Case Problem:
WMI Corporation was initially financed primarily by loans from Wells Fargo. Early on, the company got into deep financial difficulties, and needed to obtain additional loans to continue operations. To secure the needed additional loans, all members of the board of directors personally guaranteed the additional loans; no compensation was given for these loan guarantees.
Three years later, the company needed additional financing, which required loan guarantees from the shareholders. One shareholder, Baldwin, refused to give a guarantee, so the directors went ahead and secured the loan based on loan guarantees from all the directors and shareholders except Baldwin. As compensation for their guarantees, the directors issued themselves additional shares of stock. They used a formula of a 5 percent grant of shares for each $100,000 of corporate debt guaranteed—a formula that they came up with on their own, without using any outside consultants, because they feared that the stock would actually have a negative value. A couple of years later, the firm’s financial situation had improved slightly, but it still needed additional loans that required personal guarantees. Again, Baldwin refused, and the board secured the loans without his guarantees. They again issued themselves additional shares of stock as compensation for the guarantees, using the original formula for determining how much stock to issue, which further diluted Baldwin’s equity interest in WMI from 5.04 percent to 3.25 percent.
Baldwin sued, claiming that both issuances of compensatory shares constituted a breach by the directors of their fiduciary duties as directors. The district court found that the directors’ actions in the first instance were justified because emergency action was needed immediately to preserve the corporation, but not in the second situation. Both sides appealed. Do you think the directors violated their duty to Baldwin? How do you think application of the business judgment rule would affect the outcome in the court of appeals?
Your answer must be, typed, double-spaced, Times New Roman font (size 12), one-inch margins on all sides, APA format and also include references.