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Suggested Additional Assignments
Research: State Anti-Takeover Provisions
Have students research whether their state corporation code has any provisions designed to protect local
companies from takeovers.
Research: Wallace Computer Services, Inc.
Research the attempted takeover of Wallace Computer Services, Inc. by the Moore Corp. Ask students to
determine what has happened to Wallace and the price of its stock since 1995. How has Wallace fared in
comparison with the S&P 500? Alternatively, students could choose any company that successfully
fought off a takeover attempt and compare its stock price over the following few years with the offered
price and the market in general.
Wallace Computer Services turned down a $60 per share offer for its stock. Several years later, its stock
was trading for $15.44. The board essentially ignored the interests of shareholders, at least in the short
run. In contrast, faced with pressure from a large shareholder to put Chase Manhattan “in play,” bank
executives pondered the possibility of laying off workers to increase profits. These executives were
putting the interests of shareholders ahead of long-term employees.
Question: What do managers want?
Question: What do shareholders want?
General Questions: What should Wallace and Chase have done? With whose welfare were
executives concerned? Whose welfare should they have considered? Did the Chandler family,
featured in the text, do the wrong thing when it sold The Los Angeles Times?
Research: Unsuccessful Takeovers
Have students research takeovers that have not performed as well as expected. Were the shareholders of
the individual companies better off before the takeover? What are the options for the resulting company?
Chapter Overview
Chapter Theme
Directors have the authority to manage the corporate business, but they also have important
responsibilities to shareholders. They may also be responsible to other stakeholders—employees,
customers, creditors, suppliers, and neighbors—who are affected by corporate decisions. This chapter is
about the rights and responsibilities of directors and officers.
Quote of the Day
“Corporations, which should be the carefully restrained creatures of the law and the servants of the
people, are fast becoming the people’s masters.” –Grover Cleveland (1837-1908), United States
president.
conflict: Managers, Shareholders, and
Stakeholders
The courts have generally held that managers have a fiduciary duty to act in the best interests of the
corporation’s shareholders. Does the law permit—or require—directors to consider the best interests of
other stakeholders?
Landmark Case: Unocal Corp. v. Mesa Petroleum Co.1
Facts: Mesa Petroleum Co. offered to purchase 64 million shares of Unocal’s stock at a price of $54 per
share. Upon merger of the two companies, Mesa planned to exchange the remaining Unocal shares for
“junk bonds” that Mesa (but no one else, including the court) valued at $54 per share. Unocal’s
investment bankers advised the board of directors that any offer of over $60 per share would have been
reasonable. The board rejected the Mesa offer and then made its own competing offer of $72 per share to
all shareholders except Mesa (called a “selective exchange offer”). This offer effectively preempted
Mesa, because no shareholder would accept the $54 Mesa offer when the $72 Unocal offer was also
available. The Delaware court issued a temporary restraining order against Unocal’s offer unless it
included Mesa.
Issues: Could Unocal make an offer to buy stock from all shareholders except Mesa? In making this
offer, did Unocal have the right to consider the interests of other stakeholders?
Holding: The court upheld Unocal’s right to offer a selective stock repurchase on the following grounds:
The board had a fiduciary duty to act in the best interests of the corporation’s
shareholders.
The board could not offer the selective stock repurchase simply to perpetuate itself in
office, but in making the offer, it could consider the interests of other constituencies, such as
creditors, customers, employees, and even the community generally.
The board could also consider the interests of long-term investors over short-term
speculators.
Question: What was the purpose of the Unocal “selective stock repurchase”?
Question: Why did the board care if Mesa took over the company?
Answer: Pickens (the Mesa CEO) would have replaced the board of directors. In addition, Pickens
Question: According to the court, what is the board’s obligation in this situation?
Answer:
To act in the best interests of the corporation’s shareholders.
Question: Did it act in the best interests of the corporation’s shareholders?
Answer: Shareholders clearly preferred the company’s $72 per share offer to Mesa’s questionable
Question: What about the other stakeholders the court mentions: creditors, customers, employees,
and the community?
Answer: These stakeholders would probably prefer to maintain their stable relationships with current
Question: Why would the community care?
Answer: Because Mesa would probably move company headquarters and fire employees. For
1 493 A.2d 946, 1985 Del. LEXIS 482 Supreme Court of Delaware, 1985
Question: Traditionally, under corporate law, the board’s primary responsibility was to act in the best
interests of the corporation’s shareholders. Since when is the board supposed to consider other
stakeholders and long-term investors over short-term speculators?
Answer: Good question. There really is no precedent for this decision in corporate law. The
Question: Was the board really acting out of concern for shareholders and stakeholders?
Answer: That is the problem with all the takeover cases. It is hard to dismiss the belief that the
board is hiding behind the stakeholders to protect itself. It would be unacceptably greedy for the
General Question: Did the court decide this case correctly?
Shareholders
Under the business judgment rule, the courts allow managers great leeway in carrying out their fiduciary
duty to act in the best interests of their stockholders. The business judgment rule is two shields in one: it
protects both the manager and her decision. If a manager has complied with the rule, a court will not hold
her personally liable for any harm her decision has caused the company, nor will the court rescind her
decision. Analysis of the business judgment rule is typically divided into two parts: the duty of loyalty
and the duty of care.
Duty of Loyalty
The duty of loyalty prohibits managers from making a decision that benefits them at the expense of the
corporation.
Self-Dealing
Self-dealing means that a manager makes a decision benefiting either himself or another company with
which he has a relationship.
Case: In re S. Peru Copper Corp. Shareholder Derivative Litig2
Facts: Grupo Mexico was the controlling stockholder of Southern Peru Copper Corporation (SPC), an
NYSE-listed mining company. Grupo also owned 99 percent of the stock of Minera Mexico, a Mexican
mining company that was not publicly traded. Grupo offered to trade all its Minera stock for $3.1 billion
of SPC shares. Because of Grupo’s self-interest, SPC’s board formed a special committee of disinterested
SPC directors to evaluate the proposal. (The board knew that, in the event of litigation, the court would
examine the underlying fairness of the transaction, but it hoped that approval by the special committee
would influence the court’s decision.)
The committee’s financial advisor, Goldman Sachs, used many scenarios to run the numbers, but
could not find any way to value Minera’s stock at more than $2.8 billion. Rather than tell Grupo to go
mine itself, the special committee stretched to develop some plausible story about why Minera was indeed
worth the price Grupo was asking. So, for example, it tried “optimizing” Minera’s cash flows, but not
SPC’s, ignoring the fact that Minera was struggling, while SPC was thriving and nearly debt-free.
2 52 A.3d 761 Court of Chancery of Delaware, 2011
In the end, SPC’s committee approved Grupo’s offer and then stuck with it, even as SPC’s stock price
climbed. In the end, SPC paid $3.75 billion for Minera.
SPC’s minority shareholders filed suit against its board of directors, alleging that the Minera purchase
was entirely unfair. The court, however, dismissed the case against the members of the special committee
because SPC’s charter had an exculpatory clause that protected directors who had not received any
improper personal benefit. The suit continued against the directors who were employed by Grupo.
Issue: Were the board members liable for their decision?
Holding: The Special Committee members were competent, well-qualified individuals with business
experience. Moreover, the Special Committee was given the resources to hire outside advisors, and it
hired respected, top tier of the market financial and legal counsel. [T]here is little question but that the
members of the Special Committee met frequently. Their hands were on the oars. So why then did their
boat go, if anywhere, backward?
This is a story that is, I fear, not new.
From the get-go, the Special Committee extracted a narrow mandate, to evaluate a transaction
suggested by the majority stockholder. Thus, the Special Committee fell victim to a controlled mindset
and allowed Grupo to dictate the terms and structure of the Merger. [T]his acceptance took off the table
other options that would have generated a real market check and also deprived the Special Committee of
negotiating leverage to extract better terms.
Even if the practical reality is that the controlling stockholder has the power to reject any alternate
proposal it does not support, the special committee still benefits from a full exploration of its options.
What better way to “kick the tires of the deal proposed by the self-interested controller than to explore
what would be available to the company if it were not constrained by the controller’s demands?
[Instead, throughout] the negotiation process, the Special Committee’s and Goldman’s focus was on
finding a way to get the terms of the Merger structure proposed by Grupo to make sense, rather
than aggressively testing the assumption that the Merger was a good idea in the first place.
A reasonable third-party buyer free from a controlled mindset would not have ignored a fundamental
economic fact that is not in dispute here—SPC stock could have been
sold for the price at which it was trading on the New York Stock Exchange. What it did was to turn the
gold that it held (market-tested SPC stock worth in cash its trading price) into silver (equating itself on a
relative basis to a financially-strapped, non-market tested selling company), and thereby devalue its own
acquisition currency. Goldman was not able to value Minera at more than $2.8 billion, no matter what
valuation methodology it used, even when it based its analysis on Minera management’s unadjusted
projections.
For all these reasons, I conclude that the Merger was unfair. Because the deal was unfair, the
defendants breached their fiduciary duty of loyalty.
[The defendants must pay $1.347 billion.]
Question: What is the duty of loyalty?
Answer: The duty of loyalty prohibits managers from making a decision that benefits them at
Question: How was the duty of loyalty violated given that a Special Committee was formed to
evaluate the merger?
Answer: The Special Committee was focused on finding a way to get the terms of the merger
Corporate Opportunity
Managers violate the corporate opportunity doctrine if they compete against the corporation without its
consent. However, even if managers do not seek permission in advance, they are not in violation of the
corporate opportunity doctrine if they can demonstrate after the fact that the company would not have
been able to benefit from the opportunity.
Case: Anderson v. Bellino3
Facts: Richard Bellino and Robert Anderson formed LaVista Lottery, Inc. (Lottery) to operate a
restaurant, lounge, and keno game in LaVista, Nevada. They each owned 50 percent of the stock of
Lottery, and both were officers and directors. Over the next nine years, the Lottery company grossed
more than $100 million. Bellino and Anderson each received over $4 million in salary and dividends.
Bellino spent more time than Anderson working for the company, in part, because of his personal
relationship with Lottery’s lounge manager. Frustrated by Anderson’s unequal contribution, Bellino
encouraged the city of LaVista to solicit new bids for the keno contract. Bellino incorporated LaVista
Keno, Inc. (Keno) to bid on the contract. He was Keno’s sole shareholder.
When Bellino submitted a bid on behalf of Keno, he was still an officer of Lottery, as well as a
director and a 50% shareholder. Anderson also bid on the contract on behalf of Lottery. The city awarded
the new contract to Keno.
Anderson and Lottery sued Bellino and Keno, alleging that they had usurped a corporate opportunity.
The trial court found for Anderson and Lottery.
Issues: Did Bellino usurp a corporate opportunity? Is he liable to Lottery?
Holding: Judgment for Anderson and Lottery affirmed. Bellino and Keno claim that if a corporate
opportunity existed, it was limited to the opportunity to bid on the keno contract and that Bellino did
nothing to impede Lottery from bidding. In fact, the corporate opportunity was the contract itself, not just
the right to bid on it. Bellino should not have competed with Lottery.
Question: What business was LaVista Lottery in?
Question: What is keno?
Question: Was this a profitable business?
Question: So what was the problem?
Question: Did Bellino discuss his concerns with Anderson?
Question: What did he do?
Question: Is there anything wrong with that?
Answer: The corporate opportunity doctrine requires any manager who comes across a good
Question: What is the point of this doctrine?
Answer: It protects shareholders. While working for their companies, managers come across many
Question: But both Bellino and Anderson had a chance to bid on the keno contract. Didn’t they both
have the same opportunity?
3 265 Neb. 577; 658 N.W.2d 645; 2003 Neb. LEXIS 49 Supreme Court of Nebraska, 2003
Answer: The court held that the opportunity was running the keno game not just the right to bid on
Additional Case: Northeast Harbor Golf Club, Inc. v. Harris4
Facts: Nancy Harris was the president of the Northeast Harbor Golf Club in Maine for nearly 20 years.
The club’s only major asset was a golf course in Mount Desert. Harris was definitely a generous
president. She not only mowed the grass and did the gardening, she also used her own money to purchase
equipment for the club. Twenty years ago, a real estate broker informed Harris that three parcels of land
next to the golf course were for sale. The agent contacted Harris because she was the president of the
club and he believed that the club would be interested in buying the property to prevent development.
Harris immediately agreed to purchase the property in her name. Afterwards, she informed the club’s
board that she had made the purchase and that she did not intend to develop the land. Harris purchased
yet another parcel of land contiguous to the golf course. Again, she informed the board of directors after
the purchase.
The club continually experienced financial difficulties, operated annually at a deficit, and depended
on contributions from the directors to pay its bills. There was evidence, however, that the club had
occasionally engaged in successful fund-raising and had $90,000 in a capital investment fund.
Five years after her last purchase, Harris began the process of obtaining approval for a five -lot housing
development. The club sued her for violating the corporate opportunity doctrine. The trial court found
that Harris had not usurped a corporate opportunity because the acquisition of real estate was not in the
club’s line of business, and the corporation lacked the financial ability to purchase the real estate. The
club appealed.
Issue: Did Harris violate the corporate opportunity doctrine?
Holding: Judgment for Harris reversed. Instead of determining on her own that the club could not afford
the land, Harris should have given the board the opportunity to make that decision. Although the club
was in the business of operating a golf course, owning land was an inherent part of that business. Harris’s
new development could have infringed on the value of the club’s land and its ability to operate the course.
However, the SJC ordered the case dismissed because the statute of limitations had run out before the
club filed suit.
Question: Did Harris compete with the golf course?
Answer: The trial court held that she did not, because real estate was not in the club’s line of business
and the club couldn’t have afforded it anyway. The SJC disagreed, holding that:
Question: To what damages would the club be entitled?
Question: Is that what the club wants?
Answer: Probably the club would prefer that the property not be developed at all. In other words, it
Duty of Care/Rational Business Purpose
In the Wrigley case, the court held that the company did have a rational business purpose. One
commentator suggested that finding a case in which a court held that a board decision did not have a
4 1999 ME 38, 725 A.2d 1018, 1999 Me. LEXIS 36 Maine Supreme Judicial Court, 1999
“rational business purpose” was like looking for a very small number of needles in a very large haystack.
Some writers suggest that one should not even pretend that the rule exists since it exists only in theory.
Other writers argue that, while there are few reported cases, many of the cases settle out of court. The
mere existence of the rule keeps managers honest.
Legality/Informed Decision
Case: RSL Communications v. Bildirici5
Facts: Ronald S. Lauder founded RSL, Ltd., a multinational telecommunications corporation that
provided voice, mobile, and data/internet services. RSL Plc was a subsidiary of RSL Ltd. The subsidiary
began issuing $1.4 billion of bonds. A few years later, in July, Lauder provided RSL Plc with a $100
million line of credit. The company’s board of directors did not hold a meeting to approve the line of
credit, but in August drew down $25 million from the loan. The following March, the company’s board
held their first meeting in a year. Five days later, RSL Plc filed for bankruptcy.
The issue before the court is whether the members of the board of directors of RSL Plc breached their
duty of care to the company when they failed to hold a meeting for a year at a time when the company
was in such a precarious financial position.
Issue: Did the directors of RSL Plc violate their duty of care to the corporation?
Holding: Yes, the board violated its duty of due care. According to the court, under New York law, a
director shall perform his duties as director, in good faith and with that degree of care which an ordinarily
prudent person in a like position would use under similar circumstances. This duty requires that a
director’s decision be made on the basis of reasonable diligence in gathering and considering material
information.
When faced with allegations of misconduct, a director may raise the business judgment rule as a
defense. The business judgment rule applies even where conclusions were stupid or irrational, as long as
the process employed was either rational or employed in a good faith effort to advance the corporation. A
director must show an exercise of judgment, not simply the existence of a business decision. Thus, where
the director’s methodologies and procedures are so halfhearted or restricted in scope as to constitute a
pretext or a sham, their acts are not protected by the business judgment rule.
RSL Plc did not hold board meetings on behalf of RSL Plc during the time period relevant here.
Despite this, RSL Plc still operated and took actions such as drawing down $25 million from the loan,
apparently at the direction of RSL Ltd. However, no independent board meeting or discussions regarding
the propriety of this and other business decisions were held on behalf of RSL Plc.
The law does not tolerate inaction of this sort. RSL Plc allegedly failed to consider any information
regarding the company’s financial health and allegedly failed to make a business judgment as a board
regarding any financial decisions on behalf of RSL Plc.
RSL Plc argues that closely held corporation with directors who are frequently in contact with one
another do not have to abide by such formalities as board meetings when making business decisions.
However, RSL Plc is not a small company; it has accrued $1.4 billion in debt. Although some of RSL
Plc’s board members had some contact, there were no behind the scenes meetings where the business of
RSL Plc was discussed.
Lastly, RSL Plc argues that its board members were fully informed about the financial situation of the
company because some RSL Plc board members were also RSL ltd board members, and thus they
exercised their judgment on behalf of RSL ltd, the parent of RSL Plc. However, individuals who act in a
dual capacity as directors of parent and subsidiary corporation owe the same duty of good management to
both corporations.
5 2006 U.S. Dist. LEXIS 67548, United States District Court for the Southern District of New York,
2006.
Question: The board members of RSL Plc and RSL Ltd overlapped. RSL Plc claims that because of
this overlap, both boards were aware of what was going on with RSL Plc. Shouldn’t that make a
difference when determining whether the board of RSL Plc was making an informed decision?
Answer: The court does not think so. The court expressly rejected that argument, stating that it
Question: Does the fact that the board did not formally meet to discuss the loan or the draw down
mean that the members acted improperly?
Answer: Not necessarily. What the court said was that because the board did not meet, the directors
failed to follow proper procedure. Because the directors are faced with allegations of misconduct, in
order to defend themselves by using the business judgment rule, the directors would have to show that
