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Business Associations

Exam 1
30 minutes

Fact Pattern

Company X is a closely held corporation that manufactures and sells energy drinks. X mixes and bottles its drinks out of three primary manufacturing facilities, which it owns. X’s Michigan facility manufactures Irrational Energy Elixir, the company’s best-selling drink. Unfortunately, X has learned that its most recent batch of Irrational Energy Elixir may have been contaminated. 

X’s board of directors organizes a committee of its most trusted and knowledgeable employees to investigate the issue and provide the board with a report (the Employee Report). The Employee Report indicates that the batch may indeed have been contaminated, but there is only a one-percent chance that those who consume the beverage will suffer any health ramifications. The board meets shortly after the report is issued. However, other matters take precedence at the meeting, so the board fails to take any action on the contamination problem. 

A few months later, having moved production of Irrational Energy Elixir to X’s Oregon facility, X decides to sell the Michigan facility. To that end, X’s board appoints a committee of officers and directors to solicit bids. The committee returns with only one bid, for $10 million. 

Unimpressed with the bid, the board asks Mr. A, X’s outside legal counsel, whether the bid represents fair market value for the facility. Mr. A replies, “ Yes. Based on the 15 acquisition deals I closed in Michigan last year, I believe that $10 million represents fair market value for this type of facility.”  The board thus votes to accept the bid, and the sale closes the following month. 

Two months later, X receives a litany of bad news. The worst is this: approximately 25 percent of X’s customers fell ill upon consuming Irrational Energy Elixir. As a result, the contamination issue that the board did not address gets widely publicized, and X’s sales decline. Further, the board learns that three Michigan manufacturing facilities recently sold for roughly $30 million each; all three were virtually identical to the one X sold for $10 million. 

You represent a group of shareholders interested in bringing a derivative action against Company X’s directors. Assume that Company X is incorporated in a jurisdiction that has adopted the Model Business Corporation Act (MBCA), making the MBCA the governing law here.


Questions

  1. Which fiduciary duty is most likely implicated by the decisions X’s directors have made? Under the MBCA, what criteria would you need to demonstrate to establish that the directors breached this duty? Explain.
  2. As to the contamination issue, what would be the board’s best defense to the alleged breach raised in Question 1? What criteria must the directors demonstrate, to successfully invoke the defense? What fact(s) may complicate this defense? Explain.
  3. The board made decisions based on the Employee Report and the opinion of its outside legal counsel. How would a court evaluate the board’s decision to rely on these sources? Explain, but do not discuss the defenses you might reference in answering Question 2.

Question 1

Which fiduciary duty is most likely implicated by the decisions X’s directors have made? Under the MBCA, what criteria would you need to demonstrate to establish that the directors breached this duty? Explain.

Question 2

As to the contamination issue, what would be the board’s best defense to the alleged breach raised in Question 1? What criteria must the directors demonstrate, to successfully invoke the defense? What fact(s) may complicate this defense? Explain.

Question 3

The board made decisions based on the Employee Report and the opinion of its outside legal counsel. How would a court evaluate the board’s decision to rely on these sources? Explain, but do not discuss the defenses you might reference in answering Question 2.

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