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formality. Some corporations have their stock listed on an exchange, have hundreds of thousands or millions of shares of stock outstanding, and have boards of directors that are strangers to most of the shareholders. Some boards are made up largely of "outsiders," i.e., businessmen who are not active in the day-to-day management of the corporation and who usually have leading positions in other companies, in the professions, or in public affairs. Some are made up largely of "insiders," i.e., men who are also full-time officers or employees of the company. Some boards meet often, and deal with anything of moment. Some meet relatively infrequently and concern themselves only with matters of general business policy. On some boards, some members may represent different shareholder groups, while other members may be chosen because of important supplier, customer and professional relationships. And so on. But the corporation laws of the various states and of the Federal Government almost invariably take no account of these significant differences. In the eyes of the law, the boards of directors of all business corporations are (almost always) treated exactly the same. This means that the law may sometimes strike some businessmen as being unrealistic and quite removed from the practicalities of their situations. But this factor makes it all the more important that every businessman who serves as a corporate director be aware of what the law actually ("technically") requires. Otherwise, his own sense of propriety and business ethics-which often serves well as a guide to what the law expects in other areas (contracts, for example)—may here lead him astray and result in a law violation.

What follows is a "broad-brush" picture of the director's legal environment, highlighting what the law expects the directors to do or to refrain from doing-and indicating some of the ways in which civil liability or criminal penalties may be imposed for violating the law.2

I. The basic principle is that the board of

directors has the duty to manage the company.

1 This use of the word "insider" should be distinguished from its different use, with a broader meaning, in connection with the federal securities laws; in this latter usage "insider" usually refers to all directors, officers, and controlling stockholders (whether or not they are active in day-to-day management) and has in mind that all such persons usually (or presumably) have possession of inside information.

2 For simplicity in exposition, the laws of the State of New York are used to exemplify state laws. In the respects here covered, the state laws do not differ significantly.

The fundamental legal responsibilty of the board of directors is to manage the company in the interests of the shareholders. To this end, the law entrusts the board of directors with all of the power of business management except (1) to do what would be illegal; (2) to do what requires specific shareholder approval; and (3) to act contrary to the charter and by-laws. In the eyes of the law, almost everything that is done on a day-to-day basis by what is called "the management" of a company is done either pursuant to specific provisions of the corporate charter or by-laws or by virtue of authority, expressly or impliedly delegated to management by the board of directors.

In managing the company, the directors have two primary duties: (1) They must exercise reasonable business judgment; that is, the same degree of care and prudence that reasonable men would generally exercise in their own affairs when they are acting for their own personal benefit; and (2) they must always be loyal to the interests of the corporation when they act, collectively or individually, on any matter that affects the corporation.

The greatest actual legal risks in being a director stem, usually, from lawsuits against the directors by a stockholder (or, sometimes, a corporate creditor), charging that the director was negligent or disloyal in some particular situation. Usually, a question regarding a director's behavior can result in liability only where it is proved that the improper behavior has actually caused damage to the corporation or to the claimant, though sometimes a director can be subjected to substantial liability even though neither the corporation nor the claimant has been adversely affected.

II. Some corporate acts are beyond the
authority of the board of directors be-
cause they are reserved to the stock-
holders or are altogether prohibited.

As stated above, the power to manage given to the board of directors is very great. But it is not complete. The corporate charter or the corporate by-laws sometimes provide special limitations. Certain kinds of decisions are reserved to the stockholders, such as

amending the corporate charter, selling the entire business, merging with another company, dissolving, etc. And certain areas of possible corporate activity are altogether prohibited, such as engaging in any lines of business except those provided for (expressly or impliedly) in the charter, making political contributions, issuing shares of stock except for specified kinds of consideration, declaring dividends except from specified allowable sources such as surplus.

III. In its area of responsibility, the board of directors
can itself make business decisions or, with certain
mandatory exceptions, the board can delegate

decision-making authority to others.

The board of directors carries out its duty to manage the corporation in two ways: (1) the board itself makes certain business decisions; and (2) the board necessarily delegates extensive decision-making authority to officers and employees of the company, and the board then supervises and evaluates their performance.*

Certain kinds of decisions must be made by the board and cannot be delegated. These are decisions as to which the board of directors itself must exercise its discretion and judgment. Corporate statutes usually require that the board of directors itself must pass on such questions as fixing terms for issuing stock or stock options, declaring dividends, and appointing and removing the corporate officers. In addition, the corporate charter or the by-laws or stockholder resolutions may vest various kinds of decisions exclusively in the board; for example, individual indemnification payments to directors, officers, and employees for litigation expenses incurred in defending their actions as such.

3 The lawyers call such extra-charter activities "ultra vires." This prohibition is usually unimportant. The standard modern practice in drafting a corporate charter for a busi ness corporation is to empower it to engage in almost any gainful activity that can be thought of that is in any way related to the line of business the incorporators actually have in mind. If it turns out later that something was omitted that becomes needed, amendments to corporate charters are now relatively easy to make.

4 Sometimes, usually only in large corporations, the board of directors will appoint one or more director committees (e.g., an executive committee, a finance committee, etc.) to function between meetings of the full board and to be readily available when circumstances require.

5 In recent years, state corporation laws have clarified or increased the extent to which the board of directors may properly delegate its duties to a board committee. Some acts which the board still cannot lawfully delegate to management can now be lawfully delegated to a board committee. But state laws vary in this area, so that the particular applicable statute should be checked before any important board delegation is made to a board committee.

As a practical matter, boards of directors are, of course, usually in no position to manage the corporation on a day-to-day basis-or to give close attention to any but the most important aspects of the corporate business. As a result, and except for matters of over-all business policy or great importance and decisions which are nondelegable, boards of directors usually entrust the actual day-to-day operation of the corporate enterprise to the corporate executives, who constitute "the management" of the company.

A.

IV. Any act by any director which affects the
interests of the corporation must be made
with due care and undivided loyalty.

The Duty to Exercise Due Care-The So-called
Business Judgment Rule

A director should exercise his authority with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. A director should regularly attend board meetings, should keep generally informed about the company's affairs, and should promptly protest against any board action that he deems imprudent or improper. A director, of course, has the right to rely on the integrity, veracity and competence of his fellow directors and of the officers and employees, and on the adequacy and correctness of professional advice. In this connection, the New York Business Corporation Law expressly provides that:

"In discharging their duties, directors . . . when acting in good
faith, may rely upon financial statements of the corporation repre-
sented to them to be correct by the president or the officer of the
corporation having charge of its books of accounts, or stated in a
written report by an independent public or certified public account-
ant or firm of such accountants fairly to reflect the financial con-
dition of such corporation."

Thus, the legal principle here is that, where a director or the board fails to act with due care and, as a result, the corporation is in some way harmed, the careless directors will be held personally liable for the harm done.

But directors are not liable for honest mistakes in judgment,

taking calculated risks- -a director can take "the same chances that a man would take in his own business." When it turns out that some board decision was a mistake—even a bad one-the question of whether or not the directors had been careless is decided in terms of the facts as they were or reasonably appeared to be when the decision was made and not in terms of hindsight. Theoretically, the same standard of care applies to all of the directors on any board, regardless of the reasons why each was elected, regardless of whether or not a director is also a full-time officer or employee, and regardless of what his special competence, experience, or training may be. But the standard of care is applied in terms of the particular circumstances of each case; as a result, effect actually is given to differences in knowledge and background. Among the circumstances which may be relevant in any particular case are: (a) the nature of the business; (b) the administrative practices approved by the stockholders or prescribed in the charter or by-laws; (c) the general customs or ways of doing things in that type of business; (d) whether the directors are "inside" or "outside," part-time or full-time, paid or not paid; and (e) the actual information possessed by the director.

One of the charges of mismanagement sometimes brought against directors is that some decision on their part constituted a waste of the corporate assets, such as paying excessive salaries or bonuses to officers and employees or giving away corporate property (e.g., by giving officers and employees stock-option rights without getting a commensurate quid pro quo for the corporation).

B. The Duty of Loyalty

The relationship between directors and the corporation is what the law calls a fiduciary relationship. This means that it is a relationship of trust and confidence in which one side (here the stockholders) entrusts its welfare to the other (the directors). Courts frequently liken directors to trustees and guardians. The practical significance of being a fiduciary is that the fiduciary is not allowed to take advantage of the fiduciary relationship for personal gain. If he does, he is legally liable and must account to the corporation

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