State corporate laws place the responsibility of managing the corporation upon its board of directors. The primary advantage of the corporate form of business is that it enables shareholders to share in the benefits, while at the same time limiting their personal liability.
State corporate laws generally provide 2 important protections for the board in managing the daily affairs of the corporation.
The first is the benefit of ‘business judgment presumption’. In the event of litigation arising out of a business decision, the court will assume that the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the corporation. Essentially, this means that the court will trust and uphold the decision of the board, unless the plaintiff to the suit is able to prove that the directors were grossly negligent in keeping themselves informed of all material facts.
The second protection provided to the board is known as ‘demand futility’. The principle of demand futility exists to protect the central importance of the Board in the management of the corporation and to prevent meritless lawsuits. Demand futility acts as a safety valve, allowing only the right level of policing.
For instance when a shareholder intends to file a derivative shareholder suit for and against the corporation, the shareholder needs to make a claim/demand upon the directors to prosecurte the claim, or alternatively show why a demand was not made (‘demand was futile’). When a shareholder makes a claim against a corporation which is accepted by the board, then the litigation regarding the claim is controlled by the board. Alternatively, a shareholder can claim that demand was futile, if he can prove that at the time of filing of the suit, the board could not have acted impartially upon the demand. Thus, if the majority of the directors were interested in the transaction sought to be litigated, then it could be argued that the board could not have acted impartially upon the demand.
There are some situations where federal regulation provides shareholders with an advisory vote in addition to corporate law and the corporation’s documents. For e.g., the new ‘Say on Pay’ rules require public companies to provide shareholders with an advisory vote regarding the compensation of its most highly-compensated executives. Advisory votes are important because they give shareholders a chance to voice their opinion. Although these votes are beneficial in maintaining a healthy dialogue between the corporation and its shareholders, the corporation can still choose to ignore the shareholders vote if it believes that an alternate proposal is in the best interests of the corporation.
A certain degree of tension and conflict between the shareholders and the management is healthy, and would encourage good governance of the corporation. However, for the peaceful functioning of the corporation, it is necessary that a delicate balance between these (sometimes conflicting) interests be preserved. The board is and should be the final word on management and governance of the corporation – the purpose of a corporate enterprise is passive investment by shareholders while the management runs the show. However, boards need to keep in mind that shareholders have legitimate interests in the governance of the corporation and should be provided with some kind of mechanism to express their concerns to the board. This could be achieved by encouraging shareholders proposals or by providing shareholders with greater voting rights. A corporation that does not adequately address shareholder concerns could open itself up to a host of problems, including proxy battles, hostile acquisitions, or poor stock performance.
