Business Organizations
2010-2011 Lectures
PARTNERSHIPS,
CORPORATIONS
AND THE VARIANTS
PROF. BRUCE MCCANN
SPRING SEMESTER LECTURE 1
DUTY OF LOYALTY
PP. 577-607
The Duty of Loyalty and the BJR
 The Business Judgment Rule only shields directors
where there is no conflict of interest.
 Where a potential conflict of interest exists, burden
is on directors to demonstrate decision is fair and
reasonable to the corporation.
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann
The Business Judgment Rule
 Applies when what is at issue is a business decision
made by the directors
 Does not come into play where directors are accused
of failing to monitor or similar derelictions of the
duty of care, only when making a business decision
Lec. 13, pp 529-576 Corps
Prof. McCann
Calif. Corp Code Sec. 309
 (a) A director shall perform the duties of a director, including duties
as a member of any committee of the board upon which the director
may serve, in good faith, in a manner such director believes to be in
the best interests of the corporation and its shareholders and with
such care, including reasonable inquiry, as an ordinarily prudent
person in a like position would use under similar circumstances.
 (b) In performing the duties of a director, a director shall be entitled
to rely on information, opinions, reports or statements, including
financial statements and other financial data, in each case prepared
or presented by [officers, consultants, etc].
 (c) A person who performs the duties of a director in
accordance with subdivisions (a) and (b) shall have no
liability based upon any alleged failure to discharge the
person's obligations as a director. In addition, the liability
of a director for monetary damages may be eliminated or
limited in a corporation's articles to the extent provided in
paragraph (10) of subdivision (a) of Section 204.
Lec. 13, pp 529-576 Corps
Prof. McCann
Model Act
SECTION 8.30. GENERAL STANDARDS FOR DIRECTORS
(a) A director shall discharge his (sic) duties as a director, including his (sic) duties as a
member of a committee:
 (1) in good faith;
(2) with the care an ordinarily prudent person in a like position would exercise under similar
circumstances; and
(3) in a manner he (sic) reasonably believes to be in the best interests of the corporation.


(b) In discharging his (sic) duties a director is entitled to rely on information, opinions, reports,
or statements, including financial statements and other financial data, if prepared or presented
by:
 (1) one or more officers or employees of the corporation whom the director reasonably believes
to be reliable and competent in the matters presented;
(2) legal counsel, public accountants, or other persons as to matters the director reasonably
believes are within the person's professional or expert competence; or
(3) a committee of the board of directors of which he (sic) is not a member if the director
reasonably believes the committee merits confidence.

(c) A director is not acting in good faith if he (sic) has knowledge concerning the matter in
question that makes reliance otherwise permitted by subsection (b) unwarranted.
 (d) A director is not liable for any action taken as a director, or any failure to take any action, if
he (sic) performed the duties of his (sic) office in compliance with this section.

Lec. 13, pp 529-576 Corps
Prof. McCann
Shareholder Ratification
 Shareholders may ratify acts of even interested
directors PROVIDED shareholders are “fully
informed”

Burden is on directors to establish shareholders were fully
informed
Lec. 13, pp 529-576 Corps
Prof. McCann
Delaware Gen Corp Law Sec. 141
(e) A member of the board of directors, or a member of any
committee designated by the board of directors, shall, in the
performance of such member's duties, be fully protected
in relying in good faith upon the records of the
corporation and upon such information, opinions,
reports or statements presented to the corporation
by any of the corporation's officers or employees, or
committees of the board of directors, or by any other
person as to matters the member reasonably
believes are within such other person's professional
or expert competence and who has been selected
with reasonable care by or on behalf of the corporation.
Lec. 13, pp 529-576 Corps
Prof. McCann
SMITH V VAN GORKOM
 "Informed" within meaning of "due care" means
board reviewed all material information reasonably
available
 Liability under Business Judgment Rule
arises only where there is a showing of gross
negligence, meaning something more
careless than ordinary negligence.

E.g., failure to even read a report which was itself
deficient
Lec. 13, pp 529-576 Corps
Prof. McCann
ALI Version
 No liability for a business judgment reached in good
faith provided:
 1. Director or officer was disinterested
 2. Director or officer was informed as to the subject
of the decision to a degree the director or officer
reasonably believes appropriate; and
 3. Rationally believes decision is in the best interests
of the corporation
Lec. 13, pp 529-576 Corps
Prof. McCann
The Rule
 Absent fraud, illegality or conflict of interest, a
director who acts in good faith is not personally
liable for mere errors of judgment short of CLEAR
AND GROSS NEGLIGENCE
• Shlensky v Wrigley 237 N.E. 2d 776 (Ill. 1968)
 Unless director(s) had an interest in the subject of
the decision or
 Unless decision constitutes illegal conduct (e.g.,
decision to pay a bribe)
Lec. 13, pp 529-576 Corps
Prof. McCann
The Business Judgment Rule
 Applies when what is at issue is a business decision
made by the directors
 Does not come into play where directors are accused
of failing to monitor or similar derelictions of the
duty of care, only when making a business decision
Lec. 13, pp 529-576 Corps
Prof. McCann
What is “Fair and Reasonable”?
 An objective test.
 There must be procedural fairness
 There must be substantive fairness
 The transaction must be reasonable in the overall
context of the objectives of the corporation



As measured against transactions with unrelated parties
As measured against strategic goals – i.e., not only must the
terms be fair, but the transaction itself has to be one the
corporation would have pursued even were the other party not
affiliated
As measured at the time of the decision
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann
Safe Harbor for the Interested Director/Officer
Delaware provides:
No transaction void or voidable just because
interested director or officer participated if:
a. All material facts regarding the conflict of interest
were disclosed to the board or shareholders who
nonetheless approved the transaction in good faith;
or
b. The transaction was intrinsically fair to the
corporation at the time it was approved.
NOTE: Regardless of board or shareholder approval,
many states require fairness test be satisfied
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann
Split As to Application of Safe Harbor Rules
 Majority: Burden is on shareholders to prove board
action unfair so long as BJR criteria met
 Shifting burden to shareholders to show unfair
provided one of the safe harbor tests is met (i.e.,
board need not also show intrinsic fairness)
 Burden of proof on board to demonstrate intrinsic
fairness (Minority)
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann
Interplay with BJR
 Benihana:
 If fully informed disinterested directors approve the
transaction, the burden shifts to the shareholders to
show decision does not satisfy the Business
Judgment Rule (i.e. , that the process followed in
reaching the decision was flawed, regardless of the
merits of the decision)
 Effect is to insulate the decision from judicial review
for fairness
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann
Alternative Attacks on the Transaction
 Waste
 Fraud
 Exceeding Authority
 Breach of Loyalty action against the interested
director
Lec. 1 Sem 2, pp 577-600 Corps
Prof. McCann