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Read the Website, Word document, and Chapter 42 PDF
Business Organizations
https://www.goodmorningamerica.com/news/video/senators-reportedly-sell-off-stocks-coronavirus-briefings-69704192 (Links to an external site.)
You may have to review a small portion of Chapter 42 also.
In five sentences or less, what is the possible issue (or problem)here and why is it a problem?
Duty of Loyalty
Loyalty can be defined as faithfulness to one’s obligations and duties. In the corporate context,
the duty of loyalty requires directors and officers to subordinate their personal interests to the
welfare of the corporation. For instance, a director should not oppose a transaction that is in the
corporation’s best interest simply because pursuing it may cost the director his or her position.
Directors cannot use corporate funds or confidential corporate information for personal
advantage and must refrain from self-dealing. Cases dealing with the duty of loyalty typically
involve one or more of the following:
1.
2.
3.
4.
Competing with the corporation.
Usurping (taking personal advantage of) a corporate opportunity.
Pursuing an interest that conflicts with that of the corporation.
Using information that is not available to the public to make a profit trading securities
(see the discussion of insider trading in Chapter 42).
5. Authorizing a corporate transaction that is detrimental to minority shareholders.
6. Selling control over the corporation.
The following classic case illustrates the conflict that can arise between a corporate official’s
personal interest and his or her duty of loyalty.
Classic Case 40.1
Guth v. Loft, Inc.
Supreme Court of Delaware, 23 Del.Ch. 255, 5 A.2d 503 (1939).
Background and Facts In 1930, Charles Guth became the president of Loft, Inc., a candyand-restaurant chain. Guth and his family also owned Grace Company, which made syrups
for soft drinks. Coca-Cola Company supplied Loft with cola syrup. Unhappy with what he felt
was Coca-Cola’s high price, Guth entered into an agreement with Roy Megargel to acquire
the trademark and formula for Pepsi-Cola and form Pepsi-Cola Corporation. Neither Guth nor
Megargel could finance the new venture, however, and Grace Company was insolvent.
Without the knowledge of Loft’s board, Guth used Loft’s capital, credit, facilities, and
employees to further the Pepsi enterprise. At Guth’s direction, a Loft employee made the
concentrate for the syrup, which was sent to Grace to add sugar and water. Loft charged
Grace for the concentrate but allowed forty months’ credit. Grace charged Pepsi for the syrup
but also granted substantial credit. Grace sold the syrup to Pepsi’s customers, including Loft,
which paid on delivery or within thirty days. Loft also paid for Pepsi’s advertising. Finally, with
profits declining as a result of switching from Coca-Cola, Loft filed a suit in a Delaware state
court against Guth, Grace, and Pepsi, seeking their Pepsi stock and an accounting. The court
entered a judgment in the plaintiff’s favor. The defendants appealed to the Delaware
Supreme Court.
THE LANGUAGE OF THE COURT IN THE LANGUAGE OF THE COURT LAYTON, Chief
Justice, delivering the opinion of the court:
*** *
Corporate officers and directors are not permitted to use their position of trust and confidence
to further their private interests. * * * They stand in a fiduciary relation to the corporation and
its stockholders. A public policy, existing through the years, and derived from a profound
knowledge of human characteristics and motives, has established a rule that demands of a
corporate officer or director, peremptorily [not open for debate] and inexorably [unavoidably],
the most scrupulous observance of his duty, not only affirmatively to protect the interests of
the corporation committed to his charge, but also to refrain from doing anything that would
work injury to the corporation * * * . The rule that requires an undivided and unselfish loyalty
to the corporation demands that there shall be no conflict between duty and self-interest.
[Emphasis added.]
*** *
* * *If there is presented to a corporate officer or director a business opportunity which the
corporation is financially able to undertake [that] is * * * in the line of the corporation’s
business and is of practical advantage to it * * * and, by embracing the opportunity, the selfinterest of the officer or director will be brought into conflict with that of his corporation, the
law will not permit him to seize the opportunity for himself. * * * In such circumstances, * * *
the corporation may elect to claim all of the benefits of the transaction for itself, and the law
will impress a trust in favor of the corporation upon the property, interests and profits so
acquired. [Emphasis added.]
*** *
* * * The appellants contend that no conflict of interest between Guth and Loft resulted from
his acquirement and exploitation of the Pepsi-Cola opportunity [and] that the acquisition did
not place Guth in competition with Loft * * * . [In this case, however,] Guth was Loft, and Guth
was Pepsi. He absolutely controlled Loft. His authority over Pepsi was supreme. As Pepsi, he
created and controlled the supply of Pepsi-Cola syrup, and he determined the price and the
terms. What he offered, as Pepsi, he had the power, as Loft, to accept. Upon any
consideration of human characteristics and motives, he created a conflict between selfinterest and duty. He made himself the judge in his own cause. * * * Moreover, a reasonable
probability of injury to Loft resulted from the situation forced upon it. Guth was in the same
position to impose his terms upon Loft as had been the Coca-Cola Company.
* * * The facts and circumstances demonstrate that Guth’s appropriation of the Pepsi-Cola
opportunity to himself placed him in a competitive position with Loft with respect to a
commodity essential to it, thereby rendering his personal interests incompatible with the
superior interests of his corporation; and this situation was accomplished, not openly and with
his own resources, but secretly and with the money and facilities of the corporation which was
committed to his protection.
Decision and Remedy The Delaware Supreme Court upheld the judgment of the lower
court. 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
President, had no right to appropriate the opportunity to himself.”
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.
Impact of this Case on Today’s Law This early Delaware decision was one of the first to set
forth a test for determining when a corporate officer or director has breached the duty of
loyalty. The test has two basic parts: Was the opportunity reasonably related to the
corporation’s line of business, and was the corporation financially able to undertake the
opportunity? The court also considered whether the corporation had an interest or expectancy
in the opportunity and recognized that when the corporation had “no interest or expectancy,
the officer or director is entitled to treat the opportunity as his own.”
