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Chapter VIII -- Duties of Directors

Chapter VIII -- Duties of Directors

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Published by: Sui on Aug 10, 2008
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Chapter VIII – Duties of Directors and ControllingStockholders
 The law makes directors fiduciaries of the corporation
Directors are expected to serve the corporation with reasonablediligence and skill and with utmost loyalty
Obligation of directors to act within their corporate powers
Cannot act alone where SHs have the power of final approval
Personal liability would still arise if due diligence has not been observedor there is disloyalty
 Three-fold duties of directors, trustees, and officers:
Duty of obedience
Duty of diligence
Duty of loyalty
Governed by 31, 32, 33, 34
Duties and obligations of directors, trustees, and officers have theirbases in common law, derived from the nature and relationship createdin the corporate setting and the fiduciary nature of the positions held bysuch persons
Attempt of the Corpo Code to codify the nature od duties and obligationsto cover most of such situations, but cannot be considered as to excludeother forms of violations of such duties
GR: members of the board and corporate officers who purport to act forand in behalf of the corporation, keep within the lawful scope of theirauthority in so acting, and act in GF, do not become liable for theconsequences of their acts
 These acts would be attributable to the corporation alone and nopersonal liability is incurred by such officers and board members(Benguet Electric v NLRC)
Although a director may have been voted into office by a block of SHs, it is the director’s duty to vote according to his ownindependent judgment and his own conscience as to what is in thebest interets of the corporation. (SMC v Kahn)
Section 31.
Liability of directors, trustees or officers.
- Directors ortrustees who wilfully and knowingly vote for or assent to patentlyunlawful acts of the corporation or who are guilty of gross negligence orbad faith in directing the affairs of the corporation or acquire anypersonal or pecuniary interest in conflict with their duty as such directorsor trustees shall be liable jointly and severally for all damages resultingtherefrom suffered by the corporation, its stockholders or members andother persons.When a director, trustee or officer attempts to acquire or acquires, inviolation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to whichequity imposes a disability upon him to deal in his own behalf, he shallbe liable as a trustee for the corporation and must account for the profitswhich otherwise would have accrued to the corporation. (n)
Business Judgment Rule
Corporate principle recognizing corporate power and competence tobe lodged primarily with the board of directors
A resolution or transaction pursued within the corporate powers andbusiness operations of the corporation, and passed in GF by theboard is valid and binding, and generally courts have no authority toreview the same or substitute their own judgment
Business judgment rule has two (2) applications:(1)resolutions and transactions entered into by the board within thepowers of the corporation cannot be reversed by the courts(2)GR: directors and officers acting within such business judgmentcannot be personally liable for the consequences of such acts
When the director willfully and knowingly vote forpatently unlawful acts of the corporation
When he is guilty of gross negligence or BF
When he acquires any personal or pecuniaryinterest in conflict with his duty as such directors
business judgment rule is not only a substantial rule of law, but also arule on evidence
once entered into by the board in the exercise of its judgment, it willbe presumed to be valid
Duty of Diligence
Directors or trustees who willfully and knowingly vote for orassent to patently unlawful acts of the corporation or who are guiltyof gross negligence or BF in the directing the affairs of thecorporation shall be solidarily liable for all damages
available to SHs, the corporation, and to creditors
mere assent would make director liable
it is not enough that he abstains from voting; he should cast anegative vote
but mere ownership of majority of shares or mere holding of 
officership position does not make one personally liable (Board of Liquidators v Kalaw)
Directors are expected to manage the corporation with reasonablediligence, care and prudence
Can be held liable for willful dishonesty and negligence
Should keep themselves sufficiently informed about the generalcondition of their business and to some extent the manner in whichits is conducted; if due to their fault or negligence, the corporateassets are wasted or lost, each of them may be held responsible forany loss proximately caused by the wrongful acts or omissions.
But they cannot be held liable for mistakes or errors in the exerciseof their business judgment, provided the act in GF and with due careand prudence (Barnes v Andrews infra)
Degree of care and diligence:
that which is usually required of men prompted by self-interest in the exercise of their own affairs
that which is demanded by the particular circumstances
nature of business
director of a bank is held to a higher degree of diligence than an ordinary commercial transaction(Litwin v Allen)
remedy of SHs: where directors have become grossly negligent orfraudulently mismanaged the corporation, they can be removed by theSHs in accordance with Sec 28, + damages
Otis & Co. v Pennsylvania Railroad Co
. F: Otis & Co is a SH in and amongthe wholly-owned subsidiaries of the Pennsylvania Railroad Co (PRR), whichincluded Pennsylvania Ohio 7 Detroit Railroads (POD). One of its subsidiarieshad an outstanding bond issuance of $28.4M. The parent then negotiatedwith a third party, Kuhn, Loeb and Co, to refinance the bonds. The directorsof POD approved a resolution authorizing the sale of the new Series D bondsat a best obtainable price. Bonds were then sold to Kuhn and Loeb. Anotherbuyer was willing to purchase the bonds at a better price but the directorsdeclined. The Interstate Commerce Commission found that the corporationwas not able to get the best price for the sale and that other options werenot explored, that negotiations were only with one investment house andwere at “arms-length dealing”, and that it was possible to have greatersavings.I: W/N the directors are liable for failing to exercise ordinary care and judgment in the issuance and sale of $28M in bonds, which resulted inalleged losses suffered by the corporation.H: Business judgment rule: courts will not interfere in matters of business judgment, in which it is presumed that judgment—reasonable diligence—hasin fact been exercised. A director cannot close his eyes to what is going onabout him in the conduct of business judgment. Courts have given directorswide latitude in the management of the affairs of the corporationprovided that the judgment is unbiased, honest and reasonablyexercised. Negligence must be determined as of the time of transaction.Mistakes or errors in the exercise of honest business judgment do notsubject the officers and directors to liability for negligence in thedischarge of their appointed duties. Directors are entrusted with themanagement of the affairs of the corporation. If in the course of management they arrive at a decision for which there is a reasonablebasis, and they acted in GF as the result of their independent judgment,and uninfluenced by any other consideration than what they honestly feltwas in the best interests of the corporation. In the present case, the SCfound that the officers and directors of the corporations acted honestly inGF and sought to exercise their best judgment for the best interests of their corporation. No fraud was present, but only a faint suggestion of BF. The directors had the right to negotiate privately with Kuhn and Loeb. Incontracting with the latter, the directors were not contracting withanother firm in which they were interested, nor did the directorship orofficership positions interlock. There is no contention that fraud existedand fraudulent acts will not be presumed.
Montelibano et al v. Bacolod-Murcia Milling Co Inc
. Montelibano etal are sugar planters adhered to the Milling Company’s sugar central millunder identical contracts. The contracts would be in force for 30 yearsand provide that the resulting product should be divided in the ratio of 45% for the mill and 55% for the planters. It was proposed to execute themilling contracts, increasing the planter’s shares to 60% of themanufactured sugar and molasses and extending the period from 30 to45 years. The Board of the Milling company then adopted a resolutiongranting further concessions to the planters over and above the amendedcontract. 17 years later, Montelibano sues the Milling company,contending that the 3 sugar centrals with a total annual productionexceeding 1/3 of the production of all sugar millis in Negros, had alreadygranted 62.5% participation to their planters, and in accordance withPara 9 of the resolution, it had become obligated to grant similarconcessions to them.H: When a resolution is passed in GF by the board, it is valid and binding,and whether or not it will cause losses or decrease the profits of thecentral, the court has no authority to review them. Questions of policy ormanagement are left solely to the honest decision of officers anddirectors of a corporation, and the court is without authority to substituteits judgment for that of the board; the board is the business manager of the corporation and so long as it acts in GF its orders are not reviewableby the courts
Litwin v Allen et al
. H: The officers are liable for the transaction
because the entire arrangement was so improvident, risky, and unusual andcontrary to fundamental concepts of prudent banking practice. A bankdirector when appointed takes oath that he will diligently and honestlyadminister the affairs of the bank or trust company. Honesty alone would notsuffice; there must be more than honesty—there must be diligence, and thatmeans care and prudence as well. What sound reason is there for a bank,desiring to make an investment, to buy securities under an arrangementwhereby any appreciation will insure to the benefit of the seller and any losswill be borne by the bank. There is here more than a question of business judgment. The directors plainly failed to bestow the care which the situationdemanded.A director, however, is not liable for loss or damage other than what wasproximately caused by his own acts or omissions in breach of his duty. Thedirectors in this case are liable only for the loss attributable to the impropertransaction itself, and not after the option on the improper transaction hadexpired.
Walker v Man et al
. F/H: Corporation was engaged in real estate andadvanced a loan to a third person taking as security his PN. The loan was notauthorized by the board and was not for the benefit of the corporation norwas it in aid of its business. No effort was done to collect on the loan, whichbecame due and demandable. The corporation went bankrupt, and thereceiver sues the directors to collect on the amount due the insolventcorporation and for damages. Court held that the director was negligent.
Steinberg v Velasco.
F: The board of the corporation authorized thepurchase of 330 shares of capital stock of the corporation and thedeclaration of dividends at a time when the corporation was indebted and insuch a bad financial condition. The directors relied on the face value on thebooks of its A/R, which had little or no value. Furthermore it appears that twoof the directors were permitted to resign so that they could sell their stock tothe corporation. The corporation became insolvent, and the receiverSteinberg sues the directors.H: The corporation did not have a bona fide surplus with which dividendscould be declared and paid out. The directors did not act in GF and weregrossly ignorant of their duties. Directors were held personally liable forcausing the corporation to purchase their own shares and declaringdividends, which because of such failure to take into consideration of worthless receivables, worked to the detriment of the creditors. Thedirectors did not act with diligence in taking the word of their chairman andnot making an informed decision based on the facts then available to themand on not relying on other documents available to them.Creditors have the right to assume that so long as there are outstandingdebts and liabilities, the board will not use the corporate assets topurchase its own stock, and that it will not declare dividends to SHs whenthe corporation is insolvent
Barnes v Andrews
. F: Corporation manufactures starters for Ford motorvehicles and airplanes. Director Andrews, the largest SH, who wasinduced by the President to become director, held only 2 board meetings.During his term, the company business was mismanaged. Barnes wasthen appointed receiver after the corporation had gone under, and wasfound that the company had no funds. He alleged that Andrews failed togive adequate attention to the affairs of the company, which had beenconducted incompetently and without regard to the wastage in salaries.Work had languished from incompetence and extravagance and quarrelsbetween the factory manager and the other personnel affectedproduction.H: First liability must rest upon the director’s general inattention to hisduties. He cannot be charged with neglect in attending director meetings,since there had been only 2. But his liability must depend upon his failurein general to keep advised of the conduct of the corporate affairs. Whiledirectors are collectively managers of the company, they are notexpected to interfere individually in the actual conduct of its affairs. To doso would disturb the authority of the officers and destroy their individualresponsibility, without which no proper discipline is possible. Havingaccepted a post of confidence, Andrews was charged with an active dutyto learn whether the company was moving to production, and why it wasnot, and to consider what could be done to avoid the conflicts amongpersonnel or correct their incompetence, which was slowly bleeding thebusiness to death. He must go further to show that he should have beenmore active, as the cause of action against him by the receiver restsupon a tort of omission as though it had rested on a positive act on hispart.When a business fails from general mismanagement or businessincapacity, could the blame be placed upon a single director and could hehave saved the company if he had tried? A director could have leastfulfilled his duties to the company and to the SHs to have made thecompany prosper, or at least to show that he had done his duty enoughto have broken the fall of the company. This Andrews failed to do. x True, Andrews was not well-suited by experience for the job he hadundertaken. Directors are not specialists, but they must have good sense,and must have acquainted themselves with the corporate affairs, butthey need not have any technical talent. They are the general advisers of the business, and if they faithfully give such ability as they have, it wouldnot be lawful to hold them liable. Must a director guarantee that his

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