ANSWERS TO PROBLEMS
1. Brown, the president and director of a corporation engaged in owning and operating a chain of
motels, was advised, on what seemed to be good authority, that a superhighway was to be
constructed through the town of X, which would be a most desirable location for a motel. Brown
presented these facts to the board of directors of the motel corporation and recommended that
the corporation build a motel in the town of X at the location described. The board of directors
agreed, and the new motel was constructed. However, the superhighway plans were changed
after the motel was constructed, and the highway was never built. Later, a packinghouse was
built on property adjoining the motel, and as a result the corporation sustained a considerable
loss. The shareholders brought an appropriate action against Brown, charging that his proposal
had caused the corporation a substantial loss. What is the result?
2. A, B, C, D, and E constituted the board of directors of the X Corporation. While D and E were
out of town, A, B, and C held a special meeting of the board. Just as the meeting began, C
became ill. He then gave a proxy to A and went home. A resolution was then adopted directing
and authorizing the X Corporation’s purchase of an adjoining piece of land owned by S as a site
for an additional factory building. A and B voted for the resolution, and A, as C’s proxy, cast C’s
vote in favor of the resolution. The X Corporation then made a contract with S for the purchase
of the land. After the return of D and E, another special meeting of the board was held with all
five directors present. A resolution was then unanimously adopted to cancel the contract with S.
May S recover damages from X Corporation for breach of contract?
3. Bernard Koch was president of United Corporation, a closely held corporation. Koch, James
Trent, and Henry Phillips made up the three-person board of directors. At a meeting of the
board, Trent was elected president, replacing Koch. At the same meeting, Trent attempted to
have the salary of the president increased. He was unable to obtain board approval of the
increase because although Phillips voted for the increase, Koch voted against it. Trent was
disqualified from voting by the charter. As a result, the directors, by a two-to-one vote, amended
the bylaws to provide for the appointment of an executive committee composed of three
reputable businesspersons to pass upon and fix all matters of salary for employees of the
corporation. Subsequently, the executive committee, consisting of Jane Jones, James Black, and
William Johnson, increased the salary of the president. Will Koch succeed in an appropriate
action against the corporation, Trent, and Phillips to enjoin them from paying compensation to
the president above that fixed by the board of directors? Explain.
4. Zenith Steel Company operates a prosperous business. In January, Zenith’s CEO and president,
Roe, who is also a member of the board of directors, was voted a $1,000,000 bonus by the board
of directors for valuable services he provided to the company during the previous year. Roe
received an annual salary of $850,000 from the company. Black, Inc., a minority shareholder in
Zenith Steel Company, brings an appropriate action to enjoin the payment by the company of the
$1,000,000 bonus. Explain whether Black will succeed in its attempt.
Answer: Compensation of Directors. Decision for Black and against Zenith Steel Company
enjoining payment of the $1,000,000 bonus. An officer who is also a director of a corporation is
not entitled to extra compensation from the corporation for past services to the company in
5. (a) Smith, a director of the Sample Corporation, sells a piece of vacant land to the Sample
Corporation for $500,000. The land cost him $200,000.
(b) Jones, a shareholder of the Sample Corporation, sells a used truck to the Sample Corporation for
$8,400, although the truck is worth $6,000.
Raphael, a minority shareholder of the Sample Corporation, claims that these sales are void and
should be annulled. Is he correct? Why?
6. The X Corporation manufactures machine tools. The five directors of X Corporation are Black,
White, Brown, Green, and Crimson. At a duly called meeting of the board of directors of X
Corporation in January, all five directors were present. A contract for the purchase of $10
million worth of steel from the D Company, of which Black, White, and Brown are directors, was
discussed and approved by a unanimous vote. The board also discussed at length entering into
negotiations for the purchase of Q Corporation, which allegedly was about to be sold for around
$150 million. By a three-to-two vote, it was decided not to open such negotiations.
Three months later, Green purchased Q Corporation for $150 million. Shortly thereafter, a new
board of directors for X Corporation took office. X Corporation now brings actions to rescind its
contract with D Company and to compel Green to assign to X Corporation his contract for the
purchase of Q Corporation. Decisions as to each action?
Answer: Decree for D Company against X Corporation; there is not sufficient information to decide
what decree should be issued regarding Green and X Corporation.
(a) Duty of Loyalty: Conflict of Interests. The general rule is that a contract between corporations
with common directors is not voidable by either corporation even if the interlocking directors
constitute a majority of the board of the company challenging the contract, provided the contract
7. Gore had been the owner of 1 percent of the outstanding shares of the Webster Company, a
corporation since its organization ten years ago. Ratliff, the president of the company, was the
owner of 70 percent of the outstanding shares. Ratliff used the shareholders’ list to submit to the
shareholders an offer of $50 per share for their stock. Gore, on receiving the offer, called Ratliff
and told him that the offer was inadequate and advised that she was willing to offer $60 per
share and for that purpose demanded a shareholders’ list. Ratliff knew that Gore was willing and
able to supply the funds necessary to purchase the stock, but he nevertheless refused to supply
the list to Gore. Furthermore, he did not offer to transmit Gore’s offer to the shareholders of
record. Gore then brought an action to compel the corporation to make the shareholders’ list
available to her. Will Gore be able to obtain a copy of the shareholders’ list? Why?
Answer: Shareholders’ Right to Inspect Books and Records. Yes, Gore will be able to obtain the
list. A shareholder has a right to examine for a proper purpose the books and records of account,
8. Mitchell, Nelson, Olsen, and Parker, experts in manufacturing baubles, each owned fifteen of
one hundred authorized shares of Baubles, Inc., a corporation of State X that does not permit
cumulative voting. On July 7, 2007, the corporation sold forty shares to Quentin, an investor, for
$1,500,000, which it used to purchase a factory building. On July 8, 2007, Mitchell, Nelson,
Olsen, and Parker contracted as follows:
All parties will act jointly in exercising voting rights as shareholders. In the event of a failure to
agree, the question shall be submitted to George Yost, whose decision shall be binding upon all
parties.
Until a meeting of shareholders on April 17, 2014, when a dispute arose, all parties to the contract
had voted consistently and regularly for Nelson, Olsen, and Parker as directors. At that meeting,
Yost considered the dispute and decided and directed that Mitchell, Nelson, Olsen, and Parker
vote their shares for the latter three as directors. Nelson, Olsen, and Parker so voted. Mitchell
and Quentin voted for themselves and Olsen as directors.
(a) Is the contract of July 8, 2007, valid, and, if so, what is its effect?
(b) Who were elected directors of Baubles, Inc., at the meeting of its shareholders on April 17, 2014?
Answer: Shareholder Agreements.
(a) The pooling agreement of July 8, 2007, is lawful and enforceable. In most jurisdictions,
shareholder pooling agreements are valid, in the absence of fraud, illegal object, or oppression of
9. Acme Corporation’s articles of incorporation require cumulative voting for the election of its
directors. The board of directors of Acme Corporation consists of nine directors, each elected
annually.
(a) Smith owns 24 percent of the outstanding shares of Acme Corporation. How many directors can
he elect with his votes?
(b) If Acme Corporation were to classify its board into three classes, each consisting of three
directors elected every three years, how many directors would Smith be able to elect?
Answer: Election and Removal of Directors: Cumulative Voting.
(a) Smith elects 2 directors. The formula is X ac/(b + 1)
+ 1. Substituting 24 for “X”, 100 for “a”, and 9 for “b”
yields:
24 = – (100)(c)
9+1
+ 1
10. A bylaw of Betma Corporation provides that no shareholder can sell his shares unless he first
offers them for sale to the corporation or its directors. The bylaw also states that this restriction
shall be printed or stamped upon each stock certificate and shall bind all present or future
owners or holders. Betma Corporation did not comply with this latter provision. Shaw, having
knowledge of the bylaw restriction, nevertheless purchased twenty shares of the corporation’s
stock from Rice, without having Rice first offer them for sale to the corporation or its directors.
When Betma Corporation refused to effectuate a transfer of the shares to her, Shaw sued to
compel a transfer and the issuance of a new certificate to her. What result?
11. Neese, trustee in bankruptcy for First Trust Company, brings a suit against the directors of the
company for losses the company sustained as a result of the directors’ failure to use due care
and diligence in the discharge of their duties. The specific acts of negligence alleged are (a)
failure to give as much time and attention to the affairs of the company as its business interests
required; (b) abdication of their control of the corporation by turning its management entirely
over to its president, Brown; (c) failure to keep informed as to the affairs, condition, and
management of the corporation; (d) failure to take action to direct or control the corporation’s
affairs; (e) permission of large, open, unsecured loans to affiliated but financially unsound
companies that were owned and controlled by Brown; (f) failure to examine financial reports
that would have shown illegal diversions and waste of the corporation’s funds; and (g) failure to
supervise properly the corporation’s officers and directors. Which, if any, of these allegations
can constitute a breach of the duty of diligence?
Answer: Liability of Officers and Directors. Judgment for Neese. The general allegations of
negligence and mismanagement are each sufficient to constitute negligence if proven. Liability of
12. Minority shareholders of Midwest Technical Institute Development Corporation, a closed-end
investment company owning assets consisting principally of securities of companies in
technological fields, brought a shareholder derivative suit against officers and directors of
Midwest, seeking to recover on Midwest’s behalf the profits the officers and directors realized
through dealings in stock held in Midwest’s portfolio in breach of their fiduciary duty.
Approximately three years after commencement of the action, a new corporation, Midtex, was
organized to acquire Midwest’s assets. May the shareholders now add Midtex as a party
defendant to their suit? Why?
Answer: Fiduciary Duty of Officers and Directors. Judgment for the shareholders. A stockholder
derivative suit is an invention of equity designed to supply a remedy where none existed at law to
redress breaches of fiduciary duty by corporate officers and directors. The action is a derivative
13. Riffe, while serving as an officer of Wilshire Oil Company, received a secret commission for
work he did on behalf of a competing corporation. Can Wilshire Oil recover these secret profits
and, in addition, recover the compensation Wilshire Oil paid to Riffe during the period that he
acted on behalf of the competitor? Explain.
Answer: Breach of Duty. Yes. Judgment for Wilshire Oil Company. Riffe’s actions in accepting the
secret commission from a competing corporation constitute both a willful breach of his
employment contract and a breach of his fiduciary duty to the corporation stemming from his
14. Muller, a shareholder of SCM, brought an action against SCM over his unsuccessful
negotiations to purchase some of SCM’s assets overseas. He then formed a shareholder
committee to challenge the position of SCM’s management in that suit. In order to conduct a
proxy battle for management control at the next election of directors, the committee sought to
obtain the list of shareholders who would be eligible to vote. At the time, however, no member of
the committee had owned stock in SCM for the six-month period required to gain access to such
information. Then Lopez, a former SCM executive and a shareholder for more than one year,
joined the committee and demanded to be allowed to inspect the minutes of SCM shareholder
proceedings and to gain access to the current shareholder list. His stated reason for making the
demand was to solicit proxies in support of the committee’s nominees for positions as directors.
Lopez brought this action after SCM rejected his demand. Will Lopez succeed?
Answer: Right to Inspect Books and Records. . Yes. Lopez’s demand was clearly set forth so there
was no procedural basis for the defendant’s rejection. The inspection of shareholder lists to
15. Pritchard & Baird was a reinsurance broker. A reinsurance broker arranges contracts between
insurance companies so that companies that have sold large policies may sell participations in
these policies to other companies in order to share the risks. Pritchard & Baird was controlled
for many years by Charles Pritchard, who died in December 2011, controlled Pritchard & Baird
for many years. Prior to his death, he brought his two sons, Charles Jr. and William, into the
business. The pair assumed an increasingly dominant role in the affairs of the business during
the elder Charles’s later years. Starting in 2008, Charles Jr. and William began to withdraw
from the corporate account ever– increasing sums that were designated as “loans” on the
balance sheet. These “loans,” however, represented a significant misappropriation of funds
belonging to the corporation’s clients. By late 2013, Charles Jr. and William had plunged the
corporation into hopeless bankruptcy. A total of $12,333,514.47 in “loans” had accumulated by
October of that year. Mrs. Lillian Pritchard, the widow of the elder Charles, was a member of
the corporation’s board of directors until her resignation on December 3, 2013, the day before
the corporation filed for bankruptcy. Francis, as trustee in the bankruptcy proceeding, brought
suit against United Jersey Bank, the administrator of the estate of Charles, Sr. He also charged
that Lillian Pritchard, as a director of the corporation, was personally liable for the
misappropriated funds on the basis of negligence in discharging her duties as director. Is
Francis correct?
Answer: Duty of Diligence. Yes. All corporate directors, as fiduciaries, are responsible for
managing the business and affairs of the corporation. They must exercise their duties in good
16. Donald J. Richardson, Grove L. Cook, and Wayne Weaver were stockholders of Major Oil. They
brought a direct action, individually and on behalf of all other stockholders of Major, against
certain directors and other officers of the corporation. The complaint stated twelve causes of
action. The first eight causes alleged some misappropriation of Major’s assets by the defendants
and sought to require the defendants to return the assets to Major. Three of the remaining four
causes alleged breaches of fiduciary duty implicit in those fraudulent acts and sought
compensatory or punitive damages for the injury that resulted. The final cause sought the
appointment of a receiver. Richardson, Cook, and Weaver moved for an order certifying the suit
as a class action. Decision?
Answer: Derivative Suits. This is a derivative action, not a class action suit. The critical distinction
in this case is that between a derivative action and a class action. Derivative actions seek to
enforce rights belonging to the corporation, and may be initiated by a stockholder only after the
17. Klinicki and Lundgren, both furloughed Pan Am pilots stationed in West Germany, decided to
start their own charter airline company. They formed Berlinair, Inc., a closely held Oregon
corporation. Lundgren was president and a director in charge of developing the business.
Klinicki was vice president and a director in charge of operations and maintenance. Klinicki,
Lundgren, and Lelco, Inc. (Lundgren’s family business) each owned one-third of the stock.
Klinicki and Lundgren, as representatives of Berlinair, met with BFR, a consortium of Berlin
travel agents, to negotiate a lucrative air transportation contract. When Lundgren learned of the
likelihood of actually obtaining the BFR contract, he formed his own solely owned company, Air
Berlin Charter Company (ABC). Although he continued to negotiate for the BFR contract, he
did so on behalf of ABC, not Berlinair. Eventually BFR awarded the contract to ABC. Klinicki
commenced a derivative action on behalf of Berlinair and a suit against Lundgren individually
for usurping a corporate opportunity of Berlinair. Lundgren claimed that Berlinair was not
financially able to undertake the BFR contract and therefore no usurpation of corporate
opportunity could occur. Who is correct? Explain.
Answer: Duty of Loyalty/Corporate Opportunity. Judgment for Klinicki. There is no dispute that the
corporate opportunity doctrine precludes corporate fiduciaries from diverting to themselves
ANSWERS TO “TAKING SIDES” PROBLEMS
Sinclair Oil Corporation organized a subsidiary, Sinclair Venezuelan Oil Company (Sinven) for the
purpose of operating in Venezuela. Sinclair owned about 97 percent of Sinven’s stock. Sinclair
nominates all members of Sinven’s board of directors, and none of the directors were independent of
Sinclair. A minority shareholder of Sinven brought a derivative action on behalf of Sinven against
Sinclair seeking to recover damages sustained by Sinven. The derivative suit alleged that Sinclair
had caused Sinven to pay out such excessive dividends that the industrial development of Sinven was
effectively prevented.
(a) What are the arguments that the transactions between Sinclair and Sinven should be
subjected to judicial scrutiny and upheld only if Sinclair shows them to have been entirely
fair and entered in good faith?
(b) What are the arguments that the transactions between Sinclair and Sinven should be
subjected to the business judgment rule and overturned only if Sinven shows that Sinclair
had not acted with due care, in good faith, and in a manner reasonably believed to be in the
best interests of Sinven?
(c) Explain which standard should apply.
ANSWER:
(a) Sinven would argue that because of Sinclair’s fiduciary duty and its control over Sinven,
Sinclair is in a conflict of interest relationship with Sinven. Therefore, Sinclair’s dealings