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Directors, Officers,
and Controlling Shareholders
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ëhis chapter examines the business

judgment rule, and duties and
liabilities of officers, directors, and
controlling shareholders.


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@nder 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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Case 23.1 Synopsis. Smith v. Van Gorkom (1985).
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Case 23.1 Synopsis. (Cont·d)
ISS@ 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 ëhe
Delaware Supreme Court found the ërans @nion directors grossly
negligent in making such an uninformed decision. ëhe case was
settled for $25.5 million³$13.5 million in excess of the director·s
liability insurance.

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D Informed Decision ² required for the business judgment
rule.
² Reliability of Officers· Reports  cannot be taken on blind
faith.
² 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.
² Investment Banker·s Fee Structure  compensation
should not impair the investment banker·s
independence.
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D Reasonable Supervision³as fiduciaries, directors must exercise this duty
over corporate operations.

Case 23.2 Synopsis. n Re Caremark erivative Litigation (el. 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. ëhe proposed settlement
included no personal payments by directors, only a series of procedures the
company would implement. SS@E What is the scope of a director·s duty to
exercise reasonable supervision over corporate operations? HEL ëhe
court found this acceptable and said the shareholders could elect new
directors if they did not like this result.

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D þiew From Cyberspace Shareholder
Meetings in Cyberspace.
D Disinterested Decision  the business
judgment rule does not apply if the
directors have a conflict of interest.
D Disclosure þiolations by Directors.

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D Delaware·s Statute  02(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.
D 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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D 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 businessµ test.
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D One of the most controversial issues in corporate
governance today is the high level of executive
compensation.
D Stock options ² usually exercisable at the market
price at the time of grant for up to ten years.
D Golden Parachutes ² 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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D Courts want directors to consider seven factors
before deciding to sell the company
D ëhe Company·s Intrinsic þalue  as a going concern and on a
liquidation basis.
D Delegation of Negotiating Authority  board members who will
financially benefit should not negotiate the deal; may impose
greater risk of liability.
D NonPrice Considerations  all material factors should be
considered.

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è. Noëalk Provisions
5. Break@p Fees
6. ëakeover 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 maximi e share price?

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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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D Poison Pills (Shareholder Rights plan ² a plan that
would make any takeover not approved by the
directors prohibitively expensive.
D ´Dead Handµ Pills ² which could be redeemed only
by the directors in office before the hostile bidder
gained control, or their designated successors.
D Control and Blasius Standard ² action is strongly
suspect and cannot be sustained without a
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D Management Buy Out MBO ² managers hae a
real conflict of interest in deciding whether to
disclose their offer to the public, because
disclosure will often bring forth competing
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D Potential conflicts of interest between
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o Sale of Control  worth more than other shares; the
controlling shareholder normally has the right to
receie a premium payment for the controlling
shares.
o Minority shareholders may bring deriatie suit for accounting of
controlling shareholders proceeds.
o Free eouts  forcing minority shareholders to
conert their shares to cash; in Delaware, this can
be done if the transaction is fair.

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Paying much higher than mar et price for a dissident·s
shares so he or she will sell.
Case 21.7 ynopsis. Hec man v. Ahmanson Cal. Ct. App. 1! .
A group headed by teinberg purchased two million shares of Disney
stoc . Disney countered by purchasing the Arvida Corporation for $200
million in new Disney stoc and assuming $10 million in debt. ëhe
teinberg group filed a derivative suit to bloc Disney, and bought two
million more shares of Disney stoc . ëhey also advised Disney that they
were going to ma e a tender offer for at least $67.!0/share. Disney then
offered to repurchase the group·s stoc and reimburse them for their
litigation costs for a total of $32!.è million, or about $77/share.
CONëNUD


  
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_
 §
 
. Explain why the business judgment
rule is a sound judicial policy.

2. Should corporate executie compensation

be tied to earning and profits?

3. Is greenmail a breach of the directors·

fiduciary duties?