CHAPTER 40
CORPORATE DIRECTORS, OFFICERS,
AND SHAREHOLDERS
ANSWER TO CRITICAL ANALYSIS
QUESTION IN THE FEATURE
INSIGHT INTO ETHICS—CRITICAL THINKING—INSIGHT INTO THE LEGAL ENVIRONMENT (PAGE 780)
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, there will be fewer individuals who will be willing to become directors and
officers of corporations. That might mean that corporations would have to pay higher fees to directors
and higher salaries to officers. Additionally, directors’ and officers’ (D & O) insurance would become
more expensive, and this increased cost would at least partially be passed on to customers of
corporations.
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 40.1—QUESTION (PAGE 782)
WHAT IF THE FACTS WERE DIFFERENT?
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
352 UNIT EIGHT: BUSINESS ORGANIZATIONS
CASE 40.2—QUESTIONS (PAGE 790)
1A. Given that the shareholder was suing the directors and not a third party (an outsider to the
corporation), is it fair to him to require that the first demand from the directors undertake the suit?
Why or why not? In the words of the court, “The purpose of pre-suit demand is to assure that the
stockholder affords the corporation the opportunity to address an alleged wrong without litigation, to
decide whether to invest the resources of the corporation in litigation, and to control any litigation
which does occur.” This rule makes a certain amount of sense when the shareholders are suing a third
party, but there are some who question its fairness when the shareholders are suing the directors
themselves. Given the deference the courts generally show to directors’ decisions under the business
judgment rule, the scales of justice seem to be weighted in favor of the directors in such a situation. In
this case, the shareholder who brought the suit contended that it would be useless to make a pre-suit
demand that the directors undertake the suit, because it would not be in the directors’ interest to do so.
2A. Assuming that the plaintiff’s accusations were true, what should the plaintiff have done to
prevent the case from being dismissed? The court made it clear that the plaintiff could have rebutted,
CASE 40.3—QUESTIONS (PAGE 793)
THE LEGAL ENVIRONMENT DIMENSION
Why is an award of punitive damages is almost completely at the discretion of a jury and trial judge?
Awarding punitive damages is left almost entirely in the hands of a jury or a trial judge because these
factfinders hear all of the evidence and are more familiar with the “evidentiary atmosphere” at trial.
They can more accurately weigh credibility and other qualities that may not be wholly communicated by
a record on appeal.
THE ETHICAL DIMENSION
The court awarded $50,000 in punitive damages. Given the repeated culpable behavior of the three
brothers, was the damage award appropriate? Why or why not? One could argue that the court should
have awarded a larger punitive damage award because of the egregious nature of the actions of the
three brothers. There are two arguments against a higher award. One is that the total amount that Iraj
was cheated out of was $86,250, so that $50,000 seems appropriate. Second, perhaps a higher award
would reduce the probability that the other three brothers would not pay and therefore create
additional litigation.
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Duties of directors
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.
2A. Conflict of interest
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.
3A. Breach of loyalty
4A. Shareholder’s suit
CHAPTER 40: CORPORATE DIRECTORS, OFFICERS, AND SHAREHOLDERS 355
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE AT THE
END OF THE CHAPTER
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.
ANSWERS TO QUESTIONS AND CASE PROBLEMS
AT THE END OF THE CHAPTER
40-1A. Conflicts of interest
(Chapter 40—Page 782)
Various state statutes contain different standards for contracts made between two corporations when a
director of one corporation has a material interest in the other. In general, however, the courts will
uphold these contracts providing that:
(a) The contract was fair and reasonable to the corporation at the time the contract was
entered into.
356 UNIT EIGHT: BUSINESS ORGANIZATIONS
40-2A. QUESTION WITH SAMPLE ANSWER: Liability of directors
Directors are personally answerable to the corporation and the shareholders for breach of their duty to
exercise reasonable care in conducting the affairs of the corporation. Reasonable care is defined as
being the degree of care that a reasonably prudent person would use in the conduct of personal
40-3A. Preemptive rights
(Chapter 40—Pages 786–787)
Preemptive rights is a common law concept that gives an existing shareholder preference over others to
purchase (or subscribe to on a pro rata share basis) a newly authorized issue of a corporation, therefore
40-4A. Rights of shareholders
(Chapter 40—Pages 784–785 & 787–788)
(1) All shareholders have the right to exercise their ownership control through the power to vote
their shares. This right to vote is absolute unless the articles of incorporation deny certain classes of
(2) As a general rule, shareholders or their representatives have a right to inspect the corporate
books and records for a proper purpose upon making a request in advance. Therefore, unless Lucia’s
(3) A shareholder is not entitled to a yearly dividend. Dividends are declared only by and at the
discretion of the board of directors, and directors are not required to declare dividends. Unless the
40-5A. Duties of majority shareholders
(Chapter 40—Pages 791–793)
The court concluded that although Marie owned only a 50 percent share of the steakhouse, she
exercised de facto control over the business because of the extent of her participation in its operation—
40-6A. Fiduciary duties and liabilities
(Chapter 40—Pages 791–793)
The court issued a summary judgment in Hoaas’s favor. A jury then determined that Griffiths owed
$58,447.20 to Hoaas for his 49 percent of the proceeds from the casino’s sale and its profits. The jury
also determined that Hoaas owed Griffiths $68,850 as his share of the cash that Hoaas took from the
40–7A . Role of directors
(Chapter 40—Pages 775 & 776)
No. The Oregon Supreme Court reversed and remanded. Corporate directors, who serve only as
40–8A. CASE PROBLEM WITH SAMPLE ANSWER: Duties of directors and officers
Directors and officers are fiduciaries of their corporations and owe legal and ethical duties to their firms
and the shareholders, including the duty of care and the duty of loyalty. Among other things, these
duties require directors and officers to act in good faith, to exercise the care that a reasonably prudent
40–9A. Fiduciary duty of officers
(Chapter 40—Pages 778–779)
Arizona Tile supplied materials to Designer Surfaces. The statute regarding the suppliers of materials
40-10A. A QUESTION OF ETHICS
(a) Reuther, as a director, was entitled to full access to all financial information. As a
shareholder, Reuther could also have access to the information. The court extrapolated that “[t]o hold
otherwise would put directors in the untenable position of being legally and personally responsible to
shareholders for malfeasance while denying them the tools necessary to determine if malfeasance has
“The lack of respect for this simple principle of corporate governance by JES is evident in his
exchanges with the board. On many occasions he is heard to complain that board meetings are a ‘waste
of time’ . . . to what he is trying to accomplish as president. While the Court will acknowledge that
having to account to a hostile board may be difficult and frustrating, the fact remains that a president
must account. There is really no other option provided he wants to remain in the position. The president
