SEU Business Judgement Rule Case Study Discussion Questions

Companies LawsQuestion 1: Discussion Question
In 2001, British-Dutch corporation Unilever attempted to purchase the assets of Ben
& Jerry’s Ice Cream. The Board of Directors of Ben & Jerry’s refused the offer.
Unilever’s offer was very generous and would have resulted in a major windfall for
the shareholders of Ben & Jerry’s.
The Shareholders threatened to sue the Board of Directors for a breach of fiduciary
duty arguing the Board of Directors had a duty for care to make good decisions on
behalf of the Corporation. And denying the purchase offer violated that duty.
In fear of the lawsuit, the Board agreed to the sell terms. Do you believe the Board of
Directors had a duty to accept the buyout offer? And did their failure to accept it
amount to a breach of the fiduciary duties owned to the shareholders?
Action Items
1. Create your initial post responding to the discussion question above.
Question 2: Case Study
You are the Chairman of the Board of a well-known, publicly traded
corporation. You are personally responsible for convincing the Board to fund a
new product design that ultimately failed when it was placed on the market,
causing extreme losses for the corporation. The shareholders now want to
hold you personally responsible for all the losses to the corporation and have
filed a derivative lawsuit in the name of the corporation in which you are the
defendant.
Action Items
1. Read the case study above.
2. Please describe how you would defend yourself using the Business Judgment
Rule.
3. Create and describe any facts you think will support your position under this
Rule.
4. Limit your facts to only those that will support your position under this Rule
and no others.
5. Justify your answers.
Chapter 8
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction
• The book defines fiduciary relationship as:
“created when one is give the power that carries a duty to
use that power to benefit another.1”
• Fiduciary relationships include:
➢ Trustee relationships
➢ Beneficiaries of trusts
➢ Partners or agents to principals
• Enforcement of fiduciary duty is used to reduce
mismanagement of the company or unfair self-dealing.
• Fiduciaries are accountable to shareholders and directors
of the company.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
• “The characterization of someone as a fiduciary generally
means that the individual has to obey certain duties and
look out for the interests of whoever is owed the duty.”
• Fiduciaries are bound by a duty of care and duty of
loyalty.”
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of loyalty:
❖ Act in the best interests of the company and in
good faith.
❖ A lack of duty loyalty involves intent to harm the
company and dereliction of duty.
▪ Can occur when the person responsible for the
fiduciary duty puts his/her own interests over
the interests of the company.
❖ Courts will get involved in cases where the person
in charge of fiduciary duty puts their personal
interests over loyalty of duty.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
The textbook states the difference between duty of loyalty
and duty of care is as follows:
“Thus, in duty of loyalty cases involving a conflict of
interest, there is more judicial involvement and scrutiny
than in duty of care or good faith cases.11 The difference is
justified because in a duty of care case, the courts want to
protect business decisions that are intended to enhance
corporate gain, while in a duty of loyalty involving a
conflict of interest case the directors may be motivated by
personal gain.12”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• “The fiduciary duty of those who manage or control is to
the corporation and shareholders and the shareholders
have the right to enforce it through litigation.”
• Publicly traded companies have outside directors to
monitor the inside directors.
• Company representatives disagree on the involvement of
litigation to enforce fiduciary responsibility:
➢ Shareholders want judicial scrutiny.
➢ Managers who have fiduciary duties do not want judicial
scrutiny.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• Law and economics approach
➢ View the relationship between shareholders and
managers as a contract.
➢ The duties of the fiduciary manager are included in the
terms of the contract.
➢ Detractors of this approach include shareholders who
would not be able to negotiate the contract.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Duty of care
• Liability under duty of care requires:
➢ Finding duty
➢ Breach
➢ Proximate cause and loss
• “Issues of breach of duty of care can arise in two kinds
of situations; when
➢ There is a failure to act or monitor where a loss
could have been prevented (i.e., nonfeasance)
➢ There is a decision made in a negligent manner
(i.e., malfeasance).”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Malfeasance occurs when directors are accused of making
ill-advised decisions or negligence of duties.
• The ill-advised decisions are subject to judicial review and
can be protected under the business judgment rule.
• Even if malfeasance is found, finding causation may be
required.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Business judgment rule
➢ “limits judicial inquiry into business decisions and
protects directors who are not negligent in the decision
making process.”
➢ Courts defer to the director’s decision and do not infer
that they have more knowledge over business
decisions than the director’s.
➢ Under this rule, courts will review the process of the
process, not the decision.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Causation
• Breach of duty does not necessarily end the inquiry.
• The actual cause of the breach of duty must be found.
• Plaintiffs have the burden of proof and must prove
themselves free of negligence.
• Plaintiffs must also show the amount of damages.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Good faith
• “Lack of good faith would include
➢ Conduct motivated by subjective bad intent
➢ By an actual intent to harm the corporation
➢ An intentional dereliction of duty and a conscious
disregard for one’s responsibilities would also constitute
a lack of good faith because it shows more culpability..”
Chapter 9
The Duty of Loyalty and Conflicts of Interest
Duty of Loyalty and Conflicts of Interest
Introduction
• “Traditionally, the duty of loyalty was raised when the
fiduciary (or those associated with him or her) had a
conflict of interest with the corporation, suggesting that
personal interests may be advanced over corporate
interests.
• Conflicts of interest may involve a use of position for
personal gain, taking something that belongs to the
corporation,4 or some form of self-dealing with the
corporation where the fiduciary is on both sides of the
transaction and in a position to receive a benefit
unavailable to other shareholders.”
Duty of Loyalty and Conflicts of Interest
Policy
• Duty of loyalty
➢ Tries to prevent directors from going against the best
interests of the corporation or self-dealing to benefit
themselves.
➢ Different from duty of care because duty of loyalty
focuses on self-dealing rather than poor decision
making.
➢ Fiduciary rules are stricter on duty of loyalty than on
duty of care.
Duty of Loyalty and Conflicts of Interest
Interested director transactions
• Common law
➢ “Common law cases generally followed the view that
the process of approval and the terms of the transaction
itself must be fair, with the burden of proof on the
fiduciary.
➢ This rule protects shareholders from exploitation and
permits flexibility in corporate dealings.”
Duty of Loyalty and Conflicts of Interest
Interested director transactions
• Statutory responses
➢ “Many states have enacted statutory provisions that
deal with interested director transactions (“interested
director statutes”).
➢ Many states do not codify the duty of loyalty, but
provide mechanisms that may create presumptions or
deal with the burden of proof or act as safe harbors that
limit any judicial review.”
Duty of Loyalty and Conflicts of Interest
Executive compensation
• Executive compensation can be in various forms, including:
➢ Salaries
➢ Bonuses
➢ Pensions
➢ Fringe benefits
➢ Restricted stock
➢ Severance packages
➢ Golden parachutes
➢ Stock options
Duty of Loyalty and Conflicts of Interest
Corporate opportunity and abuse of position
• Abuse of position happens when the fiduciary taking
advantage of his/her position.
• Fiduciary’s should not benefit personally from their
position.
Duty of Loyalty and Conflicts of Interest
Corporate opportunity and abuse of position
• Financial inability
➢ Corporation’s lack the ability to take advantage of corporate
opportunities.
• Multiple boards
➢ Directors serve on boards for multiple corporations.
• Use of information and competition
➢ “A corporate fiduciary cannot use corporate information, a
corporate position150 or assets unfairly for personal profit151 and
may not be able to compete with the corporation.152”
• Undisclosed profits
➢ Improper use of information for personal profits which are not
disclosed to the corporation.
Duty of Loyalty and Conflicts of Interest
Shareholder voting and ratification
•
•
•
“When shareholders vote on a transaction, an issue arises
as to the effects of that vote.
A shareholder vote is not optional, but a statutory
requirement, such as voting amendments to the articles of
corporation or to effectuate a merger or fundamental
transaction.”
Shareholders sometimes vote on ratification of a
transaction.
Duty of Loyalty and Conflicts of Interest
Shareholder voting and ratification
•
There are two types of shareholder voting:
➢ Required voting
❖ Voting that is not to validate a transaction. The
voting is more authorize the transaction. The
transaction requires the shareholder vote.
➢ Optional shareholder voting and ratification
❖ Voting when the shareholder vote is not required,
but is optional.
❖ By having the shareholders vote on a transaction, it
may limit the extent of judicial scrutiny.
Chapter 10
Controlling Shareholders
Controlling Shareholders
Introduction
• De jure control
➢ Shareholder or group owns a majority of voting shares
of a corporation.
• De facto control
➢ Working control because no shareholders or group of
shareholders has majority control.
• Control group
➢ Group of shareholders acting together or another
corporation owning control.
Controlling Shareholders
Introduction
• Advantages/disadvantages for shareholders in the control
group
➢ Control group is less diversified
❖ Lack of diversification leads to the corporation fortunes having
a larger impact on the control group.
➢ Control group can monitor potential mismanagement.
❖ Corporation, because of this monitoring by the control group,
could be run more effectively.
➢ “A significant disadvantage occurs when there is an
unfair conflict of interest transaction (i.e., self-dealing)
between the control group and the corporation where
the shareholders are excluded.”
Controlling Shareholders
Use of control
• The Zahn case
➢ “Controlling shareholders cannot use their control to
self-deal unfairly with the assets of the corporation.”
• Parent-subsidiary dealings
➢ “A corporation that is a controlling shareholder
(“parent”) of another corporation (“subsidiary”) often
contracts with the controlled corporation.”
• Sale of corporation
➢ Judicial scrutiny may be higher if controlling
shareholders are involved in a sale of a corporation.
Controlling Shareholders
Sale of control
• “When the control group sells its shares, they are sharing
their personal property, which does not automatically
implicate any breach of fiduciary duty.
• Controlling shareholders who sell their controlling shares
often receive a premium from a purchaser, that is, they
receive more for their shares than the current market price,
and that may raise issues of fiduciary duty.”
Controlling Shareholders
Sale of control
• “The premium for control may represent the advantages of
control, which include the ability to establish business
policy and decide how the business will run,138 as well as
the ability to receive the perquisites of control, including
reasonable salary and benefits from legitimate fair selfdealing transactions.”
• “The premium may also enable the control group to unfairly
use corporate assets for its own advantages.”
• “Sale of control raises the issue of whether a rule of equal
treatment of shareholders should be a goal of corporate
law.141”
Controlling Shareholders
Sale of control
• Pro rate sharing rule
➢ Purchaser may buy as many shares as they want to
achieve control without buying 100% of the shares.
❖ Purchaser must make the same offer to the
shareholders.
• Mandatory bid rule
➢ Purchaser must offer to buy 100% of the shares at the
same price.
➢ Controlling shareholders would not get a premium price
on their shares as opposed to the minority
shareholders.
Controlling Shareholders
Sale of control
• Looting
➢ Purchasers bought “controlling interest at a premium to
loot the company of its primary liquid assets.”
• The Perlman case
➢ “Perlman v. Feldman150 dealt with the sale of control
issue and explored the idea of a pro rata sharing rule
and equal opportunity for all shareholders to share in
the premium paid to the controlling shareholders.”
➢ “The court recognized that this was no ordinary case of
duty of loyalty because their was no fraud, misuse of
confidential information, contracting with the corporation
or looting.”
Controlling Shareholders
Sale of control
• The California approach
➢ Controlling shareholders in a savings and loan decided
to profit from the increased market value of their
shares.
➢ To profit from the increase in market value, the
controlling shareholders transferred their shares to a
private holding company that became a part of the
parent company.
➢ When the private holding company offered public
shares, the sale of these shares would make the
controlling shareholders a profit.
Controlling Shareholders
Sale of control
• The California approach
➢ Minority shareholders brought a lawsuit against the
controlling shareholders for breach of fiduciary duties.
➢ Court ruled in favor of the minority shareholders.
➢ The controlling shareholders had not established that
their actions were in “good faith”.
Controlling Shareholders
Sale of office
• “When the sale of control takes place, the directors usually
resign and select the designated nominees of the
purchaser of control to replace them as directors.
• While the purchaser could arrange for a shareholder vote,
they prefer to act quickly and without the expense.”
• Resignations of directors can raise the issue of whether or
not an illegal sale of office has happened.
• Purchasers should have actual or de facto control before
electing new directors.