US Corporate Law/Directors

Control over a corporation is vested in a board of directors. The board of directors have great leeway to operate the corporation as they see fit, but they owe duties to shareholders, and often to others as well.

The board

Board meetings

The meeting rule states that directors cannot act unless they meet as a board. See Baldwin v. Canfield, 1 N.W. 261 (Minn. 1879) (board members each individually signed a deed on behalf of the corporation; transfer deemed invalid because board never met). There are legal ways for boards to act without actually meeting, but the general rule is that they must meet if possible.

Although the prototypical board meeting takes place in a "board room," hidden away inside a skyscraper, board meetings can take place anywhere and at any time. Under MBCA § 8.20 and DGCL § 141(i), the entire board does not even have to physically meet: a meeting can take place by teleconference or any other method in which the directors can simultaneously hear each other. This permissive rule has caused some courts to take a harder line against board action without a meeting, on the grounds that boards should be able to meet in just about any situation.

Notice

MBCA § 8.22 provides that notice is not necessary for regular board meetings, and that special meetings may be called on two days' notice. The DGCL contains no provisions for statutory notice. The articles or bylaws may fix a different notice requirement. If the board acts at a meeting held without the required notice, the action is invalid. See Schmidt v. Farm Credit Svcs., 977 F.2d 511 (10th Cir. 1992).

Quorum

A quorum must be present at the meeting in order for the board's action to be legally effective. The statutory quorum is a majority of the total number of directors, but can be increased or reduced to as low as one-third under MBCA § 8.24 and DGCL § 141(b).

Voting

Each director has one vote, and the majority of the quorum rules. Directors may not vote by proxy; they must be "present" (i.e. communicating) at the meeting. See MBCA § 8.24; Lippman v. Kehoe Stenograph Co., 95 A. 895 (Del. Ch. 1910).

Board decisions without a meeting

Written consent

Under MBCA § 8.21 and DGCL § 141(f), a board may act by unanimous written consent without a meeting. The idea behind this rule is that forcing unanimous consent ensures that opposing argument will not be silenced during the decision-making process: if a director opposes the action, they can force a meeting by refusing to sign the consent.

Emergency powers

If a quick decision is necessary to prevent great harm or take advantage of great opportunity, and a quorum of the board cannot be assembled in time, the directors who are available may make the decision.

Shareholder consensus

If the shareholders meet and reach a unanimous agreement, that agreement can bind the corporation. See In re Kartub, 152 N.Y.S.2d 34 (Sup. Ct. 1956).

Majority approval

If a majority of directors owning a majority of the corporation's stock reach an agreement, that agreement can bind the corporation. See Phillips Petroleum Co. v. Rock Creek Mining Co., 449 F.2d 664 (9th Cir. 1971).

Duties of directors

Directors' duties are primarily a matter of common law. The DGCL does not address directors' duties at all. MBCA § 8.31 codifies a simplified version of the common law business judgment rule.

Business judgment rule

The business judgment rule is a safe harbor for directors. A director's decision is not subject to review in court so long as it is made in good faith, on an informed basis, and in the best interest of the corporation (i.e. absent a conflict of interest). So long as the director's decision is mere "business judgment," they will not be personally liable for it.

In Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. 1968), a shareholder of the Chicago Cubs' holding company attempted to sue Cubs president Philip Wrigley. At the time, the Cubs were the only Major League Baseball team that didn't have lighting at its home field, Wrigley Field. The court refused to force Wrigley to install lights for night games, stating that "there must be fraud or a breach of good faith which directors are bound to exercise... in order to justify the courts entering into the internal affairs of corporations."

The business judgment rule has been set aside when directors approve a criminal act in the interest of maximizing profit. See Roth v. Robertson, 118 N.Y.S. 351 (Sup. Ct. 1909) ("strict accountability" for director who paid "hush money" to individuals claiming illegal operation of business); Miller v. AT&T Co., 507 F.2d 759 (3d Cir. 1974) (directors not insulated from liability on ground that illegal campaign contribution was made in exercise of business judgment).

Duty of loyalty

Directors are required to deal fairly in any transaction that creates a conflict of interest, such as when the corporation is dealing with the director himself, or another corporation upon whose board the director sits. Directors cannot take personal windfalls from corporate transactions, and if they run a business that competes with the corporation, they must do so in good faith. They cannot use corporate assets for their personal business.

Duty of oversight

Business activities

A director cannot be a "dummy" on the board. Each director has a duty to attend meetings on a regular basis and to keep track of what is happening in the corporation, including its financial status. Directors who do not fulfill this duty breach their fiduciary duty to the shareholders, and potentially to others; see Francis v. United Jersey Bank, 432 A.2d 814 (N.J. 1981) (holding negligent director of reinsurance broker liable to clients).

Legal compliance

Some courts have held that a director need only investigate possible criminal misconduct within the corporation if a "red flag" comes up to alert them to the problem. See Graham v. Allis-Chambers Mfg. Co., 188 A.2d 125 (Del. 1963).

Others have held that the board must have a reasonable information gathering process in place to monitor the corporation's compliance with the law. See In re Caremark Intl., Inc., 698 A.2d 959 (Del. Ch. 1996).

Duty to become informed

Somewhat more problematic than the duty of oversight is the duty to become informed. Many courts have imposed a duty upon directors to actively seek information on any major transaction. One of the most controversial cases regarding the duty to become informed is Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), described below.

The Trans Union case

Van Gorkom was chairman and CEO of the Trans Union Corporation, which made much of its revenue from leasing out railway cars. Due to tax issues, Trans Union needed to boost its revenues in order to stay competitive. In September of 1980, Van Gorkom sat down with a friend, Pritzker, who specialized in corporate takeovers. He proposed a sale of Trans Union to Pritzker at $55 a share, and Pritzker accepted this offer a couple of days later. They worked out a deal over the next couple of days in which Trans Union's shareholders would receive $55 cash for each of their shares, and Pritzker would have the option to buy one million shares of Trans Union's unissued treasury stock at $38 per share, 75 cents above market price. Pritzker demanded a response from the board by September 21, just three days away.

On September 20, Van Gorkom called a senior management meeting. Almost all of the other managers thought the idea was ridiculous. The CFO objected to the $55 per share price and to the option to buy treasury shares. Immediately after the management meeting, Van Gorkom summoned the board. He outlined the deal to them without handing over the actual agreement. He brought in a lawyer from an outside firm, who instructed the board that they might face a lawsuit if they didn't take the offer; after all, it was for a shareholder meeting to decide. The CFO told the board that $55 was "at the beginning of the range" of a fair price. The board approved the merger offer after two hours, on the condition that Trans Union would be able to accept any better offer brought within the next 90 days. Van Gorkom signed the merger agreement that night at a party. Neither he nor any members of the board had actually read it.

After the deal was made public on September 22, many officers threatened to resign. Van Gorkom quieted them down by negotiating amendments that would allow Trans Union to solicit other bids through its investment banker, Salomon Brothers. The board approved these amendments on October 8. Two other offers came in, but neither could be completed within the 90-day window. On December 19, a derivative suit was filed. The Delaware Supreme Court overturned the Court of Chancery's ruling for defendants, stating that:

Under the business judgment rule there is no protection for directors who have made "an unintelligent or unadvised judgment." A director's duty to inform himself in preparation for a decision derives from the fiduciary capacity in which he serves the corporation and its stockholders. Since a director is vested with the responsibility for the management of the affairs of the corporation, he must execute that duty with the recognition that he acts on behalf of others. Such obligation does not tolerate faithlessness or self-dealing. But fulfillment of the fiduciary function requires more than the mere absence of bad faith or fraud. Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present here. Thus, a director's duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty.

...In the specific context of a proposed merger of domestic corporations, a director has a duty under (the law), along with his fellow directors, to act in an informed and deliberate manner in determining whether to approve an agreement of merger before submitting the proposal to the stockholders. Certainly in the merger context, a director may not abdicate that duty by leaving to the shareholders alone the decision to approve or disapprove the agreement. Only an agreement of merger satisfying the requirements of (the law) may be submitted to the shareholders.

The Supreme Court sent the case back to the Court of Chancery with instructions to determine the fair market value of the plaintiffs' shares in Trans Union, and award damages to the extent that the fair value exceeded $55 per share. Before this could happen, the directors agreed to settle the claim for $23.5 million, $10 million of which was paid from liability insurance taken out by the directors, and the remaining $13.5 million paid by Pritzker.

Chicago school academics were up in arms over the case. How could directors be liable for approving a deal where shareholders got a 50% premium over the market price of their stock? And what business did the court have second-guessing the directors' judgment? Ira Millstein contended that "99% of boards didn't think that anything wrong had happened. Most everybody wrote about the decision as 'the Delaware courts are going nuts.'"

On the other hand, the decision put board members on notice that they had to be careful not to rush to judgment, especially in deals where there's a lot of money involved. Millstein again: "If you went into a board room before Van Gorkom and tried to talk about legal obligations, they'd say 'We have more important things to do...' When it came down, you were able to walk into a boardroom for the first time and really be heard."

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