No outsider would knowingly assume the position of the disadvantaged minority. The
outsider would have the same difficulties. To cut losses, the minority stockholder may be
compelled to deal with the majority. This is the capstone of the majority plan. Majority
“freeze-out” schemes which withhold dividends are designed to compel the minority to
relinquish stock at inadequate prices * * *. When the minority stockholder agrees to sell out at
less than fair value, the majority has won.
Because of the fundamental resemblance of the close corporation to the partnership, the trust
and confidence which are essential to this scale and manner of enterprise, and the inherent
danger to minority interests in the close corporation, we hold that stockholders in the close
corporation owe one another substantially the same fiduciary duty in the operation of the
We contrast this strict good faith standard with the somewhat less stringent standard of
fiduciary duty to which directors and stockholders of all corporations must adhere in the
discharge of their corporate responsibilities. Corporate directors are held to a good faith and
inherent fairness standard of conduct [citation] and are not “permitted to serve two masters
whose interests are antagonistic.” [Citation.] “Their paramount duty is to the corporation, and
their personal pecuniary interests are subordinate to that duty.” [Citation.]
The more rigorous duty of partners and participants in a joint adventure, here extended to
stockholders in a close corporation, was described by then Chief Judge Cardozo of the New York
Court of Appeals in [citation]: “Joint adventurers, like co-partners, owe to one another, while the
Under settled Massachusetts law, a domestic corporation, unless forbidden by statute, has the
power to purchase its own shares. When the corporation reacquiring its own stock is a close
corporation, the purchase is subject to the additional requirement, in the light of our holding in
this opinion, that the stockholders, who, as directors or controlling stockholders, caused the
corporation to enter into the stock purchase agreement, must have acted with the utmost good
faith and loyalty to the other stockholders.
To meet this test, if the stockholder whose shares were purchased was a member of the
controlling group, the controlling stockholders must cause the corporation to offer each
stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an
identical price. * * *
* * * If the close corporation purchases shares only from a member of the controlling group,
the controlling stockholder can convert his shares into cash at a time when none of the other
stockholders can. Consistent with its strict fiduciary duty, the controlling group may not utilize
its control of the corporation to establish an exclusive market in previously unmarketable shares
from which the minority stockholders are excluded. * * *
A. FUNCTION OF THE BOARD OF DIRECTORS
Directors are neither trustees nor agents of the shareholders or the corporation.
But they are $duciaries who must perform their duties in good faith, in the best
interests of the corporation, and with due care.
All corporate power is exercised under the authority of the board of directors. In
some corporations, the board members actively manage the company’s
business, but in most publicly held corporations someone else manages the daily
a”airs of the business, but still under the authority of the board. In publicly held
corporations, directors who are also corporate offcers or employees are known
as inside directors, in contrast to outside directors, who are not offcers or
employees. Outside directors who have no business contacts with the
corporation are unaffliated directors; outside directors who do have such
Selection and Removal of Officers
In most states, the board is responsible for choosing the corporate offcers and
may remove any offcer at any time. Offcers are agents of the corporation; their
responsibilities are delegated to them by the board of directors.
Capital Structure
Determining the capital structure and financial policy of the corporation may
include the power to $x the selling price of newly issued shares (unless the
charter reserves that right to the shareholders); to determine the value of
consideration received in exchange for shares it issues; to borrow money, issue
notes, bonds, and other obligations, and to secure any of the corporation’s
obligations; and to sell, lease, or exchange corporate assets in the usual and
regular course of business.
Fundamental Changes
The board has the power to amend or repeal the bylaws, unless the articles of
incorporation reserve this power exclusively to the shareholders. The board
initiates certain actions that exceed its power and require shareholder approval.
Dividends
The board declares the amount and type of dividends, subject to the restrictions
imposed by the state incorporation statute, articles of incorporation, and
corporate loan and preferred stock agreements. The board also may purchase,
redeem, or otherwise acquire shares of the corporation’s equity securities.
Management Compensation
The board usually determines the compensation of offcers. In addition, a
number of states allow the board to $x the compensation of board members.
The Dodd-Frank Act requires that, at least once every three years, publicly held
companies include a provision in certain proxy statements for a non-binding
shareholder vote on the compensation of executives. In a separate resolution,
shareholders determine whether this “say on pay” vote should be held every
one, two, or three years.
Under the Sarbanes-Oxley Act, if a publicly held company is required to issue an
accounting restatement due to a material violation of securities law, the chief
executive offcer and the chief financial offcer must forfeit certain bonuses and
compensation received, as well as any profit realized from the sale of the
company’s securities, during the twelve-month period following the original
issuance of the noncomplying financial document.
B. ELECTION AND TENURE OF DIRECTORS
A director’s quali$cations are determined by the incorporation statute, articles of
incorporation, and bylaws. The statute, charter, and bylaws also determine the
election, number, tenure, and compensation of directors.
Election, Number, and Tenure of Directors
When a corporation is new, the articles of incorporation usually name the initial
board of directors, which serves until the first meeting of shareholders, who then
elect the next directors. Thereafter, directors are elected annually and hold offce
for one year unless their terms are staggered. State statutes traditionally
Vacancies and Removal of Directors
The Revised Act provides that a vacancy in the board may be filled either by the
shareholders or by an affrmative vote by a majority of the remaining directors —
even if those remaining constitute less than a quorum. The term of a director
elected to $ll a vacancy expires at the next shareholders’ meeting at which
directors are elected.
Some states have no statutory provision for removal of directors, although a
common law rule permits removal for cause by action of the shareholders. The
Revised Act and an increasing number of other statutes permit shareholders to
Compensation of Directors
Traditionally, directors did not receive salaries for their service as directors,
though they often received a fee or honorarium for attendance at meetings. The
Revised Act and a number of state statutes now specifically authorize the board
to $x the compensation of directors, unless a contrary provision exists in the
charter or bylaws.
C. EXERCISE OF DIRECTORS’ FUNCTIONS
Board members cannot bind the corporation when acting individually; they must
act as a board, and only through a meeting of the directors or through an
authorized written consent signed by all of the directors, if such consent without
Quorum and Voting
A quorum is the minimum number of members that must be present at a
Action Taken without a Meeting
The Revised Act and most states provide that, unless the charter or bylaws
provide otherwise, any action the statute requires or permits to be taken at a
board meeting may be taken without a meeting if all directors consent in writing.
Delegation of Board Powers
Unless the charter or bylaws provide otherwise, the board of directors, by a
majority vote of the full board, may appoint one or more committees, all of
whose members must be directors. The committees may exercise all authority of
the board, except with regard to certain matters specified in the incorporation
statute, such as declaring dividends or authorizing the sale of stock. Commonly
Directors’ Inspection Rights
Permits directors access to corporate records so that they can make informed
judgments.
D. OFFICERS
The board appoints offcers to hold the offces provided in the corporation’s
bylaws, which set forth the duties of each offcer. Statutes generally require at
minimum that offcers include a president; one or more vice presidents, as
prescribed by the bylaws; a secretary, and a treasurer. A person may hold more
Selection and Removal of Officers
Most state statutes provide that the offcers be appointed by the board and that
they serve at the pleasure of the board; thus, offcers may be removed with or
Role of Officers
The offcers, like the directors, are $duciaries to the corporation. In contrast to
directors, offcers are also agents of the corporation. The roles of offcers are set
forth in the corporate bylaws.
• President — principal executive offcer, generally supervises and controls
business a”airs subject to the board of directors; presides at meetings; has
authority to sign legal papers for corporation
Authority of Officers
The Revised Act provides that each offcer has the authority provided in the
bylaws or prescribed by the board of directors to the extent such prescribed
authority is consistent with the bylaws. Like that of other agents, the authority of
an offcer to bind the corporation may be (1) actual express, (2) actual implied,
or (3) apparent.
Actual express authority — when the corporation manifests its assent to the
offcer that the offcer should act on its behalf. It is derived from the articles,
E. DUTIES OF DIRECTORS AND OFFICERS
Generally, directors and offcers owe the duties of obedience, diligence, and
loyalty to the corporation. Common law is the most signiticant source of
directors’ and offcers’ duties, but liability for specific acts may also be imposed
on directors and offcers by state and federal statutes. A corporation may not
*** Chapter Outcome***
Explain management’s duties of loyalty, obedience, and diligence.
Duty of Obedience
Directors and offcers must act within their respective authority. For any loss the
corporation su”ers because of their unauthorized acts, they are held absolutely
liable in some jurisdictions; in others they are held liable only if they exceeded
their authority intentionally or negligently.
Duty of Diligence
Most states and the Revised Act require that a director or offcer discharge
corporate 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 the director or offcer reasonably believes to be in the best interests of
the corporation. A director or offcer who performs her duties in compliance with
these requirements is not liable for any action that she takes as a director or
offcer, or for any failure to act.
In 1999 an amendment to the Revised Act was adopted re$ning the Act’s
standards of conduct and liability for directors. It substituted this for number 2
above: “When becoming informed in connection with their decision making
As long as the directors and offcers act in good faith and with due care, the
courts will not substitute their judgment for that of the board or offcer — the
so-called business judgment rule. Conversely, directors and offcers will be held
liable for bad faith or negligent conduct or for failing to act.
Reliance on others — Directors and offcers are permitted to entrust important
work to others and are not personally liable for the negligent acts or willful
wrongs of those employees whom they selected carefully. Nevertheless,
reasonable supervision is required. Directors may also rely on information
Business judgment rule — This rule precludes the courts’ imposing liability on
the directors or offcers for honest mistakes of judgment. (With respect to
directors, the 1999 amendments to the Revised Act added a new section 8.31
codifying much of the business judgment rule and providing guidance as to its
application.) Directors and offcers are continuously called on to make decisions
that require balancing benefit and risks to the corporation, and they may not