Officers, Directors and Shareholder Fiduciary Duties

Officers, Directors and Shareholder Fiduciary Duties

Company Officers and Directors have fiduciary duties to the company and to its owners, the shareholders.

Duty of Care or Due Dilgence:

A director's duty of care is frequently broken-down and explained in reference to a director's obligation to manage the corporation in good faith and requiring a director to: (1) be informed and educated with respect to their decision-making obligations ; (2) devote attention to; (3) and to form a “reasonable belief” about certain matters.  Considering that a director's role includes providing direction and oversight to officers, employees, and other agents of the corporation who carry out day-to-day management functions, it is easy to see why directors must abide by these important characteristics. Thankfully this duty  is fairly straightforward.  As you may suspect, the duty to become informed requires a director to become sufficiently familiar with background facts and circumstances relating to a particular issue before taking action.  Not surprisingly, the process typically involves directors reviewing written materials provided before or at a board meeting and paying attention to or participating in the deliberation leading up to a vote on a particular matter.

The board of directors of a corporation have a fiduciary duty to exercise the same due care in the management of the corporation's business as a prudent man would exercise under similar circumstances. Corporate officers and directors must use their uncorrupted business judgment for the sole benefit of the corporation. The fiduciary duty is to exercise same care as prudent man usually exercises in the management of his own affairs. Texas requires a director to exercise his unbiased or honest judgment in pursuit of corporate interests with undivided loyalty and in utmost good faith.

In determining whether the standard has been met, courts may consider such factors as (a) the character of the corporation; (b) the condition of its business; (c) the usual method in which such corporations are managed; and (d) any and all relevant facts that tend to throw fight upon the question of the proper discharge of one's duty as director. As a general rule, a director may be liable to the corporation, and occasionally to its shareholders, creditors, or other persons, for losses caused by his failure to exercise the proper care.  A director breaches his duty if (i) he commits overt acts constituting mismanagement or (ii) his inaction amounts to a failure to direct.

Duty of Loyalty

The Duty of Loyalty requires Officers and Directors of a Corporation to act in good faith for the benefit of the Corporation and its stockholders, and not for the Officer/Director's own interest. It may seem obvious, but Officers and Directors may not engage in fraud, use their position with the Corporation for personal gain or advantage, or take opportunities from the Corporation.

Violations of the duty of loyalty include:

  • A conflict of interest (where the Director has an interest in the “other party” in a transaction);
  • Usurping a corporate opportunity (where the Director uses an opportunity for his or her other company, instead of recommending the opportunity to the Corporation);
  • Personal benefit to the Director (golden parachute, promise of employment);
  • Fraud upon the Corporation; and
  • Misappropriating corporate assets (where a corporate asset – say a jet – is used for non-corporate purposes).

Standard

In contrast to the duty of care, there is no business judgment rule shield for Officers or Directors. Instead, once the mere existence of a personal benefit or other allegation of displaced loyalty is established, the Directors and Officers must show that their actions were entirely fair to the Corporation: a very high standard to prove.

To balance this high standard, states have enacted statutory procedures for transactions involving a conflict. Virginia's Stock Corporation Act provides that a conflict of interest transaction is not voidable by the Corporation solely because of the Director's interest in the transaction if (i) the material facts of the transaction and the Director's interest were disclosed or known to the board of Directors and the board of Directors authorized the transaction; or (ii) the material facts of the transaction were disclosed or known to the shareholders and the shareholders authorized the transaction, or (iii) the transaction was fair to the Corporation.

How to Avoid Breaching the Duty of Loyalty

In order to avoid breaching their duty of loyalty, Directors should always disclose any personal benefit they have in a transaction and have the transaction approved by either the non-conflicted Directors or the shareholders. If a Director has any reason to suspect they might have a conflict of interest, such Director should bring it to the attention of the board so that the board can consider appropriate actions. The conflicted Director can then abstain from voting upon the subject transaction.

Things can get a little more complicated when there is not a majority of non-conflicted Board members. That would occur when there is only one director or two directors (with one having a conflict) of the Corporation. In that case, it may make sense to appoint an independent director to the Board in order to obtain the necessary approvals, or to request shareholder consent. The statutory provisions allowing for shareholder approval to “cure” any conflicts do not exclude conflicted shareholders from the approval process. In that case, the shareholders are considered to be wearing their “shareholder” hats and they can approve transactions that are in their best interests – not just the Corporation's best interests.

Officers and Directors of a corporation can avoid liability for a breach of the duty of loyalty by disclosing any possible conflict of interest to the Board and then obtaining consent of the non-conflicted Board.

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