Corporate Law

Corporate Law

In this lesson, you’re expected to learn about:
– the operation and management of a corporation
– the functions, responsibilities, and characteristics of a board of directors
– fiduciary duties in a corporation

Operation and Management of a Corporation

The corporate operation and management are basically held by corporate officers and the board of directors.

As a rule, shareholders elect a board of directors, which oversee the management of the corporation. The directors, in turn, name and employ the officers, who are responsible for the operation of the business.

Corporate officers are agents of the corporation. The members of the board of directors, however, are not its agents and do not need to follow the wishes of the majority of shareholders. The board is often legally treated as though it were a “quasi-principal”of the company.

Main Characteristics of the Board of Directors

1) It has broad powers and realizes centralized management.

2) Election of directors: the statutory default rule is one-year term with all classes of stock voting together to elect each member via simple majority

3) Board’s mandate:
 Delegates day-to-day operation to CEO (main corporate officer)
 Appoints and compensates officers
• Declares and pays dividends
• Amends bylaws
• Initiates and approves extraordinary corporate actions
• Makes major and strategic business decisions

4) A valid board action can be taken:
 by majority vote in a duly constituted board meeting
• by unanimous written consent (even if board meeting is not formally constituted)

[Optional] Board Functions and Responsibilities
Watch this 6-minute video from Kauffman Founders School:
The default rule for the corporate decisions taken by the board is the “business judgment rule”.

Under this standard, a court will not second guess the decisions of independent and disinterested directors when running the business if they are made:
• in good faith.
• with the care that a reasonably prudent person would use.
• with the reasonable belief that they are acting in the best interests of the corporation.

Exceptions to this rule are when a director takes action carelessly or based on a conflict of interest or improper motivation, which can result in liability for the corporate loss.

All corporate directors and officers owe a fiduciary duty of careand duty of loyalty to the corporation and to all of its shareholders:
1) Duty of Care

Requires directors and officers, in making all decisions in their capacities as corporate fiduciaries, to act in good faith and with the care that an ordinarily prudent person would reasonably be expected to exercise in a similar position.

Prior to making a business decision, directors and officers need to obtain and consider all material information reasonably available to them. In addition, they should make a reasonable effort to monitor corporate activities.

2) Duty of Loyalty

Requires directors and officers, in making all decisions in their capacities as corporate fiduciaries, to act in the best interests of the corporation and its stockholders, and it forbids the fiduciaries to “stand on both sides” of a transaction.

The duty of loyalty can be breached either by making a self-interested transaction or taking a corporate opportunity.

Examples of a breach of the duty of loyalty are:

• Sales to or purchases by the corporation from directors in which the directors have an interest
• Dealings by a parent corporation with a subsidiary
• Use of corporate funds to perpetuate control
• Insider trading
• Usurpation of corporate opportunities
• Improper use of corporate positions, property, or information

In order to prevent a violation of the duty of loyalty, if a fiduciary wishes to make a self-interested transaction, or take a corporate opportunity, he/she must first:

• fully disclose both the facts of the conflict and the transaction.
• get approval of both a special committee of directors and a majority of the minority shareholders.
• guarantee the special committee is independent, empowered to freely select its own advisors and to say no to the transaction, and it meets its duty of care in negotiating a fair price.
• the vote of the minority is informed and with no coercion.
• the transaction is entirely “fair”, encompassing both the fair dealing and fair price.

Courts usually rely on two standards of review for assessing disputed business transactions: the business judgment rule and the entire fairness standard.

Usually they will adjudge lawsuits against directors’ actions to meet the duty of care under the business judgment rule and the plaintiff will have the burden of proof. For lawsuits challenging their duty of loyalty, the case will be reviewed under the “entire fairness standard”.

This standard is triggered where a majority of the directors approving the transaction are interested or where the controlling stockholder stands on both sides of the transaction.

Once it is triggered, the board has the burden to demonstrate that the transaction is inherently fair to the stockholders, including both fair dealing (i.e. process, timing, negotiation, adequate disclosure) and fair price (i.e. amount, form of payment).

Protection for Directors & Officers

The three major sources of protection for directors and officers who have breached the fiduciary duties or for other liabilities are:

1) The business judgment rule: is the first line of defense and often the best protection a company has in an action brought against a director for breach of fiduciary duties.

2) Statutory indemnification: a director or officer of a corporation can be indemnified for liability (and litigation expenses) incurred by reason of a violation of the duty of care, but not for a violation of the duty to act in good faith.

3) Directors and officers’ liability insurance (often called “D&O”): is a liability insurance by which a corporation may indemnify its directors and officers for their liabilities arising out of their corporate activities.

[Optional] Chairman vs. CEO
Watch this 7-minute video to see the difference between a chairman and CEO:
[Optional] Cumulative Voting
Watch this 2-minute video about cumulative voting:
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