28 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
director typically breaches his or her duty of loyalty when he or she (1) competes with the corporation; (2) usurps a
corporate opportunity; (3) has an interest that conflicts with the interest of the corporation; (4) engages in insider
trading; (5) authorizes a corporate transaction that is detrimental to minority shareholders; and (6) sells control over
whole or in part.
whole or in part.
whole or in part.
CHAPTER 5: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 31
whole or in part.
In Disney v. Walt Disney Co., the court denied Disney’s request to remove the confidentiality designation and
in other cases, which would not “advance the best interests of the corporation or its stockholders.” The court found “no
basis in the language of the [inspection rights] statute to limit the proposed use . . . to executive compensation issues.
Instead, the court would have to recognize a right to make a books and records demand for the purpose of
investigating any well grounded suspicion of mismanagement and then publicly disclosing information discovered
from that investigation. In addition, the expansion . . . would extend equally to any single stockholder, not only to those
Are there circumstances in which a shareholder is entitled to use information obtained by making a
demand in a way that will lead to its public disclosure? Yes. As the court explained, shareholders use their right
to inspect corporate records “as one of the tools at hand in conducting pre-suit investigation of suspected
mismanagement or corporate waste. When such investigation reveals a good faith basis for suit, the stockholder will
court understands that there can be exigent circumstances (e.g., an active election contest) in which time constraints
will not allow a stockholder to draft and file a complaint and then deal with issues of confidentiality in the ordinary
course. In those limited circumstances, and upon a clear showing, this court will entertain extraordinary applications to
remove confidential designations from documents.
REVIEWING—
CORPORATE DIRECTORS,
OFFICERS, AND SHAREHOLDERS
David Brock is on the board of directors of Firm Body Fitness, Inc., which owns a string of fitness clubs in
New Mexico. Brock owns 15 percent of the Firm Body stock and he is also employed as a tanning technician
at one of the fitness clubs. After the January financial report showed that Firm Body’s tanning division was
operating at a substantial net loss, the board of directors, led by Marty Levinson, discussed the possibility of
terminating the tanning operations. Brock successfully convinced a majority of the board that the tanning
division was necessary to market the clubs’ overall fitness package. By April, the tanning division’s financial
32 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
losses had risen. The board hired a business analyst, who conducted surveys and determined that the
tanning operations did not significantly increase membership. A shareholder, Diego Peñada, discovered that
Brock owned stock in Sunglow, Inc., the company from which Firm Body purchased its tanning equipment.
Peñada notified Levinson, who privately reprimanded Brock. Shortly thereafter Brock and Mandy Vail, who
owned 37 percent of Firm Body stock and also held shares of Sunglow, voted to replace Levinson on the
board of directors. Ask your students to answer the following questions, using the information presented in the
chapter.
1. What duties did Brock, as a director, owe to Firm Body? As a director, Brock is in a fiduciary
relationship with the corporation, which means that he owes to Firm Body the duty of care and the duty of
loyalty.
2. Does the fact that Brock owned shares in Sunglow establish a conflict of interest? Why or why
not? The duty of loyalty requires officers and directors to disclose fully to the board of directors any possible
conflict of interest that might occur in conducting corporate transactions. Because Brock failed to disclose his
interest in Sunglow and continued to encourage Firm Body to purchase tanning equipment from Sunglow, he
has a conflict of interest that violates his duty of loyalty to Firm Body.
3. Suppose that Firm Body brought an action against Brock claiming that he had breached the duty
of loyalty by not disclosing his interest in Sunglow to the other directors. What theory might Brock
use in his defense? The business judgment rule immunizes decisions that are made in good faith as long as
the decision complies with the manager’s fiduciary duties and was within the manager’s power to make. Here,
Brock breached his duty of loyalty by not informing the other director’s of his interest in Sunglow, so he cannot
claim the business judgment rule immunizes him from liability.
4. Now suppose that Firm Body did not bring an action against Brock. What type of lawsuit might
Peñada be able to bring based on these facts? If the corporation does not bring suit against Brock for
breaching his duty of loyalty, then Peñada could file a shareholder’s derivative suit to redress a wrong
suffered by the corporation. In other words, Peñada could file a suit on behalf of the corporation claiming that
Brock’s breach of his fiduciary duties caused harm to the corporation. If the suit was successful, any damages
recovered would go to the corporation, not Peñada.
DEBATE THIS
Because most shareholders never bother to vote for directors, shareholders have no real control
over corporations. The statistics are indeed shocking—almost no shareholders of corporations ever bother
to vote for directors. Most shareholders don’t know who the directors are and clearly don’t know how publicly
held companies are governed. Therefore, even though on paper shareholders control corporations because
they can vote out bad directors, they really never do.
When a corporation is badly managed, that corporation’s stock price drops. That is because
shareholders vote with their “wallets” by selling the shares in that company, thereby lowering the price of the
stock. When the price of the stock gets low enough, outside groups attempt a takeover in order to put in
place their preferred group of directors. That’s how the market for corporate control works.
whole or in part.
EXAMPREP—
ISSUE SPOTTERS
1. Wonder Corporation has an opportunity to buy stock in XL, Inc. The directors decide that instead
of Wonder buying the stock, the directors will buy it. Yvon, a Wonder shareholder, learns of the
purchase and wants to sue the directors on Wonder’s behalf. Can she do it? Explain. Yes. A
shareholder can bring a derivative suit on behalf of a corporation, if some wrong is done to the corporation.
Normally, any damages recovered go into the corporate treasury.
2. Nico is Omega Corporation’s majority shareholder. He owns enough stock in Omega that if he
were to sell it, the sale would be a transfer of control of the firm. Discuss whether Nico owes a duty to
Omega or the minority shareholders in selling his shares. Yes. A single shareholder—or a few sharehold-
ers acting together—who owns enough stock to exercise de facto control over a corporation owes the cor–
poration and minority shareholders a fiduciary duty when transferring those shares.
whole or in part.
whole or in part.
CHAPTER 5: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 31
whole or in part.
In Disney v. Walt Disney Co., the court denied Disney’s request to remove the confidentiality designation and
in other cases, which would not “advance the best interests of the corporation or its stockholders.” The court found “no
basis in the language of the [inspection rights] statute to limit the proposed use . . . to executive compensation issues.
Instead, the court would have to recognize a right to make a books and records demand for the purpose of
investigating any well grounded suspicion of mismanagement and then publicly disclosing information discovered
from that investigation. In addition, the expansion . . . would extend equally to any single stockholder, not only to those
Are there circumstances in which a shareholder is entitled to use information obtained by making a
demand in a way that will lead to its public disclosure? Yes. As the court explained, shareholders use their right
to inspect corporate records “as one of the tools at hand in conducting pre-suit investigation of suspected
mismanagement or corporate waste. When such investigation reveals a good faith basis for suit, the stockholder will
court understands that there can be exigent circumstances (e.g., an active election contest) in which time constraints
will not allow a stockholder to draft and file a complaint and then deal with issues of confidentiality in the ordinary
course. In those limited circumstances, and upon a clear showing, this court will entertain extraordinary applications to
remove confidential designations from documents.
REVIEWING—
CORPORATE DIRECTORS,
OFFICERS, AND SHAREHOLDERS
David Brock is on the board of directors of Firm Body Fitness, Inc., which owns a string of fitness clubs in
New Mexico. Brock owns 15 percent of the Firm Body stock and he is also employed as a tanning technician
at one of the fitness clubs. After the January financial report showed that Firm Body’s tanning division was
operating at a substantial net loss, the board of directors, led by Marty Levinson, discussed the possibility of
terminating the tanning operations. Brock successfully convinced a majority of the board that the tanning
division was necessary to market the clubs’ overall fitness package. By April, the tanning division’s financial
32 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
losses had risen. The board hired a business analyst, who conducted surveys and determined that the
tanning operations did not significantly increase membership. A shareholder, Diego Peñada, discovered that
Brock owned stock in Sunglow, Inc., the company from which Firm Body purchased its tanning equipment.
Peñada notified Levinson, who privately reprimanded Brock. Shortly thereafter Brock and Mandy Vail, who
owned 37 percent of Firm Body stock and also held shares of Sunglow, voted to replace Levinson on the
board of directors. Ask your students to answer the following questions, using the information presented in the
chapter.
1. What duties did Brock, as a director, owe to Firm Body? As a director, Brock is in a fiduciary
relationship with the corporation, which means that he owes to Firm Body the duty of care and the duty of
loyalty.
2. Does the fact that Brock owned shares in Sunglow establish a conflict of interest? Why or why
not? The duty of loyalty requires officers and directors to disclose fully to the board of directors any possible
conflict of interest that might occur in conducting corporate transactions. Because Brock failed to disclose his
interest in Sunglow and continued to encourage Firm Body to purchase tanning equipment from Sunglow, he
has a conflict of interest that violates his duty of loyalty to Firm Body.
3. Suppose that Firm Body brought an action against Brock claiming that he had breached the duty
of loyalty by not disclosing his interest in Sunglow to the other directors. What theory might Brock
use in his defense? The business judgment rule immunizes decisions that are made in good faith as long as
the decision complies with the manager’s fiduciary duties and was within the manager’s power to make. Here,
Brock breached his duty of loyalty by not informing the other director’s of his interest in Sunglow, so he cannot
claim the business judgment rule immunizes him from liability.
4. Now suppose that Firm Body did not bring an action against Brock. What type of lawsuit might
Peñada be able to bring based on these facts? If the corporation does not bring suit against Brock for
breaching his duty of loyalty, then Peñada could file a shareholder’s derivative suit to redress a wrong
suffered by the corporation. In other words, Peñada could file a suit on behalf of the corporation claiming that
Brock’s breach of his fiduciary duties caused harm to the corporation. If the suit was successful, any damages
recovered would go to the corporation, not Peñada.
DEBATE THIS
Because most shareholders never bother to vote for directors, shareholders have no real control
over corporations. The statistics are indeed shocking—almost no shareholders of corporations ever bother
to vote for directors. Most shareholders don’t know who the directors are and clearly don’t know how publicly
held companies are governed. Therefore, even though on paper shareholders control corporations because
they can vote out bad directors, they really never do.
When a corporation is badly managed, that corporation’s stock price drops. That is because
shareholders vote with their “wallets” by selling the shares in that company, thereby lowering the price of the
stock. When the price of the stock gets low enough, outside groups attempt a takeover in order to put in
place their preferred group of directors. That’s how the market for corporate control works.
whole or in part.
EXAMPREP—
ISSUE SPOTTERS
1. Wonder Corporation has an opportunity to buy stock in XL, Inc. The directors decide that instead
of Wonder buying the stock, the directors will buy it. Yvon, a Wonder shareholder, learns of the
purchase and wants to sue the directors on Wonder’s behalf. Can she do it? Explain. Yes. A
shareholder can bring a derivative suit on behalf of a corporation, if some wrong is done to the corporation.
Normally, any damages recovered go into the corporate treasury.
2. Nico is Omega Corporation’s majority shareholder. He owns enough stock in Omega that if he
were to sell it, the sale would be a transfer of control of the firm. Discuss whether Nico owes a duty to
Omega or the minority shareholders in selling his shares. Yes. A single shareholder—or a few sharehold-
ers acting together—who owns enough stock to exercise de facto control over a corporation owes the cor–
poration and minority shareholders a fiduciary duty when transferring those shares.