Question 6: Criminal Law

Alice is a director and Bob is a director and the President of Sportco, Inc. (SI), a sporting goods company. SI owns several retail stores. Larry, an attorney, has performed legal work for SI for ten years. Recently, Larry and Carole were made directors of SI. SI has a seven-person board of directors.

Prior to becoming a SI director, Carole had entered into a valid written contract with SI to sell a parcel of land to SI for $500,000. SI planned to build a retail store on the parcel. After becoming a director, Carole learned confidentially that her parcel of land would appreciate in value if she held it for a few years because it was located next to a planned mall development. At dinner at Larry's home, Carole told Larry about the planned mall development. Carole asked for, and obtained, Larry's legal opinion about getting out of her contract with SI. Later, based on Larry's suggestions, Carole asked Bob to have SI release her from the contract. She did not explain, nor did Bob inquire about, the reason for her request. Bob then orally released Carole from her contract with SI.

The next regular SI board meeting was attended only by Bob, Alice, and Larry. They passed a resolution to ratify Bob's oral release of Carole from her contract with SI. Larry never disclosed what Carole had told him about the proposed mall development. Three years later, Carole sold her parcel of land for $850,000 to DevelopCo, which then resold it for $1 million to SI.

  1. Was Bob's oral release of Carole from her contract with SI effective? Discuss.
  2. Was the resolution passed by Bob, Alice, and Larry to ratify Bob's oral release valid? Discuss.
  3. Did Carole breach any fiduciary duty to SI? Discuss.
  4. Did Larry commit any ethical violation? Discuss.

Answer

1. Was Bob's Oral Release Effective?

Actual Authority
Officers are agents of the company. They generally receive power to manage from the company's directors. An officer's authority may be expressly provided by the company's directors, its bylaws or articles of incorporation, or by statute. Absent an express provision to the contrary, there is a presumption a President of a company has actual authority to enter into contracts and act on behalf of the corporation in the ordinary course of its affairs.

Here, Bob is the President of SI. There are no facts suggesting the normal authority granted to a President has been limited by SI's Board, its articles or bylaws. Entering into or releasing contracts are within the general scope of a President's duties. Thus, Bob likely had the actual authority to effectively rescind SI's contract with Carole.

Apparent Authority
An officer may have apparent authority to act and to bind the company in situations where actual authority does not exist, has not been granted, or when the company "holds out" an officer as possessing certain authority, inducing others to reasonably believe that the authority exists. Determinations of implied authority require consideration of the circumstances surrounding the actions of the officer, including the reasonable beliefs of the other party to the transaction.

Here, as a sporting goods business that owns several retail stores, Carole would argue SI is in the business of buying, selling, and leasing property. Further, Carole's attorney instructed her to speak with Bob, President of SI, on how to get a release. As such, Carole reasonably believed Bob had authority to take such action on behalf of SI. Thus, it is likely Bob had apparent authority to effectively release Carole from the contract.

Statute of Frauds
The Statute of Frauds requires certain agreements to be in writing and signed by the parties sought to be bound. A promise creating an interest in land falls within the Statute of Frauds and must be in writing.

Here, Bob's oral release of Carole from the valid written contract would result in the land being owned by Carole and not SI. It, therefore, created an interest in land in favor of Carole. Bob's agreement to rescind the contract with Carole was not in writing nor was the Board's purported ratification. Thus, Bob's oral agreement releasing Carole from the contract violated the Statute of Frauds and is not valid.

2. Was the Board's Resolution Valid?

Quorum
A quorum is the minimum number of directors required to be present at a meeting to transact business. Generally, a majority of the directors present at a meeting constitutes a quorum unless the rules of the jurisdiction, the articles, or the bylaws require the presence of a greater, or lesser, number. If a quorum is met, resolutions passed by a majority of the directors will be deemed approved unless the articles or bylaws require the vote of a greater number.

Here, SI has a Board of seven directors. The resolution ratifying Bob's oral release was approved at a meeting where only three directors (Bob, Alice, and Larry) were present. There are no facts indicating that the articles of incorporation or bylaws required less than a majority of directors present for a quorum. Thus, because a majority of directors were not present, there was no quorum and the resolution was invalid.

Business Judgment Rule
Directors are vested with the duty to manage the company to the best of their ability. Under the Business Judgment Rule, directors are not liable if they act: (1) in good faith; (2) with the care of an ordinary prudent person in a like position would exercise under similar circumstances; and (3) in a manner they reasonably believe to be in the best interests of the company. If directors meet this standard, they are not liable even if their decisions are erroneous. Further, directors are entitled to rely on information or advice provided to them by other directors, officers, employees, and outside experts.

Here, Bob, Alice, and Larry voted to approve Bob's oral release of Carole from the land sale contract. There is no evidence that the Board questioned Bob's actions or sought any information related to the effect of the release on SI. Larry did not disclose the information about the planned mall development, presumably because he was bound by an attorney-client privilege. The Board could claim that they were relying on information provided by Carole, Bob and Larry, however, there is no indication that they provided any relevant information to the Board regarding the release. Although, there is no evidence of bad faith, an ordinary prudent person in the Board's position likely would have conducted a more thorough investigation before ratifying the release of a land sale contract. Thus, if the resolution was valid, the Business Judgment Rule would not protect the Board from liability.

3. Did Carole Breach her Fiduciary Duty to SI?

Duty of Loyalty -- Conflict of Interest
Directors owe fundamental duties of care and loyalty to the corporation and its shareholders. A director's self-dealing or advancing his/her self-interest ahead of a corporation's interest demonstrates a breach of such duties. Where a director obtains a material financial benefit, the transaction will be evaluated by whether it was just and reasonable to the corporation.

Here, although Carole was not a director of SI at the time she entered into the agreement to sell the parcel of land to SI, she was a director at the time she asked Bob to rescind the contract. She, therefore, owes SI a duty of loyalty with respect to this transaction. She is both a party to the transaction, and has a beneficial financial interest in the transaction since she believes the property is going up in value. Carole sought advice from SI's counsel as to how to rescind the contract against the interest of the company, arguably in bad faith. Carole also withheld information from the Board regarding the anticipated increase in value of the parcel. Thus, Carole, as a director, breached her duty of loyalty to SI.

Transaction Involving a Conflict of Interest
A conflicting interest transaction may be approved and release a director from a possible violation of his/her duty of loyalty if: 1) the transaction was approved by a majority of the disinterested directors after all material facts were disclosed; 2) the transaction was approved by a majority of the disinterested shareholders; or 3) the transaction, at the time of commitment, was judged to be fair to the corporation. In determining fairness, a court will consider the adequacy of consideration, the corporation's need to enter into the transaction, the financial position of the corporation, and whether there were available alternatives.

Here, Carole did not disclose material facts to the board regarding the anticipated increase in value because of the shopping mall. The transaction was not approved by a majority of the disinterested shareholders or directors as only Bob, Alice, and Larry (3 of the 6 disinterested directors) approved the transaction. A court would likely not find the release to be fair to SI as there was very little if any consideration for SI to release Carole and no need for SI to enter into this transaction. Thus, this conflict of interest transaction was not approved and Carole would be held to have violated her duty of loyalty.

Duty of Loyalty - Corporate Opportunity Doctrine
The Corporate Opportunity Doctrine prevents directors from usurping an opportunity in which their company has an interest. A director may not divert a business opportunity from their corporation without first giving the corporation an opportunity to act. The corporation must have an interest or expectancy in the opportunity. By diverting a corporate opportunity for personal gain, a director violates his/her duty of loyalty.

Here, SI had an interest in the parcel of land and would have an expectancy in any increased land value. Carole withheld information about the proposed development with the intention to divert the potential profits SI could have realized. She did not give SI an opportunity to act. Thus, Carole would be guilty of usurping a business opportunity in violation of her duty of loyalty.

4. Larry's Ethical Violations

Duty of Confidentiality
The duty of confidentiality prevents a lawyer from disclosing the confidential information of their client. An attorney is prohibited from using confidential information obtained during the representation of a client for purposes other than the client's representation, unless reasonable prior consent is obtained from the client. Here, there is no indication that Larry used or disclosed any confidential information of SI in rendering his advice to Carole. Thus, there is no apparent violation of Larry's duty of confidentiality to SI.

Duty of Competence
Competent representation requires the legal knowledge, skill, thoroughness, and preparation reasonably necessary for the representation. Here, as SI's lawyer for 10 years, Larry should have had knowledge of both the Statute of Frauds and quorum requirements. Larry failed to advise the directors of these requirements. Thus, Larry breached his duty of competence to SI.

Duty of Loyalty -- Conflict of Interest (Dual Representation)
A lawyer must not represent a client if the representation of that client will be directly adverse to another client unless: (1) the lawyer reasonably believes representation will not adversely affect the relationship with the other client; and (2) each client consents in writing after consultation. If a reasonable attorney would not advise a client to consent to such representation, then consent will not abate the conflict.

Here, Larry was SI's attorney for 10 years. Carole asked for Larry's legal opinion on her position that was adverse to SI's interest. Because the mall development would increase the value of the parcel, it would not be reasonable for Larry to believe that he could advise Carole on this matter without adversely affecting his relationship with SI. Further, Larry was required to notify both parties of the potential conflict and receive their written consent. He did not do this and proceeded to give Carole legal advice. Under these circumstances, it is likely a reasonable attorney would not have advised the clients to consent to Larry's representation. Thus, Larry breached his duty of loyalty to SI by providing advice to Carole.

Duty of Loyalty -- Conflict of Interest (Attorney Director)
A lawyer for a corporation who is also a member of its Board of Directors should determine whether the responsibilities of his/her two roles could create a conflict. As a director, an individual is ethically bound to perform his or her fiduciary duties to the corporation, such as participation in Board deliberations and voting. However, as corporate counsel, the lawyer is subject to the rules of professional conduct.

Here, Larry became a director after serving as counsel to SI for 10 years. He should have been aware of the potential conflict of interest when asked to join the Board. Even if Larry did not believe his roles were conflicting, he should have resigned when required to vote on ratification of the release because he knew that the release was adverse to SI's interests. Thus, Larry violated his duty of loyalty as a director to SI.

Duty of Loyalty -- Conflict of Interest (Personal Relationships)
An attorney may not undertake representation that creates a conflict due to personal loyalties, arising from familial or personal relationships. Here, Carole was at dinner at Larry's home, which suggests they may have a friendship or contact beyond being co-directors. Thus, based on the facts provided, Larry's friendship with Carole may have created a conflict of interest.