Friday, October 12, 2012

Corporations Law: The Duty of Care outline

 II. The Duty of Care

What is the duty of care?
  1. Involves corporate managers’ breach of duty to the corporation itself.
  2. Involves conduct by the directors or officers that causes loss to the corporation but with seemingly no direct or indirect benefit to the defendants themselves.
  3. “Negligence uncomplicated by self-dealing”
  4. Can also be labeled as “mismanagement”, “waste”, “negligence”, “lack of business judgment”, or “lack of reasonable diligence”.

Shlensky v. Wrigley (Ill. App. 1968)
  • Plaintiff was minority stockholder of a corporation that owns and runs the Chicago Cubs. Defendants were directors of the corporation, including the president Philip K. Wrigley.
  • Plaintiff argued that directors violated their duty to the corporation by not installing lights and scheduling night games to boost attendance and revenues.
  • The court held that the directors were entitled to business judgment rule protection.
    • “The judgment of the directors of corporations enjoys the benefit of the presumption that it was formed in good faith and was designed to further the best interests of the corporation they serve.”
  • The court held that the directors must be permitted to control the business of the corporation in their discretion unless their decisions are tainted by “fraud, illegality or conflict of interest”.

Smith v. Van Gorkum (Del. 1985)
  • Does the business judgment rule apply to the board’s decision?
    • The rule itself is a “presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company”.
    • Court looks at the process of the board’s decision making.
  • How much information does a board have to get?
    • To determine this, the court looks whether the directors have informed themselves “prior to making a business decision, of all material information reasonably available to them”.
    • The court doesn’t require a fairness opinion from an investment banker, but no board since this case has risked not getting one.
  • The court stated that the board breached its duty of due care when it approved the $55 share price without adequate information.
    • The board never asked questions about the share price.
    • The board could have asked the CFO to do an analysis on the value of the company.
    • The board could have hired an outside firm to do an analysis.
    • The board didn’t read the merger agreement or have in-house counsel read it.
    • The board didn’t negotiate and they just took the numbers presented to them by Van Gorkum.
    • The board could have asked for more than the 3 days Pritzker gave them.
  • The business judgment rule does not insulate directors who act without being fully informed and their actions will be reviewed under an “entire fairness” standard.

So for most operational decisions that do not involve a large piece of the corporation’s assets the rule from Wrigley still applies. But the bigger the decision and the less often it is made, the stricter “entire fairness” standard of Van Gorkum applies.

What would you advise a board to do after Van Gorkum?
  1. Have an investment banker value the company.
  2. Have the board meet and meet to discuss.
  3. Involve legal counsel. Hear their views and have them review the documents in the merger agreement.
  4. You want to hear management’s views.
  5. If the board decides to go ahead with the merger make sure the board
    1. Can still shop for other offers
    2. Ask for more time
    3. Don’t have a stock lock-up but have a goodbye fee (agree to pay cash to first offer if you don’t take it)
    4. In order to avoid breach of contract to first offer, add a fiduciary out clause.

A board has a duty to inquire when the circumstances would alert a reasonable director of the need to.

In re Caremark International, Inc. Derivative Litigation (Del. Ch. 1996)- It is important that a board exercise good faith judgment that the corporation’s information and reporting system is adequate to assure the board that appropriate information will come to its attention in a timely manner.

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