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The Lessons of the Example

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					             [1](1): Torts - Breach of Legal Duty
• State Common Law Judges Create Civil Duties
   – Decisions create tort duties NOT based on property or contract obligations
   – Breach of the duty by person with duty (defendant D) allows an injured person
     (plaintiff P) to recover damages from the defendant who caused the injuries
• What is the duty?
   – Take care to avoid causing injuries to certain types of persons
   – Defendant must exercise some minimum level of care to prevent such injuries
• What is a breach? What is the minimum standard of care?
   –   Intentional: D intentionally causes harm to P
   –   Recklessness (gross negligence): D recklessly disregards potential harm to the P
   –   Negligence: D did not exercise “reasonable care”, and caused harm to the P
   –   Strict Liability: D has an absolute duty to avoid harming the P irrespective of
       the level of care taken by the D

       Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
                        [1](2): Torts - Background
• Early English Torts
   – Crimes: first torts created for battery, theft, and trespass of land
   – Nuisance: early tort for damage to the property of others
   – Fraud: early tort for misrepresentations in contracts
• Examples of Torts relevant for topics in this course
   – breach of fiduciary duties such as the board of directors of a corporation
   – product liability for manufacturers, beyond contractual warranties
   – fraud for misrepresentations by corporations
• Many Common Law Torts have become Statutory
   – Statutes define civil liabilities for particular actions
   – Statutes have also created criminal liabilities for the same actions



     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
    [1](3): Duty of Care for Directors/Officers
• Fiduciary Duty of Care
   –   Perform responsibilities in good faith and with reasonable care
   –   Act in the best interests of the corporation
   –   Exercise care not to harm the corporation
   –   Make decisions based on adequate information and deliberation
   –   Prevent the corporation from violating the laws
• Business Judgment Rule: for business decisions
   – Courts will not second guess the substantive merits of business decisions
   – Delaware: Directors breach their duty of care only when they are grossly
     negligent in making decisions
   – Gross negligence surely means that the decision “process” was clearly flawed
      • inadequate information or deliberation
   – Gross negligence might mean that the “substance” of the decision was clearly
     harmful to the corporation
       Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
               [1](4): Duty of Care - To Whom?
• To whom do directors and officers have a duty of care?
   – To the corporation itself, and thus to the shareholders? YES
   – To creditors? MAYBE, if bankrupt or insolvent
   – To employees? Generally NO To customers? NO
• Some states (New York but NOT Delaware) allow directors to
  consider the interests of these other groups, besides shareholders
   – But no state allows these other groups to sue the directors or officers
• Why is there no general duty of care to these other groups?
   – Creditors, employees, and customers can and should protect themselves by
     contractual provisions in their business relationships with the corporation
   – Problem with this view: Contractual protections have little value when the
     corporation declares bankruptcy

     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
  [1](5): Duty of Loyalty for Directors/Officers
• Fiduciary Duty of Loyalty
   – Directors and Officers must place the financial interests of the corporation above
     their own financial interests
• Conflicts of Interest arise when
   – Directors or Officers engage in contracts with the corporation
   – Directors or Officers learn of profitable opportunities which could be undertaken
     by either the corporation or themselves
   – Directors or Officers can take actions to protect their jobs at the expense of
     shareholders
• Business Judgment Rule does not apply if a Conflict of Interest exists
   – Shareholders can sue to void the contract or rescind the decision
   – Director/Officer can defend the contract or decision only if they can prove that
     the it was substantively “fair” to the corporation and the shareholders

     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
                       [1](6): Conflicts of Interest
• Conflicts of interest can be resolved if the contract or decision is
   – Approved by a vote of the disinterested directors
   – Approved by a vote of the shareholders
• If approved, then the contract or decision has the protection of the
  Business Judgment Rule
   – Contract becomes voidable or decision rescindable only if there is a breach of
     the duty of care in that the director/officer was grossly negligent
• BUT Approval by the disinterested directors (or shareholders) must be
  fully informed as to the conflict
   – Director/Officer must fully disclose his/her conflict AND the material facts
     about the contract or decision
   – If so, then approval removes the need to prove that the contract or decision was
     substantively fair to the corporation

     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
     [1](7): Shareholder Lawsuits
• Shareholder Derivative Actions for Breach of Duties
   – Incorporation statutes permit shareholders to sue on behalf of the corporation
       • after they have made some effort to get the Board to remedy the problem
   – Harm to the corporation, and thus only indirectly to the shareholders
   – Remedies: rescind contracts, recover property or payments for the corporation
   – Shareholders benefit indirectly, but the plaintiffs will be paid attorney’s fees
   – To avoid collusive settlements in which the corporation purchases the shares of
     the plaintiffs, the statutes require that the court approve any settlement
• Shareholder Class Actions for Breach of Duties
   – Harm is directly to the shareholders
      • Directors approve a merger which forces shareholders to sell their stock
      • Directors fraudulently induce shareholders to purchase or sell their stock
   – Remedies: shareholders can obtain damages

     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry
     [1](8): Indemnification and Insurance
• Can corporations indemnify their directors, officers, and
  employees for their legal expenses from lawsuits arising out of
  actions and decisions in their jobs?
• If the director prevails on the merits, incorporation statutes generally
  require indemnification
• If the director does not prevail on the merits or settles the lawsuit
  without a trial, can the corporation still indemnify the director?
   – Civil: YES, if the director satisfied the duties of care and loyalty
   – Criminal: YES, if the director reasonably believed the action was not illegal
• Suppose the director settles a criminal case by paying a fine?
   – Delaware statute would permit indemnification
• Corporations may purchase insurance for the legal expenses of their
  directors and officers which cannot be indemnified
     Wharton School: Government & Legal Environment of Business - BPUB 621 - Visiting Professor Martin K. Perry

				
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