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Business Associations II
University of Kansas School of Law
Lovitch, Fred B.

B.A. II Outline
 
II. Fiduciary Duties of Directors and Controlling Shareholders
A.     NATURE OF DERIVATIVE CAUSE OF ACTION
a.      Hypo
                                                                          i.      Own 10% of X,Y,Z inc. and each x,y,z own 30% and elect themselves as only directors and officers- employee just tipped you off that they have been buying every 4/5 project that the company does at 50% cost- so yo ask them to make the corporation wholeà reimburse the corporation- they respond—ask them to cause the corporation to sue themselves because the shareholders and corporation have been harmed by what they have been doing—
1.      Many times minority shareholders believe that the persons in control have harmed the corp. but they can’t get any action either way, therefore a couple of centuries ago, Courts developed a device minority shareholders can use to protect corporations and themselves, derivative suit
b.      Shareholder Suits
                                                                          i.      “derivative suits”: viewed in this country as a suit to enforce a corporate cause of action against officers, directors, and third parties
1.      Preconditions for the suit:
a.      valid claim on which the corporation could have sued
b.      the corporation itself had refused to proceed after suitable demand, unless excused by extraordinary conditions
2.      called a derivative suit because the shareholder’s right to bring the suit derives from the corporation
3.      Features:
a.      Extraordinary procedural complexity inherent in such actions—complexity involving for example:
                                                                                                                                                  i.      Proper parties and their alignment
                                                                                                                                                ii.      Jurisdiction
                                                                                                                                              iii.      Demand on the board
                                                                                                                                              iv.      Demand on the shareholders
                                                                                                                                                v.      Right to sue
                                                                                                                                              vi.      Intervention
                                                                                                                                            vii.      Settlement
                                                                                                                                          viii.      Dismissal
b.      Difficult problem of social policy raised by these actions
                                                                                                                                                  i.      Problem; shareholder with small investment can force expenditure by the corporation of a large amount of funds and executive time
                                                                                                                                                ii.      Cost put on non-complaining shareholders
4.      Publicly Held Corporations
a.      Plaintiff-shareholder’s gain is not only indirect, but usually very small and infinitestimal
5.      usually won or lost on procedural issue and do not get to the merits of the case
                                                                        ii.      dual nature of the stockholder’s actions
1.      the Plaintiff’s right to sue on behalf of the corporation
2.      the merits of the corporation’s claim itself
c.      Shareholder Status
                                                                          i.      Plaintiff must:
1.       be a shareholder at the time the action begins AND
2.       remain a shareholder during the pendency of the action (Tooley v. D,L,J)
a.      S, a shareholder of corporation C, brings a derivative action on C’s behalf, and then C mergers into T corporation, which is the survivor of the mergerà S loses standing to continue prosecuting the actions, since she is no longer a shareholder in C
b.      2 exceptions:
                                                                                                                                                  i.      where the merger is subject to the claim that it was perpetrated merely to deprive shareholders of the right to bring a derivative action
                                                                                                                                                ii.      where the merger is in reality a reorganization that does not affect the plaintiff’s ownership of the business enterprise
d.     Creditors
                                                                          i.      If Plaintiff has to be a shareholder at the time he brings the suit, implies that a creditor ordinarily has no right to bring a derivative action
                                                                        ii.      Some Courts argue that the holder lacks standing to sue derivatively until the debenture has been converted, while other held that the conversion feature provides the holder a sufficient equity interest to confer standing to sue derivatively—or have recognized that the question is disputed
e.      Directors?- sometimes a statute gives an officer or director the right to bring a derivative claim
f.        Corporation as an Indispensable Party
                                                                          i.      Corporation is an indispensable party to a derivative action and therefore must be joined in the suit
g.      Distinction Between Derivative and Direct Actions
                                                                          i.      The Impact of a Determination that an Action is Derivative
1.      Different and sometimes more difficult procedural rules to get through in a derivative action so some will prefer to classify as direct
                                                                        ii.      Reasons for Distinguishing Between Direct and Derivative Actions
1.      Derivative Action: which is brought on the corporation’s behalf against either corporate fiduciaries or third persons
2.      Direct Action: brought on a shareholder’s behalf against either the corporate fiduciaries or the corporation itself
a.      Must have experienced some special injury
3.      2 reasons to distinguish
a.      theorhetical:
                                                                                                                                                  i.      since a corporation is a legal person separate from its shareholders, an injury to the corporation is not an injury to its shareholders
b.      pragmatic:
                                                                                                                                                  i.      to avoid multiplicity of suits by each injured shareholder
                                                                                                                                                ii.      to protect corporate creditors
                                                                                                                                              iii.      to protect all the stockholders since a corporate recovery benefits all equally
                                                                      iii.      Easy Cases
1.      DERIVATIVE: A wrongful act that depletes corporate a

ity of Directors as to Dividends or Stock Redemption
1.      A member of the BoD or a member of any committee designated by the BoD, shall 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 corporations by any of its officers or employees, or committees of the BoD, or by any other person as to matters the director 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, as to the value and amount of the assets, liabilities and/or net profits….
2.      HYPO
a.      X was a non-officer Director of Corp, raised .5 million dollars- went to directors meetings, hired some employees, couldn’t stop fighting or find type of enginner needed- when able to get going they were bankrupt- receiver decided to sue X because he never went to a meeting- case would be derivative because dealing with corporate harm, failure to act as a director
b.      Assume that failing to attend meetings as a director violates your fiduciary duty
                                                                      iv.      ACTIVE MISCONDUCT- misconduct so bad- should be held personally liable for damages- business decision that turned out so poorly
b.      liability deriving from unprofitable business decisions
                                                                          i.      Smith v. Van Gorkum
1.      Director’s approved merger @ secret meeting without regard to merger agreement
2.      No evidence of fairness of the price, except from Gorkum himself
3.      Business Judgment Rule: see below
4.      not claiming any corporate harm, complaining on their behalf, direct case, NOT derivative
5.      HOLDING: directors breached their fiduciary duty to their stockholders by their failure to inform themselves of all information reasonably available to them and relevant to their decision to recommend the merger
                                                                        ii.      Selheimer case
1.      Conduct as directors and officers held, under § 408 of Business Corp. Law or by common law- their conduct offended their fiduciary relationship to this corporation in such manner as to justify the imposition upon them of personal liability for such conduct
 
                                                                      iii.      Standard of Conduct: states how an actor should conduct a given activity or play a given role
1.      “a director or officer has a duty to the corporation to perform the director’s or officer’s functions in good faith, in a manner that he or she reasonably believes to be in the best interests of the corporation, and with the care that an ordinary prudent person would reasonably be expected to exercise in a like position and under similar circumstances”- ALI’s principles of corporate governance
2.      Application of this standard of conduct results in Duties:
a.      The duty to monitor
b.      Duty of inquiry
c.      Duty to make prudent or reasonable decisions on matters that the board is obliged or chooses to act upon