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— — — — — — The law makes directors fiduciaries of the corporation Directors are expected to serve the corporation with reasonable diligence 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 observed or there is disloyalty Three-fold duties of directors, trustees, and officers: o Duty of obedience o Duty of diligence o Duty of loyalty Governed by 31, 32, 33, 34 Duties and obligations of directors, trustees, and officers have their bases in common law, derived from the nature and relationship created in the corporate setting and the fiduciary nature of the positions held by such persons Attempt of the Corpo Code to codify the nature od duties and obligations to cover most of such situations, but cannot be considered as to exclude other forms of violations of such duties GR: members of the board and corporate officers who purport to act for and in behalf of the corporation, keep within the lawful scope of their authority in so acting, and act in GF, do not become liable for the consequences of their acts o These acts would be attributable to the corporation alone and no personal liability is incurred by such officers and board members (Benguet Electric v NLRC) o 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 own independent judgment and his own conscience as to what is in the best interets of the corporation. (SMC v Kahn)
violation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to which equity imposes a disability upon him to deal in his own behalf, he shall be liable as a trustee for the corporation and must account for the profits which otherwise would have accrued to the corporation. (n) Business Judgment Rule — — Corporate principle recognizing corporate power and competence to be lodged primarily with the board of directors A resolution or transaction pursued within the corporate powers and business operations of the corporation, and passed in GF by the board is valid and binding, and generally courts have no authority to review the same or substitute their own judgment Business judgment rule has two (2) applications: (1) resolutions and transactions entered into by the board within the powers of the corporation cannot be reversed by the courts (2) GR: directors and officers acting within such business judgment cannot be personally liable for the consequences of such acts — Exceptions:
i. ii. iii.
When the director willfully and knowingly vote for patently unlawful acts of the corporation When he is guilty of gross negligence or BF
When he acquires any personal or pecuniary interest in conflict with his duty as such directors business judgment rule is not only a substantial rule of law, but also a rule on evidence once entered into by the board in the exercise of its judgment, it will be presumed to be valid
Duty of Diligence
Section 31. Liability of directors, trustees or officers. - Directors or trustees who wilfully and knowingly vote for or assent to patently unlawful acts of the corporation or who are guilty of gross negligence or bad faith in directing the affairs of the corporation or acquire any personal or pecuniary interest in conflict with their duty as such directors or trustees shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons. When a director, trustee or officer attempts to acquire or acquires, in
31: Directors or trustees who willfully and knowingly vote for or assent to patently unlawful acts of the corporation or who are guilty of gross negligence or BF in the directing the affairs of the corporation shall be solidarily liable for all damages o available to SHs, the corporation, and to creditors o mere assent would make director liable o it is not enough that he abstains from voting; he should cast a negative vote o 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 reasonable diligence, care and prudence o Can be held liable for willful dishonesty and negligence o Should keep themselves sufficiently informed about the general condition of their business and to some extent the manner in which its is conducted; if due to their fault or negligence, the corporate assets are wasted or lost, each of them may be held responsible for any loss proximately caused by the wrongful acts or omissions. o But they cannot be held liable for mistakes or errors in the exercise of their business judgment, provided the act in GF and with due care and prudence (Barnes v Andrews infra) o Degree of care and diligence: that which is usually required of men prompted by selfinterest 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 or fraudulently mismanaged the corporation, they can be removed by the SHs in accordance with Sec 28, + damages Otis & Co. v Pennsylvania Railroad Co. F: Otis & Co is a SH in and among the wholly-owned subsidiaries of the Pennsylvania Railroad Co (PRR), which included Pennsylvania Ohio 7 Detroit Railroads (POD). One of its subsidiaries had an outstanding bond issuance of $28.4M. The parent then negotiated with a third party, Kuhn, Loeb and Co, to refinance the bonds. The directors of POD approved a resolution authorizing the sale of the new Series D bonds at a best obtainable price. Bonds were then sold to Kuhn and Loeb. Another buyer was willing to purchase the bonds at a better price but the directors declined. The Interstate Commerce Commission found that the corporation was not able to get the best price for the sale and that other options were not explored, that negotiations were only with one investment house and were at “arms-length dealing”, and that it was possible to have greater savings. 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 in alleged 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—has in fact been exercised. A director cannot close his eyes to what is going on about him in the conduct of business judgment. Courts have given directors
wide latitude in the management of the affairs of the corporation provided that the judgment is unbiased, honest and reasonably exercised. Negligence must be determined as of the time of transaction. Mistakes or errors in the exercise of honest business judgment do not subject the officers and directors to liability for negligence in the discharge of their appointed duties. Directors are entrusted with the management of the affairs of the corporation. If in the course of management they arrive at a decision for which there is a reasonable basis, and they acted in GF as the result of their independent judgment, and uninfluenced by any other consideration than what they honestly felt was in the best interests of the corporation. In the present case, the SC found that the officers and directors of the corporations acted honestly in GF 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. In contracting with the latter, the directors were not contracting with another firm in which they were interested, nor did the directorship or officership positions interlock. There is no contention that fraud existed and fraudulent acts will not be presumed. Montelibano et al v. Bacolod-Murcia Milling Co Inc. Montelibano et al are sugar planters adhered to the Milling Company’s sugar central mill under identical contracts. The contracts would be in force for 30 years and 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 the milling contracts, increasing the planter’s shares to 60% of the manufactured sugar and molasses and extending the period from 30 to 45 years. The Board of the Milling company then adopted a resolution granting further concessions to the planters over and above the amended contract. 17 years later, Montelibano sues the Milling company, contending that the 3 sugar centrals with a total annual production exceeding 1/3 of the production of all sugar millis in Negros, had already granted 62.5% participation to their planters, and in accordance with Para 9 of the resolution, it had become obligated to grant similar concessions 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 the central, the court has no authority to review them. Questions of policy or management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its 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 reviewable by 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 and contrary to fundamental concepts of prudent banking practice. A bank director when appointed takes oath that he will diligently and honestly administer the affairs of the bank or trust company. Honesty alone would not suffice; there must be more than honesty—there must be diligence, and that means care and prudence as well. What sound reason is there for a bank, desiring to make an investment, to buy securities under an arrangement whereby any appreciation will insure to the benefit of the seller and any loss will 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 situation demanded. A director, however, is not liable for loss or damage other than what was proximately caused by his own acts or omissions in breach of his duty. The directors in this case are liable only for the loss attributable to the improper transaction itself, and not after the option on the improper transaction had expired. Walker v Man et al. F/H: Corporation was engaged in real estate and advanced a loan to a third person taking as security his PN. The loan was not authorized by the board and was not for the benefit of the corporation nor was it in aid of its business. No effort was done to collect on the loan, which became due and demandable. The corporation went bankrupt, and the receiver sues the directors to collect on the amount due the insolvent corporation and for damages. Court held that the director was negligent. Steinberg v Velasco. F: The board of the corporation authorized the purchase of 330 shares of capital stock of the corporation and the declaration of dividends at a time when the corporation was indebted and in such a bad financial condition. The directors relied on the face value on the books of its A/R, which had little or no value. Furthermore it appears that two of the directors were permitted to resign so that they could sell their stock to the corporation. The corporation became insolvent, and the receiver Steinberg sues the directors. H: The corporation did not have a bona fide surplus with which dividends could be declared and paid out. The directors did not act in GF and were grossly ignorant of their duties. Directors were held personally liable for causing the corporation to purchase their own shares and declaring dividends, which because of such failure to take into consideration of worthless receivables, worked to the detriment of the creditors. The directors did not act with diligence in taking the word of their chairman and not making an informed decision based on the facts then available to them and on not relying on other documents available to them. Creditors have the right to assume that so long as there are outstanding
debts and liabilities, the board will not use the corporate assets to purchase its own stock, and that it will not declare dividends to SHs when the corporation is insolvent Barnes v Andrews. F: Corporation manufactures starters for Ford motor vehicles and airplanes. Director Andrews, the largest SH, who was induced by the President to become director, held only 2 board meetings. During his term, the company business was mismanaged. Barnes was then appointed receiver after the corporation had gone under, and was found that the company had no funds. He alleged that Andrews failed to give adequate attention to the affairs of the company, which had been conducted incompetently and without regard to the wastage in salaries. Work had languished from incompetence and extravagance and quarrels between the factory manager and the other personnel affected production. H: First liability must rest upon the director’s general inattention to his duties. He cannot be charged with neglect in attending director meetings, since there had been only 2. But his liability must depend upon his failure in general to keep advised of the conduct of the corporate affairs. While directors are collectively managers of the company, they are not expected to interfere individually in the actual conduct of its affairs. To do so would disturb the authority of the officers and destroy their individual responsibility, without which no proper discipline is possible. Having accepted a post of confidence, Andrews was charged with an active duty to learn whether the company was moving to production, and why it was not, and to consider what could be done to avoid the conflicts among personnel or correct their incompetence, which was slowly bleeding the business to death. He must go further to show that he should have been more active, as the cause of action against him by the receiver rests upon a tort of omission as though it had rested on a positive act on his part. When a business fails from general mismanagement or business incapacity, could the blame be placed upon a single director and could he have saved the company if he had tried? A director could have least fulfilled his duties to the company and to the SHs to have made the company prosper, or at least to show that he had done his duty enough to 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 had undertaken. Directors are not specialists, but they must have good sense, and must have acquainted themselves with the corporate affairs, but they 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 would not be lawful to hold them liable. Must a director guarantee that his
judgment is good? Can SHs call him to account for deficiencies which their votes assured him did not disqualify him for office? Bates v Dresser. F: Bank employee was able to embezzle cash from the branch operations for a considerable period of time, unbeknown to the bank officers, who relied to heavily and trusted the employee. He was able to swindle money by concealing his withdrawals through entries in the records of the bank, and matched it with the correct statements which were relied upon by the cashier. H: Under the circumstances of this case, the directors did not neglect their duty in accepting the statement of the cashier and failing to inspect the depositor’s ledger. They should not be held answerable for taking the cashier’s statement to be as correct as the statement of assets always was. The statement of assets were always correct. A committee was appointed to examine the operations of the bank. The bank itself was in sound financial condition. Their confidence seemed warranted by the semi-annual examinations by the government examiner and they were encouraged in their belief that all was well by the president. They were not bound by virtue of the office gratuitously assumed by them to call in the passbooks and compare them with the ledger, and until the event showed the possibility they hardly could have seen that their failure to look at the ledger opened a way to fraud. The position of the president, however, is different. Practically he was the master of the situation. He was at the bank daily for hours, had the ledger in his hands at time. He had hints and warnings of the unexplained shortages and rapid decline in deposits. He knew the errant employee had been living at a fast pace and had been dabbling in stocks. He had been put on his guard, and had they been heeded by the President, it would have led to an examination of the ledger’s and would have prevented future thefts. In accepting the presidency Dresser must be taken to have contemplated responsibility for losses to the bank. Duty of Obedience Board is bound to observe the duty of obedience—they will direct the affairs of the corporation only in accordance with the purposes for which its was organized — 26: Directors and officers to be elected shall perform the duties enjoined on them by law and by the BLs of the corporation. — Duty of Loyalty; Fiduciary Duties; Conflict of Interests — Under 31: Directors or trustees who acquire any personal or pecuniary
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interest in conflict with their duty as directors shall be liable solidarily for all damages resulting therefrom o When a director attempts to acquire or acquires any interest adverse to the corporation, equity imposes a liability upon him to deal in his own behalf, he shall be liable as a trustee for the corporation and must account for the profits which otherwise would have accrued to the corporation director is a fiduciary of the corporation in case of conflict of interest, he cannot sacrifice the interests of the corporation without incurring liability for his disloyal act Code sets up standards but ultimately must be decided on the merits of each case 1. the self-dealing director
a director who enters into a contract with the corporation of which he is a SH or member since he participates in the decision as to whether or not the contract is to be accepted, he will be exposed to the temptation of putting his interest above those of the corporation and could exert influence to obtain board approval of his contract with the corporation but not all dealings of the director with his own corporation when it’ll be beneficial or have the best interest in its welfare the rule thus absolutely disqualifying a fiduciary from dealing with his cestui que trust has not been strictly applied to directors
sec 35: A contract of the corporation with one or more of its directors or trustees or officers is voidable at the option of such corporation, unless all the following conditions are present that: (a) the presence of such director or trustee in the board meeting in which the contract was approved was not necessary to constitute a quorum (b) the vote of such director or trustee was not necessary for the approval of the contract (c) the contract is fair and reasonable under the circumstances (d) the contract with the officer has been previously authorized by the board — — — — — where any of the first two (2) conditions is absent, in the case of a contract with a director or trustee, such contract may be ratified by a vote of 2/3 OCS but full disclosure of the adverse interest must be made not all conditions must be present also applies to corporate officers contract of a self-dealing director is VOIDABLE at the option of the corporation, w/n there has been damages
self-dealing contract is presumed unfair until the self-dealing director proves otherwise — to validate the contract of a self-dealing director: o ratification by the SHs thru a vote of at least 2/3 OCS (including the shares of the self-dealing director) although he may not have voted, if the other members of the board are under his dominating influence, he will still be considered a self-dealing director covered by the provision (Globe Woolen Co v Utica Gas & Electric) even when the director resigns in order to consummate the contract, but after he has laid the foundation for the successful completion of the same, he can still be held liable to account for the profits he may have reaped (Steinberg v Velasco) o full disclosure of the adverse interest o contract must be fair and reasonable — Palting v San Jose Petroleum Inc. F: Case involves provisions in the bylaws of a corporation seeking to have its securities registered and distributed in the Philippines. H: Considering the questioned provision that no contract or transaction between the company and any other association or corporation shall be affected except in case of fraud, by the fact that any of the directors or officers of the company may be interested in or are directors or officers of such other associations or corporation, the impact of these provisions upon the traditional fiduciary relationship between the directors and SHs of a corporation is too obvious to escape notice. The directors and officers of the corporation can do anything, short of actual fraud, with the affairs of the corporation, even to benefit themselves, with immunity. This and other provisions which authorized the election of non-SHs as directors, completely disassociate the SHs from the government and management of the business in which they have invested. Mead v EC McCullough. H: While a corporation remains solvent, there is no reason why a director or officer, by authority of a majority of the SHs or board may not deal with the corporation, loan it money or buy property from it. So long as a purely private corporation remains solvent, its director are agents or trustees for the SHs. They owe no duties or obligations to others. But the moment such a corporation becomes insolvent, its directors are trustees of all the creditors, whether they are members of the corporation or not, and must manage its property and assets with strict regard to their interest. A director or officer may in GF and for an adequate consideration purchase from a majority of the directors or SHs the property even of an insolvent corporation, and a sale thus made to him is valid and binding upon the minority.
Where a director in a corporation accepts a position in which his duties are incompatible with those as such director it is presumed that he has abandoned his office as director of the corporation. 2. Fixing compensation of directors and officers — — — — — Typical situation of self-dealing Takes various forms: per diems, salaries and profit-sharing arrangements like bonuses, stock options plans, pension plans, etc GR: directors are NOT entitled to compensation for performing services ordinarily attached to their office; they are presumed to serve without pay Exception: unless the AOI or BLs expressly provide or a contract is made in advance (Lingayen gulf v Baltazar infra) Only the SHs and NOT the directors themselves may fix the amount of compensation o A SHs resolution to grant such compensation can only refer to future and NOT to PAST services (Barretto v La Previsora infra) Principles also applicable to non-stock corporations… … but NOT applicable to an officer who is not a director … also not applicable to directors who render service outside his usual duties
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Sec 30 Sec 87 — — Directors can receive compensation other than per diems only if the by-laws fix the same or in the absence thereof, approval of majority of SHs Sec 30 allows directors to fix the amount of their own per diems; technically is self-dealing but allowed by express provision of law o But the per diems must be REASONABLE o Total amount of compensation—including per diems—must not exceed 10% of the corporation’s net income before taxes As to corporate officers and employees not directors: may consist not only of salaries but also bonuses, stock options, and other profitsharing schemes As to the president: Code is silent, but SC held that he is expected to serve without salary, and that the per diems paid were sufficient compensation for services (Lingayen Gulf v Baltazar) SEC: stock option plans of widely-held corporations o must be subject to full disclosure before they can publicly sell their securities o must be approved by SHs representing 2/3 of SUBSCRIBED capital stock
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amount set aside must not be more than 20% of the subscribed capital stock
Gov’t of PI vs. El Hogar Filipino. (supra) Barretto v La Previsora Filipina. F: Suit by the resigned directors of a building and loan association to recover 1% of the profits to each complainant in accordance with an amendment to the by-laws, which stipulate that they are entitled to a lifetime annuity from the profits of the corporation. H: The amended by-laws does create any obligation to pay to the persons name therein such a life gratuity or pension out of the profits. A by-law of this nature must be clearly regarded as beyond the lawful powers of a mutual building and loan association and is thus ultra vires. As it were, the by-law cannot be held to establish a contractual relation between the parties. The authority conferred upon corporations in the code refers to providing compensation for future services of directors, officers, and employees after the adoption of the by-law and cannot in any sense be held to authorize the giving of continuous compensation to particular directors after their employment has terminated for past services rendered gratuitously by the them to the corporation. To permit the transaction would be to create an obligation unknown to the law, and to countenance a misapplication of funds of the building and loan association to the prejudice of SHs. Contracts between a corporation and third persons must be made by or under authority of its board and not by the SHs. The action of the SHs is only advisory and is not binding on the corporation. Kerbs v California Eastern Airways. F: The stock option plan of the company provides that 250,000 shares of the corporation’s unissued stock be subject to options to purchase at $1/share, exercisable at any time within a period of 5 years. The profit sharing plan provides that when quarterly earning exceeded $30,000 before taxes, 10% shall be distributed among the name officers and executive personnel. If a loss is incurred, cumulative deficiency plus operating losses shall be carried forward to succeeding quarterly periods. Both plans were adopted at a board meeting, but only the stock options plan was ratified by the SH. H: The SH ratification cures any voidable defect in the action of the board on the stock options plan. Ratification by SHs of voidable acts of directors is effective for all purposes unless the action of the directors constituted a gift of corporate assets to themselves or was ultra vires, illegal, or fraudulent.
The validity of a stock option plan depends directly upon the existence of consideration to the corporation. Sufficient consideration to the corporation may be inter alia, the retention of the services of an employee, or the gaining of services of a new employee, provided there is a reasonable relationship between the value of the services rendered and the value of options granted. In this case, the stock option plan is deficient because it is not reasonably calculated to insure that the corporation will receive the contemplated benefits. No rule of thumb can be devised to test the sufficiency of the condition which are urged as insurance that the corporation will receive the contemplated benefit. The most that can be said is that in each case there must be some element which, within reason, can be expected to lead to the desired end. The plan and options issued do not of themselves insure that benefit of retaining the services of the employee to whom the option is granted will inure to the corporation. They are too insecure in nature to be regarded as a condition of the stock option plan designed to insure that the corporation will receive the contemplated benefit. 3. Using inside information — — — — Directors and corporate officers are insiders having access to confidential information relating to the business of the corporation Fiduciary position prohibits them from using any information to benefit themselves or any competitor corporation Liability of guilty and disloyal director can be based on Sec 31 RSA (now SRC) contains express provisions regarding use of inside information
Sec 36 RSA Sec 30 RSA Sec 53 RSA Strong v Repide. F: Erica Strong is the owner of 800 shares of the Phil Sugar Estates Devt Company, which owned ½ of the value of friar lands in the Philippines. Repide is director and majority SH. The government made an offer to purchase the lands owned by the corporation and from the other owners. The offer was rejected by Repide, without consulting the other SHs, and held out for a better deal. He was aware that the value of the lands and the shares would be of no value if the sale were not consummated, since the company had not paid dividends, was living on credit, and could not even paid taxes. The land was the only valuable asset of the corporation. Repide than took steps to purchase 800 shares of stock owner by Strong. He employed Kaufmann, who then employed Sloan the broker, to purchase the stock for him. Negotiations ensued. Strong through Jones agreed to sell Strong’s shares to Repide. He thus obtained the 800 shares for 1/10th the amount they were worth by the
eventual sale of the lands two months after he bought the shares. The probable value of the shares was unknown to anyone except Repide, while the agent of Strong had no idea that it was Repide who wanted to purchase the shares. I: W/n it was the duty of Repide, in GF, to disclose to the agent of Strong the facts which would affect the value of the stock he purchased from the latter. H: In this case, Repide was the chief negotiator for the sale of the lands, acting for all the other SHs. Only he knew the state-of-play in the proposed sale. He owned ¾ of the shares of the corporation. Under these circumstances, and before the negotiations for the sale were completed, he employs agents to purchase shares of his company from another SH and conceals his own identity and knowledge of the state of the negotiations on the sale of the lands and their probable effect on the value of the shares to be purchased. A director may be accountable directly to the SH where the special facts surrounding the transaction give rise to the obligation to disclose his identity or the inside information he possesses. This is known as the special facts doctrine. Taylor v Wright et al. F: Mrs Wright and Allen Wright, majority SH and both director respectively, employed an agent to purchase from Emma Taylor 3750 shares in the corporation to which they are directors in. Said shares were pledged as security for a loan by Taylor which the Wrights knew. The Wrights also knew that the company was operating at a loss, and they knew the true value of the shares (which was not traded in the exchange). They also concealed their identity and purpose in purchasing the stock from Taylor. I: W/n the directors and officers of a corporation owe any duty to all SHs in relation to transactions whereby officers and directors buy for themselves shares of stock from the SHs H: Three (3) rules are recognized as applying to the case. The Majority rule—directors and officers owe no fiduciary duty at all to SHs, but may deal with them at arm’s length. A director is a fiduciary with respect to the corporation as an entity, and not to the SHs as individuals. In dealings with or for the corporation, the director is exercising a corporate function, and is subject to the usual fiduciary duty to disclose all material facts; but that in personal dealings with SHs he is not exercising a corporate function, and is free to deal with them at arm’s length. It is based on the theory that the corporation—the collective SHs—is a separate and distinct legal entity, an artificial personality, to whom the director owes his duty. — The Minority Rule—recognizes the director’s obligation to the SHs — —
individually as well as collectively, and refuses to permit him to profit at the latter’s expense by the use of information obtained as a result of his official position and duties. Such a duty exists because the SHs have placed the directors in a strategic position where they can make it appear the shares are much less valuable than they really are. The Special Facts rule—an exception to the Majority rule; where special circumstances are present which make it inequitable for the director to withhold information from the SH, the duty to disclose arises, and concealment is fraud.
Assuming the Special Facts rule to be applicable, there is no doubt that the Wrights owed Taylor a duty and violated that duty to her damage. The stock was not sold or traded in any exchange. They concealed their position as directors, and had full knowledge of the real value of the stock, but kept that knowledge to themselves. They had full control over the corporation. Under such circumstances the findings that the Wrights are guilty of fraud within the meaning of the Special Facts rule are supported by the evidence. 4. Seizing corporate opportunity — Significant aspect of fiduciary obligation is the duty to refrain from usurping a business opportunity rightly belonging to the corporation
Sec 34: Where a director acquires for himself a business opportunity which should belong to the corporation, thereby obtaining profits which should belong to the corporate corporation, he must account to the latter for all such profits by refunding the same, unless his act has been ratified by vote of the SHs owning 2/3 OCS — Applicable only to directors and NOT to officers — Allows ratification of a transaction by vote of 2/3 OCS Sec 31: Directors or trustees who acquire any personal or pecuniary interest in conflict with their duty as directors shall be liable solidarily for all damages resulting therefrom — Applicable to directors, trustees, and officers — Does NOT allow ratification of a self-dealing transaction — — — — — If the transaction is one which the corporation has the right to appropriate, then the director has a positive duty not to seize it for himself Should he do so, he must account for all profits he obtains, even if he used personal funds Ratification by SHs representing 2/3 OCS cures the transaction Sec 34 covers only directors and not officers… … but an officer may still be held liable under Sec 31, para 2
officer is a full time corporate agent and is paid a salary for his services, and thus there would be stronger reasons to make an officer liable o director not an officer spends only a part of is business time and efforts for the corporation, for which he is not entitled to compensation unless expressly granted — when is a corporate opportunity belonging to the corporation? o Singer et al v Carlisle. F: Singer et al are SHs of the United Corporation which owns all capital stock of its subsidiary, NY United Corp, both of which are engaged in the business of underwriting securities. Carlisle et al are directors of the two corporations. Other defendants are investment houses JP Morgan, Drexel & Co, and Morgan Stanley. United Corp acquired substantial voting stock of various holding and operating companies/utilities, which were all publicly listed and obtained their funds through the public sale of their securities. JP Morgan et al were able to obtain large profits from the underwriting of such securities to the exclusion of United and NY United. Plaintiff Singer charge that the defendant bankers and investment houses and the directors of the two corporations fraudulently caused the latter corporations to use their influence and control over the subsidiaries in order to induce them to award the underwriting business to the defendant bankers. Having eliminated United Corp and NY United as their competitors for the underwriting business of the subsidiaries, the defendants allegedly proceeded to utilize their control and influence to obtain the business for themselves. Singer et al also claimed that the directors of the corporation, as fiduciaries, eliminated their cestui as a competitor in the underwriting profits. H: United and NY United were also engaged in underwriting as do the defendant banks. It was the duty of their directors and officers to make every effort consonant with good, honest judgment to obtain for those corporations as much of the underwriting business as possible, and to make this business as profitable as possible. This does not mean, however, that the directors and controlling SHs of United and NY United were required to do anything detrimental to the affairs of other corporations of which they were officers and directors, and to the affairs of United and NY United. One in control of a majority of the stock and of the board of a corporation occupies a fiduciary relation towards the minority, and is charged with the duty of exercising a high degree of GF, care, and diligence for the protection of the same. Every act in its own interest to the detriment of the minority interests becomes a breach of duty and of trust, and entitled them to plenary relied. So strict is the rule of undivided loyalty to the beneficiary that the mere fact that a trustee has an interest inconsistent with the interest of his cestui, casts upon him that burden of justification. Where this duty exists, the duty of the trustee is to manage the property and affairs of the corporation with an eye single to the advantage of the corporation itself. It is
not proper for the fiduciary to take those opportunities unto itself, while at the same time it stayed the processes of its subsidiary directed towards the same business ends. It is not only a case of a fiduciary seizing business opportunities of the cestui. The trustee at the same time kept its dominant hand over the cestui, suppressing any attempt by the cestui to go out and compete with the trustee. Where a fiduciary is engaged in a business in competition with his corporation, he cannot actively use his position and power over his corporation so as to prevent the corporation from seeking certain businesses in competition with himself. It is charged that the directors here not only failed and refused any attempt to obtain certain business for their own corporation, but that they affirmatively prevent the corporation from competing with them for that business. This they may not do. Directorship in two competing corporation does not in and of itself constitute a wrong. It is only when a business opportunity arises which places the director in a position of serving two masters, and when dominated by one, he neglects his duty to the other, that a wrong has been done. Irving Trust Co v Deutsch et al. F: Irving is the trustee of the insolvent company Sonora Acoustic. Acoustic desired the patents of the De Forest company and wanted gain at least minority stake to have a voice in the management of its patents and products, which goes to Acoustic’s corporate purpose. Reynolds & Co, receiver of the insolvent De Forest, offered to give Acoustic 1/3 participation in the purchase of 600,000 shares of De Forest stock. It also stipulated that Acoustic’s nominees should hold 4 of 9 seats in the board and that it should have the right to enter into a contract to handle the managing and selling of De Forest products. This offer was presented to the board of Acoustic and a resolution was passed authorizing its president, Deutsch, to obtain sufficient funds to enable Acoustic to carry out its obligations in case it accepts the offer. No funds were obtained but Biddle and Deutsch et al, agreed to put up the money and accept the certificates of De Forest stock issued when date of payment came under the offer. Reynolds agreed and issued the certificates. The deal was consummated on the purchase of De Forest stock. It was then traded in the exchange and Biddle, Deutsch et al were able to reap huge profits in selling their shares. Acoustic declares bankruptcy and sues the Biddle group, three of whom were directors of De Forest, appropriated to themselves Acoustic’s right under its contract, when as fiduciaries they were obligated to preserve those rights for Acoustic and were forbidden to take position where personal interest would conflict with the interest of their principal. H: The theory of the suit is that a fiduciary may make no profit for himself out of a violation of duty of the cestui, even though he risked his own
funds in the venture, and that any one who assists in the fiduciary’s dereliction is likewise liable to account for the profit so made. It is clear that there is no contract between Acoustic and Reynolds because the offer did not run to Acoustic but to the Biddle group as individuals. The management contract, once entered into, would enable access to the patents, stock ownership in De Forest as a going concern after receivership was lifted, and were all concededly legitimate corporate purposes. Thus the proposed purchase is not ultra vires. The facts of the present case militate strongly against the directors since in this case, they absolutely bound Acoustic by contract to make payments to Reynolds and exposing it to risk of a suit for damages for nonperformance, without committing themselves to it to relieve it of this obligation if necessary when time for payment arrives. Directors of a solvent corporation are forbidden to take over for their own profit a corporate contract on the plea of the corporation’s financial inability to perform. If the directors are uncertain whether the corporation can make the necessary outlays, they need not embark upon the venture. If they do, they cannot substitute themselves for the corporation any place along the line and divert possible benefits into their own pockets. Litwin v Allen et al. F: JP Morgan, in disposing of 1,250,000 shares of CS of Alleghany corporation, offered 500,000 to Guaranty Corporation to be sold on a commission at $24/share. Before the public offering, Morgan also offered the other 750,000 to friends at $20. Among those receiving the shares were some directors of Guaranty Corp, who received 40,000 shares. The market opened at a premium and the directors were able to dispose of their stock at a substantial profit. H: A director of a corporation is in a position of fiduciary. He will not be permitted to improperly profit at the expense of the corporation. Undivided loyalty will ever be insisted upon. Personal gain will be denied to a director when it comes because he has taken a position adverse to or in conflict with the best interests of the corporation. The fiduciary relationship imposes a duty to act in accordance with the highest standard. There is thus no basis for holding that in acquiring stock through JP Morgan at $20, any of the defendants were guilty of a breach of fiduciary duty. The CS purchased did not represent in any case a business opportunity for the Guaranty Corporation. Having fulfilled their duty to the corporation in accordance to their best judgment, the directors were not precluded from a transaction for their own account and risk. In order to constitute a corporate opportunity that was deprived by the directors, it was necessary to prove the ff: — The shares purchase were in contemplation of equity offered to the cestui
That the cestui had some legitimate right or expectancy in these shares
The question to ask is, have the directors profited at the expense of their corporation; have they gained because of disloyalty to its interest and welfare? In this case, the “opportunity” was a routine piece of business wholly lacking in the unique and special quality which distinguished other corporate opportunity cases. The interest of the directors in the stock was purely speculative, and they even incurred a definite risk which at the time was totally eliminated from the cestui’s position in the same stock. In other words, the profit of the cestui was assured; that of the directors were still at hazard. 5. Interlocking directors — — One who occupies a positioning two (2) corporations dealing with each other Sometimes presented definite advantages to the corporation
Sec 33: GR: A contract between two or more corporations having interlocking directors shall not be invalidated on that ground alone — Exceptions: o Cases of fraud o if the contract is not fair and reasonable under the circumstances o if merely nominal interest, interlocking director shall still be subject to the same ratificatory vote required in cases of dealings of directors, trustees, and officers — interests exceeding 20% of OCS is considered substantial — — The burden is on the corporation which seeks to uphold the contract to prove the fairness or unfairness of the transaction Interlocking director may actually be a self-dealing director where his interest in one corporation is merely nominal, but his interest in the other corporation is greater than 20% of its OCS:
Globe Woolen Co v Utica Gas & Electric. F: Globe Woolen needed electric power to run its mills. Its president and majority SH, Maynard, was able to get a contract with the electric company Utica Gas which was ratified by the executive committee of Globe’s board. Maynard was a nominal SH in the electric company also, and did not vote in the meeting. Globe desires to enforce the contract. H: Contracts are voidable at the instance of Utica Gas. Globe argues that by refusing to vote, Maynard shifted responsibility to his associates, and may reap a profit from their errors. One does not divest oneself so readily of one’s duties as trustee. The refusal to vote, has indeed this
importance: it gives to the transaction the form and presumption of propriety, and requires one who would invalidate it to prove beneath the surface. The trustee or director holds a duty of constant and unqualified fidelity. He cannot rid himself of the duty to warn and to denounce, if there is improvidence or oppression, either apparent on the surface, or lurking beneath it. There was an influence in this case which was exerted by Mr Maynard the president of Globe Woolen. From beginning to end he dealt with a subordinate, who was alert to serve at his pleasure. The unfairness in the contract is startling and the consequences could be disastrous. No matter how large the business, or how great the increase in prices of labor or fuel, or there be extensions to the plant, the electric company had pledged that for 10 years there will be saving of $600/month, $300 for each mill, $7200/year. As a result of that pledge it has supplied the plaintiff with electric current for practically nothing, and even owes it some money thereafter. Mr Maynard knew the unfairness of the contract, and he cannot have failed to know that he held a one-sided contract which left the defendant at his mercy. Thus his refusal to vote does not nullify, as of course an influence and predominance exerted without a vote. A constant duty rests on a trustee to seek no harsh advantage to the detriment of his trust, but rather to protect and renounce he gains what is unfair. Close corporation SHs of a close corporation can choose to manage the corporation themselves, instead of having a board, and thus the law treats them as Jack: not limited to the board; it also has to directors with all the powers, duties, and liabilities attached thereto be assumed by the SHs who own the Sec 97 (1-3) majority; all boils down to control! — Sec 100 (5) — 100: SHs can be made personally liable for corporate torts o in other corporations: liable only if there is negligence in his duties o SHs are solidarily liable with the corporation
GR: controlling SH may dispose of his stock at any time and at any price o But they cannot abuse by transferring office to persons who re known as intending to raid the corporate treasury or improperly benefit or enrich themselves (Insuranshares Corp case)
Insuranshares Corporation v Northern Fiscal Corp. F: The Management group (composed of Philadelphia banks) transferred control over the Insuranshares Corporation, an investment trust specializing in shares of small life insurance companies, to the Boston Group, none of whom ever had any interest of any in it. With the control went plenary power under the by-laws to sell or transfer all the securities in the company’s portfolio. Such acquisition of control was the first step of a grand scheme, planned by the Boston Group with the connivance of brokers, to strip the corporation of its valuable assets, leaving a mere shell to the remaining SHs. H: This case involves more than just a question of liability in the sale of corporate stock: it is the sale of control by a minority—but controlling— interest. Those who control a corporation either by the majority or minority stock ownership owe some duty to the corporation in respect of the transfer of the control to outsiders. Owners of control in a corporation are under a duty not to transfer ownership to outsiders if the circumstances surrounding the proposed transfer are such as to awaken suspicion and put a prudent man on his guard. In this case the evidence shows that the Boston group were acquiring control over the corporation by improper means and for an improper purpose. Duty to creditors — — Jack: a systematic, orchestrated move to transfer mgt/control to an irresponsible group; duty to inform SHs applied to situations where there is a clearcut No express duty in Corpo Code; based on contract law GR: directors cannotmajority be personally liable to corporate creditors for general inefficient management of a solvent corporation o Remedy of creditors is against the corporation itself
Duty of controlling interest A SH who is able to control a corporation by owning a majority of voting shares or otherwise, owes a duty as well of GF to the corporation and to the minority — Majority SH is subject to the duty of GF when he acts by voting at a SH meeting — persons enjoying management control hold it in behalf of the SHs, and not as their personal property —
Exception: when corporation is insolvent, the directors will be DEEMED trustees of the creditors and should manage its assets with strict regard to the creditor’s interest (Mead v McCullough) Upon insolvency of the corporation, the board is duty bound to hold the assets of the corporation primarily first for the payment of liabilities 31: should they willfully and knowingly assent to patently unlawful acts of the corporation or are guilty of gross negligence or BF in
directing the affairs of the corporation, they become solidarily liable with for damages to the corporation + damages to third persons including creditors 65: director who fails to object in writing to the issuance of stock for less than par or issued value is solidarily liable with the guilty SH to the corporation as well as to its creditors for the difference Fiduciary obligation: Commences at the time director assumes office Remission can be action, inaction, gross negligence Liability not the SHs but to the corporation One word: fiduciary Trust imposed by SH collectively Directors collectively mandated to make full use of corporate property Fiduciary obligation owed to corporation, not the SH 2 types of responsibilities: As a Board, collectively As a director, individually Degree of responsibility is greater as an individual director 31: repository of duties of directors collectively and individually distinguish if director is an interlocking director directors transaction with corporation can prove to be beneficial prohibition against self-dealing is not absolute threshold: fraud burden of proof: corporation fixing compensation directors sit on board, can do anything and everything with the corporate assets success or downfall is borne by directors board can only recommend compensation! Subj to SH approval Determination: did they discharge their duties mandated by the statute?
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