2. The contract is voidable at the option of the corporation unless the interested director sustains the burden of proving the good faith of the transaction and its fairness to the corporation.48 3. The contract is void.49 The rule applied in a given case may also depend upon applicable statute or charter provisions. In any event, under any of the rules, the dealings of directors with the corporation they are elected to serve are subject to rigorous scrutiny. If any of their contracts or dealings with the corporation are challenged, the burden usually is upon the director to sustain its fairness. Some matters that might disqualify disqualify directors of an association from voting, if personally interested, or would at least bring the validity of the transaction into question are: the sale of property of a director to the association, 50 the giving of a mortgage on association property to a director,51 the execution of association notes to him, 52 or any transaction in which the personal interests of the director would be adverse to those of the association.53 Contracts with Directors The form of cooperative marketing act enacted in many States usually contains the following or similar language relative to directors contracting with their association: No director, during the term of his office, shall be a By reason of this provision, any contract of the prohibited type entered into by a director with an association formed under a 4819 Am. Jur. 2d, Corporations, § 1291 and cases cited. 50 Dean v. Shingle, 198 Cal. 652, 246 P. 1049, 46 A.L.R. 1156 (1926). 51 In re Webster Loose Leaf Filing Co., 240 F. 779 (D. N.J. 1916). Cf Farmers Cooperative Association v. Kotz, 222 Minn. 153, 23 N. W. 2d 576 (1946). 52 Smith v. Los Angeles I. & L. Co-op Association, 78 Cal. 289, 20 P. 677, 12 Am. St. Rep. 53 (1889). 53 Wardell v. Union Pacific R. R. Co., 103 U.S. 651 (1880). 54See Kentucky Agricultural Cooperative Associations Act, KRS 272.171(5). statute containing this provision is invalid. The prohibition is primarily against the director. If a contract of the type prohibited is entered into by a director and is carried out, it would seem that he would be liable to account to the association, its receiver, or its members for any benefits or gains resulting from the contract.55 Any other rule would render the prohibition valueless. It is immaterial that the statute prescribes no penalty or imposes no liability. All directors are conclusively charged with knowledge of the law, so that they cannot plead ignorance of it.57 Even though all members of the board of directors of an association, except the contracting director, voted for the contract, it would not seem to authorize a prohibited act because the directors cannot override the statute but must function within its limits. Obligations and Liabilities of Directors The directors of an association, in directing its affairs, must use care to keep within the powers conferred by the charter and the plan of operation set forth in its bylaws and its marketing contracts. Directors and officers of an association are simply agents. If they exceed their authority or violate the charter, bylaws, or marketing contracts of the association, legal liability results. 58 The office of director is not one for a figurehead. The courts refer to directors as trustees, quasi trustees, fiduciaries, and agents, and require them to exercise the most scrupulous good faith toward the corporation and its stockholders. 59 Although 55 Rutland Electric Light Co. v. Bates, 68 Vt. 579, 35 A. 480, 54 Am. St. Rep. 904 (1896); Thompson v. Greeley, 107 Mo. 577, 17 S. W. 962 (1891); Wardell v. Union Pacific R. R. Co., 103 U.S. 651 (1880). 56 Thompson v. Greeley, 107 Mo. 577, 17 S.W. 962 (1891). 57 Morrison v. Farmers' Elevator Co., 319 III. 372, 150 N.E. 330 (1926); Croninger v. Bethel Grove Camp Ground Association, 156 Ky. 356, 161 S. W. 230 (1913). 58 Wells, et al. v. Neill, et al. (Mississippi Farm Bureau Cotton Association), 162 Miss. 30, 138 So. 569 (1932); Fergus Falls Woolen Mills Co. v. Boyum, 136 Minn. 411, 162 N. W. 516, L.R.A. 1918A 919 (1917); McCauley v. Arkansas Rice Growers' Co-op Association, 171 Ark. 1155, 287 S.W. 419 (1926); Hoffman v. Farmers' Co-op Shipping Association, 78 Kan. 561, 97 P. 440 (1908). See also Dome Realty Co. v. Rottenberg, 285 Mass. 324, 189 N.E. 70 (1934), and Knepper, Liability of Corporate Officers and Directors, 2d ed., The Allen Smith Co., Indianapolis, Ind. (1972). 59 Arkansas Valley Agricultural Society v. Eichholtz, 45 Kan. 164, 25 P. 613 (1891); L. E. Fosgate Company v. Boston Market Terminal Company, 275 Mass. 99, 175 N.E. 86 (1931). directors of an association occupy positions of trust, responsibility, and liability, they are not insurers of the success of the association. However, they should exercise the same degree of care in directing and supervising the affairs of an association that ordinarily prudent and diligent men would exercise under similar circumstances, namely, reasonable care. 60 Failure to exercise this degree of care or to be honest and diligent in attending to the affairs of an association may render directors liable at common law to the association, to its receiver if in the hands of a receiver, or under some circumstances, to members of the association acting in its behalf. Directors and officers of an association in the conduct of its affairs should keep within the charter powers of the association. If, by reason of ultra vires acts, an association suffers losses, they may be liable.61 In Kentucky, directors of a farm bureau were held personally liable on the ground that they had permitted the association to exceed its debt limit.62 It has been said that "Directors have been held personally liable in an almost infinite variety of cases that are not subject to definite classification, but may properly belong either to negligence or fraud."63 "The president and board of directors of a corporation are trustees, and act in a fiduciary capacity for its stockholders, and while doing so are forbidden, in equity, to acquire any interest in the property hostile to the interests of the stockholders."64 Transactions with a corporation under which its directors obtain advantages for themselves are, broadly speaking, at least voidable.65 Thus, when directors knowing of the insolvency of a corporation authorized payments to be made by the corporation on notes held by some of them, which notes were barred by the 60 Briggs v. Spaulding, 141 U.S. 132 (1891). See also Casey v. Woodruff, 49 N.Y.S. 2d 625 (1944), where the court pointed out that the basic obligations of a corporation's directors as fiduciaries are to be loyal to the corporation and act with reasonable diligence in the management of its affairs. 61 Wells, et al. v. Neill, et al. (Mississippi Farm Bureau Cotton Association), 162 Miss. 30, 138 So. 569 (1932); Fagerberg v. Phoenix Flour Mills Co., 50 Ariz. 227, 71 P. 2d 1022 (1937). 62 Federal Chemical Company v. Paddock, 264 Ky. 338, 94 S. W. 2d 645 (1936). 632 Thompson on Corporations, p. 968. 64 Center Creek Water & Irrigation Co. v. Lindsay, 21 Utah 192, 60 P. 559 (1900). 65 See "Conflicting Personal Interests," supra, p. 125. statute of limitations, it was held that this was "a breach of that faith to which the law holds fiduciaries, generally." A suit by a receiver of a farmer cooperative to set aside a chattel mortgage in favor of a former director to secure sums of money he had lent the association and for future advances was reversed on appeal and a new trial granted.67 The appellate court stated that the evidence failed to show that defendant had made arrangements for the mortgage while a director, and there was no evidence of fraud. It pointed out that the securing of a preference by a general creditor from an insolvent corporation was not, in itself, fraudulent under the laws of Minnesota. All authorities agree that an association may recover from its directors any losses suffered because of their fraud or dishonesty. Gross negligence on the part of directors that permits other directors to defraud an association will render all of them liable.68 Inattention on the part of a director may render him liable to his association, at least in those instances where attention to duty should have prevented the loss of a specific amount.69 Illness or other sufficient cause will excuse failure to attend board meetings.70 But failure to attend board meetings will not excuse directors for failure to supervise the corporation's affairs."1 In addition to the right of an association to compel a director to account for any benefits arising out of a prohibited contract, an association, its receiver, or members acting in its behalf, would also have the right to recover, from the directors who attempted to authorize such a contract, any losses the association sustained from the prohibited act.72 However, even in the absence of a statute prohibiting 66 Hein v. Gravelle Farmers Elevator Company, 164 Wash. 309, 2 P. 2d 741, 744, 78 A.L.R. 631 (1931). 67 Farmers Cooperative Association v. Kotz, 222 Minn. 153, 23 N. W. 2d 576 (1946). 68 McGinnis v. Corporation Funding & Finance Co., 8 F. 2d 532 (M.D. Pa. 1925); Coddington v. Canaday, 157 Ind. 243, 61 N.E. 567 (1901). 69 Bowerman v. Hamner, Receiver, 250 U.S. 504 (1919); Besselieu v. Brown, 177 N.C. 65, 97 S.E. 743, 2 A.L.R. 862 (1919). 70 Briggs v. Spaulding, 141 U.S. 132 (1891). 71 Platt Corp. v. Platt, 42 Misc. 2d 640, 249 N.Y.S. 2d 1 (1964), affirmed, 258 N.Y.S. 2d 629 (1965); Dinsmore v. Jacobson, 242 Mich. 192, 218 N.W. 700 (1928). 72 12 Thompson v. Greeley, 107 Mo. 577, 17 S. W. 962 (1891); Oakland Bank of Savings v. Wilcox, 60 Cal. 126 (1882); Citizens Building and Loan Association v. Coriell, 34 N.J. Eq. 383 (1881). directors from entering into unconscionable contracts with their associations, the courts scrutinize such contracts closely. They have been set aside on slight grounds, even if all the directors of an association except the one receiving the contract voted for it.73 If a director acted both for himself and for the association, an additional reason for scrutinizing the contract would seem to exist.74 Such contracts, under common law principles, may be set aside at the election of the association unless of advantage to the association and unless fair and reasonable.75 Withheld facts, large profits, suspicious circumstances or unfavorable terms may afford an association a basis for setting aside such a contract. On the other hand, if a contract is made by a director with an association when the association is represented by a majority of the directors, the contract will be upheld if fair and reasonable and if without disadvantage to the association.76 Rarely is a director, although inattentive to his duties, held liable on account of a general collapse of a corporation, where fraud or specific losses traceable to specific transactions were not involved." This may be due in part to the difficulty of showing the amount of loss suffered in such a case or of showing that it is chargeable to the director's neglect. But a director who fails to attend properly to the duties of his office is always faced with the fact that, generally, he will be held liable for losses resulting from fraud on the part of officers, agents, or other directors of the association. Moreover, he may be held liable for specific losses, such as one caused by the unlawful expenditure or employment of association funds, if he could reasonably have been expected to prevent the losses by attending to his duties.78 A director, 73 Twin-Lick Oil Co. v. Marbury, 91 U.S. 587 (1875). 74 Wainwright v. P. H. & F. M. Roots Co., 176 Ind. 682, 97 N.E. 8 (1912). See also "Conflicting Personal Interests." supra, p. 125. 75 Wing v. Dillingham, 239 F. 54 (5th Cir. 1917), certiorari denied, 244 U.S. 654 (1917); Geddes v. Anaconda Copper Mining Co., 254 U.S. 590 (1921); Lembeck & Betz Eagle Brewing Co. v. McAnarney, 287 F. 927 (W.D.N.Y. 1923); Stanton v. Occidental Life Ins. Co., 81 Mont. 44, 261 P. 620 (1927). 76 Nicholson v. Kingery, 37 Wyo. 299, 261 P. 122 (1927). See also "Conflicting Personal Interests," supra, p. 125. " Barnes v. Andrews, 298 F. 614 (S.D.N.Y. 1924); but see Coddington v. Canaday, 157 Ind. 243, 61 N.E. 567 (1901), in which a receiver of a corporation recovered from directors on account of their gross negligence. 78 McGinnis v. Corporation Funding & Finance Co., 8 F. 2d 532 (M.D. Pa. 1925); Smith v. Cornelius, 41 W.Va. 59, 23 S.E. 599, 30 L.R.A. 747 (1895). |