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Business Organizations 2010-2011 Lectures

Business Organizations 2010-2011 Lectures. Partnerships, Corporations And the variants PROF. BRUCE MCCANN SPRING SEMESTER Lecture 2 Duty of LOYALTY. The Emerging Duty of Good Faith. Walt Disney:

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Business Organizations 2010-2011 Lectures

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  1. Business Organizations2010-2011 Lectures Partnerships, Corporations And the variants PROF. BRUCE MCCANN SPRING SEMESTER Lecture 2 Duty of LOYALTY

  2. The Emerging Duty of Good Faith • Walt Disney: • The decision of the compensation committee will be sheltered by the BJR if they acted with due care (i.e., were not grossly negligent) and if they were not acting in BAD FAITH. • BAD FAITH can be • Subjective: motivated by an actual intent to do harm, or • Unintentional but grossly negligent • QUESTION: If the board is grossly negligent for duty of care purposes, are they then automatically acting in bad faith? • ANSWER: No, gross negligence alone does not constitute bad faith. (Otherwise, exculpation statutes meaningless.) Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  3. What is Bad Faith for Purposes of Liability? • Intentional dereliction of duty or a conscious disregard for one’s responsibilities • Deliberate inattention and inaction in the face of a duty to act. Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  4. A Taste of Waste • Board is guilty of corporate waste only if • Transaction is so one-sided that no business person of ordinary sound judgment would have concluded that the corporation has received adequate consideration Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  5. Compensation as Waste • If compensation decision concerns non-insider (i.e., not a director), directors alone decide if adequate consideration is received by corporation • If for insider, directors have burden of showing fair to corporation and in good faith – BJR does not apply (because self-interest exception)…UNLESS • Full disclosure and subsequent ratification by disinterested directors or by the shareholders • In which case, BJR again protects the directors Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  6. The Evolving Good Faith Standard • Not an independent basis for director liability • A subset of the Duty of Loyalty • Caremark remains the standard insofar as duty to monitor Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  7. The Duty of Good Faith and Compensation • “Spring Loaded” Options: options granted to employees at a time directors reasonably believe value is going to rise in near future as a result of non-public information • “Bullet Dodging” Options: options timed to be issued right after stock is going to drop as the result of information not yet made public Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  8. Option Grants and the BJR • Tyson I: • The BJR does not protect directors who grant spring-loaded or bullet-dodging options if plaintiff pleads and proves: Options were issued per shareholder approved employee compensation plan and When they approved the options the directors possessed material non-public information that would impact share price and Issued the options with the intent to circumvent restrictions in the shareholder-approved plan Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  9. The Corporate Opportunity Doctrine • Corporate fiduciary may not take an opportunity for herself if: • 1. The Corporation is financially able to exploit the opportunity • 2. The opportunity is within the Corporation’s line of business • 3. The Corporation has an interest or expectancy in the opportunity, and • 4. By taking the opportunity the fiduciary will be placed in a position inimicable to her duties to the Corporation Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  10. The Corporate Opportunity Doctrine • Corporate fiduciary may take an opportunity for herself if: • 1. The opportunity is presented to the fiduciary as an individual and not in her corporate capacity • 2. The opportunity is not essential to the Corporation • 3. The Corporation has no interest or expectancy in the opportunity, and • 4. The fiduciary has not wrongfully used Corporate resources in pursuing or exploiting the opportunity Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  11. The Line of Business Test • Guth v Loft: • Fiduciary cannot take opportunity for herself if • A. The corporation is financially able to exploit it • B. It is “in the line of the corporation’s business” • C. It is of “practical advantage” to the corporation • D. The corporation has an interest in the opportunity and • E. If the fiduciary were to take the opportunity she would be brought into “conflict” with the interests of the corporation Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  12. The A.L.I. Test • Fiduciary may not take advantage of a corporate opportunity unless: • A. The fiduciary first offers it to the corporation and discloses the conflict of interest. • B. The corporation rejects the opportunity and • C. Either the rejection is fair to the corporation or • D. The decision to reject satisfies the BJR or • E. The rejection is authorized in advance following disclosure by disinterested shareholders and does not constitute waste. Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  13. ALI Test Continued: • What is a corporate opportunity? • A business opportunity presented initially by someone who believes it is being presented to the corporation. • An opportunity developed using corporate information or property • Any opportunity which a senior executive knows is closely related to the corporation’s current or projected business activities Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  14. Duties of Controlling Shareholders • A dominant shareholder owes a fiduciary duty to the corporation to conform its actions to the “intrinsic fairness” doctrine. • Such a shareholder bears burden of proving transaction was objectively fair. • BUT only comes into play when self-dealing is involved, where parent is on both sides of transaction with subsidiary and receives benefit from the transaction that minority shareholders of subsidiary do not. Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

  15. Intrinsic Fairness vs BJR • Absent showing transaction benefited dominant s/h and not minority, standard is BJR • Example: declaring dividend which equally applies to minority s/h not unfair regardless of disparity in number of shares held • If transaction satisfies BJR re methodology, will be upheld unless • Improper motive and • Amounted to waste Lec. 2 Sem 2, pp 600-631 Corps Prof. McCann

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