a)Right to Inspect Corporate Records--if done in good faith for purposes germane to his position as dir, this right is absolute.

b)Duty of Care--dirs must exercise the care of an ordinarily prudent and diligent person in a like position, under similar circumstances. There is no liability (absent a conflict of interest, bad faith, illegality, or gross negligence) for errors of judgment (business judgment rule--the rebuttable presumption that action was taken on an informed basis, in good faith and exercising reasonable care), but the dir must have been reasonably diligent before the rule can be invoked (Shlensky)

1)The duty of care requires:

I)Education--a dir should acquire at least a rudimentary understanding of the business of the corporation;

ii)Information--a dir is under a continuing obligation to keep informed about the activities of the corp;

iii)Participation--dirs must “generally monitor” corporate affairs, but need NOT involve themselves in the day-to-day operations; (i.e. they should attend board of dirs meetings with reasonable regularity).

iiii)Inquiry--a dir has a duty to inquire when circumstances would alert a reasonable person for the need of inquiry.

iiiii)Action--where wrongdoing is revealed, a dir should object, correct, or resign. Object to the course of conduct, steer toward correction, and resign if it isn’t corrected.

2)Extent of liability--dirs are personally liable for corporate losses directly resulting from their breach of duty or negligence in falling to discover wrongdoing. a director may seek to avoid being held personally liable for acts of the board by recording his dissent.

I)Many statutes permit the articles to abolish or limit dir’s liability for breach of the duty of care absent bad faith, intentional misconduct, or knowing violation of law.

3)Defenses to liability--these include good faith reliance on management or expert’s reports. Disabilities may be considered in determining whether the dir has met the standard of care.

c)Duty of Loyalty--a catch-all duty designed to prevent unfairness--the duty to act in good faith (BJR applies). Application:

1)Self-dealing transactions

I)Common Law:

(1)early absolute prohibition against self-dealing renders transactions void or voidable;

(2)permissive self-dealing: dirs and officers may contract with the corp if (a)done in “strictest good faith.”; (b)with full disclosure; and (c)consent of “all concerned.”

[1]--burden of proof is on the dir to establish good faith, honesty & fairness;

[2]--courts weigh self-dealing transactions with “closest scrutiny”

(3)self-dealing prohibition also applies to intercorporate transactions where dirs are common.

ii)Statutory (example):

(1)quasi-safe harbor approach (Iowa statute)--transaction is not void or voidable because of dirs’ interest, if either:

[1]--interest is disclosed and approval is made without counting the vote of the interested dir.

[2]--interest is disclosed to shs and shs authorize

[3]--transaction is fair and reasonable

(2)Note--dir must still establish that he acted in good faith, honesty, and fairness

2)Domination of subsidiary by parent--courts look at the transaction to see if self-dealing has occurred. Example (Sinclair Oil):

I)declaration of dividends shared pro rata was NOT self-dealing; BJR applies

ii)contract between parent and sub was self-dealing; apply intrinsic fairness test

3)Manager’s compensation:

I)Ordinary corporations--conflicts are inevitable but all firms need to set compensation. The burden of proof is placed on challengers as a matter of convenience.

ii)Close corporations--the income generated by the firm may be diverted to salaries, so there is an option for self-dealing by the parties in control to take tax-advantaged compensation in the form of salaries (taxed once) as opposed to dividends (taxed twice).


d)Statutory Duties and Liabilities--in addition to general duty of care, federal and state laws also impose certain duties and liabilities, e.g., registration requirements under the Securities Act of 1933, liability for rule 10b-5 violations, liability for illegal dividends. Some statutes also impose criminal liability on corporate managers for unlawful corporate actions.





1.ELECTION--officers are usually elected by the board of dirs. Some statutes permit election of officers by shs.


2.AUTHORITY OF CORPORATE OFFICERS (liability of corp to outsiders)--only authorized officers can bind the corp. Authority may be: actual (expressed in bylaws or by valid board resolution), apparent (corp gives third parties reason to believe authority exists), or power of position(inherent to position). If ratified by the board, even unauthorized acts can bind the corp.

a)Authority of President--the majority rule is that the president has the power to bind the corp in transactions arising in regular course of business.


3.DUTIES OF CORPORATE OFFICERS--the duty of care owed by a officer is similar to that owed by dirs ( and sometimes higher).





1.DUTY OF LOYALTY--because of their fiduciary relationship with the corp, officers and dirs have the duty to promote the interests of the corp without regard for personal gain.


2.BUSINESS DEALINGS WITH THE CORPORATION--conflict of interest issues arise when a corp transacts business with one of its officers or dirs, or with a company in which an officer or dir is financially interested.

a)Effect of Self-Interest on Right to Participate in Meeting--most statutes permit an “interested” dir to be counted toward quorum, and interested dir’s transactions are NOT automatically voidable by the corp because the interested dir’s vote was necessary for approval.

b)Voidability Because of Director’s Self-Interest--today, such transactions are voidable only if unfair to the corporation. The burden of establishing fairness is on the interested director. Note that a dir’s failure to fully disclose material facts may be per se unfair.

1)Unanimous shareholder ratification--if, after full disclosure, shareholder ratification is unanimous, the corp will be estopped from challenging the transaction with the interested dir (except at to creditors).

I)Less-than-unanimous ratification--courts then will look at whether the majority shares were owned or controlled by the interested director. Courts are more likely to uphold ratification by a disinterested majority so as to preclude the transaction from being attacked by the corp or by a sh in a derivative suit.

2)Statutes--most statutes provide that such transactions are NOT voidable if: (1)approved, after full disclosure, by a disinterested board majority or by majority of shs, or (2)the transaction is fair to the corp notwithstanding disclosure.

I)”Interested”--an “interested” dir or officer is one who has a business, financial, or familial relationship with a party to the transaction that would reasonably affect the person’s judgment so as to adversely affect the corp.

c)Remedies--the corp may rescind, or affirm and sue for damages.

3.INTERLOCKING DIRECTORATES--generally, transactions between corps with common dirs are subject to the same rules of interested director transactions. There is no conflict of interest if one corp is the wholly owned subsidiary of the other. However, a question of fairness arises where the parent owns only a majority of the subsidiary’s shares.


4.CORPORATE OPPORTUNITY DOCTRINE (Also see duty of loyalty)

a)Definition--COD bars dirs from taking any business opportunity belonging to the corp without first offering it to the corp.. If the corp is unwilling to pursue an opportunity (after an independent board is fully informed of the opportunity), then the dir may pursue it.

b)Defenses (available in most, but not all jurisdictions):

1)Inability--If the corp is legally or financially unableto take the opportunity, then the dir generally may take advantage of it. (But the question of who caused the financial inability is quite relevant. Example: Irving Trust Co--the defense of inability was rejected).

2)Rejection, abandonment, or approval--then the fiduciary has a valid defense.

c)Remedies--constructive trust or damages--the fiduciary must account to the firm for all the profits he has made as a result of usurpation.

d)Definition of a Corporate Opportunity:

1)Line of business test--does the firm have fundamental knowledge, practical experience, and ability to pursue the opportunity? If yes, then it is within the firm’s line of business. It should be a natural fit, and not a mere desire by a firm to pursue the opportunity.

2)Interest/expectancy test

e)Application--Guth Rule and Corollary:

1)Guth rule (offered in corporate capacity)--if there is presented to O/D a business opportunity which the corp is (1)financially able to undertake, which is from its nature (2a) in the line of business and is of practical advantage to it OR (2b)is one in which the corp has an interest or reasonable expectancy (under an established corporate policy or plan), and, (3)by embracing the opportunity the self-interest of the dir will be brought into conflict with that of his corp, then officer or dir may NOT take the opportunity.

2)Guth corollary (a safe harbor; satisfy all provisions and dir can take)--if a business opportunity (1)comes to O/D in his individual capacity and (2) is not essential to the corp and is (3)one in which corp has no interest or expectancy, then the O/D can treat it as his own, IF he has not taken corporate resources to pursue the opportunity.

I)”Essential”--indispensably necessary to the continued viability of the firm;

ii)Individual or corporate? Look at O/D capacity to determine how offer was made



5.COMPETING WITH CORPORATION--such competition by a dir or officer may be a breach of fiduciary duty even when the competing business is not a corporate opportunity


6.COMPENSATION FOR SERVICES TO THE CORPORATION--the compensation plan must be duly authorized by the board, and its terms must be reasonable. Good faith and the BJR ordinarily protect disinterested dirs from liability to the corp for approving compensation.

a)Publicly Held Corporations--The SEC has authorized shs to make proposals about executive pay in management’s proxy statements. Further, the tax code now limits expense deductions for executive pay over $1mln, unless it is tied to the corp’s performance.

b)Past and Future Services--compensation for past services is generally invalid. Compensation for future services is proper if there is reasonable assurance that the corp will receive the benefit of the services.

VI.INSIDER TRADING--purchase or sale of securities by someone with access to material

nonpublic information. It may be illegal. It affects corps with more than $1 mln in total assets and with at least 500/750 shs.

a)Who may be hurt by insider trading:

1)Target shareholders--they sell too early;

2)Other arbitrageurs--they lose a portion of the gain that they make from honest effort

3)Other issuers--they lose confidence in the stock market

4)The acquiring company--insider trading drives up their cost of acquisition, since the target may adopt defensive measures otherwise not in place.

b)Possible Sources of Liability:

1)Common Law;

2)10b-5 traditional;

3)10b-5 misappropriation theory (O’Hagan);

4)Mail or wire fraud;


6)Statutory liability under 16(b)--insiders are forced to give their profits to the corp, if the y buy and sell securities within a 6-month period regardless of whether they are using insider info. (Need to know 2, 3, 6)

c)O’Hagan--insider trading violation where a partner in law firm took info rom his firm regarding the firm’s client’s plans for acquisition of Pillsbury and used that info to buy shares in Pillsbury

d)Penalties For Insider Trading--ITSA (Insider Trading Sanctions Act)--3 measures:

1)Out-of-pocket measure--if a sh buys a share for $10, while in fact it costs $9, his out-of-pocket expense is $1.

2)Causation-in-fact--because an insider engaged in insider trading, it caused a loss

3)Disgorgement--we look at D’s profit. ITSA measures the damage to sh by the amount of profit that D received from the transaction.

2)SEC civil penalties--treble damages; SEC may seek penalty capped by three times profit gained or loss avoided.



A.COMMON LAW--under the majority rule, there was no duty to disclose to the shs inside info affecting the value of shares. Therefore, the protection of investors was very weak.

a)For lability to exist there should be:

1)At least fraud or deceit upon purchasers;

2)May also be a device or scheme;

3)May also be an implied misrepresentation.

b)Two Elements (relationship and unfairness):

1)Relationship--existence of a relationship giving access, directly or indirectly, to information intended to be available for a corporate purpose and no other.

I)Insiders include at least officers, dirs, controlling shs (In re Cady Roberts)

ii)Persons charged with confidentiality by contractual or fiduciary relationship

2)Unfairness--inherent unfairness that results when a party takes advantage of such information knowing it is unavailable to person with whom he is dealing.


B.SECURITIES EXCHANGE ACT OF 1934--IN GENERAL--the act superseded common law. Section 12 of the Act requires registration of any security traded on a national exchange, or any equity security (held by 500 or more persons) of a corp with assets exceeding $5 million.


C.SECTION 10(B) AND RULE 10B-5--section 10(b) prohibits any manipulation or deception in the purchase or sale of any security, whether or not it’s registered. Rule 10b-5 prohibits the use of the mails or other instrumentality of interstate commerce to defraud, misrepresent, or omit a material fact in connection with a purchase or sale of any security.

1.COVERED CONDUCT--rule 10b-5 applies to nondisclosure by dirs or officers, as well as to misrepresentations. It applies not only to insider trading but also to any person who makes a misrepresentation in connection with a purchase or sale of stock.

2.COVERED SECURITIES--rule 10b-5 applies to the purchase or sale of any security, registered or unregistered. a jurisdictional limitation requires that the violation must involve the use of some instrumentality of interstate commerce.


3.WHO CAN BRING SUIT UNDER 10B-5--private plaintiffs and the SEC. Private plaintiffs must be either purchasers or sellers of security.


4.MATERIALITY--for rule 10b-5 to apply, the information misrepresented or omitted must be material (i.e., a reasonable sh would consider it important in deciding whether to buy or to sell).


5.FAULT REQUIRED (SCIENTER)--a defendant is not liable under rule 10b-5 if he was without fault or merely negligent. The scienter requirement is satisfied by recklessness or an intent to deceive, mislead, or convey a false impression. Scienter is also required for injunctive relief.

a)Recklessness Defined:

1)D knew the hazard and proceeded nonetheless (subjective test);

2)D proceeded despite what a reasonable person would perceive (objective test);

b)Recklessness Under PSLRA:

1)Knowing conduct-- yields jointly and severally liable;

2)Non-knowing conduct (e.g., recklessness)--yields fair share (proportionate liability), found in accordance with special interrogatories.


6.CAUSATION AND RELIANCE--a plaintiff must prove that violation caused a loss (i.e., he must establish reliance on the wrongful statement or omission). However, in omissioncases, there is a rebuttable presumption of reliance once materiality is established.

a)Fraud On The Market--where securities are traded on a well-developed market (rather than in a face-to-face transaction), reliance on a misrepresentation may be shown by alleging reliance on the integrity of the market.

b)Face-to-Face Misrepresentations--a plaintiff can show actual reliance in these cases by showing that the misrepresentation was material, testifying that he relied upon it, and showing that he traded soon after misrepresentation.


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