LEGL 4750 - Shareholder and Director Liability

Exam 1

More on Shareholders

• Owners of the company who vote on the directors—and it’s the directors who possess management power.

• Shareholders do NOT typically owe fiduciary duties

  • After all, S/Hs are almost always passive.

• As such, S/Hs are almost never “personally” liable for the liabilities of a corp. A plaintiff must typically sue the corp for the corp’s assets, but can’t reach beyond the corp to the S/H

• Shareholders do have some rights: 1) vote on the BoDs, 2) voting on mergers, 3)vote on changing the corp’s bylaws, 4) vote to dissolve the corp, 5) vote to sell substantially all of the corp’s assets (a de facto merger, 6) inspect books 7 records

• A S/H is more likely to owe fiduciary duties, or even to become liable, when a S/H controls the corp (by virtue of owning a majority of the shares) and ”controls” the corp--more on this shortly...

Shareholder Liability

• Shareholders of a corporation enjoy limited liability

  • This means that debtors of a corporation must sue the corporation, not the S/Hs

  • If the corporation lacks enough assets to cover the debtors’ debts, that’s unfortunate and not the problem of shareholders.

  • This is true even if a corporation is entirely owned and run by a singular person

• Parent corps and subsidiary corps (i.e., a corporation that owns another corp), even if it owns 100% of its shares, enjoys limited liability, distinct from its subsidiary.

• Except, courts can—BUT RARELY– “pierce the corporate veil”

  • This occurs when a court disregards the corporate form and holds S/Hs’ liable for frauds and illegal activities perpetrated by the shareholders themselves

  • In Georgia: to disregard the corporate entity because a corporation is a mere alter ego, it should have been used as a subterfuge so that to observe it would work an injustice. To prevail based upon this theory it is necessary to show that the shareholders disregarded the corporate entity and made it a mere instrumentality for the transaction of their own affairs... The concept of piercing the corporate veil is applied in Georgia to remedy injustices which arise where a party has over extended his privilege in the use of a corporate entity in order to defeat justice, perpetuate fraud...

  • Courts will almost never pierce the corporate veil if a corporation made an honest, or even sloppy, attempt to run a business.

  • The key is generally whether a s/h (or a few) used the corporate form to run an illegal enterprise.

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