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Chapter 40
Corporate Directors,
Officers, and Shareholders
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.
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
corporation, and directors collectively control a corporation in a way that no agent can control a principal.
2 UNIT EIGHT: BUSINESS ORGANIZATIONS
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
1. Removal of Directors
A director can be removed for cause (and usually not without cause).
2. Vacancies on the Board
A vacancy can occur through a director’s death or resignation or if a new position is created.
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.
1. Quorum of Directors
A quorum is generally a majority of the number of authorized directors.
2. Voting
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
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 3
4 UNIT EIGHT: BUSINESS ORGANIZATIONS
THE ISSUE OF PROPER NOTICE
In May 2001, Edward Sample, the chairman of the board of directors of Piranha, Inc., called a special
meeting for May 25 to consider restructuring Piranha’s management in response to serious financial
problems. The four members of the board of directors at that time were Sample, Richard Berger, Larry
Greybill, and Michael Steele. Berger objected to the lack of notice of the May 25 meeting and refused to
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.
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
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?
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 5
D. COMMITTEES OF THE BOARD OF DIRECTORS
• Executive committee—Most states permit a board to elect an executive committee from among the
directors to handle management between board meetings. The committee is limited to ordinary
business matters.
E. RIGHTS OF DIRECTORS
1. Right to Participation
3. Right to Indemnification
Most states (and RMBCA 8.51) permit a corporation to indemnify a director for costs, fees, and
judgments in defending corporation-related suits.
F. CORPORATE OFFICERS AND EXECUTIVES
The board normally hires officers. Qualifications are set in the articles or bylaws. Rights are defined by
II. Duties and Liabilities of Directors and Officers
Directors and officers are corporate fiduciaries.
A. DUTY OF CARE
1. Duty to Make Informed Decisions
2. Duty to Exercise Reasonable Supervision
Directors must exercise reasonable supervision when work is delegated.
3. Dissenting Directors
Directors must attend board meetings; if not, he or she should register a dissent to actions taken (to
avoid liability for mismanagement).
B. THE BUSINESS JUDGMENT RULE
6 UNIT EIGHT: BUSINESS ORGANIZATIONS
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 and acting on the decision is within the powers
of the corporation.
1. When the Rule Applies
• The director took reasonable steps to become informed about the matter.
CASE SYNOPSIS—
Case 40.1: Oliveira v. Sugarman
iStar, Inc., promised to award shares to employees for their performance if the stock averaged a certain
price per share. The price rose 300 percent but the target was missed. The board changed the basis for an
award from performance to service—an employee who had been with iStar for a certain period was entitled to
an award. Albert and Lena Oliveira, iStar shareholders, demanded that the board rescind the awards and file
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Notes and Questions
What sort of legal protection is offered to directors and officers by the business judgment rule?
The business judgment rule immunizes directors and officers from liability when a decision is within mana-
2. Provides Broad Protections
Unless there is evidence of bad faith, fraud, or a clear breach of fiduciary duties, most courts will
apply the rule and protect directors and officers who make bad business decisions.
C. DUTY OF LOYALTY
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 7
Directors and officers must subordinate their self-interest to the interest of the corporation. This means
that they should not—
CASE SYNOPSIS—
Case 40.2: 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
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Notes and Questions
8 UNIT EIGHT: BUSINESS ORGANIZATIONS
(a) No contract or transaction between a corporation and 1 or more of its directors or officers, or between
(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
Under the more recent rule, with full disclosure, an interested director might even vote on a matter without
that vote effectively voiding a board’s approval. In that situation, had Guth set out in full detail a proposal for
Pepsi’s use of Loft’s facilities, and Loft’s board had approved, there might have been no case.:”
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,
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Duty of Loyalty
Recent cases involving conflicts between a corporate official’s personal interest and his or her duty
of loyalty include the following.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 9
• 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).
D. 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).
E. LIABILITY OF DIRECTORS AND OFFICERS
ENHANCING YOUR LECTURE—
LIABILITY FOR LYING
The federal government defines and prosecutes almost 4,500 crimes. In addition to prosecuting
defendants for allegedly committing these crimes, the government can also charge them with lying about their
actions. Under Section 1001 of Title 18 of the United States Code, any person convicted of knowingly and
10 UNIT EIGHT: BUSINESS ORGANIZATIONS
FALSE STATEMENTS DURING A PHONE INTERVIEW
Attorney Melissa Ann Mahler was interviewed by phone by an official at the Securities and Exchange
MISLEADING VIDEO EDITS
Nancy Black, a marine biologist who operates a whale-watching boat company in California, also ran
afoul of Section 1001. When a humpback whale appeared near one of her boats, the captain of the boat
INACCURATE TIME SHEETS
The courts have interpreted Section 1001 as encompassing almost any statement made to a federal
official. The statement may be oral or in writing. The person making it need not be under oath, and the
government does not have to have warned the person that any falsehood could have very serious
consequences.
CRITICAL THINKING
Many businesspersons believe that the federal government’s power under, Section 1001 is almost
without limits. What ethical issues are at stake here? Among the ethical issues at stake here is the
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 11
12 UNIT EIGHT: BUSINESS ORGANIZATIONS
III. The Role of Shareholders
A. SHAREHOLDERS’ POWERS
Shareholders approve fundamental changes to the corporation before the changes are effected.
Shareholders elect the board and may remove a director (in some cases, without cause).
B. SHAREHOLDERS’ MEETINGS
1. Notice of Meetings
2. Proxies
Shares are often voted by proxy.
3. Shareholder Proposals
4. Rules for Proxies and Shareholder Proposals
ENHANCING YOUR LECTURE—
SHAREHOLDER ACCESS
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
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 13
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
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 words of law professor Lynn A. Stout of the UCLA-Sloan Research Program on Business
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 much more sensitive to shareholder
opinion and are much more likely to engage in a meaningful dialogue with the institutions that hold
their shares.” How important is such a dialogue? What might be some of the topics of such a
dialogue?
14 UNIT EIGHT: BUSINESS ORGANIZATIONS
Fed.Reg. 43488-01 (Aug. 03, 2007).
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)
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.
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 15
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
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?
a. 17 C.F.R. Parts 240, 249, and 274.
ADDITIONAL BACKGROUND—
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
ADDITIONAL BACKGROUND—
Rules for Proxies and Shareholder Proposals
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
