Corporate law is an umbrella term that refers to the entire written body of laws and regulations that govern how corporations are formed, as well as how corporations may interact with other companies, individuals, their shareholders, and the public at large. Corporate laws address the legal rights and responsibilities of all people who are involved with operating, owning, and managing a corporation.
Although the exact legal definition differs by state, a corporation is commonly defined as a legal entity that is separate from its owners, or its shareholders. This means that the assets of the members of the corporation are safe from liability from corporate actions and only the corporation itself can be held liable for corporate obligations.
In general, a corporation is classified according to specific factors such as:
- The corporation’s tax structure;
- The purpose of the corporation; and
- The number of shareholders and amount of stock to be issued by the corporation.
Examples of common characteristics of corporations include:
- Decreased or limited liability of members of the company;
- Separate legal personality of the company.
- This means that a corporation may be treated as an “individual” for some purposes;
- Different rules regarding stocks and ownership of the company;
- Increased rights and responsibilities of the board of directors and other leaders.
- These legal rights and responsibilities are typically outlined in the initial company organizational documents, such as the charter and bylaws of the company; and/or
- Preferential tax treatment, in many states.
How Are Corporations Formed?
A corporation is generally formed when articles of incorporation are first filed with the Secretary of State in the state in which the business owners seek to incorporate. In order to form the articles of incorporation, the individual owners or shareholders must all agree on a number of different matters, including:
- What the legal name of the corporation will be;
- The amount of shares that the organization will issue;
- The amount of shares of stock that each owner will buy initially;
- The total amount of money each owner will contribute to business assets and expenses;
- The specific type of corporation that is to be formed; and
- The people who will initially form and manage the corporation, as well as how these people will be elected or appointed.
- These persons are commonly referred to as the board of directors.
Once again, each state has its own corporate law requirements, and as such there may be additional factors that need to be addressed when forming a corporation.
What Is a Board of Directors?
A board of directors is essentially the center of corporate power within a company. Under corporate laws of most states, a board of directors is the group that holds the authority to manage the entirety of a corporation’s business and affairs.
Once again, a board of directors are typically shielded from certain liabilities within certain forms of corporations, such as a limited liability corporation (“LLC”). However, the board of directors and individual board members will be liable for actions that they take which are not:
- Made In good faith;
- Performed with ordinary and reasonable care; and/or
- Made in the best interests of the corporation based on the reasonable beliefs of the directors at large.
It is important to note that the biggest way in which a board member can be held liable for their actions is by violating their fiduciary duty.
What Are Directors and Officers Fiduciary Duty?
Fiduciary duty is one of the highest legal duties that is imposed by the United States legal system. The term fiduciary duty refers to the legal obligation of the fiduciary to act in the best interests of their principal(s). A fiduciary is defined as a person responsible for taking care of money or other assets for the benefit of another person or entity, which are known as the principal.
A fiduciary duty is composed primarily of two duties: the duty of loyalty and the duty of care. The duty of loyalty means that the fiduciary must act at all times in the business’s best interest, even over their own self-interest. As such, directors and officers as a fiduciary must avoid any conflicts of interest that may arise between their interests and the interests of their principal, i.e. the shareholders and members of the company.
The duty of care refers to the legal responsibility of a fiduciary to act according to a standard of reasonable care. This means acting in a way that is typical for a person to act that is in a role similar to themselves.
As such, when a director or officer of a company does not act in the business’s best interests or otherwise violates their fiduciary duty to the shareholders or business owners, a civil suit may be initiated by the injured party to recover against the company or that officer or director for their breach.
What Constitutes a Breach of Fiduciary Duty for a Board of Directors?
Although the exact legal elements for breach of fiduciary duty vary by state, in general the following legal elements need to be proven in order for a plaintiff (i.e. the party that was injured) to succeed in their civil lawsuit against the breaching party:
- First the plaintiff must prove that a fiduciary relationship exists between themselves and the breaching party;
- The plaintiff must then outline the scope of the relationship and the duties of the fiduciary;
- Next, the plaintiff must prove that the defendant did in fact breach their duties as outlined in the scope of the relationship.
- Typically this is done by showing the breaching party violated the corporation’s charters and by laws; and
- Finally, the plaintiff must show that they were actually harmed, by showing some quantifiable financial loss.
How Can Directors, Officers, and Corporations Benefit From Directors and Officers (“D&O”) Insurance?
Directors and officers insurance (“D&O” insurance) provides additional monetary protection for insured directors and officers, as well as the corporate entity itself. Specifically, a corporation is protected because D&O insurance covers an agreed amount of corporate indemnification and expense advances.
Directors and officers are also protected by the insurance coverage in cases in which a corporation is unwilling or unable to indemnify its directors and officers. Besides providing additional liability protection for directors, officers, and the corporation, D&O insurance may also be useful by:
- Helping to provide investors assurances or meeting investor requirements for insurance as a condition for investor funding; and
- Helps a company assure its directors and officers that they will be protected in scenarios in which they may become liable.
What Is Typically Covered by D&O Insurance?
The following is a list of items that are commonly covered by D&O Insurance:
- Employment practices liability, such as liability insurance for any employment related lawsuits;
- Fiduciary liability, such as liability resulting from any fiduciary duty violations by directors or individual officers of the company; and/or
- Liability protection from stockholders’ and clients’ claims that arise against the corporation, its directors, and its officers.
What Is Not Covered by D&O Insurance?
Because every company is unique, D&O insurance coverage varies widely. Additionally, D&O insurance is often complex, and will have various exclusions depending on the type and structure of the business. Examples of common exclusions of coverage include:
- Any exclusions and conditions that are already in place when the company applies for coverage;
- Conduct for which indemnification is prohibited by local state laws, such as criminal acts;
- Criminal or civil fraud and criminal fines; and/or
- Any cases in which punitive damages may be ordered against the company, directors, or officers.
It is important to note that even as to covered conditions, insurance companies may still assert a defense regarding the coverage if they believe the matter falls out of the scope of the agreement between the company and insurance provider. As such, it is important to review the complete terms of the D&O insurance contract.
Do I Need an Attorney for Help With Directors and Officers Liability Insurance?
If you have any questions regarding D&O insurance and coverage, or if you are involved in a dispute with a D&O insurance provider, it is in your best interests to consult with an experienced insurance attorney.
An experienced attorney can help you review any D&O insurance agreement, as well as help you analyze what claims fall within the coverage. Finally, in a dispute with the insurance provider, an attorney can also represent your interests in court, as needed.