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Chapter 47
MANAGEMENT OF CORPORATIONS
RESTATEMENT
Shareholders have only an indirect say in the management of the corporation in that they elect directors. But
they also have the right to vote on various corporate matters including amendments to the articles of
incorporation or mergers or consolidations. Shareholders usually vote for directors at the annual meetings and
may have special meetings for other matters. All meetings require notice and all states have quorum
requirements for shareholder representation at the meetings.
Directors who are elected by the shareholders manage the corporation. Directors ’ qualifications can be specified
by the articles of incorporation or bylaws, but, in the absence of such restrictions, anyone who has capacity to
contract can be a director.
Directors are given great discretion in the management of the company. In the absence of fraud or illegality,
courts will not intervene in the corporate governance process. Directors must use great caution to be certain that
they do not have conflicts of interest, where their loyalty is divided between their own interests and those of the
corporation. Directors are liable for the failure to exercise prudent business judgment. The directors must take
action on an informed basis, in good faith and with the honest belief that the action was in the best interest of the
company. Directors must exercise caution in takeovers because of the potential for self-interest. Corporations
are now entitled to pass amendments that permit corporations to indemnify directors for duty of care violations.
These indemnification provisions apply assuming there is no bad faith, breach of loyalty or improper personal
gain.
Directors delegate the day-to-day responsibilities to officers, agents and employees of the corporation. Directors
elect the officers, and the RMBCA allows for as many officers as the board desires and with any title. Officers
also have a fiduciary duty to the company and cannot make gains at the corporation ’s expense as when they
take a corporate opportunity. With the Dodd-Frank reforms, the issue of officer pay/compensation now includes a
shareholder vote – at least once every three years.
Officers and employees have authority to bind the corporation to third parties under the same rules of authority
covered in agency. Criminal liability can be imposed on officers and employees for conduct carried on for the
corporation. Examples of potential criminal liability statutes include licensing, environmental statutes and acts of
bribery prohibited under the Foreign Corrupt Practices Act. In some cases, federal statutes impose criminal
liability on corporate officers supervising the employees engaged in the conduct. The extent of the fines and
sentences are controlled under the Federal Sentencing Guidelines. Companies, through compliance and ethics
programs, can minimize their sentences under the guidelines.
STUDENT LEARNING OUTCOMES
LO.1: Explain how shareholders, as owners of the corporation, exercise limited control over management by
voting at shareholders' meetings to elect directors.
LO.2: Explain the qualifications and powers of directors.
LO.3: Explain the liability of directors and the meaning of the business judgment rule (BJR).
LO.4: Explain the obligation of officers – who have access to corporate information and agency powers – to
not violate their fiduciary duties to the corporation.
LO.5: Explain the rationale for the "say-on-pay" provision of the Dodd-Frank Act.
LO.6: Explain how directors, officers, and the corporation itself may be criminally liable for regulatory offenses.
INSTRUCTOR’S INSIGHTS
Break the chapter down into four components – related Learning Outcomes are indicated in ( ):
1. What is the role of shareholders in management of the corporation?
2. What are the role and power of directors in a corporation?
Discuss the qualifications of directors (LO.2)
Cover the powers of directors (LO.2)
3. What are the roles, authority, powers, and liability of the officers, agents, and employees of the corporation?
(LO.4)
4. What liability does a corporation have to third persons? (LO.5)
Discuss the liability of management to third persons
Explain when criminal liability can be imposed on the officers, directors and employees of a corporation
(LO.6)
CHAPTER OUTLINE
I. What is the Role of Shareholders in Management of the Corporation?
A. Extent of management control by shareholders
1. Management control is generally limited to the election of directors
2. Explain how shareholders function at a shareholders’ meeting
a. Regular meetings – annual
b. Special meetings
3. Action without meeting
II. What are the Role and Power of Directors in a Corporation?
A. Qualification
B. Powers of directors (See Figure 47-1 in text)
CASE BRIEF: Boston Athletic Association v. International Marathon, Inc.
467 N.E. 2d 58 (Mass. 1984)
FACTS: The Boston Athletic Association (BAA) is a nonprofit corporation created to sponsor the annual
Boston Marathon. In 1981, the BAA authorized William Cloney, president of the BAA, to
negotiate contracts for it. Cloney executed a contract with attorney Marshall Medoff, giving
Medoff exclusive power to promote the marathon. The BAA transferred to Medoff all rights to
use the marathon name and logos. The contract ’s financial terms were extremely favorable to
Medoff, who could renew the contract from year to year. When the BAA’s board members
learned of the contract, they declared that it was beyond the authorization vested in Cloney.
The board brought an action to have the contract set aside. Medoff contended that Cloney had
authority to make the contract and that therefore the contract bound the corporation.
ISSUE: Did Medoff have a contract with BAA? Did Cloney have authority?
REASONING: It is the obligation of the board to direct the corporation. Consistent with this obligation, a board
may delegate general managerial functions to corporate officers. But certain powers cannot be
delegated. The contract made with Medoff surrendered virtually complete control of the
marathon to Medoff. The board in this case improperly delegated to Cloney the authority to
make such a contract, which prevented accomplishment of the BAA’s corporate purpose, that of
sponsoring the marathon. Authority to make such a contract was beyond the power of the
board to delegate.
C. Conflict of interest
1. Conflict between personal interests and fiduciary interests
2. Disqualifies director
3. Unless interest disclosed and transaction fair and reasonable – The Sarbanes-Oxley Act of 2002
requires the SEC to adopt rules requiring "rapid and correct" disclosure of material changes in
D. Meetings of directors
E. Liability of directors
1. Directors have a fiduciary duty to the corporation
2. Directors who have acted in good faith and exercised reasonable care will not be liable for losses
resulting from an error in judgment. Locate some cases in your state in which directors lost the
3. The business judgment rule
a. Shield for directors
i. The traditional rule – informed, in good faith, and with an honest belief
CASE BRIEF: In re Walt Disney Co. Derivative Litigation
907 A. 2d 693 (Del. Ch. 2005)
FACTS: Michael Ovitz was a founder of Creative Artists Agency (CAA), a powerful Hollywood talent
agency. Because of the untimely death of Disney’s prior president in a helicopter crash, Disney
CEO, Michael Eisner, focused on hiring Ovitz as president. The Chairman of Disney’s
Compensation Committee, Irwin Russell, in consultation with Eisner negotiated Ovitz’s
employment agreement (OEA). As part of the OEA, if Disney fired Ovitz for any reason other
than gross negligence or malfeasance, Ovitz would be entitled to a Non-Fault Termination
(NFT) package consisting of his remaining salary for the five-year period, bonuses, and the
immediate vesting of stock options. The full Disney board of directors met and elected Ovitz
president of Disney. After joining Disney, it soon became apparent that a “mismatch of cultures
and styles” ensued and Ovitz was not succeeding as president. Eisner considered his options,
and he was advised that Ovitz had not been grossly negligent or malfeasant in his year at
Disney, and no cause existed to avoid the NFT payments. Eisner decided it was necessary to
terminate Ovitz on a non-fault basis and notified the board members. The board members
supported this decision under the NFT, and Ovitz was ultimately paid $140 million in severance
pay. Stockholders brought a derivative suit asserting that Eisner and the board of directors had
breached their fiduciary duties in connection with the hiring and termination of Ovitz.
ISSUE: Were Eisner’s and the board of directors’ actions a breach of fiduciary duty to Disney
shareholders?
REASONING: While Eisner’s actions should not serve as a model for directors and CEOs, and he failed to
keep the board informed and to better involve them in the process of hiring Ovitz, they were still
taken in good faith and did not breach his fiduciary duty of care because he was not grossly
negligent. The redress for failures that arise from faithful management (not in violation of
fiduciary duties) must come from the markets and not the courts.
DISCUSSION POINTS: Have the students discuss the In re Walt Disney Co. Derivative Litigation case in which
an unsuccessful action taken by directors was protected by the BJR.
CASE BRIEF: Smith v. Van Gorkom
488 A. 2d 858 (Del. 1985)
FACTS: Van Gorkom was interested in taking over Trans Union Inc., of which he was chairperson and
chief executive officer. After meeting with a takeover specialist, a $55-per-share offer was
made on September 18, providing for a decision to be made by the board no later than Sunday,
September 21. On Friday, September 19, Van Gorkom called a special meeting of the board of
directors with no announced agenda. At the meeting, he made a 20-minute oral analysis of the
merger. Copies of the proposed merger agreement were delivered too late to be studied
before or during the meeting. The merger was approved by the board at the conclusion of the
two-hour meeting. Shareholders sued the directors for damages, contending that the board ’s
decision was not the product of informed business judgment. The directors defended with the
business judgment rule. Decision was for the directors. The shareholders appealed.
ISSUE: Did the directors’ approval of the merger meet the requirements of the business judgment rule?
HOLDING: No. The business judgment rule is a presumption that in making a business decision, the
directors of the corporation acted on an informed basis, in good faith, and in the honest belief
REASONING: As a result of the Smith v. Van Gorkom decision, many states have passed laws, as set forth in
the text, that allow shareholders to approve a provision in the articles of incorporation, or an
amendment thereto, to protect directors from damages due to their gross negligence.
Generally, a court will not disturb the business judgment of the board of directors under the
business judgment rule unless fraud, illegality or a conflict of interest is present. This rule
serves to protect the director or officer from personal liability when this director or officer carries
out a transaction in good faith and with due care. The business judgment rule falls is within the
Duty of Care owed by the director or officer as a fiduciary duty to the corporation and
shareholders.
DISCUSSION POINTS: Have the students discuss the Smith v. Van Gorkom case in which directors were not
protected by the BJR because they were grossly negligent in their judgment.
III. What are the Roles, Authority, Powers, and Liability of the Officers, Agents, and Employees of the
Corporation?
A. Powers of officers
1. The powers are usually contained in bylaws
2. Can have powers by implication, custom – agency theories apply
5. Other officers and employees
B. Liability relating to fiduciary duties
1. Corporate opportunities – discuss diverting a corporate opportunity; full disclosure
To help the students visualize corporate opportunities, create some simple examples. Emphasize
that it is not always clear what is a corporate opportunity. It should be fairly easy to expand on your
CASE BRIEF: Demoulas v. Demoulas Super Markets, Inc.
677 N.E. 2d 159 (Mass. 1997); see also 787 N.E. 2d 1059 (Mass. 2003)
FACTS: Demoulas Super Markets, Inc. (DSM) was owned by brothers George and Telemachus
Demoulas, each owning an equal number of shares of stock. From 1964 through May 1971, the
company grew from 5 stores to a chain of 14 supermarkets, including 2 stores in New
Hampshire. George died suddenly on June 27, 1971, and at his death, Telemachus assumed
control of DSM under the terms of a voting trust. In 1990, George ’s son Arthur, age 22 and a
shareholder of DSM, brought a shareholder derivative action on behalf of DSM, contending that
since George’s death Telemachus had diverted business opportunities away from DSM into
other businesses that were solely owned by Telemachus’s branch of the family. The evidence
showed that in the 1970s two new corporations were formed and operated supermarkets in New
Hampshire; DSM supplied the financing and management, but ownership was held in
Telemachus’s sister’s and daughter’s names. By 1986, these stores grew into a single
supermarket chain operating under the Market Basket name and entirely owned by members of
Telemachus’s branch of the family. The trial court judge determined that Telemachus diverted
these corporate opportunities from DSM, and the court ordered the transfer back to DSM of the
assets and liabilities of the new corporations. In her decision, the judge cited lines from
Ulysses, by Alfred, Lord Tennyson, in which Ulysses speaks lovingly of his son, Telemachus,
expressing the belief that he would rule wisely and decently after his death. Telemachus denied
that any acts were improper or gave rise to liability and charge that the judge was not impartial,
as evidenced by her quotation from Tennyson’s poem.
ISSUE: Did Telemachus divert corporate opportunities?
REASONING: Judicial bias was not present, and the literary reference was simply the judge ’s stylistic way of
stating the theme of her decision against Telemachus, based on the facts she had found.
Telemachus had a fiduciary duty to DSM. A fiduciary violates his duty of loyalty by advancing
the pecuniary interests of a child or a sibling in a manner that would constitute a breach if he
had acted for himself. The record is clear that the New Hampshire companies were set up
under Telemachus’s direction and were independent in name only, with DSM managing and
financing them. The return to DSM of the assets and liabilities of the diverted business was the
proper remedy.
DISCUSSION POINTS: Have the students discuss the Demoulas v. Demoulas Super Markets, Inc. case
regarding diverting corporate opportunities.
CASE BRIEF: Security Title Agency, Inc. v. Pope
200 P. 3d 977 (Ariz. App. 2008)
FACTS: Linda Pope ran one of the largest and most successful title insurance branches in the
title insurance industry for Security Title Insurance. First American Title Insurance sought to
regain its top position in title insurance sales through its Talon division by recruiting key people
from other companies who had relationships with key customers and other key employees.
Talon recruited Pope. While still employed by Security Title, Pope secretly solicited key
management employees to join Talon First American. She arranged to inform employees about
Talon’s beneficial compensation, signing bonuses, medical benefits, and superior computer
system. Security Title sued Pope for breach of fiduciary duty of loyalty and sued Talon-First
American for aiding and abetting Pope. Pope defended that she was merely making
arrangements to compete in the future.
ISSUE: Did Pope breach her fiduciary duty to Security Title by improperly recruiting Security
Title employees for Talon while she was still employed by Security Title?
REASONING: Pope secretly solicited key management employees to join a competitor and enticed
employees to leave by telling them of bonuses and benefits.
DISCUSSION POINTS: Have the students discuss the Security Title Agency, Inc. v. Pope case regarding a
manager's duty of loyalty.
DISCUSSION POINTS: Ethics & the Law
Executive Compensation
Discuss whether market demand should set executive compensation or whether executives should have to be
more accountable for their performance. Have students discuss whether say-on-pay legislation is likely to cause
CEOs to pay more attention to shareholders’ opinions.
D. Executive compensation under Dodd-Frank
1. Say-on-pay – nonbinding shareholder vote to approve or disapprove executive compensation
2. Independent compensation committees
3. Pay for performance
4. Clawback of erroneously awarded compensation
IV. What Liability Does a Corporation Have to Third Persons?
A. Liability of management to third persons
1. Generally not liable for effect of management or advice
B. Criminal liability
1. Directors are liable for crimes they commit
2. Active participation in certain crimes renders officers liable (Environmental Foreign Corrupt Practices
Act)
3. Controlling persons can also be liable
DISCUSSION POINT: Thinking Things Through
Responsible Corporate Officers − The Park Doctrine Revisited
Ask students to discuss whether officers should be criminally responsible for harm caused by their products.
C. Indemnification of officers, directors, employees, and agents
D. Liability for corporate debts – as a legal person, the corporation itself is usually liable for debts
ANSWERS TO QUESTIONS AND CASE PROBLEMS
1. Business Judgment Rule. The board of directors approval of the merger did not subject them to liability
because their decisions were protected by the Business Judgment Rule. Relying on teams of legal and
2. Director liability for board of director decisions. The board of directors had no actual knowledge that BAG’s
work was deficient. Accordingly, the trial judge determined that the board members had acted in good faith
and should not be held personally liable for approving a merger plan based on the flawed evaluations of an
outside “expert”. Under state law directors must “discharge their duties in good faith and with that degree of
3. Directors’ conflicts; responsibilities; disclosure requirements. Dunaway’s duty was to the Dunaway stores, not
4. Privilege of officers and directors to interfere with contracts. Judgment for Phillips as to the corporation.
Judgment against Phillips as to the individual defendants. When a corporation breaks a contract, it is liable
for breach of the contract, regardless of why it broke the contract. The fact that officers or employees
5. Criminal liability of the corporation. Judgment against the corporation. Christy Pontiac, not Hesli, received the
GM rebate money, so it is clear that Hesli acted in furtherance of the corporation ’s interests. When one of the
buyers complained to the corporation’s president, he attempted to negotiate a settlement and did not contact
6. Liability relating to fiduciary duties. Swinnea owed fiduciary duties to both ERI, the corporation, and to
Snodgrass. Fraudulently inducing the buyout agreement contracts were breaches of his fiduciary duty. The
actual profits lost were $178,000. Punitive or exemplary damages are in order in this case. A fiduciary may be
7. Power of corporate president. Courts differ as to the right of the president to hire a person who is as
important to the corporation as a sales manager. If the president is also the general manager of the
Under any view, the president would not have authority by virtue of being president to make the contract
insofar as the compensation is concerned. The promise to pay the new sales manager a percentage of the
8. Secret profits of corporate officers. Judgment against Grassgreen. The corporation did lose the commitment
fees over the five-year period before it was discovered, and only after he was caught did Grassgreen return
the fees to the corporation. Clearly the fact that Grassgreen elected to secretly divert the fees to himself
9. Appropriation of business opportunity; ethical principles of conflict of interest, loyalty, fairness, doing no harm,
integrity [Preface]. Judgment for SE. Officers, such as general managers, may avail themselves of
opportunities outside the field of their business when the opportunities come to them on an individual basis.
Certain ethical principles set forth in Figure 1 of the Preface were violated in this case. Hill acted in conflict
with SE’s interests when he took for himself the opportunity that should have been obtained for SE. This was
10. Conflict of interests. The statement is not correct. There is no flat rule against a director ’s lending money to
the corporation. This is so, even though it does give rise to a situation of conflicting interests because as
creditor, the director will desire to take steps to collect the debt, regardless of the effect on the corporation.
In contrast, as director, there will be the desire to prevent the enforcement of the debt if that would harm the
corporation. In spite of this possible conflict, it is proper for a director to lend money to the corporation when
Once it is concluded that the lending transaction was proper, the director may then enforce rights as creditor
11. Appropriation of a corporate opportunity; ethical principles regarding conflict of interest, loyalty, doing no harm,
integrity [Preface]. The directors had an obligation to act in a fiduciary capacity for the benefit of the
shareholders and not themselves. They were not free to set salaries for themselves as officers that
amounted to a waste of corporate assets. Their fiduciary duties owed to the corporation and the
The directors violated the ethical principles of doing no harm, loyalty, and conflict of interest in that they took
corporate funds under the guise of pay though little time or talent was actually devoted to the business of the
12. Authority of president. No. The president of a corporation is not the fiscal officer and therefore has no
implied authority to cash checks drawn to the order of the corporation. Ordinarily, checks drawn to the
corporation would be deposited in its account, and any money to be spent would then be paid on the basis of
13. Appropriation of a corporate opportunity; ethical principles regarding conflict of interest, loyalty, doing no harm,
integrity. Judgment for Berlinair Inc. An officer may take advantage of a corporate opportunity only after full
In this case, Lundgren did not offer the opportunity to Berlinair. He thus breached his fiduciary duty to that
Certain ethical principals set forth in Figure 1 appear to apply to this case. You might ask your students
whether Lundgren had a conflict of interest when he formed a new corporation to bid for the BFR charter
contract. Were the ethical principles of loyalty, fairness, doing no harm, and integrity violated by Lundgren,
14. Liability relating to fiduciary duties. Judgment for Abbott. The court stated:
A former employee may, of course, go into competition with his ex -employer and can use general
information concerning the method of business and names of customers of his ex -employer in his
new venture.... But he cannot, as here, utilize specific information he obtained during his
15. Conflict of interests. As president, Gurtler had a fiduciary duty to the corporation. He clearly violated this duty
by encouraging the plant manager to leave, selling products to his son at reduced prices to be resold to
Gurtler’s action were so improper that it might be argued that he knew nothing of the law relating to an
LAWFLIX
Smartest Guys In The Room (2005) (R)
The story of the Enron executives and their ploys that duped creditors, shareholders, and employees.
To access additional videos that illustrate business law concepts, visit www.cegage.com/blaw/dvl.
management system for classroom use.
