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(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 (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 (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 (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 (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 (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 (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 (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
"The Lessons of the Example"