969
Chapter 40
Corporate Directors, Officers,
and Shareholders
See Separate Lecture Outline System
INTRODUCTION
Sometimes, actions that benefit a corporation as a whole do not coincide with the separate interests of the individuals
making up the corporation. In considering those situations, it is important for your students to be aware of the rights and duties
of the participants in the corporate enterprise.
970 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
ADDITIONAL RESOURCES—
VIDEO SUPPLEMENTS
The following video supplements relate to topics discussed in this chapter—
PowerPoint Slides
To highlight some of this chapter’s key points, you might use the Lecture Review PowerPoint slides compiled for
Chapter 40.
Business Law Digital Video Library
The Business Law Digital Video Library at www.cengage.com/blaw/dvl offers a variety of videos for group or
individual review. Clips on topics covered in this chapter include the following.
• Real World Legal
CHAPTER OUTLINE
I. Roles of Directors and Officers
Directors act for and on behalf of their corporation, but no individual director can act as an agent to bind the corpora-
tion, and directors collectively control a corporation in a way that no agent can control a principal. Directors hold
positions of trust and control over their corporation, but unlike trustees, they do not own or hold title to property for
the use and benefit of others.
A. ELECTION OF DIRECTORS
The number of directors is stated in the articles or bylaws. Close corporations may eliminate the board
altogether. The incorporators, or the corporation in the articles, appoint the first board, which serves until the
first shareholders’ meeting. A majority vote of the shareholders elects subsequent directors. Directors typically
serve for a year or more.
2. Vacancies on the Board of Directors
A vacancy can occur through a director’s death or resignation or if a new position is created.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 971
B. COMPENSATION OF DIRECTORS
C. BOARD OF DIRECTORS’ MEETINGS
The dates for regular board meetings are set in the articles and bylaws or by board resolution, without further
notice. A quorum is generally a majority of the number of authorized directors. Each director has a vote [RMBCA
8.24] Ordinary matters require majority approval; certain extraordinary matters may require more.
D. RIGHTS OF DIRECTORS
Directors’ basic right is to participate in management, which includes a right to be notified of board meetings, and
to have access to all corporate books and records. Most states (and RMBCA 8.51) permit a corporation to
indemnify a director for costs, fees, and judgments in defending corporation-related suits.
ENHANCING YOUR LECTURE—
THE TIMING OF DIRECTORS’ ACTIONS
IN AN ELECTRONIC AGE
Corporate directors can hold special board meetings to deal with extraordinary matters, provided that they give
proper notice to all members of the board. If a special meeting is called without giving sufficient notice to all of the
directors, are the resolutions made at that meeting invalid? If so, can the directors validate these resolutions by
holding a second special board meeting with proper notice? In today’s electronic age, matters of timing can be
complicated and can affect a variety of other issues, including the effective date of a director’s resignation and the
validity of a resolution appointing a new director. These were the central issues presented by In re Piranha, Inc.a
THE ISSUE OF PROPER NOTICE
972 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
directors. The SEC form stated that Steele had resigned as director and contained Steele’s electronic signature.
THE SECOND MEETING
By early June, Piranha’s legal counsel concluded that insufficient notice had probably rendered the May 25
meeting—and the resolutions made at that meeting—invalid. The attorneys informed the directors that, to effect the
changes to the board, they would need to call another special meeting and provide sufficient notice. A second special
meeting was held on June 15 with proper notice (to Berger, Sample, and Steele), and Churchill was voted in as a
director. Steele, now confident that Churchill was validly appointed as a director, submitted his written resignation the
following day.
THE COURT’S CONCLUSION
Ultimately, a federal appellate court held that Steele’s electronic signature on the SEC filing did not operate as his
formal resignation. Under the Uniform Electronic Transactions Act (UETA), a signature may not be denied legal effect
solely because it is in an electronic form. Section 107(a) of the UETA, however, also allows a person to disavow the
signature. Here, Steele claimed that he did not authorize his signature on the form submitted to the SEC. Therefore,
the court found that Steele had not resigned until he submitted his written resignation following the second meeting.
Thus, Churchill was a corporate director and could vote for the corporation to file bankruptcy.
FOR CRITICAL ANALYSIS
What would the legal consequences have been if Berger had attended the first special board meeting despite the
lack of sufficient notice?
E. COMMITTEES OF THE BOARD OF DIRECTORS
1. Executive Committee
2. Audit Committee
3. Nominating Committee
Chooses candidates on which shareholders vote for the board of directors [RMBCA 8.25].
5. Litigation Committee
Decides whether to pursue litigation on behalf of the corporation.
F. CORPORATE OFFICERS AND EXECUTIVES
II. Duties and Liabilities of Directors and Officers
Directors and officers are corporate fiduciaries.
974 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
A. DUTY OF CARE
The duty of care includes acting in good faith and in the best interests of the corporation, and exercising the care
that an ordinarily prudent person would use in similar circumstances [RMBCA 8.30(a), 8.32(a)]. Breach of the duty
may result in liability for negligence.
1. Duty to Make Informed and Reasonable Decisions
2. Duty to Exercise Reasonable Supervision
Directors must exercise reasonable supervision when work is delegated.
3. Dissenting Directors
4. The Business Judgment Rule
Directors and officers are immune from liability when a decision is within managerial authority, as long as the
decision complies with management’s fiduciary duties, acting on the decision is within the powers of the
corporation, and—
• `The director took reasonable steps to become informed about the matter.
• `The director had a rational basis for the decision.
• There was no conflict of interest between the director’s personal interest and the interest of the
corporation.
ANSWER TO CRITICAL THINKING QUESTION IN THE FEATURE—
INSIGHT INTO ETHICS
If courts were to ignore the business judgment rule, what might the consequences be? Obviously, if directors and
officers cannot use the business judgment rule as a defense when, after the fact, they made an incorrect decision,
B. DUTY OF LOYALTY
Directors and officers must subordinate their self-interest to the interest of the corporation. This means that they
should not—
• Compete with the corporation.
Case 40.1: Guth v. Loft, Inc.
Loft, Inc., made and sold candies, syrups, beverages, and food in Long Island City, New York. Loft operated 115
retail outlets in several states and also sold its products wholesale. Charles Guth was Loft’s president. Guth and his
family owned Grace Co., which made syrups for soft drinks. Guth acquired the trademark and formula for Pepsi-Cola
and formed Pepsi-Cola Corp. but neither Guth nor Grace could finance the venture. Without the knowledge of Loft’s
board, Guth used Loft’s capital, credit, facilities, and employees to further the Pepsi enterprise. Guth also made Loft a
Pepsi customer. Eventually, losing profits at its stores as a result of switching from Coca-Cola, Loft filed a suit in a
Delaware state court against Guth and others, seeking their Pepsi stock and an accounting. The court entered a
judgment in the plaintiff’s favor. The defendants appealed.
The Delaware Supreme Court upheld the judgment. The state supreme court was “convinced that the opportunity
to acquire the Pepsi-Cola trademark and formula, goodwill and business belonged to [Loft], and that Guth, as its
committed to his charge, but also to refrain from doing anything that would work injury to the corporation.” Thus “if
of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize
…………………………………………………………..……………………………………………………………………
Notes and Questions
How could this case have been brought before courts in Delaware? Grace and Pepsi were both incorporated in
Delaware..
After the decision in the Guth case, the rule applied with respect to corporate transactions involving interested
directors was that, when a matter in which they had an interest came before their board for a vote, their vote was not
counted. Courts could therefore hold the transactions voidable. (Under that rule, of course, Guth’s vote on Pepsi’s use
of Loft’s resources could have voided the deal even if he had proposed it to Loft’s board.
Is this still the rule? No, at least not in Delaware, where Guth was decided. In 1967, Delaware altered this rule with
(1) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are
known to the board of directors or the committee, and the board or committee in good faith authorizes the
contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the
disinterested directors be less than a quorum; or
(2) The material facts as to his relationship or interest and as to the contract or transaction are disclosed or are
known to the shareholders entitled to vote thereon, and the contract or transaction is specifically approved in
good faith by vote of the shareholders; or
(3) The contract or transaction is fair as to the corporation as of the time it is authorized, approved or ratified, by
the board of directors, a committee or the shareholders..
board of directors or of a committee which authorizes the contract or transaction..
In taking advantage of Loft’s capital and facilities, Pepsi-Cola was utilizing resources that arguably might otherwise
have gone unused. Why did the court rule against this “resourcefulness”? The principal reason that the court would not
accept this argument is that Loft’s resources belonged to Loft, not Guth, who used them without Loft’s permission.
Guth referred to it as “borrowings.” The court was “certain it is that borrowing is not descriptive of them. A borrower
presumes a lender acting freely. Guth took without limit or stint from a helpless corporation . . . without the
knowledge or authority of the corporation’s Board.”. He “commandeered for his own benefit and advantage the
money, resources and facilities of his corporation and the services of its officials. He thrust upon Loft the hazard, while
he reaped the benefit. . . . A genius in his line he may be, but the law makes no distinction between the wrong doing
genius and the one less endowed.”
ANSWER TO “WHAT IF THE FACTS WERE DIFFERENT?” IN CASE 40.1
Suppose that Loft’s board of directors had approved Pepsi–Cola’s use of its personnel and equipment. Would the
court’s decision have been different? Discuss. Possibly. Guth contended that the Loft board had approved Pepsi’s use
committee which authorizes the contract or transaction, or solely because his or their votes are counted for such
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 977
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Recent cases involving conflicts between a corporate official’s personal interest and his or her duty of loyalty
include the following.
• NCMIC Finance Corp. v. Artino, 638 F.Supp.2d 1042 (S.D. Iowa 2009) (a company vice president violated his
fiduciary duty to the company when, without his employer’s knowledge, he entered into an agreement with his
employer’s competitor to divert business to the competitor and expended time and effort to establish a competing
business).
• Gundaker/Jordan American Holdings, Inc. v. Clark, __ F.Supp.2d __ (E.D.Ky. 2009) (corporate directors who
attempted to remove their president to preserve their employment after they learned the president intended to
downsize the company to save money acted in wanton disregard for the best interests of their firm and in breach of
their fiduciary duty).
• Auburn Chevrolet-Oldsmobile-Cadillac, Inc. v. Branch, __ F.Supp.2d __ (N.D.N.Y. 2009) (a company president
• Brewer v. Insight Technology, Inc., __ Ga.App. __, __ S.E.2d __ (2009) (the president of a company breached his
• Patmon v. Hobbs, 280 S.W.3d 589 (Ky.App. 2009) (the managing member of a limited liability company (LLC) that
was having difficulty securing financing for its projects breached his fiduciary duty to the other members of the LLC by
diverting the projects to his own company without informing the other members).
• Yates v. Holt-Smith, 319 Wis.2d 756, 768 N.W.2d 213 (App. 2009) (a director of a corporation was motivated by
self-dealing in pressuring a shareholder to sell her shares and was not entitled to the protection of the business
judgment rule on the shareholder’s claim of a breach of the director’s fiduciary duty).
C. DISCLOSURE OF POTENTIAL CONFLICTS OF INTEREST
Directors and officers must fully disclose any potential conflict of interest. After full disclosure, the individual may
go ahead if the other directors or shareholders approve (assuming the circumstances are otherwise fair and
reasonable).
D. LIABILITY OF DIRECTORS AND OFFICERS
Directors and officers are personally liable for their torts and crimes, and may be liable for those of subordinates
(under the “responsible corporate officer” doctrine or the “pervasiveness of control” theory). The corporation is
liable for acts done within the scope of employment.
III. The Role of Shareholders
1. Notice of Meetings
Shareholders must be notified of shareholders’ meetings [RMBCA 7.05]. Special-meeting notices must in-
3. Shareholder Proposals
Shareholders that own stock worth at least $1,000 can submit proposals to include with proxy materials.
The materials may be furnished online.
ENHANCING YOUR LECTURE—
A SHAREHOLDER ACCESS RULE
Shareholders elect the board of directors. Shareholders who have a relatively small percentage of the outstanding
shares of any corporation have little success, though, in proposing candidates to boards of directors.
Enter the possibility of a “shareholder access” rule. Such a rule would make it easier for shareholders to use the
proxy process to elect dissident candidates for a board of directors of a publicly held company. The Securities and
Exchange Commission (SEC) made a modest attempt to allow such shareholder access in the early part of the 2000s.
Such a proposed change was highly controversial and died in 2003.
directors.
INVESTOR ACTIVISTS AND OTHERS ARE IN FAVOR OF SHAREHOLDER ACCESS
Whatever the decision the SEC takes on interpretation of its own rule, shareholder access will remain a
controversial topic. Investor activists have always claimed that without a shareholder access rule, directors have little
Much of the media have also argued that shareholders in public companies are relatively helpless in the face of
SHAREHOLDER ACCESS MAY LOWER RETURNS TO SHAREHOLDERS
The arguments against shareholder access have a certain amount of empirical data to substantiate them.
Opponents of shareholder access point out that, if passed, such a rule would dramatically accelerate “an already
dangerous trend: ‘the flight of corporation away from public investors into the arms of private equity.’” These are the
980 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
words of law professor Lynn A. Stout of the UCLA-Sloan Research Program on Business Organizations. Stout points out
that, in any event, today’s shareholders have more influence and power over top management and directors than ever
before. They can be part of class-action lawsuits, they benefit from the passage of the Sarbanes-Oxley Act, and they
can buy their shares through mutual funds, which wield much more power than individual shareholders.
It is also true that an increasing number of public corporations are going private by being purchased by private
equity funds (see page XXX in Chapter 38). Public shareholders of companies taken private earn a small premium over
the market value of their shares. Once the corporation goes private, though, previous public shareholders are no
longer owners. Consequently, in the long run, public shareholders may earn lower returns if a public access rule is put
into place. As more public shareholders impose more costs on publicly held companies, more top managers will
suggest that the corporation “do without them.” That is to say, more publicly held companies will make it known to
private equity funds that they are for sale.
FOR CRITICAL ANALYSIS
Several dozen managers and directors of foreign-based pension plans and insurance companies—which invest in
U.S. securities—wrote a joint letter to the head of the SEC. In that letter, they stated that “experience in the United
Kingdom, Australia, and the Netherlands has shown that boards whose members may be removed by shareholders are
dialogue?
ENHANCING YOUR LECTURE—
MOVING COMPANY INFORMATION
ONTO THE INTERNET
Anyone who has ever owned shares in a public company knows that such companies often are required to
distribute voluminous documents relating to proxies to all shareholders. Traditionally, large packets of paper
documents were sent to shareholders, but in 2007 the Securities and Exchange Commission (SEC) permitted publicly
held companies to voluntarily distribute electronic proxy (e-proxy) materials. In 2009, the SEC’s e-proxy rules became
mandatory. Now all public companies must post their proxy materials on the Internet, although they may still choose
among several options—including paper documents sent by mail—for actually delivering the materials to
shareholders.a
Enter the possibility of a “shareholder access” rule. Such a rule would make it easier for shareholders to use the
proxy process to elect dissident candidates for a board of directors of a publicly held company. The Securities and
Exchange Commission (SEC) made a modest attempt to allow such shareholder access in the early part of the 2000s.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 981
Such a proposed change was highly controversial and died in 2003.
NOTICE AND ACCESS E-PROXY RULES
Companies that want to distribute proxy materials only via the Internet can choose the notice and access delivery
option. Under this model, the corporation posts the proxy materials on a Web site and notifies the shareholders that
the proxy materials are available online.
The notice and access model involves the following steps—
• The company posts the proxy materials on its publicly accessible Web site.
• Subsequently, the company sends a (paper) notice to each shareholder at least forty calendar days before the
date of the shareholders’ meeting for which the proxy is being solicited.
• No other materials can be sent along with the initial notice (unless the proxy is being combined with the
meeting notice required by state law)..
• After receiving the initial paper notice, a shareholder can permanently elect to receive all future proxy
materials on paper or by e-mail.
OTHER DELIVERY OPTIONS
Rather than using notice and access delivery, public companies can choose to deliver the full set of proxy materials
to the shareholders in paper or electronic form, such as on a CD or DVD. They can also use a blend of these two
options, as long as they also post the materials on a Web site. Many corporations choose one option for certain
shareholders and another option for other shareholders, depending on the number of shares owned or whether the
FOR CRITICAL ANALYSIS
Why might a company or other party choose to solicit proxies the old-fashioned way—by providing paper
documents instead of Internet access—despite the added costs?
982 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
a. 17 C.F.R. Parts 240, 249, and 274.
ADDITIONAL BACKGROUND—
Conducting Shareholders’ Meetings
Corporate articles or bylaws may provide for the conduct of shareholders’ meetings. Typically, the company
president or the chairperson of the board of directors presides, and the corporate secretary records the minutes of the
meeting. The agenda may include reports of management, the amendment or repeal of bylaws, resolutions submitted
on behalf of management or shareholders, extraordinary corporate matters or decisions that require shareholder
shareholders concerned about social and political issues have used shareholders meetings to propose changes in
ADDITIONAL BACKGROUND—
SEC Rule 14a-8
The following is the text of SEC Rule 14a-8, which requires that when a company sends proxy materials to its
shareholders, the company must include whatever proposals will be considered at the meeting.
TITLE 17—COMMODITY AND SECURITIES EXCHANGES
CHAPTER II—SECURITIES AND EXCHANGE COMMISSION
PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
SUBPART A—RULES AND REGULATIONS UNDER THE SECURITIES EXCHANGE ACT OF 1934
REGULATION 14A: SOLICITATION OF PROXIES
§ 240.14a-8 Proposals of security holders.
(a) If any security holder of a registrant notifies the registrant of his intention to present a proposal for action at a
(1) Eligibility. At the time he submits the proposal, the proponent shall be a record or beneficial owner of at least 1% or
$1000 in market value of securities entitled to be voted on the proposal at the meeting and have held such securities
for at least one year, and he shall continue to own such securities through the date on which the meeting is held. If the
registrant requests documentary support for a proponent’s claim that he is the beneficial owner of at least 1% or $1000
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 983
(ii) A copy of a Schedule 13D (s 240.13d-101 of this chapter), Schedule 13G (s 240.13d-102 of this chapter), Form 13F (s
249.325 of this chapter), Form 3 (s 249.103 of this chapter) and/or Form 4 (s 249.104 of this chapter), or amendments
thereto, filed with the Commission and furnished to the registrant by the proponent, provided that such filings indicate
the proponent’s beneficial ownership as of or prior to the date on which the relevant one year period commences, and
are supported by
(A) A copy of all subsequent amendments reporting a change in ownership level,
(B) The proponent’s affidavit, declaration, affirmation or other similar document provided for under applicable state
law attesting that the proponent continued to be the beneficial owner of at least 1% or $1000 in market value of such
voting securities of the registrant throughout the required one year period and as of the date of the affidavit,
declaration, affirmation or other similar document provided for under applicable state law, and
(2) Notice and Attendance at the Meeting. At the time he submits a proposal, a proponent shall provide the registrant
in writing with his name, address, the number of the registrant’s voting securities that he holds of record or
under state law to present the proposal on the proponent’s behalf at the meeting. In the event that the proponent or
(3) Timeliness. The proponent shall submit his proposal sufficiently far in advance of the meeting so that it is received
by the registrant within the following time periods:
(i) Annual Meetings. A proposal to be presented at an annual meeting shall be received at the registrant’s principal
executive offices not less than 120 calendar days in advance of the date of the registrant’s proxy statement released to
984 INSTRUCTOR’S MANUAL TO ACCOMPANY BUSINESS LAW, TWELFTH EDITION
the registrant a reasonable time before the solicitation is made.
(4) Number of Proposals. The proponent may submit no more than one proposal and an accompanying supporting
statement for inclusion in the issuer’s proxy materials for a meeting of security holders. If the proponent submits more
than one proposal, or if he fails to comply with the 500 word limit mentioned in paragraph (b)(1) of this section, he
(b)(1) Supporting Statement. The registrant, at the request of the proponent, shall include in its proxy statement a
(2) Identification of Proponent. The proxy statement shall also include either the name and address of the proponent
and the number of shares of the voting security held by the proponent or a statement that such information will be
written request therefore.
(c) The registrant may omit a proposal and any statement in support thereof from its proxy statement and form of
(1) If the proposal is, under the laws of the registrant’s domicile, not a proper subject for action by security holders.
Note.—Whether a proposal is a proper subject for action by security holders will depend on the applicable state law.
may be proper under such state laws.
(2) If the proposal, if implemented, would require the registrant to violate any state law or federal law of the United
States, or any law of any foreign jurisdiction to which the registrant is subject, except that this provision shall not apply
(3) If the proposal or the supporting statement is contrary to any of the Commission’s proxy rules and regulations,
(4) If the proposal relates to the redress of a personal claim or grievance against the registrant or any other person, or if
(5) If the proposal relates to operations which account for less than 5 percent of the registrant’s total assets at the end
(6) If the proposal deals with a matter beyond the registrant’s power to effectuate;
(8) If the proposal relates to an election to office;
(10) If the proposal has been rendered moot;
proponent, which proposal will be included in the issuer’s proxy material for the meeting;
(12) If the proposal deals with substantially the same subject matter as a prior proposal submitted to security holders
in the registrant’s proxy statement and form of proxy relating to any annual or special meeting of security holders held
within the preceding five calendar years, it may be omitted from the registrant’s proxy materials relating to any
(13) If the proposal relates to specific amounts of cash or stock dividends.
(d) Whenever the registrant asserts, for any reason, that a proposal and any statement in support thereof received
(1) The proposal;
(2) Any statement in support thereof as received from the proponent;
shared with the other security holders at large;