Management Powers And Duties Outline

A. The Business Judgment Rule

Basic Power Structure:

• director runs co.,

• directors owes duties to shareholders in the manner they run the co.

• shareholders elects directors and approve major changes of co.

Conceptual Framework

• Agency Costs (of Equity) Paradigm

• Conflicts of Interests: how divergent and how important

  • Financial

  • Effort

  • Job Retention

  • Profitability versus other goals (growth?)

  • Compensation

• Potential Constraints on Conflict

  • Voting (shareholders or elected board)

  • Fiduciary Duties (court)

• Are constraints effective? For which conflicts? Do they have downsides?

Agency Costs of Equity

• Shareholders and directors/managers creates agency costs of equity: managers may pursue their own personal interests, and which may be bad for the shareholders

• Constrains effective?

• E.g. Andrea, a CEO/ chairperson of a company would rather

  • Rest than to work long

  • Raise her own salary

  • Sell real-estate to co. owned by his brother

  • Promote people she prefers

  • oppose a group of shareholders who run against Andrea for election to XYZ's board of directors

  • approve of a charter amendment making directors removable only for cause

  • have XYZ sell stock of Alpha Inc. which have a (historic) book value of $5 million, but a market value of $7.5 million

  • not to have XYZ sell stock of Beta Inc. which have a (historic) book value of $5 million, but a market value of only $2.5 million

• How would any of the following factors affect the degree of conflict and/or Andrea's inclination to pursue her own, rather than XYZ's shareholders', interests?

  • Andrea owns no stock of XYZ

  • Andrea owns 50% of the stock of XYZ

  • XYZ has no large shareholder

• Bill (who is unrelated to Andrea) owns 51% of XYZ's stock.

• The other two directors of XYZ are personal friends of Andrea.

• The other two directors of XYZ are CEO's of large companies.

• The other two directors of XYZ are personal friends of Bill (from 4 above).

• The other two directors of XYZ are XYZ's outside legal counsel and the dean of a law school to which XYZ makes major contributions.

• XYZ is in sound financial shape.

• XYZ is close to insolvency.

• XYZ has two classes of common stock. Voting class A stock, all of which are held by Andrea and non-voting class B stock held by all other shareholders. (In all other aspects, the two classes are identical.)

The Business Judgement Rule, Fiduciary Duties, and Shareholder Suits

• Elements: If the decision by board is

  1. Disinterested,

     • No conflict of interest

     • Court categories conflict of interest into categories, some are categorized as no conflict of interest

  2. Independent,

     • Directors were not dependent on somebody else who have a conflict of interest, linked to disinterested (no other person who you are dependent on, who had a conflict of interest)

  3. Informed, and

  4. [Good faith]

     • Did not used to be an independent element, now starting to develop and still revolving

Court would not intervene such decision

• Not required: intelligent

  • Going to court and arguing that board made a “stupid” decision that resulted in big losses does not get you anywhere.

• Court uses business judgment rule in 3 different meanings, depending on the context

  1. Evidentiary presumption (burden of proof on P) Cinerama

     • ‘Independent’ not mentioned, but doesn’t matter

     • Cinerama: The rule is a rebuttable presumption that directors … acted without self-dealing or personal interest and exercised reasonable diligence and acted with good faith. A party challenging a board of directors' decision bears the burden of rebutting the presumption that the decision was a proper exercise of the business judgment of the board.

  2. Substantive decision rule to certain claims for breach of fiduciary duty courts will not pay much attention to [core meaning] if not rebutted court should not interfere

     • Gries: If the directors are entitled to the protection of the rule, then the courts should not interfere with or second-guess their decisions.

     • Cinemara: If a shareholder plaintiff fails to [rebut the BJR presumptions], the business-judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.

     • Caveat: For claims other than claims for breach of fiduciary, one does not need to rebut BJR presumptions. Examples

       • Company declared dividend and paid everyone but me.

       • Company did not hold annual meeting when required.

       • “Waste”

  3. Characterization of the legal conclusion that P loses (without the court substantively reviewing the fairness of the board decision) even though P did rebut the presumptions of the Business Judgment Rule

     • No substantive review = no assessment of the fairness of the transaction

• What happen if the Business Judgment Rule is rebutted?

• Complicated, Topic of Many More Classes

• Generally: Court will make further inquiries as to whether there was a breach of fiduciary duty.

  • Gries: If a director fails to pass muster as to any one of these three, he is not entitled to the business judgment presumption. This does not mean that the director's decision is necessarily wrong; it only removes the protection provided by the business judgment presumption.

• If (merely) “uninformed”, generally inquiry as to whether there was a breach of duty of care.

• If interested/ independent is rebutted, inquiry as to whether there was breach of duty of loyalty.

• Complications: “informed” considerations are often also relevant when some directors were interested and others are disinterested.

• Complications: what about breach “good faith” complicated

• This doctrine is guidance of judges’ preferred outcome, reflection of what the court think is right

  1. Unlike normal doctrine, which imposes constrain on the judges’ judgment judges had to follow what doctrine tells them to

• Substantively – issue of whether board is informed

• Fiduciary duty owed by directors and officers

• Shareholders are the parties who benefit from and seek to enforce fiduciary duty

• Court should take care to define and...

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