Shareholder and Director Liability

Exam 1

Roman Catholic Archbishop of San Francisco v. Sheffield - Facts

A San Francisco man travelling in Switzerland visited the Hospice du Great St. Bernard. He made arrangement with the Canons Regular of St. Augustine who ran the Church to purchase a dog for $175, which was to be shipped to San Francisco. The Canons Regular, which are an order of the Roman Catholic Church, then refused to ship the dog until further payments were made.

Roman Catholic Archbishop of San Francisco v. Sheffield - Court and Holding

• Sheffield sued: The Canons Regular, The Roman Catholic Archbishop of San Francisco, The Pope, and the Holy See (the Vatican) for the contract breach, claiming that “there exists a unity of interests and ownership between all and each of the defendants.”

  • Plaintiff:

    • He must be able to sue parties in San Francisco because travelling back to Switzerland would be too expensive and thus, he would never get relief.

    • His argument: piercing the veil is appropriate to avoid this injustice

• Court: “It is not sufficient that the plaintiff will not be able to collect if the corporate veil is not pierced. In almost every instance where a plaintiff has attempted to invoke the doctrine he is an unsatisfied creditor The purpose of the piercing the corporate veil doctrine is not to satisfy creditors, but rather to afford him protection where some conduct amounting to bad faith makes it inequitable.”

• Holding: Cannot sue the other parties for contract breach due to each being a unique entity, despite being interrelated.

  • He must sue the correct party in Switzerland (which he won’t do)

Walkovsky v. Carlton - Facts and Issue

• Facts: A man who owns a dozen taxi cabs in NYC, organized ten corporations, each of which housing 1 or 2 taxis. He then took out the statutory minimum amount of insurance on each cab. When one cab was involved in a catastrophic accident, the victim sued. The amount owed to the victim exceeded the statutory minimum insurance.

• Plaintiff: The 10 corps were essentially run as one corporation. Because of that, their combined assets should be used to satisfy the judgment. “None of the corporations had their own separate existence.” Each cab (and thus corporation) was run from the same dispatch and garage, appearing as one corporation

• Issue: Pierce the corporate veil to hold the S/H liable for evading legal duties using the corp form?

Walkovsky v. Carlton - Court and Holding

• Court:

  • “The fact that the taxi fleet had been deliberately split up among many corps does not ease the plaintiff’s burden”

  • “The corporate form may not be disregarded merely because the assets of the corp, together with the minimum insurance coverage, are insufficient to assure him the recovery sought”

• Key: the taxi corporation was legitimately intended to turn a profit and followed all corporation and legal formalities

  • The fact that the corporate form allowed the s/h to avoid a portion of liability is not an unexpected consequence of the corporate form.

• Holding: No piercing the corporate veil even though the company appears to be run as one corporation, not 10 of them.

Director Liability

• Directors are AGENTS of the corporation and thus, are bounded fiduciary duties.

• Duty of Loyalty:

  • A director must put the corporation’s interests ahead of the directors’ interests.

  • Examples of prohibited conducts:

    • Self-Dealing (e.g., using the corporation to buy products from the director’s personal biz)

    • Usurping a corporate opportunity (profiting from an opportunity that the corp could have profited from)

    • Conflict of interest (e.g. being on the board of Coke and Pepsi).

• Duty of Care

  • A director must exercise reasonable care when running a company.

  • For instance, a director must be reasonable informed about decisions, avoid negligence, and reference materials given to the director before decisions.

• Business Judgment Rule:

  • A director is generally NOT liable when the board made a reasonable yet bad decision

  • Courts do not want to supplant the board’s judgment for its own, given that the Board will installed by the shareholders due to the board’s expertise--and hindsight is 20/20

  • Plus, director liability would chill smart and capable people from serving on boards

  • To defeat the BJR, you must show that the directors would conflicted, operating a fraud, doing something illegal, or made an absurdly irrational decision.

Duty of Loyalty

• Directors must exhibit loyalty to the company by avoiding self-dealing, usurpations of opportunities, conflicts of interest, and otherwise acting in their corporations’ best interest.

  • The duty of loyalty has also been interpreted as requiring directors to actively be involved in their corporations’ activities (i.e., must act in good faith to satisfy loyalty demands).

• The duty of loyalty is considered the most important duty.

• In instances where some directors might be conflicted in a transaction, corps can arrange subcommittees of independent or non-conflicted directors.

• If a board votes on a transaction in which a director is conflicted, the director should disclose their conflict as well as not vote.

• Duty of loyalty applies to all agents of a corporation, including directors and officers—but again, rarely shareholders who aren’t typically fiduciaries of corps.

Shlensky v. Wrigley (1968) - Facts

• Shareholders of Chicago National League Ball Club Inc. brought suit against the directors, which operates the Chicago Cubs, claiming negligence and mismanagement. The S/Hs claimed that the Cubs’ refusal to install lights on Wrigley Field, preventing the team from playing night games, was leading to substantial lost profits.

• “Mr. Wrigley has refused to install lights, not because of interest in the welfare of the corporation, but because of his personal opinions that “baseball is a daytime sport” and that the installation of lights will have deteriorating effect on the surrounding neighborhood.

• “It is charged that the directors are acting for reasons contrary and wholly unrelated to the business interests of the corporation; that such arbitrary and capricious acts constitute mismanagement and waste of corporate assets… Plaintiffs argue that the directors are acting for reasons unrelated to the financial interests and welfare of the Cubs”

Shlensky v. Wrigley (1968) - Court, Effect, and Holding

• Court:

  • “It appears to us that the effect of the surrounding neighborhood might well be considered by a director who was considering the patrons who would or would not attend a game in a poor neighborhood.

  • “We do not mean to say that we have decided that the decision of the directors is a correct one. That is beyond our jurisdiction and ability. We are merely saying that the decision is one properly before directors and the motives alleged in the complaint show no fraud, illegality, or conflict of interest by the directors.

  • “Directors are elected for their business capabilities and judgment and the courts cannot require them to forego their judgment because of the decisions of other companies.”

• Effect: this ruling cemented the BUSINESS JUDGEMENT RULE, meaning that courts will not second guess the decisions of rational, nonconflicted, and informed directors.

• Holding: no breach of duties

Francis v. United Jersey Bank - Facts

Pritchard & Baird Intermediary Corp was a closely held corporation. When the single largest shareholder and director, Charles Pritchard, died, he left the company to his two sons (who became directors) and elderly wife. Lillian Pritchard received 48% interest and became a director. The sons essentially stole millions in client money leading the company to bankruptcy. Mrs. Pritchard, at all times, was elderly, enfeeble, an alcoholic, grief stricken, and unable to run the company. She knew virtually nothing about the reinsurance business. Mrs. Pritchard died shortly thereafter. The creditors sued her personally for breaching the DUTY OF CARE.

Francis v. United Jersey Bank - Court and Holding

• Court

  • General Rule: A director should acquire at least rudimentary understanding of the business and the fundamentals of the industry.

  • Because directors are bound to exercise ordinary care, they cannot set up as a defense lack of the knowledge needed to exercise the requisite degree of care

  • Directors may not shut their eyes to corporate misconduct and then claim that because they did not see the misconduct, they did not have a duty

• Holding: She violated the duty of care. The wrongdoing of her sons, although the immediate cause of the loss, should not excuse Mrs. Pritchard from her negligence which also was a substantial cause

  • Discussion board question: what was so special about this situation where the court decided to hold Mrs. Pritchard’s estate liable. There’s some going on….

Guth v. Loft (1939) - Facts and Issue

• Facts: Charles Guth was the president of Loft, Inc. which was a candy store. Guth also owned Grace Co., which made syrups for soft drinks supplied by Coca Cola. Unhappy with Coke’s prices, Guth—in his Grace capacity—purchased Pepsi Corp (majority s/H). Needing money to finance the transaction, Guth as Loft’s Prez secretly borrowed money from Loft. Guth then used Loft employees to make the syrup for Grace Company (for which Grace Co. paid 40 months later). Grace Co. then began selling Pepsi to Loft, Inc, leading to significant losses. Loft then spent $20,000 to advertise pepsi, which it didn’t have to do with coca cola

• Did: Guth breach his fiduciary duty of loyalty to Loft

  • But why not Grace co.?

Guth v. Loft (1939) - Court

• Court:

  • Corporate officers are not permitted to use their position of trust and confidence to further their private interests. They stand in a fiduciary relationship to their company and shareholders.

    • Here, he used his power as loft’s president to engage in transactions HARMING loft’s shareholders but BENEFITING himself personally as Grace’s owner

  • “If there is presented to a corporate officer or director a business opportunity which the corp is financially able to undertake in the line of the corp’s business and is of practical advantage to it and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity himself.”

  • Two problems:

    • 1) Usurping corporate opportunity: if purchasing Pepsi was a profitable venture, he should have done so in his corporate capacity as Loft’s president. But he took it form himself personally.

    • 2) Self-dealing: he then using his corporate power to benefit himself (via loans and manufacturing) and harm the corporation. His interests were conflicted.

Guth v. Loft (1939) - Ruling

• Ruling: “in this case, Guth was Loft, and Guth was Pepsi. He absolutely controlled Loft. His authority over Pepsi was supreme. As Pepsi, he created and controlled the supply and determined the price and terms. What he offered, as Pepsi, he had the power, as Loft, to accept… He created a conflict.”

  • Guth's appropriation of the Pepsi-Cola opportunity to himself placed him in a competitive position with Loft with respect to a commodity essential to it, thereby rendering his personal interests incompatible with the superior interests of his corporation”

• Guth breached his duty of loyalty to Loft Inc.

Smith v. Van Gorkom

• The directors breached their duty of care by not reasonably inspecting and evaluating a merger.

• Notice, though, that the S/Hs received a huge premium on their stock price: about a 60%

• The case helps to illustrate the importance of a sound process, which can insulate directors for bad decisions (after all, BJR).

• A director’s biggest source of liability is a poor or conflicted process.

Van Gorkom Fallout

• Delaware amended its DGCL to adopt §102(b)(7): A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.

• In essence, a §102(b)(7) provision allows a corporation, with shareholder approval, to adopt language in its bylaws exculpating directors of personal liability for certain breaches of the duty of care.

• There is no exculpation for breaching the duty of loyalty.