Legal Memo: Did the Board of Directors breach their duty of care?
TO: The Board of Directors, Vash United Films, Inc.
FROM: Legal Department
RE: Legal Memorandum re: Shareholder Lawsuit
DATE: November 3, 2010
Three years ago, Charles Michener, the chairman of Vash United Films (VUF) approved production of Hormonal Wars, a romantic-comedy starring teen-pop stars Nathan Blieber and Sasha Gometski. The film was supposed to capitalize on the two pop-stars' actual off-screen romance, as well as their popularity with tween girls. The Board conducted an extensive statistical review on the profitability of similar teen-pop romance flicks, and determined that these films have done well in the past and that a similar film will be profitable both in the United States and abroad. The Board also chose to hire director Michael Curtiz, who had previously produced several blockbuster hits. The Board is not responsible for casting decisions.
Unfortunately, due to unexpected cost issues related to filming, including labor disputes and the breakup of the two stars, Hormonal Wars fared poorly at the box office and the studio has lost an estimated $100,000,000. Several shareholders plan to file suit against the Board, claiming it breached its Duty of Care. At issue: Did the Board breach its Duty of Care and can it be held liable for the film's losses?
The Duty of Care
Directors have a Duty of Care to their corporation. The courts have ruled that "directors and officers of companies [must] discharge their duties in good faith and with the care of an ordinary prudent person" (Rath-Klein, 25). Since the courts do not want to second guess business decisions, directors "are presumed to have acted properly and in good faith, and are called to account for their actions only when they are shown to have engaged in fraud, bad faith or an abuse of discretion" (Elton, 20) or "act in a manner that cannot be attributed to a rational business purpose" (Geralt, 16). This legal protection, called the Business Judgment Rule, "protects the defendants from liability absent a clear showing of fraud, bad faith, or abuse of discretion" (Elton, 23).
Courts have previously ruled that directors who diligently perform in a reasonable manner will be protected by the Business Judgment Rule. For instance, in Rath-Klein, where directors were accused of acting in bad faith for approving a merger, the Board researched its options and hired an outside firm to assess how it could maximize shareholder value if the company was to be consolidated. The court found that directors acted in good faith because the "record is replete with evidence that the directors and officers consulted legal and financial experts" (Rath-Klein, 28) as they endeavored to merge and sell the company. While VUF did not contract with outside experts, the Board acted in good faith by conducting extensive statistical research on the profitability of teen romantic comedies.
Likewise, the Business Judgment Rule has been applied to situations involving personnel matters. In Geralt, when Knightmare Studios was sued over its departing CEO Jennifer Argas's $30 million severance package, directors were found to have acted reasonably, as they received substantial consideration by ridding themselves of Argas. The court ruled that in that case, there was "no reasonable doubt as to the disinterest or of absence of fraud by the Board" (Geralt, 18). While VUF's case involves the hiring of Curtiz, not the firing of a CEO, the Board acted reasonably and in good faith as it chose an individual who had a successful track record at the box office, even though Curtiz had not produced a similar film before.
Finally, Vash United Film's Board did not abuse their discretion, as was alleged in Elton, where directors were sued for failing to examine CableGroup's alternative offer. The Storer directors acted in good faith by working with an independent advisor, and deciding that shareholder value would be better maximized with a sale to Reels, not Cablegroup (Elton, 33-35). In VUF's case, the Board did not interfere with Curtiz's casting decisions - his area of expertise. The fact that the film performed poorly was largely out of the Board's hands.
No breach of Duty of Care; the Board is protected by the Business Judgment Rule.
660 words, 3 pages