In such cases, the directors or trustees shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders or members and other persons.
When a director, trustee or officer attempts to acquire or acquires, in violation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, as to which equity imposes a disability upon him to deal in his own behalf, he shall be liable as a trustee for the corporation and must account for the profits which would otherwise have accrued to the corporation. (Sec. 31)
In addition to this general liability, the Corporation Code provides for specific rules to govern the following situations:
(1) Self-dealing directors (Sec. 32)
(2) Contracts between interlocking directors (Sec. 33) (3) Disloyalty to the corporation (Sec. 34)
(4) Watered stocks (Sec. 65)
WHAT IS THE BUSINESS JUDGMENT RULE?
As a general rule, directors and trustees of the corporation cannot be held liable for mistakes or errors in the exercise of their business judgment, provided they have acted in good faith and with due care and prudence. Contracts intra vires entered into by the board of directors are binding upon the corporation, and the courts will not interfere unless such contracts are so unconscionable and oppressive as to amount to a wanton destruction of the rights of the minority.
However, if due to the fault or negligence of the directors the assets of the corporation are wasted or lost, each of them may be held responsible for any amount of loss which may have been proximately caused by his wrongful acts or omissions. Where there exists gross negligence or fraud in the management of the corporation, the directors, besides being liable for damages, may be removed by the stockholders in accordance with Sec. 28 of the Code. (Campos &
Campos)
GENERAL RULE: Contracts intra vires entered into by BoD are binding upon the corporation and courts will not interfere.
EXCEPTION: When such contracts are so unconscionable and oppressive as to amount to a wanton destruction of the rights of the minority.
WHAT KIND OF DILIGENCE IS EXPECTED OF DIRECTORS?
Directors are expected to manage the corporation with reasonable diligence, care and prudence, i.e. the degree of care and diligence which men prompted by self-interest generally exercise in their own affairs. Thus, they can be held liable not only for willful dishonesty but also for negligence.
Although they are not expected to interfere with the day-to-day administrative details of the business of the corporation, they should keep themselves sufficiently informed about the general condition of the business.
WHAT FACTORS SHOULD BE CONSIDERED IN DETERMINING WHETHER REASONABLE DILIGENCE HAS BEEN EXERCISED?
The nature of the business, as well as the particular circumstances of each case. The court should look at the facts as they exist at the time of their occurrence, not aided or enlightened by those which subsequently took place. (Litwin v. Allen)
Duty of Diligence: Business Judgment Rule.
OTIS AND CO. VS PENNSYLVANIA RAILROAD CO. (155 F. 2d 522; 1946)
If in the course of management, the directors arrive at a decision for which there is a reasonable basis and they acted in good faith, as a result of their independent judgment, and uninfluenced by any consideration other than what they honestly believe to be for the best interest of the railroad, it is not the function of the court to say that it would have acted differently and to charge the directors for any loss or expenditures incurred.
In the present case, the bond issue was adequately deliberated and planned, properly negotiated and executed; there was no lack of good faith; no motivation of personal gain or profit; there was no lack of diligence, skill or care in selling the issue at the price approved by the Commission and which resulted in a saving of approximately $9M to the corporation.
MONTELIBANO VS. BACOLOD-MURCIA MILLING CO. (5 SCRA 36; 1962)
The Bacolod-Murcia Milling Co. adopted a resolution which granted to its sugar planters an increase in their share in the net profits in the event that the sugar centrals of Negros Occidental should have a total annual production exceeding one-third of the production of all sugar central mills in the province. Later, the company amended its existing milling contract with its sugar planters, incorporating such resolution. The company, upon demand, refused to comply with the contract, stating that the stipulations in the resolution were made without consideration and that such resolution was, therefore, null and void ab initio, being in effect a donation that wasultra vires and beyond the powers of the corporate directors to adopt. This is an action by the sugar planters to enforce the contract.
The terms embodied in the resolution were supported by the same cause and consideration underlying the main amended milling contract; i.e., the premises and obligations undertaken thereunder by the planters, and particularly, the extension of its operative period for an additional 15 years over and beyond the thirty years stipulated in the contract.
As the resolution in question was passed in good faith by the board of directors, it is valid and binding, and whether or not it will cause losses or decrease the profits of the central, the court has no authority to review them. They hold such office charged with the duty to act for the corporation according to their best judgment, and in so doing, they cannot be controlled in the reasonable exercise and performance of such duty. It is a well-known rule of law that questions of policy or of management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its judgment of the board of directors; the board is the business manager of the corporation, and so long as it acts in good faith, its orders are not reviewable by the courts.
LITWIN (ROSEMARIN ET. AL., INTERVENORS) VS. ALLEN ET. AL.
(25 N.Y.S. 2d 667; 1940)
FACTS: Alleghany Corp. bought terminals in Kansas City and St. Joseph. It needed to raise money to pay the balance of the purchase price but could not directly borrow money due to a borrowing limitation in its charter. Thus, it sold Missouri Pacific bonds to J.P. Morgan and Co. worth $IOM. J.P. Morgan, in turn, sold $3M worth of the bonds to Guaranty Trust Company. Under the contract, the seller was given an option to repurchase at same price within six months.
HELD: Option given to seller is invalid. It is against public policy for a bank to sell securities and buy them back at the same price; similarly, it is against public policy for the bank to buy securities and give the seller the option to buy them back at the same price because the bank incurs the entire risk of loss with no possibility of gain other than the interest derived from the securities during the period that the bank holds them. Here, if the market price of the securities rise, the holder of the repurchase option would exercise it to recover the securities at a lower price at which he sold them. If the market price falls, the seller holding the option would not exercise it and the bank would sustain the loss.
Directors are not in a position of trustees of an express trust who, regardless of good faith, are personally liable. In this case, the directors are liable for the transaction because the entire arrangement was improvident, risky, unusual and unnecessary so as to be contrary to fundamental conceptions of prudent banking practice. Yet, the advice of counsel was not sought. Absent a showing of exercise of good faith, the directors are thus liable.
WALKER VS. MAN, ET. AL. (253 N.Y.S. 458; 1931)
FACTS: Frederick Southack and Alwyn Ball loaned Avram $20T evidenced by a promissory note executed by Avram and endorsed by Lacey. The loan was not authorized by any meeting of the board of directors and was not for the benefit of the corporation. The note was dishonored but defendant-directors did not protest the note for non-payment; thus, Lacey, the indorser who was financially capable of meeting the obligation, was subsequently discharged.
HELD: Directors are charged not with misfeasance, but with non-feasance, not only with doing wrongful acts and committing waste, but with acquiescing and confirming the wrong doing of others, and with doing nothing to retrieve the waste. Directors have the duty to attempt to prevent wrongdoing by their co-directors, and if wrong is committed, to rectify it. If the defendant knew that an unauthorized loan was made and did not take steps to salvage the loan, he is chargeable with negligence and is accountable for his conduct.
STEINBERG VS. VELASCO (52 Phil. 953; 1929)
FACTS: The board of directors of Sibuguey Trading Company authorized the purchase of 330 shares of stock of the corporation and declared payment of P3T as dividends to stockholders. The directors from whom 300 of the stocks were bought resigned before the board approved the purchase and declared the dividends. At the time of purchase of stocks and declaration of dividends, the corporation had accounts payable amounting to P9,241 and accounts receivable amounting to P12,512, but the receiver who made diligent efforts to collect the amounts receivable was unable to do so.
It has been alleged that the payment of cash dividends to the stockholders was wrongfully done and in bad faith, and to the injury and fraud of the creditors of the corporation. The directors are sought to be made personally liable in their capacity as directors.
HELD: Creditors of a corporation have the right to assume that so long as there are outstanding debts and liabilities, the BOD will not use the assets of the corporation to buy its own stock, and will not declare dividends to stockholders when the corporation is insolvent.
In this case, it was found that the corporation did not have an actual bona fide surplus from which dividends could be paid. Moreover, the Court noted that the Board of Directors purchased the stock from the corporation and declared the dividends on the stock at the same Board meeting, and that the directors were permitted to resign so that they could sell their stock to the corporation. Given all of this, it was apparent that the directors did not act in good faith or were grossly ignorant of their duties. Either way, they are liable for their actions which affected the financial condition of the corporation and prejudiced creditors.
BARNES V. ANDREWS (298 F. 614; 1924)
A complaint was filed against a corporate director for failing to give adequate attention (he relied solely on the President‘s updates on the status of the corp) to the affairs of a corporation which suffered depletion of funds.
The director was not liable. The court said that despite being guilty of misprision in his office, still the plaintiff must clearly show that the performance of the director‘s duties would have avoided the losses. When a business fails from general mismanagement, business incapacity, or bad judgment, it is difficult to conjecture that a single director could turn the company around, or how much dollars he could have saved had he acted properly.
FOSTER V. BOWEN (41 N.E. 2d 181; 1942)
Cushing, a director and in charge of leasing a roller skating rink of the corp, leased the same to himself. Minority stockholders filed suit against Bowen, the corporation's President, to recover for company losses arising out of an alleged breach of fiduciary duty.
Bowen was held to be not liable because: (1) Cushing's acts were not actually dishonest or fraudulent; (2) Cushing performed personal work such as keeping the facility in repair which redounded to the benefit of the company and even increased its income; (3) Bowen did not profit personally through Cushing's lease; and (4) the issue of the possible illegality of the lease was put before the Board of Directors, but the Board did not act on it but instead moved on to the next item on the agenda. Absent any bad faith on Bowen's part, and a showing that it was a reasonable exercise of judgment to take no action on the lease agreement at the time it was entered into, Bowen was not liable.
LOWELL HOIT & CO. V. DETIG (50 N.E. 2d 602; 1943)
Lowell Hoit filed action against directors of a cooperative grain company for an alleged willful conversion by the manager of grain stored in the company facility. The court said that the directors were not personally liable. There was no evidence that the directors had knowledge of the transaction between the manager and Lowell Hoit.
The court will treat directors with leniency with respect to a single act of fraud on the part of a subordinate officer/agent. But directors could be held liable if the act of fraud was habitual and openly committed as to have been easily detected upon proper supervision. To hold directors liable, he must have participated in the fraudulent act; or have been guilty of lack of ordinary and reasonable supervision; or guilty of lack of ordinary care in the selection of the officer/agent.
BATES V. DRESSER (40 S.Ct.247; 1920)
Coleman, an employee of the bank, was able to divert bank finances for his benefit, resulting in huge losses to the bank. The receiver sued the president and the other directors for the loss.
The court said that the directors were not answerable as they relied in good faith on the cashier‘s statement of assets and liabilities found correct by the government examiner, and were also encouraged by the attitude of the president that all was well (the president had a sizable deposit in the bank). But the president is liable. He was at the bank daily; had direct control of records; and had knowledge of incidents that ordinarily would have induced scrutiny.
The self-dealing director
WHAT IS A SELF-DEALING DIRECTOR? (Sec. 32)
A self-dealing director is one who enters into a contract with the corporation of which he is a director.
WHAT IS THE NATURE OF CONTRACTS ENTERED INTO BY SELF-DEALING