A corporate board of directors is entrusted with stockholder investments and the directors act as agents for the stockholders themselves. The directors are ultimately responsible for managing and overseeing the Company’s operations. They must maintain their fiduciary duties to protect the interests of the corporation and simultaneously act in the best interest of the stockholders. The core fiduciary duties a director must maintain are the i) duty of care, and the ii) duty of loyalty.
Duty of Care and the Business Judgment Rule
The duty of care requires the directors to be fully and adequately informed. They must act with care when making decisions and acting for the corporation. Whether codified (in most states) or developed through case law (Delaware), a director breaches the duty of care when she/he fails to take action in a situation where a careful person would have acted. The business judgment rule helps to define whether or not a director has breached the duty of care.
Decisions of the board must be attributed to “any rational business purpose.” Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720(Del. 1971). The Business Judgment Rule presumes that the board acted on an informed basis and in the honest belief that the action was taken in the best interest of the corporation. Luckily for the director, a court will make this presumption unless the plaintiff can show that a majority of the directors i) did not stay informed, ii) did not act in good faith, and iii) did not take action in the best interest of the corporation.
A Director Must Stay Informed, Act in Good Faith, and In the Best Interest of the Corporation
Directors must inform themselves of all material information reasonably available to them before making a business decision. (see Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985)). For this reason it is important for a director to attend meetings, carefully read reports and other materials and ask questions.
Directors must use a substantive decision-making process. In other words, “rubber-stamping” management actions is insufficient. Good faith is often defined as the “absence of bad faith.” A bad faith act is qualitatively more culpable than gross negligence and requires a showing of actual or constructive knowledge (scienter). (See In re Disney, 906 A.2d 27, 66 (Del. 2006)).
The director must reasonably believe the actions taken were in the best interest of the corporation. If a majority of the board qualifies for the presumption of the business judgment rule, the standard for finding breach of the duty of care is gross negligence. (See In re Citigroup Inc., 964 A.2d 106, 124 (Del. Ch 2009), citing Aronson v. Lewis, 473 A.2d 805, 812 (Del 1984).)
Duty of Loyalty and the Corporate Opportunity Doctrine
The duty of loyalty embodies an affirmative duty to protect corporate interests (also embedded in the duty of care), but the loyalty duty also demands an obligation to refrain from conduct that would harm the corporation and its stockholders. A fiduciary-director might breach this duty by holding a personal interest in the transaction or by expecting to receive a personal financial benefit from self-dealing. In such cases, the court will not presume they acted in the corporation’s best interest.
When a director usurps a corporate opportunity, or takes the business opportunity for herself, the director has breached the duty of loyalty. A director should ask the following questions before engaging in any corporate-interested transaction:
Is the opportunity in the same line of business as the corporation’s?
Does the corporation have an interest or expectancy in this opportunity?
Would the corporation financially be able to take this opportunity?
Would taking this opportunity create a conflict of interest?
Conclusion
The duty of loyalty and the duty of care are not the only fiduciary duties of directors, but following fundamental fairness, staying loyal to the corporation, and acting rationally and informed about business decisions will set a director on a path to succeed as a fiduciary.
Disclaimer: This post discusses general legal issues and developments, is intended to serve as informational only, and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Archetype Legal PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.
