Legal environment of business

Heimdall Corporation’s board of directors hired a new CEO, Essa Alharbi. The Executive Search Firm that hired him found that in their search of over 200 candidates, he was the most qualified. He had extensive experience in helping businesses succeed. After the Board of Directors hired him, 11 months into the job, the company experienced significant losses in revenue and market share. As a result, the Board forced him to resign but paid him a handsome sum to leave the company, as was customary in this situation. A group of shareholders filed a lawsuit against the Board of Directors indicating that they were liable for the hiring of the incompetent CEO, and demanding they reimburse the shareholders for their losses due to his actions.

Are the members of the board liable for hiring Mr. Alharbi, and for the losses of the company?

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Chapter 39

Corporations, Directors, Officers, and Shareholders

McGraw-Hill/Irwin

Chapter 39: Corporations, Directors, Officers, and Shareholders

Chapter 39 Case Hypothetical and Ethical Dilemma

Zaxxon-Mobile Oil Company, Inc., headquartered in Mobile, Alabama, is a multinational corporation with 2009 annual profits of $45 billion. Zaxxon-Mobile has twelve (12) board members who serve the company on a part-time basis, with each board member receiving an average of $300,000 per year in compensation.

Emily D. Chanel, a pre-law student at The University of Alabama at Mobile, is very familiar with Zaxxon-Mobile Oil Company, Inc., and she has studied her business law textbook material on corporations and their directors, officers and shareholders very carefully. She recalls that the board of directors and its members owe a strict fiduciary duty to the corporation; as part of this fiduciary duty, the board must exercise oversight in monitoring the actions of corporate employees, including the executives and officers of the corporation.
Emily ponders, “How can board members of a major corporation be truly objective when they are being paid such lavish sums of money? Would not board members have a “Don’t rock the boat” mentality in terms of exercising their oversight function? Why, for example, would a Zaxxon-Mobile board member question the practices of the company’s high-ranking executives and officers, when such an inquiry might jeopardize his or her $300,000 per year annual compensation? ‘Make no bones about it,’ if I were a board member at Zaxxon-Mobile, I would probably be a ‘yes-woman” and approve of everything the chief executive officer, the chief financial officer and the chief operating officer wanted to do!”

How do you respond to Emily D. Chanel’s questions and overall concerns about board member compensation and objectivity?

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Chapter 39 Case Hypothetical and Ethical Dilemma: Zaxxon-Mobile Oil Company, Inc., headquartered in Mobile, Alabama, is a multinational corporation with 2009 annual profits of $45 billion. Zaxxon-Mobile has twelve (12) board members who serve the company on a part-time basis, with each board member receiving an average of $300,000 per year in compensation. Emily D. Chanel, a pre-law student at The University of Alabama at Mobile, is very familiar with Zaxxon-Mobile Oil Company, Inc., and she has studied her business law textbook material on corporations and their directors, officers and shareholders very carefully. She recalls that the board of directors and its members owe a strict fiduciary duty to the corporation; as part of this fiduciary duty, the board must exercise oversight in monitoring the actions of corporate employees, including the executives and officers of the corporation. Emily ponders, “How can board members of a major corporation be truly objective when they are being paid such lavish sums of money? Would not board members have a “Don’t rock the boat” mentality in terms of exercising their oversight function? Why, for example, would a Zaxxon-Mobile board member question the practices of the company’s high-ranking executives and officers, when such an inquiry might jeopardize his or her $300,000 per year annual compensation? ‘Make no bones about it,’ if I were a board member at Zaxxon-Mobile, I would probably be a ‘yes-woman” and approve of everything the chief executive officer, the chief financial officer and the chief operating officer wanted to do!” How do you respond to Emily D. Chanel’s questions and overall concerns about board member compensation and objectivity?

Chapter 39 Case Hypothetical and Ethical Dilemma
Dr. Charles Finnegan is a newly-appointed member of the Board of Directors of Walnut Grove Community College (W.G.C.C.) in Walnut Grove, California. The position is unpaid, but does come with the “perks” of positive exposure and prestige in the local community.

At his first board meeting, the directors are discussing and considering for approval service contracts between W.G.C.C. and the local business community. The third contract for consideration is a janitorial service contract, valued at $150,000, between W.G.C.C. and Antiseptic Andy Cleaning Service, Inc. Finnegan is quite surprised; after all, “Antiseptic Andy” is owned and operated by his first cousin, Andrew Deere. Cousins Finnegan and Deere have not seen each other in three years, nor have they otherwise communicated during that period of time.

The chairperson of the Board of Directors calls for a vote on the janitorial service contract. According to W.G.C.C. regulations, the board must unanimously approve contracts with the business community.

Finnegan is perplexed. If he votes and says nothing about his kinship to Deere, he still feels he can “sleep at night,” since he will not receive any financial gain from the contract. If he discloses his kinship to Deere, he fears that Deere’s business opportunity will be jeopardized.

Does Finnegan have a legal obligation to disclose his relationship to Deere? Would it be a “conflict of interest” for Finnegan to vote in favor of the contract? Does he have an ethical obligation to disclose the relationship?

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Chapter 39 Case Hypothetical and Ethical Dilemma: Dr. Charles Finnegan is a newly-appointed member of the Board of Directors of Walnut Grove Community College (W.G.C.C.) in Walnut Grove, California. The position is unpaid, but does come with the “perks” of positive exposure and prestige in the local community. At his first board meeting, the directors are discussing and considering for approval service contracts between W.G.C.C. and the local business community. The third contract for consideration is a janitorial service contract, valued at $150,000, between W.G.C.C. and Antiseptic Andy Cleaning Service, Inc. Finnegan is quite surprised; after all, “Antiseptic Andy” is owned and operated by his first cousin, Andrew Deere. Cousins Finnegan and Deere have not seen each other in three years, nor have they otherwise communicated during that period of time. The chairperson of the Board of Directors calls for a vote on the janitorial service contract. According to W.G.C.C. regulations, the board must unanimously approve contracts with the business community. Finnegan is perplexed. If he votes and says nothing about his kinship to Deere, he still feels he can “sleep at night,” since he will not receive any financial gain from the contract. If he discloses his kinship to Deere, he fears that Deere’s business opportunity will be jeopardized. Does Finnegan have a legal obligation to disclose his relationship to Deere? Would it be a “conflict of interest” for Finnegan to vote in favor of the contract? Does he have an ethical obligation to disclose the relationship?

Summary of Roles of Directors, Officers, and Shareholders

Directors–

Officers–

Shareholders–

Vote on important corporate decisions
Appoint and supervise officers
Declare and pay corporate dividends
Manage corporation

Run “day-to-day” business of firm
Agents of corporation

Elect board of directors
Approve major board decisions

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Directors vote on important corporate decisions, appoint and supervise officers, declare and pay corporate dividends, and manage the corporation. Officers run the “day-to-day” business of the firm, and are agents of the corporation. Shareholders elect the board of directors, and approve major board decisions.

Summary of Rights of Directors, Officers, and Shareholders

Directors–

Officers–

Shareholders–

Right to Compensation
Right to Participation
Right to Inspection
Right to Indemnification

Rights determined in employment contract

Stock certificates
Preemptive rights
Right to Dividends
Right to Transfer Shares
Inspection Rights
Right to Corporate Dissolution
Right to File Derivative Suit
Right to File Direct Suit

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Corporate directors have the rights to compensation, participation, inspection, and indemnification. Officers’ rights are determined by their employment contracts. Shareholders have the rights to stock certificates, pre-emption, dividends, share transfers, inspection, corporate dissolution, derivative suits and direct lawsuits.

Fiduciary Duties

Definition: Duties to corporation that individuals

within corporation have

Primary fiduciary duties include:

Duty of Care
Duty of Loyalty
Duty to Disclose Conflict of Interest

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Fiduciary duties represent responsibilities to the corporation that individuals within the corporation have. Primary fiduciary responsibilities include the duty of care, the duty of loyalty, and the duty to disclose actual or potential conflicts of interest.

Exhibit 39-2: Liability of Directors and Officers

Can be held personally liability for their own torts and crimes

Can be held personally liable for torts and crimes of other employees they supervise
Can be held liable for wrongful transactions involving company stock
Cannot be held liable for decisions that harm company if they were acting in good faith at time of decision

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Corporate directors and officers can be held personally liability for their own torts and crimes, and they can be held personally liable for the torts and crimes of other employees they supervise. Further, directors and officers can be held liable for wrongful transactions involving company stock. Directors and officers cannot be held liable for decisions that harm the company if they were acting in good faith at the time of the decision.

Exhibit 39-3: Liability of Shareholders

Shareholders liable (to extent of their investment) for debts of corporation
Shareholders liable for breach of contract if stock subscription agreement signed and no stock purchased
Shareholders liable for watered stock
Shareholders personally liable for receiving illegal dividends

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In terms of the liability of shareholders, shareholders are liable, to the extent of their investment, for the debts of the corporation. They are liable for a breach of contract if a stock subscription agreement was signed and yet no stock was purchased. Shareholders are liable for watered stock, and they can be held personally liable for receiving illegal dividends.

Quorum (Definition):

Minimum number of directors necessary to validate corporate directors meeting

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A quorum constitutes the minimum number of directors necessary to validate a corporate directors’ meeting.

Proxy (Definition):

Provides authorization for third party to vote in place of shareholder at shareholder’s meeting

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A proxy provides authorization for a third party to vote in place of a shareholder at a shareholders’ meeting.

Voting Trust (Definition):

Agreement between stockholder and trustee in which stockholder transfers his/her legal share titles to trustee; trustee is then responsible for voting for those shares

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A voting trust is an agreement between a stockholder and a trustee in which the stockholder transfers his or her legal share titles to the trustee; the trustee is then responsible for voting for those shares.

Business Judgment Rule (Definition):

Provides that directors and officers are not liable for decisions that harmed corporation if they were acting in good faith at time of decision

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The business judgment rule provides that directors and officers are not liable for decisions that harmed the corporation if they were acting in good faith at the time of the decision.

“Watered” Stock (Definition):

Stock issued to individuals at value below fair market value

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“Watered” stock is stock issued to individuals at a value below fair market value.

Corporations: Directors, Officers, and Shareholders–Other Relevant Terminology

Par-Value Shares: Fixed face value noted on stock certificate
No-Par Shares: Stock shares without a par value
Stock Subscription Agreement: Contractually obliges individual to buy shares in corporation
Pre-emptive Rights: Preferential rights given to existing shareholders to purchase shares of new stock issue; preference given in proportion to percentage of stock shareholder already owns
Dividend: Distribution of corporate profits/income ordered by directors and paid to shareholders in proportion to their respective shares in corporation

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In terms of other relevant terminology regarding corporate directors, officers, and shareholders, par-value shares have a fixed face value noted on the stock certificate, while no-par shares are stock shares without a par value. A stock subscription agreement contractually obliges an individual to buy shares in the corporation. Pre-emptive rights are preferential rights given to existing shareholders to purchase shares of a new stock issue, with a preference given in proportion to the percentage of stock the shareholder already owns. A dividend is a distribution of corporate profit or income ordered by directors and paid to shareholders in proportion to their respective shares in the corporation.

Corporations: Directors, Officers, and Shareholders–Other Relevant Terminology (Continued):

Right of First Refusal: Given to existing shareholders to purchase any shares of stock offered for resale by shareholder within specified period of time
Inspection Rights: Protect shareholder interest by giving them right to inspect corporation’s books and records after asking in advance to inspect and having proper purpose
Stock Warrants: Vouchers issued to shareholders, entitling them to given number of shares at specified price
Shareholder’s Derivative Suit: Filed by corporate shareholder when corporate directors fail to sue in situation where corporation has been harmed by individual/another corporation

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Other relevant terminology regarding corporate directors, officers, and shareholders include the right of first refusal, given to existing shareholders to purchase any shares of stock offered for resale by a shareholder within a specified period of time. An inspection right protects shareholder interests by giving shareholders the right to inspect the corporation’s books and records, after asking in advance to inspect and establishing a proper purpose for inspection. Stock warrants are vouchers issued to shareholders, entitling them to a given number of shares at a specified price. Finally, a shareholder’s derivative suit is filed by a shareholder when corporate directors fail to sue in a situation where the corporation has been harmed by an individual or another corporation.

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