A fiduciary duty is the duty to act in another party’s interests. Directors and Officers of a Corporation owe fiduciary duties to the Corporation itself and to the Corporation’s shareholders. There are two core fiduciary duties owed by Directors and Officers: the duty of care and the duty of loyalty. This blog post discusses the duty of care and subsequent blog posts will discuss the duty of loyalty and special circumstances regarding fiduciary duties.
While this blog post refers to the company as a “Corporation” and the fiduciaries as “Directors” or “Officers” of the Corporation, the same principles are in effect for limited liability companies or limited partnerships. The actors may be called Managers or Members, but share in many of the same obligations to act in another party’s interests.
Corporate Management Generally
Generally speaking, a Corporation will have shareholders who own the Corporation. The shareholders, in that role, do not participate in management, but they elect Directors to serve on the Corporation’s Board of Directors. The Directors then in turn elect Officers to run the Corporation’s day-to-day operations. Both Directors and Officers of a Corporation, acting in those roles for the Corporation, owe fiduciary duties to the Corporation and the shareholders.
Duty of Care
The Duty of Care is the affirmative duty of a Director to make informed decisions for the Corporation, after using reasonable diligence in gathering and considering material information. Delaware Courts have routinely described this duty as being the amount of care which an ordinarily prudent person would use in a similar circumstance. Virginia’s Stock Corporation Act provides that “A Director shall discharge his duties as a Director, including his duties as a member of a committee, in accordance with his good faith business judgment of the best interests of the Corporation.” §13.1-690.A.
Under Delaware and Virginia case law, in order to fulfill the Duty of Care, Directors need to:
- Inform themselves of all available material information regarding a transaction,
- Devote sufficient time and attention to the matters under consideration; and
- Participate in board discussions and ask questions.
The Business Judgment Rule
Because courts recognize that Directors must take business risks in the management of a Corporation, and those risks may not always be successful, courts use the Business Judgment Rule to presume that a Director has acted appropriately. The Business Judgment Rule is a common law presumption that a Director has acted properly and in good faith of the best interests of the Corporation. The presumption can be rebutted, or overturned, if a party can show that the Directors did not act in an informed manner, in good faith, or in the best interests of the Corporation. In that case, the burden of proof then shifts to the Directors to show that their actions were entirely fair to the Corporation – a much tougher standard to overcome.
How to Avoid Breaching the Duty of Care
In order to avoid breaching their fiduciary duty of care, Directors should have procedures in place for approving transactions – particularly significant transactions in the life of the Corporation. Each Director would need to be aware of the transaction, participate in board meetings or board calls regarding the transaction, and inform his or herself about the transaction. If the Corporation is considering borrowing money, Directors would need to understand the intended use of the borrowed money, the basic terms of the loan, what other options are available to secure funding, and the effect on the Corporation and the shareholders. Directors may use outside information or opinions from consultants to influence their decision-making, but must use their own judgment in approving transactions. Rubber-stamping a transaction recommended by management would not be enough.
While Officers and Directors need be aware of their duty of care to a Corporation, by making themselves aware of the Corporation’s business and participating in a well-defined process to approve transactions, they can insulate themselves from any liability.