Directors and officers of corporations owe fiduciary duties to corporate stockholders and to the corporate business entity itself. Therefore, corporate directors and officers are said to be "fiduciaries." Basically, fiduciary duties in a corporate setting require directors to apply their best business judgment, to act in good faith, and to promote the best interests of the corporation.
Protection from Fiduciary Duties Violations: What is the Business Judgment Rule?
Although directors and officers must be careful not to violate their fiduciary duties, they can take reasonable risks, direct corporate business and affairs, and make innocent mistakes without judicial scrutiny and court's second-guessing. The so called "business judgment rule" is a rebuttable presumption that directors and officers:
- Made decisions on an informed basis as well as in good faith
- Honestly believing their actions to be in corporation's and shareholders' best interests
In another words, unless the opposing party is successful in rebutting the "business judgment rule" presumption, that presumption will protect directors and officers from personal liability to corporation and its shareholders.
However, the business judgment rule presumption can be successfully rebutted by showing that at least one of fiduciary duties had been breached. So, what are these different fiduciary duties?
Classifying Fiduciary Duties: What are the Three Basic Types of Fiduciary Duties?
At least the laws of Delaware, where many businesses incorporate, seem to point out three basic fiduciary duties. These duties are as follows:
1) Duty of Care – directors and officers must use care and be diligent when making decisions on behalf of the corporation and its shareholders (who are the true owners of the corporation). Directors and officers meet their duty of care if they act:
- In good faith
- With the care of a reasonable person in like position
- With reasonable belief their decisions are in best interest of the corporation
These standards may sound like the ones described under the business judgment rule. However, some Delaware case law points that even a careless, negligent director or officer may be protected. This is because to violate a duty of care, director or officer may have to be "grossly negligent," rather than simply negligent or careless.
2) Duty of Loyalty – directors and officers must have an undivided duty of loyalty to the corporation and shareholders. In another words, they must put the interests of shareholders and the corporation above their own interests. To understand the duty of loyalty, let us illustrate several ways it in which can be violated:
- Gaining secret profit belonging to corporation
- Competing with corporation
- Seizing corporate opportunity
- Self-dealing with corporation
The above situations often arise in conflicted or related-party transaction settings. In another words, these transactions do not involve free market, arms length dealing.
The key is disclosure, as well as appropriate approval from other disinterested (i.e., without personal stake in transaction) directors and shareholders. Director should disclose suspicious transaction and ask others (i.e., shareholders and directors) for permission to conduct it.
3) Duty of Good Faith – while under Delaware law, it is not clear whether this is a freestanding fiduciary duty or a part of duty of loyalty, the duty of good faith may be understood as "conscious disregard" or "intentional dereliction of duty." Without getting bogged down in legal theories, what's important is that a director who escapes liability for duty of care violation may still be on the hook for his lack of good faith. Basically, courts may use this duty as an alternative means for finding director liable.
Do I Need to Consult an Attorney?
Directors, officers, and concerned shareholders may benefit from the advice of a qualified business lawyer. Directors and officers may need an attorney to develop a strategy of compliance with fiduciary duties. An attorney may help set up a risk and compliance oversight system to ensure that directors' and officers' actions are covered by the business judgment rule. On the other hand, a shareholder may benefit from legal advice if fiduciary duties had been violated.