Lugar de Noticias Haynes and Boone
Directors and officers managing corporations, especially when the corporation is insolvent or operating in insolvency situations, need to be cognizant of their fiduciary duties. This alert provides a brief overview of these fiduciary duties, including practical considerations in the exercise of these duties.
Fiduciary Duties When a Corporation is Solvent
Fiduciary duties of directors arise under the law of the state of the corporation’s formation, and include the duty of care and the duty of loyalty, which are generally owed to the corporation and its shareholders. Therefore, if a director breaches one of the duties, shareholders have standing to bring a cause of action on behalf of the corporation (called a derivative action) against the director for breach of the duty. While a corporation is solvent, creditors of the corporation generally have no standing to bring derivative or direct actions against directors. Creditor rights are generally governed by contract, such as a credit agreement or promissory note which create no obligations on the directors.
The duty of care requires that directors exercise the degree of care, “which ordinary, careful and prudent persons would use in similar circumstances.”
The duty of loyalty requires directors to act in good faith and in the best interests of the corporation and its shareholders. This duty prohibits directors from receiving an improper personal benefit from their relationship with the corporation, self dealing, and usurpation of corporate opportunities.
In exercising their fiduciary duties, directors have the benefit of the business judgment rule. The business judgment rule is a presumption that, in making a business decision, the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. The exercise of a valid business judgment will be respected by the courts and provides a fundamental defense in litigation challenging a director’s actions.
However, there are circumstances in which directors are not entitled to the defense of the business judgment rule, such as when a director has a personal interest in a matter that comes before the board, implicating the director’s duty of loyalty. In such cases, care must be taken by the board in connection with the approval process in order to maintain the applicability of the business judgment rule or courts will review the transaction with heightened scrutiny to make sure the decision is intrinsically fair to the corporation.
In addition to the business judgment rule, most states have enacted statutes that permit the corporation to provide in its charter or bylaws an exculpation provision that insulates a director from liability stemming from an alleged breach of the duty of care (including acts constituting negligence). These exculpations are generally enforced so long as there is no breach of the duty of loyalty, there is no knowing violation of law, and the director did not receive a personal benefit.
To continue reading the alert, please click on the linked PDF below. (Other topics include Fiduciary Duties When a Corporation is Insolvent or Near Insolvency; and Practical Considerations When Exercising Fiduciary Duties.)
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