Ch3. Corporate Governance — Board of Directors, Officers & Auditors

Corporate Governance Structure

Shareholders' Meeting (ultimate decision-making body):
- Ordinary matters: majority of shares present and voting
- Extraordinary matters (charter amendments, mergers, dissolution):
  supermajority — typically 2/3 of shares outstanding
  (exact threshold set by state statute or corporate charter)

Board of Directors:
- Minimum 1 director (most states); public companies typically larger
- Quorum: majority of directors; decisions by majority vote
- Authority: set corporate policy, elect/remove officers,
  approve major transactions

Officers (CEO, CFO, etc.):
- Elected by the board
- Authority to bind the corporation in day-to-day operations
- Actual authority + apparent authority

Audit Committee / External Auditors:
- Audit committee: board-level committee (required for NYSE/Nasdaq
  listed companies under Sarbanes-Oxley)
- External auditors: independent public accounting firm
  (required for SEC-reporting companies)

Directors’ Fiduciary Duties

Duty of Care:
Directors must act in good faith, with the care that a
reasonably prudent person in a like position would exercise.
→ Business Judgment Rule: courts defer to board decisions
  made on an informed basis in good faith

Duty of Loyalty:
Directors must act in the best interest of the corporation,
not in their own self-interest.
→ Conflicts of interest must be disclosed and approved
  by disinterested directors or shareholders

No-Competition Duty:
Directors may not compete directly with the corporation
without board approval; may not usurp corporate opportunities.

Corporate Opportunity Doctrine:
A director who learns of a business opportunity that the
corporation could pursue must present it to the corporation
before exploiting it personally.

Confidentiality:
Directors must keep corporate confidences both during and
after their tenure.

Directors’ Liability

Duty Breach — Liability to the Corporation:
A director who fails to meet the standard of care or loyalty
is personally liable to the corporation for resulting damages.

Third-Party Liability:
Where a director acts in bad faith or with gross negligence,
causing harm to a third party, that director may face
direct liability to the third party.

Joint and Several Liability:
Directors who voted in favor of an unlawful board resolution
may be jointly and severally liable.

Derivative Suit (Shareholder Derivative Action):
When the corporation fails to pursue a claim against a director,
a shareholder may bring suit on the corporation's behalf.
→ Requirements (DGCL / Model Business Corporation Act):
   - Contemporaneous ownership (held shares at time of wrong)
   - Make a demand on the board OR plead demand futility
→ Any recovery goes to the corporation

Audit Committee & External Auditors

Audit Committee (SOX § 301):
- Elected by shareholders (not the board) to ensure independence
- No officer may serve on the audit committee
- Must include at least one "financial expert"
- Oversees financial reporting, internal controls,
  and the external auditor relationship

Audit Committee Independence:
- Committee members must be independent directors
- Controlling-shareholder voting restrictions apply
  (analogous to 3% cap concept under some state statutes)

External Auditor:
- Appointed by and accountable to the audit committee
- Must be a registered public accounting firm (PCAOB oversight)
- Provides annual opinion on financial statements (10-K)

Shareholder Vote Thresholds ★★★★★ : Ordinary resolutions = majority of votes cast. Extraordinary resolutions (mergers, charter amendments) = typically 2/3 supermajority. Memory hook: ordinary = majority, extraordinary = supermajority

Duty of Care vs. Duty of Loyalty ★★★★★ : Care = act like a reasonably prudent director (Business Judgment Rule applies). Loyalty = put the corporation first; self-dealing requires disclosure and approval. Memory hook: care = prudence, loyalty = no self-dealing

Derivative Suit ★★★★☆ : Shareholders sue on the corporation’s behalf when the board refuses to act. Recovery flows to the corporation, not the plaintiff-shareholder. Memory hook: derivative = on behalf of the corporation

Practice Questions

Q. What happens if a director competes with the corporation without board approval?

The director has breached the duty of loyalty (no-competition and corporate opportunity rules). The corporation may seek damages and disgorgement of any profits the director earned. The act itself may not be voidable as against third parties (to protect reliance), but the director faces removal and personal liability.

Q. How does the audit committee differ from the board of directors?

The board sets corporate strategy and elects officers. The audit committee is a subset of independent directors that oversees financial reporting, internal controls, and the external auditor. The audit committee reports to the full board and ultimately to shareholders, ensuring that the auditing function is independent of management.