US Corporate Law in an International

Perspective

Class 2: Directors’ Fiduciary Duties

Monday July 17, pm
Delaware, USA
Pop. 1,003,000
What Is Delaware’s Court of Chancery and Its Role in Elon Musk’s Twitter Deal?
New York Times, July 12, 2022
Created in 1792, the Delaware Court of Chancery is one of three courts established by the State
Constitution, alongside the Supreme and Superior Courts. It is known as a court of equity, rather than a
court of law, because it allows for more flexible resolutions than the law formally provides.
Like many U.S. businesses, Twitter is registered as a company in Dover, Del. More than 1.8 million
businesses are incorporated in the state, including more than two thirds of Fortune 500 companies,
according to the State Division of Corporations.
As a result, Delaware’s Court of Chancery has heard many kinds of corporate cases over the years,
building up expertise in this area. Many companies want cases heard by the court because of that
knowledge, which also makes the arc of legal disputes there more predictable.
“If you want to have your business disputes resolved by experts, you will generally prefer Delaware,” said
Joseph Grundfest, a professor of corporate governance at Stanford Law School. “You might be able to
fool some judges somewhere, but you’re less likely to be able to fool these judges because they see this
stuff all the time.”
 Structural Features of the Corporate Charter
Marketplace
U.S. firms are not constrained by headquarters, place of business, or other operational
factors in choosing where to incorporate.

State of incorporation dictates which corporate law rules apply under “internal affairs”
doctrine.

States charge annual franchise taxes. Eg Delaware’s is based on # authorized shares,

minimum $175 (5,000 shares or less) up to max $200,000 (link).

Mechanics of reincorporation are straightforward: creation of a new firm in the

destination state, followed by tax-free merger of the existing corporation into the new
one.

Reincorporation requires shareholder approval.

 U.S. Public Corporations (2000)

Headquarters State State of Incorporation

From: Guhan Subramanian, The Influence of Antitakeover Statutes on Incorporation Choice: Evidence
on the “Race” Debate and Antitakeover Overreaching, 150 U. Penn. L. Rev. 1795, Figures 1 & 2 (2002) .
N = 7,841 companies.
 International Comparison -- Europe

Netherlands, Ireland, Denmark, U.K. apply incorporation theory (like the US), i.e., a
corporation is regulated by the country in which it is incorporated, which can differ from
where it is headquartered or does business.

Germany, France, Portugal apply the “real seat” theory: to incorporate under the laws of
these countries, must have headquarters in relevant country.

BUT: European Court of Justice activism:

Centros (March 1999) : EU Member States must recognize existence of
corporations formed under laws of other Member States (even if don’t apply same
theory)
Cartesio (December 2008) : EU Member States must permit corporations to change
their country of incorporation within the EU.
Brexit (December 2020) : UK left the EU; EU Member States no longer required to
recognize existence of companies formed there.
 Effects of Centros decision

From : John Armour, Who Should Make Corporate Law? EC Legislation versus
Regulatory Competition, 48 Cur. Leg. Prob. 369 (2005)
Directors’ Fiduciary Duties
 The Duty of Care

Flipside of board autonomy is accountability

Directors’ fiduciary duties: an important mechanism for
ensuring accountability
Duty of care: care—taken in performing functions
Duty of loyalty: motivation—acting in good faith in the interests of
the corporation
But how useful is it to have a court scrutinize what directors
do?
Protection for directors’ ‘good faith business judgment’
 Duty of Care (ALI § 4.01(a))

A director or officer has a duty to the corporation to perform

the director’s or officer’s functions:
(1) in good faith,
(2) in a manner that he or she reasonably believes to be in
the best interests of the corporation, and
(3) with the care that an ordinarily prudent person would
reasonably be expected to exercise in a like position and
under similar circumstances.
 Business Judgment Rule (ALI § 4.01(c))

A director or officer who makes a business judgment in good faith

fulfills the duty under this section if the director or officer:
(1) is not interested in the subject of the business judgment;
(2) is informed with respect to the subject of the business
judgment to the extent that the director or officer reasonably
believes is appropriate under the circumstances; and
(3) rationally believes that the business judgment is in the best
interests of the corporation.
 Gagliardi v Trifoods International
Chancellor Allen: “The [business judgment] ‘rule’ in effect provides that where a
director is independent and disinterested, there can be no liability for corporate loss,
unless the facts are such that no person could possibly authorize such a transaction if
he or she were attempting in good faith to meet their duty.”
 Gagliardi v Trifoods International
Chancellor Allen: “The [business judgment] ‘rule’ in effect provides that where a
director is independent and disinterested, there can be no liability for corporate loss,
unless the facts are such that no person could possibly authorize such a transaction if
he or she were attempting in good faith to meet their duty.”

Less risky project

Prob
of
Payoff

More risky project

Low Payoff High

 Gagliardi v Trifoods International
Chancellor Allen: “The [business judgment] ‘rule’ in effect provides that where a
director is independent and disinterested, there can be no liability for corporate loss,
unless the facts are such that no person could possibly authorize such a transaction if
he or she were attempting in good faith to meet their duty.”

Less risky project

Prob Liability
of imposed under
Payoff (hypothetical)
negligence
standard
More risky project

Low Payoff High

 Gagliardi v Trifoods International
Chancellor Allen: “The [business judgment] ‘rule’ in effect provides that where a
director is independent and disinterested, there can be no liability for corporate loss,
unless the facts are such that no person could possibly authorize such a transaction if
he or she were attempting in good faith to meet their duty.”

Less risky project

Prob Liability
of imposed under
Payoff (hypothetical)
negligence
standard
More risky project

Low Payoff High

Liability imposed under

business judgment rule
 Kamin v. American Express

In 1972 Amex acquired 2.0 million shares of DLJ common stock for
$29.9 million; by 1976 the stake was worth approximately $4.0 million.
Amex declares a special dividend to all shareholders distributing the
DLJ shares in kind.
Two shareholders file suit to enjoin the distribution, or for monetary
damages, claiming waste of corporate assets because Amex could sell
the DLJ shares and use the capital loss to offset capital gains, which
allegedly would have resulted in a net tax savings of $8 million.
Defendant directors claim that this possibility was considered but
rejected due to negative impact on accounting profits; move for
summary judgment.
 Liability Shields

Business Judgment Rule: presumes that

the duty of care standard has been met
Waiver of Liability (DGCL §102(b)(7)):
100% of Delaware public companies
eliminate D&O liability for duty of care
violations
D&O Insurance: corporation may buy
D&O insurance “whether or not the
corporation would have the power to
indemnify such person against such
liability.” (DGCL §145(g)).
 Hayes Oyster Co.
Verne Hayes is director, 23% shareholder, and CEO of Coast Oyster, a public
corporation. Coast faces cash flow problems and Verne convinces the board
to sell two oyster beds.
Verne then suggests to Engman, a Coast employee, that Engman form a new
corporation (Keypoint) to buy the oyster beds. Verne arranges for his own
family corporation, Hayes Oyster, to help Keypoint with financing, in exchange
for which Hayes Oyster receives 50% of the equity in Keypoint.
The agreement whereby Hayes Oyster gets 50% equity in Keypoint happens
after Coast board votes to sell, but before Coast shareholders approve sale.
Coast’s new management discovers what Verne has done and brings suit to
recover Verne’s and Hayes Oyster’s “secret profits.”
Trial court rules for Verne.
 Hayes Oyster Co.

Sam Verne
Hayes Engman
Hayes

75% 25% 23% two

50%
oyster
beds
Hayes Coast Keypoint
Oyster Oyster Co. Oyster Co.
(Verne CEO)
$250K

50%
 Safe Harbor Statutes – e.g. DGCL §144

Self-dealing transaction with a director (or corporation in which a director

is interested), is not void(able) solely for this reason (or for the director’s
participation in voting or quorum at decision to authorize) if

(1) disclosure to + good faith authorization by majority of disinterested

members of board; or

(2) disclosure to + good faith authorization by vote of shareholders; or

(3) transaction is fair to the corporation at the time approved

 Safe Harbor Statutes – e.g. DGCL §144

Self-dealing transaction with a director (or corporation in which a director

is interested), is not void(able) solely for this reason (or for the director’s
participation in voting or quorum at decision to authorize) if

(1) disclosure to + good faith authorization by majority of disinterested

members of board; or

(2) disclosure to + good faith authorization by vote of shareholders; or

(3) transaction is fair to the corporation at the time approved

 Cookies Food Products

L.D. Cook’s original “Speed” Herrig’s

Bar “B” “Q” sauce taco sauce
 Cookies Food Products
L.D. Cook forms Cookies, Inc. to produce and distribute his original
barbecue sauce.
Cookies enters into a distributorship agreement with one of its minority
shareholders, Duane “Speed” Herrig.
Distributorship proves so successful that in a matter of years, Herrig has
bought out Cook, become the controlling shareholder (with 53%),
becomes a director, takes control of the board, and entered into several
more self-dealing contracts with Cookies, all of which are successful, but
which take out about half the company’s cash flows.
Minority shareholders bring suit alleging that self-dealing contracts
“grossly exceeded the value of services rendered” and that Herrig did not
fully disclose the benefit he would gain.
Trial court finds no breach of fiduciary duty and rules for Herrig.