CHAPTER 23
Directors, Officers,
and Controlling Shareholders
INTRODUCTION
This chapter examines the business
judgment rule, and duties and
liabilities of officers, directors, and
controlling shareholders.
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THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
Under the business judgment rule a court will
normally let a decision by a corporate board
acting in good faith stand and not replace it with
the court’s own decision.
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THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
Case 23.1 Synopsis. Smith v. Van Gorkom (1985).
Van Gorkom, chairman of the board of Trans Union, a publicly
traded company, asked the CFO to work out a price per share for
Trans Union stock. The CFO did not try to fix the intrinsic value of
the company, but came up with a cash-flow and debt-financing
price. Van Gorkom used that price to negotiate a merger plan with
Pritzker. A board meeting was called with one day’s notice. The
board approved the plan after a two-hour meeting. The plaintiff
sued challenging the stock price as too low. CONTINUED
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THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
Case 23.1 Synopsis. (Cont’d)
ISSUE: Were directors who accepted and submitted to the
shareholders a proposed cash merger without determining the
intrinsic value of the company grossly negligent in failing to inform
themselves adequately before making their decision? HELD: The
Delaware Supreme Court found the Trans Union directors grossly
negligent in making such an uninformed decision. The case was
settled for $25.5 million—$13.5 million in excess of the director’s
liability insurance.
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THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
 Informed Decision – required for the business judgment
rule.
– Reliability of Officers’ Reports - cannot be taken on blind
faith.
– Reliability of Experts’ Reports - the board should hire
reputable advisors and engage in reasonable oversight
of them; conclusions drawn by experts should have a
stated, factual basis for them.
– Investment Banker’s Fee Structure - compensation
should not impair the investment banker’s
independence.
THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
 Reasonable Supervision—as fiduciaries, directors must exercise this duty
over corporate operations.
Case 23.2 Synopsis. In Re Caremark Derivative Litigation (Del. Ch. 1996).
Caremark was charged with many felonies and entered agreements to pay
nearly $250 million. A shareholder derivative suit was filed seeking to make
the directors personally liable for this amount. The proposed settlement
included no personal payments by directors, only a series of procedures the
company would implement. ISSUE: What is the scope of a director’s duty to
exercise reasonable supervision over corporate operations? HELD: The
court found this acceptable and said the shareholders could elect new
directors if they did not like this result.
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THE BUSINESS JUDGMENT RULE
AND THE DUTY OF CARE
 View From Cyberspace: Shareholder
Meetings in Cyberspace.
 Disinterested Decision - the business
judgment rule does not apply if the directors
have a conflict of interest.
 Disclosure Violations by Directors.
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STATUTORY LIMITATIONS ON
DIRECTORS’ LIABILITY FOR
BREACH OF DUTY OF CARE
 Delaware’s Statute - §102(b)(7) permits the certificate
of incorporation to limit or eliminate directors’
personal liability for monetary damages for breach of
fiduciary duty; but not for a breach of loyalty, bad
faith, or violation of securities laws.
 California’s Statute - more restrictive than Delaware;
e.g., liability for an unexcused pattern of inattention
that amounts to an abdication of corporate duties.
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DUTY OF LOYALTY
 Corporate Opportunities - directors
may not take personal advantage of
corporate opportunities. If so, there
may be a constructive trust. Court
apply several tests, including the
“line of business” test.
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EXECUTIVE
COMPENSATION
 One of the most controversial issues in corporate
governance today is the high level of executive
compensation.
 Stock options – usually exercisable at the market
price at the time of grant for up to ten years.
 Golden Parachutes – lucrative severance payments
or stock awards made in the event the CEO loses
control of the company due to a takeover or other
change of control.
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DUTIES IN THE CONTEXT OF
TAKEOVERS, MERGERS, AND
ACQUISITIONS
 Courts want directors to consider seven factors
before deciding to sell the company:



The Company’s Intrinsic Value - as a going concern and on a
liquidation basis.
Delegation of Negotiating Authority - board members who will
financially benefit should not negotiate the deal; may impose
greater risk of liability.
Non-Price Considerations - all material factors should be
considered.
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DUTIES IN THE CONTEXT OF
TAKEOVERS, MERGERS, AND
ACQUISITIONS
4. No-Talk Provisions
5. Break-Up Fees
6. Takeover Defenses - the business judgment rule
favors directors, but care is needed. Poison Pills
(shareholder rights plan) and Golden Parachutes in the event
of takeover (Pantry Pride hostile takeover of Revlon).
7. When Is a Company in Revlon Mode?
- What constitutes an event that triggers the Revlon
duty for directors to maximize share price?
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DUTIES IN THE CONTEXT OF
TAKEOVERS, MERGERS, AND
ACQUISITIONS
Case 23.3 Synopsis. Paramount v. QVC Network Inc (Del. 1994).
Paramount had entered friendly negotiations with Viacom to purchase Viacom.
They both said other bidders were not welcome or wanted; this was part of a
strategic plan. QVC made a bid for Viacom. This started a bidding war. Viacom
stopped listening to QVC bids and accepted Paramount’s bid. ISSUE: Does a
board of directors have an obligation to consider an unsolicited tender offer (the
Revlon duty) from one corporation when the board has expressed a desire not
to receive competing bids because it is engaging in a friendly merger agreement
with another corporation? HELD: YES. The Supreme Court of Delaware ruled
that it did not matter that this merger started off as part of a strategic plan. Once
competitive bids were received, the board had a duty to listen to them all to
maximize the shareholders’ wealth because there would be a change in control
of the corporation (the Revlon duty).
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ALLOCATION OF POWERS
BETWEEN THE DIRECTORS AND
THE SHAREHOLDERS
Potential conflict between the two groups over
selling the corporation in hostile takeovers and in
using defensive tactics; directors control
corporate assets, but may not always represent
the shareholders interests.
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ALLOCATION OF POWERS
BETWEEN THE DIRECTORS AND
THE SHAREHOLDERS
 Poison Pills (Shareholder Rights plan) – a plan that
would make any takeover not approved by the
directors prohibitively expensive.
 “Dead Hand” Pills – which could be redeemed only
by the directors in office before the hostile bidder
gained control, or their designated successors.
 Control and Blasius Standard – action is strongly
suspect and cannot be sustained without a
compelling justification.
ALLOCATION OF POWERS
BETWEEN THE DIRECTORS AND
THE SHAREHOLDERS
Case 23.4 Synopsis. Quickturn Design v. Shapiro, (Del. 1998).
Mentor launched a hostile bid for Quickturn with a tender of $12.125 a share, a 50
percent premium over Quickturn’s pre-offer price. Mentor also announced its
intent to replace the Quickturn board at a special meeting. Quickturn board
concluded that Mentor’s offer was inadequate and recommended that Quickturn
shareholders reject it. The board also amended Quickturn’s shareholder rights
plan to add a Deferred Redemption Provision, under which no newly-elected
board could redeem the rights plan for six months after taking office if the
redemption would facilitate a transaction with the person who proposed the
election of the new directors (the “No Hand” pill). The board also amended
Quickturn’s bylaws to provide that any special shareholders’ meeting requested
by shareholders must take place not less that 90 nor more than 100 days after the
receipt of the shareholders’ request. CONTINUED
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ALLOCATION OF POWERS
BETWEEN THE DIRECTORS AND
THE SHAREHOLDERS
Case 23.4 Synopsis. (Cont’d)
The combined effect of the two defensive measures would be
to delay any acquisition of Quickturn by Mentor for at least
nine months, even if Mentor received tenders of shares,
which, together with the shares Mentor already owned,
represented more than 51 percent of Quickturn’s
outstanding stock. Mentor sued to invalidate the defenses.
CONTINUED
ALLOCATION OF POWERS
BETWEEN THE DIRECTORS AND
THE SHAREHOLDERS
Case 23.4 Synopsis. (Cont’d)
ISSUE: Are defensive measures (including a “no-hand” pill)
designed to prevent a hostile bidder from acquiring control of a
Delaware corporation for at least nine months valid? HELD:
NO. The Delayed Redemption Provision (no hand pill)
impermissibly circumscribes the board’s statutory power to
manage the business and affairs of the company and the
directors’ ability to fulfill their concomitant fiduciary duties. In
other words, the provision was against public policy.
Control and Blasius Standard.
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DUTY OF DIRECTORS TO DISCLOSE
PRELIMINARY MERGER
NEGOTIATIONS
 Management Buy Out (MBO) – managers have a
real conflict of interest in deciding whether to
disclose their offer to the public, because
disclosure will often bring forth competing
bidders.
 Potential conflicts of interest between
director(s) and shareholders.
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DUTIES OF CONTROLLING
SHAREHOLDERS
• Sale of Control - worth more than other shares; the
controlling shareholder normally has the right to
receive a premium payment for the controlling
shares.
•
Minority shareholders may bring derivative suit for accounting of
controlling shareholders proceeds.
• Freeze-outs - forcing minority shareholders to
convert their shares to cash; in Delaware, this can
be done if the transaction is fair.
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DUTIES OF CONTROLLING
SHAREHOLDERS
Case 21.6 Synopsis. Jones v. Ahmanson & Co. (Cal. 1969).
The majority shareholders of United Savings and Loan traded their
shares to United Financial Corporation and became the majority
shareholders in that company. The minority shareholders were not
allowed to do make a similar transaction.
ISSUE: Did majority shareholders who transferred their shares to a
holding corporation, then took it public without allowing the minority
to exchange their shares, breach their fiduciary duty to the minority
shareholders? HELD: YES. majority shareholders breached their
fiduciary duty to the minority shareholders and therefore had to pay
them damages.
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GREENMAIL
Paying much higher than market price for a dissident’s
shares so he or she will sell.
Case 21.7 Synopsis. Heckman v. Ahmanson (Cal. Ct. App. 1985).
A group headed by Steinberg purchased two million shares of Disney
stock. Disney countered by purchasing the Arvida Corporation for $200
million in new Disney stock and assuming $190 million in debt. The
Steinberg group filed a derivative suit to block Disney, and bought two
million more shares of Disney stock. They also advised Disney that they
were going to make a tender offer for at least $67.50/share. Disney then
offered to repurchase the group’s stock and reimburse them for their
litigation costs for a total of $325.4 million, or about $77/share.
CONTINUED
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GREENMAIL
Case 21.7 Synopsis. (Cont’d)
ISSUES: Was a shareholder who induced the board of directors to pay
greenmail liable as an aider and abettor of the board’s breach of its duty
to the company? Was the shareholder, who (as part of the greenmail
transaction) abandoned a derivative suit against the company, also
liable to the other shareholders for breaching his fiduciary duty to
them?HELD: The court found this to be a breach of the board’s
fiduciary duty to pay greenmail, and that the shareholder was an aider
and abettor in this. Further, the shareholder is liable to the other
shareholders for not pursuing the derivative suit.
Hushmail—combination of greenmail and hush money
paid to silence the problem-causing shareholder.
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THE RESPONSIBLE MANAGER
Carrying Out Fiduciary Duties
Officers, directors, and controlling shareholders are
fiduciaries. They must:
- Owe their principal undivided loyalty.
- Act in good faith.
- May not put their interests before those of the
corporation and its shareholders.
- Cannot use the company’s confidential information
for their personal gain.
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REVIEW
1. Explain why the business judgment
rule is a sound judicial policy.
2. Should corporate executive compensation
be tied to earning and profits?
3. Is greenmail a breach of the directors’
fiduciary duties?
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