Dynamic business law 4e kubasek 4e CH39

Chapter 39
Corporations: Directors, Officers, and Shareholders

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Overview

• LO39-1: Why is it important to regulate the interactions among directors,
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officers, and shareholders within a corporation?
LO39-2: What is the role of a director, an officer, and a shareholder?
LO39-3: What are the duties of directors, officers, and shareholders?
LO39-4: In what ways can a director, officer, and shareholder be held
liable?
LO39-5: What are the rights of directors, officers, and shareholders?

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Chapter 39 Hypothetical Case 1
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Having built a successful lawn care service over the past five years, Brian Creighton has decided to incorporate his
business. The new company, Pastures of Plenty Lawn Care Service, Inc., will have four shareholders: Creighton, his
wife Tamara, his father Albert, and his father-in-law Hal Stockton.

Creighton remembers from his college business law class that the the board of directors has an important role in the
operation of a corporation—specifically, deciding what action the corporation should take when facing an important
decision. Creighton wonders whether his new company must have a board.

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Will Pastures of Plenty Lawn Care Service, Inc. be required to have a board of directors?

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Chapter 39 Hypothetical Case 2
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Zaxxone Oil Company, Inc., headquartered in Mobile, Alabama, is a multinational corporation with 2012 annual
profits of $45 billion. Zaxxone has 12 board members who serve the company on a part-time basis, with each board
member receiving an average of $300,000 per year in compensation.

Emily Chanel, a pre-law student at the University of Alabama at Mobile, is very familiar with Zaxxone, and she has
studied her business law textbook material on corporations and their directors, officers, and shareholders very
carefully. She recalls that a board of directors and its members owe a strict fiduciary duty to the corporation; as part
of this fiduciary duty, the board must exercise oversight in monitoring the actions of corporate employees, including
the executives and officers of the corporation.

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Chapter 39 Hypothetical Case 2
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Chanel ponders, "How can board members of a major corporation be truly objective when they are being paid such lavish sums of
money? Wouldn't Zaxxone board members have a 'don't rock the boat' mentality in terms of exercising their oversight function?

"Why, for example, would a Zaxxone board member question the practices of the company's high-ranking executives and officers
when such an inquiry might jeopardize his or her $300,000 per year annual compensation? Make no bones about it—if I were a
board member at Zaxxone, I would probably be a 'yes-woman' and approve of everything the chief executive officer, the chief
financial officer, and the chief operating officer wanted to do!"

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How would you respond to Chanel's questions and overall concerns about board member compensation and objectivity?

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Critical Corporate Actors

• Directors
• Officers
• Shareholders

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Why Is Regulation Important?

• Each has different interests, sometimes interests conflict
• Directors and officers' goals: Survival of institution, keeping their jobs
• Shareholders' goal: Raising value of stock
• Different roles regulate one another and maintain checks and balances

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Roles of Directors, Officers, and Shareholders

• Directors
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Vote on important corporate decisions

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Run day-to-day business of firm

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Elect board of directors

Appoint and supervise officers
Declare and pay corporate dividends
Manage corporation

• Officers

Agents of corporation

• Shareholders

Approve major board decisions

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Fiduciary Duties

• Definition: Duties to corporation that individuals within corporation have
• Primary fiduciary duties include:
• Duty of care
• Duty of loyalty
• Duty to disclose conflict of interest

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Liability of Directors and Officers

• Can be held personally liable for their own torts and crimes
• Can be held personally liable for torts and crimes of other employees they
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supervise
Can be held liable for wrongful transactions involving company stock
Cannot be held liable for decisions that harm company if they were acting

in good faith at time of decision

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Liability of Shareholders

• Liable (to extent of their investment) for debts of corporation
• Liable for breach of contract if stock subscription agreement signed and
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no stock purchased
Liable for watered stock
Personally liable for receiving illegal dividends

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Rights of Directors, Officers, and Shareholders

• Directors
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Right to compensation

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Rights determined in employment contract

Right to participation
Right to inspection
Right to indemnification

• Officers

• Shareholders
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Stock certificates
Preemptive rights
Right to dividends
Right to transfer shares
Inspection rights
Right to corporate dissolution
Right to file derivative suit
Right to file direct suit

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Terminology Relating to Directors, Officers, and Shareholders
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Quorum: Minimum number of directors necessary to validate corporate directors' meeting
Proxy: Provides authorization for third party to vote in place of shareholder at shareholders' meeting
Voting trust: Agreement between stockholder and trustee in which stockholder transfers his/her legal
share titles to trustee; trustee is then responsible for voting for those shares

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Business judgment rule: Provides that directors and officers are not liable for decisions that harmed
corporation if they were acting in good faith at time of decision

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Other Terms Relating to Directors, Officers, and Shareholders
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Stock subscription agreement: Contractually obliges individual to buy shares in corporation

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Stock warrants: Vouchers issued to shareholders, entitling them to given number of shares at specified price

Par-value shares: Fixed face value noted on stock certificate
No-par shares: Stock shares without a par value
Watered stock: Stock issued below its fair market value
Preemptive rights: Preferential rights given to existing shareholders to purchase shares of new stock issue;
preference given in proportion to percentage of stock shareholder already owns

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Other Terms Relating to Directors, Officers, and Shareholders
(cont'd)
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Dividend: Distribution of corporate profits/income ordered by directors and paid to shareholders in
proportion to their respective shares in corporation
Inspection rights: Protect shareholder interest by giving them right to inspect corporation's books and
records after asking in advance to inspect and having proper purpose
Right of first refusal: Given to existing shareholders to purchase any shares of stock offered for resale by
shareholder within specified period of time
Shareholder's derivative suit: Filed by corporate shareholder when corporate directors fail to sue in situation
where corporation has been harmed by individual/another corporation

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Chapter 39 Hypothetical Case 3
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Dr. Charles Finnegan is a newly-appointed member of the Board of Directors of Walnut Grove Community College (WGCC) in
Walnut Grove, California. The position is unpaid, but it does come with the perks of positive exposure and prestige in the local
community.

At his first board meeting, the directors are discussing and considering for approval service contracts between WGCC and the local
business community. The third contract for consideration is a janitorial service contract, valued at $150,000, between WGCC and
Antiseptic Andy Cleaning Service, Inc. Finnegan is quite surprised; after all, Antiseptic Andy is owned and operated by his first
cousin, Andrew Deere. Cousins Finnegan and Deere have not seen each other in three years, nor have they otherwise
communicated during that period of time.

The chairperson of the Board of Directors calls for a vote on the janitorial service contract. According to WGCC regulations, the
board must unanimously approve contracts with the business community.

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Chapter 39 Hypothetical Case 3 (cont'd)
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Finnegan is perplexed. If he votes and says nothing about his kinship to Deere, he still feels he can sleep at
night, since he will not receive any financial gain from the contract. If he discloses his kinship to Deere, he
fears that Deere's business opportunity will be jeopardized.

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Does Finnegan have a legal obligation to disclose his relationship to Deere? Would it be a conflict of interest
for Finnegan to vote in favor of the contract? Does he have an ethical obligation to disclose the relationship?

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Chapter 39 Hypothetical Case 4
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Marc Mayweather is the brother of tech genius Brian Mayweather. He has been a strong financial supporter of his
brother's many business ventures, most of which resulted in substantial losses to both brothers.

Brian Mayweather hit it big with his latest fledgling corporation, ParaDoubt. Last year, ParaDoubt, a public company
with more than 2,000 investors, launched a mobile app called Identibug. The app allows a smartphone user to take a
photo of a pest and immediately identify what the pest is and the best ways to get rid of it.

Marc Mayweather was an initial investor in ParaDoubt, just as he was with his brother's previous companies, but his
stake was relatively small—only 10 percent of the company's shares.

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Chapter 39 Hypothetical Case 4 (cont'd)
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A year ago, pest control giant Pestex approached ParaDoubt about an acquisition. Brian Mayweather shared information about the
upcoming acquisition with his brother and offered him an opportunity to buy another 5,000 shares (about five percent of the overall total
of shares in the company) at a greatly reduced price. Marc Mayweather joyfully accepted his brother's offer and bought the shares.

The deal with Pestex was finalized a month ago, and ParaDoubt is now part of Pestex. An original ParaDoubt shareholder, who is now also a
Pestex shareholder, learned of Marc Mayweather's on-the-cheap stock buy just before the acquisition was announced and has demanded
an emergency shareholder meeting.

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Was Brian Mayweather wrong to share information of the upcoming acquisition with his brother? Was he wrong to offer up additional
shares a reduced price? Was Marc Mayweather wrong to accept? What are the Mayweather brothers' respective liabilities in this matter?
Explain your answer.

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