PARTNERSHIPS, CORPORATIONS AND THE VARIANTS PROF. BRUCE MCCANN LECTURE 13 DUTY OF CARE Business Organizations Lectures

Directors’ Duty of Care Lec. 13, pp Corporations Prof. McCann Francis v United Jersey Bank:  Director is fiduciary of the corporation and its shareholders  And in the context of the business of the corporation, may be a fiduciary to its creditors  Where there is constructive or actual trust Director must “discharge duties in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions”

Francis v United Jersey Bank Lec. 13, pp Corporations Prof. McCann Where director breaches duty, personally liable if negligence was a proximate cause of a loss to the creditor or shareholder or corporation Plaintiff has burden of showing loss would have been avoided if defendant had performed her duties Analysis includes determination of “reasonable steps” director should have taken BUT causation will be inferred where reasonable to conclude particular result from a failure to act and that result has occurred.

Caremark Lec. 13, pp Corporations Prof. McCann Director liability can be grounded on several theories:  Liability following poor decision by board because decision was negligent and ill advised  Liability based on failure to act where due diligence would prevent the loss BUT, “absent cause for suspicion there is no duty…to install and operate a system of corporate espionage to ferret out wrongdoing that they have no reason to suspect exists.”

Caremark cont’d Lec. 13, pp Corporations Prof. McCann There must be a system in place adequate to assure the board that appropriate information will come to its attention in a timely manner Failure to insist upon and maintain such a system may render a director liable

Caremark cont’d Lec. 13, pp Corporations Prof. McCann Plaintiffs must show: Director knew or Should have known were violations of law Took no steps to prevent or remedy Failure proximately caused the loss

Rule Lec. 13, pp Corporations Prof. McCann Model Act and ALI, and most statutes, allow directors to rely on others if that reliance is reasonable because the adviser “merits confidence”

The Powers and Duties of the Board Lec. 13, pp Corporations Prof. McCann Key Functions:  Provide advice and counsel  Instill discipline in the decision-making of the corporation  Oversee crises  Monitor the conduct of Management

The Business Judgment Rule Lec. 13, pp Corporations Prof. McCann Applies when what is at issue is a business decision made by the directors Does not come into play where directors are accused of failing to monitor or similar derelictions of the duty of care, only when making a business decision

The Rule Lec. 13, pp Corporations Prof. McCann Absent fraud, illegality or conflict of interest, a director who acts in good faith is not personally liable for mere errors of judgment short of CLEAR AND GROSS NEGLIGENCE Shlensky v Wrigley 237 N.E. 2d 776 (Ill. 1968) Unless director(s) had an interest in the subject of the decision or Unless decision constitutes illegal conduct (e.g., decision to pay a bribe)

ALI Version Lec. 13, pp Corporations Prof. McCann No liability for a business judgment reached in good faith provided: 1. Director or officer was disinterested 2. Director or officer was informed as to the subject of the decision to a degree the director or officer reasonably believes appropriate; and 3. Rationally believes decision is in the best interests of the corporation

Lec. 13, pp Corporations Prof. McCann

SMITH V VAN GORKOM Lec. 13, pp Corporations Prof. McCann "Informed" within meaning of "due care" means board reviewed all material information reasonably available Liability under Business Judgment Rule arises only where there is a showing of gross negligence, meaning something more careless than ordinary negligence.  E.g., failure to even read a report which was itself deficient

Delaware Gen Corp Law Sec. 141 Lec. 13, pp Corporations Prof. McCann (e) A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.

Shareholder Ratification Lec. 13, pp Corporations Prof. McCann Shareholders may ratify acts of even interested directors PROVIDED shareholders are “fully informed”  Burden is on directors to establish shareholders were fully informed

Model Act Lec. 13, pp Corporations Prof. McCann SECTION GENERAL STANDARDS FOR DIRECTORS (a) A director shall discharge his (sic) duties as a director, including his (sic) duties as a member of a committee: (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner he (sic) reasonably believes to be in the best interests of the corporation. (b) In discharging his (sic) duties a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel, public accountants, or other persons as to matters the director reasonably believes are within the person's professional or expert competence; or (3) a committee of the board of directors of which he (sic) is not a member if the director reasonably believes the committee merits confidence. (c) A director is not acting in good faith if he (sic) has knowledge concerning the matter in question that makes reliance otherwise permitted by subsection (b) unwarranted. (d) A director is not liable for any action taken as a director, or any failure to take any action, if he (sic) performed the duties of his (sic) office in compliance with this section.

Calif. Corp Code Sec. 309 Lec. 13, pp Corporations Prof. McCann (a) A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances. (b) In performing the duties of a director, a director shall be entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, in each case prepared or presented by [officers, consultants, etc]. (c) A person who performs the duties of a director in accordance with subdivisions (a) and (b) shall have no liability based upon any alleged failure to discharge the person's obligations as a director. In addition, the liability of a director for monetary damages may be eliminated or limited in a corporation's articles to the extent provided in paragraph (10) of subdivision (a) of Section 204.

Arnold v Society for Savings Lec. 13, pp Corporations Prof. McCann Lock-up provision is a term used in corporate finance which refers to the option granted by a seller to a buyer to purchase a target company’s stock as a prelude to a takeover. The major or controlling shareholder is then effectively "locked-up" and is not free to sell the stocks to a party other than the designated party (potential buyer). Typically, a lockup agreement is required by an acquirer before making a bid and facilitates negotiation progress. Lock-ups can be “soft” (shareholder permitted to terminate if superior offer comes along) or “hard” (unconditional).

No Shop Lec. 13, pp Corporations Prof. McCann No-shops are promises by one or both corporations involved in a merger only to deal with their merger partner and not to solicit other bids or provide information to other possible bidders.