Corporations (Part 2)

Deference, and where it ends

A corporation’s shareholders own it, but they hand the running of it to a board, and the law mostly lets the board decide. A shareholder who thinks the directors priced a product too high, or opened a plant in the wrong city, usually has no case. Many suits against directors come down to where that deference ends. Two questions sit behind the disputes you will research for the activity: when will a court look behind a board’s decision, and who can ask it to?

A suit over the Chicago Cubs shows how far the deference reaches. In the 1960s a minority shareholder sued the club’s directors for refusing to install lights at Wrigley Field. His complaint alleged that nineteen of the twenty major league teams played night games and that the Cubs had lost money on baseball operations from 1961 through 1965. It blamed Philip K. Wrigley, the club’s president and owner of about 80 percent of its stock. Wrigley, the complaint said, thought baseball was a daytime sport and feared that night games would hurt the neighborhood around the park. He did not care, it said, whether lights would make the club money.

The Appellate Court of Illinois affirmed the dismissal of the suit in Shlensky v. Wrigley, 237 N.E.2d 776 (Ill. App. Ct. 1968) (opens in a new tab). A director might well weigh the neighborhood, the court reasoned. Fans might stay away from a park in a declining area, and the club had a long-run interest in the value of its property there. The court said it was not deciding whether the directors were right, a question beyond its jurisdiction and its ability. The decision belonged to the directors, and the complaint alleged no fraud, illegality, or conflict of interest.

That is the business judgment rule at work. Courts presume that directors decided on an informed basis, in good faith, and in the honest belief that the decision served the corporation. A shareholder who attacks the decision has to overcome that presumption. Florida’s corporation statute, Chapter 607 of the Florida Statutes, even names the kind of reason Wrigley gave. A director may consider how a decision affects the communities where the corporation operates (section 607.0830). The presumption gives way in several ways. Two of them follow the two duties every director owes, care and loyalty.

Two hours in September

On September 20, 1980, the board of Trans Union Corporation met in a special session. Most of the directors had not been told why. Jerome W. Van Gorkom, the chairman and chief executive, gave a twenty-minute oral presentation of an offer to buy the company for $55 a share in cash. The stock was trading at $38. There was no study of what the company was worth; Van Gorkom had arrived at $55 by working out what a leveraged buyout could finance. Copies of the merger agreement came too late to study, and Van Gorkom himself had not read it. After about two hours, the directors approved the sale. That evening Van Gorkom signed the agreement at a formal event he hosted for the opening of the Chicago Lyric Opera, and no director had read it.

The shareholders brought a class action, and the Delaware Supreme Court held the directors liable in Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) (opens in a new tab). The business judgment rule protects only an informed decision, the court explained. A decision is informed only if the directors first learned all the material information reasonably available to them. The Trans Union board had not. Selling the company on two hours’ consideration, with no notice and no emergency, was at a minimum grossly negligent. The court ordered judgment against the directors for whatever the shares were worth above $55.

A Florida director would answer under a different statute, section 607.0831 (opens in a new tab). It bars money damages against a director for a decision unless the breach fits a category the statute lists. Some are specific, such as a criminal violation, an improper personal benefit, or an unlawful distribution to shareholders. Otherwise, in a suit by the corporation or its shareholders, the breach must amount to conscious disregard for the corporation’s best interest, or willful or intentional misconduct. Carelessness does not qualify by itself. In Delaware, the General Corporation Law (opens in a new tab) lets a corporation’s certificate of incorporation eliminate directors’ liability for damages for breaching the duty of care (section 102(b)(7)). The certificate can never excuse disloyalty, bad faith, or an improper personal benefit.

In other words, the duty of care tells a court what directors owed, and these statutes decide whether a director who fell short pays personally. Both reach only money damages. A court can still block a deal a board approved without the facts.

A director on both sides

Deference rests on an assumption: that the directors are judging only what is good for the corporation. The assumption fails when a director is on the other side of the deal. That is where the duty of loyalty comes in, and Florida’s statute on conflicted deals is section 607.0832 (opens in a new tab).

The statute covers a director’s conflict of interest transaction: a deal between the corporation and a director, or with another business in which the director has a material financial interest. It does not forbid such a deal. It asks whether the deal was fair to the corporation, which means that the deal, taken as a whole, benefits the corporation and its shareholders. Two things weigh in that judgment: whether the director dealt fairly with the corporation, and whether the terms match what an arm’s-length bargain would have produced.

Who has to prove fairness depends on what happened before the vote. Suppose the director’s interest and the material facts were disclosed to or known by the board, and a majority of the qualified directors approved the deal. Then whoever challenges it must prove it unfair. Qualified directors are those with no conflict in the deal and no relationship with the interested director that would cloud their judgment (section 607.0143). Approval by a majority of the votes cast by disinterested shareholders, after the same disclosure, works the same way. Without either approval, whoever defends the deal must prove it fair.

Your textbook (opens in a new tab) says an unfair contract can still be permitted after disclosure and disinterested approval. Florida’s statute does not go that far: approval shifts the burden, and a deal proven unfair loses the statute’s protection. Nor does the statute make the interested director leave the room. A fair deal stands even if that director attended the meeting and voted, though that vote does not count toward the qualified majority.

Suppose a company that runs three hotels in Palm Coast hires a landscaping firm owned by one of its directors. If she tells the board she owns the firm and the other directors approve, a shareholder who sues must prove the contract unfair. The proof might be that other firms bid a third less. If she says nothing, whoever defends the contract must prove it fair, and those lower bids become evidence against it.

Whose claim it is

Suppose a board did breach a duty. Whose claim is that? Directors owe their duties to the corporation, so a breach that costs the company money gives the company a claim. Whether to sue on it is normally the board’s decision. A derivative suit lets a shareholder bring the company’s claim when the board will not, and whatever it recovers goes to the company.

Florida puts conditions on the suit. The shareholder generally must have owned shares when the conduct occurred and must still own them when the suit is filed (section 607.0741 (opens in a new tab)). The complaint must be verified and must say with particularity whether the shareholder asked the board to act. If so, it must say that the board refused, rejected, or ignored the demand, or why waiting 90 days would cause the company irreparable injury or waste its assets. If not, it must give the reasons (section 607.0742 (opens in a new tab)). Qualified directors, or a panel the court appoints, can investigate the suit. If they decide in good faith, after a reasonable inquiry, that it does not serve the corporation, the court may dismiss it. The corporation carries the burden of proving that group’s qualifications, good faith, and inquiry (section 607.0744). And the court must approve any settlement (section 607.0745).

When the suit ends, the court may order the corporation to pay a successful plaintiff’s reasonable expenses, attorney fees included, from what it recovered. It may instead order a plaintiff who sued without reasonable cause or for an improper purpose to pay the defendants’ expenses (section 607.0746).

Some claims do belong to the shareholder. A direct action is a shareholder’s suit for the shareholder’s own injury, and the recovery is the shareholder’s too. Florida courts sort the two with a test the Third District drew from nearly fifty years of cases in Dinuro Invs., LLC v. Camacho, 141 So. 3d 731 (Fla. 3d DCA 2014) (opens in a new tab). A shareholder may sue directly only for a harm that is both direct and special. Direct means it does not flow from an injury to the company; special means it is separate and distinct from what the other owners suffered. The one exception is a duty the defendant owed the plaintiff personally, under a contract or a statute.

In Dinuro itself, three companies each owned a third of a limited liability company formed to develop land. One claimed the other two let the venture default on its bank loans so they could buy the loans and foreclose, which left the venture with nothing. Even taking that as true, the court held, the third owner’s loss came through the venture’s loss, so the claim was the venture’s.

The vote, and the fight for it

A lawsuit is one check on a board. The vote is the other, and it heads the list of shareholder rights. In Florida, directors are elected by a plurality of the votes cast unless the articles, or at a public company the bylaws, require more (section 607.0728). A shareholder may vote in person or through a proxy, someone appointed to vote the shares (section 607.0722).

A proxy contest turns the vote into a campaign. In the usual contest, a dissident shareholder or group nominates its own candidates for the board and asks the other shareholders for their proxies. Management asks for the same proxies. At a public company, federal rules apply as well. The SEC requires a proxy statement, filed under its Schedule 14A, before shareholders vote by proxy, as Cornell’s Wex entry on proxies (opens in a new tab) explains.

A campaign needs a list of voters. Before a meeting, a Florida corporation must let any shareholder inspect its list of the shareholders entitled to notice. If it refuses, a shareholder who was denied access can have the meeting adjourned until it complies (section 607.0720). A shareholder with a proper purpose may also inspect excerpts of board minutes, accounting records, and the record of shareholders (section 607.1602 (opens in a new tab)). The purpose must be reasonably related to the shareholder’s interest as a shareholder.

Boards set the meeting calendar, and a Delaware case shows where that power stops. In 1971, dissident stockholders of Chris-Craft Industries told the SEC they would wage a proxy fight. Management had resisted giving them a stockholder list. It then used a new provision of Delaware law to move the annual meeting from January 11, 1972, up to December 8, 1971. That left the dissidents little time to campaign. Management said it had followed the statute exactly. The Delaware Supreme Court restored the January date in Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437 (Del. 1971) (opens in a new tab). Its answer to management was that “inequitable action does not become permissible simply because it is legally possible.”

Placing your dispute

Once the survey gives you a dispute, three questions will place it. Did the board decide without the facts, or did a director stand on both sides? Who brought the claim: a shareholder for the company, a shareholder alone, or a dissident asking for proxies? And what did the case end with: a judgment, a settlement, or seats on the board?

Answer each one from what you verify, not from the AI’s summary. The survey comes first, with the Deep Researcher on the activity page.