Individual or Collective Liability for Corporate Directors?

• Author: Darian M. Ibrahim
• Position: Associate Professor, University of Arizona James E. Rogers College of Law
• Pages: 03

Associate Professor, University of Arizona James E. Rogers College of Law. I thank my colleagues at Arizona for their many helpful comments and Arizona law students Jennifer Roth, Susan Schwem, and Jesse Showalter for their excellent research assistance. Larry Ribstein, Usha Rodrigues, Bill Sjostrom, and Brad Wendel also provided valuable feedback, as did participants at the 2007 AALS Section on Business Associations, where this paper was presented. My special thanks go to Deborah DeMott, Hillary Sale, and Gordon Smith, who were instrumental in helping me think through these ideas. All errors, of course, are my own.

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I Introduction

Efforts to improve corporate governance routinely focus on the board of directors, which enjoys almost unfettered control over the corporation.¹Given the board's broad authority,² policymakers, courts, and legal scholars constantly look for ways to improve board functioning, especially in the wake of scandals at Enron, WorldCom, and other corporations.³ Making directors independent of management is a popular theme,⁴ as are calls for subjecting directors to more robust fiduciary duties. Fiduciary duties are meant to reduce agency costs between shareholders and directors. Currently, however, fiduciary duties are generally a weak impetus for motivating directors to act in the best interests of shareholders, at least to the extent that fiduciary law would seek to impose liability for director wrongdoing. This recognition has led some corporate law scholars to call for stricter fiduciary duties, which could take the form of an explicit duty to act in good faith⁵ or a revival of the duty of care, which is now on life support.⁶ Other Page 932 corporate law scholars (and, judging by the recent Disney case,⁷ Delaware courts) take a more pessimistic view of fiduciary duty liability as a potential cure for what ails boards, preferring to leave corporate governance to other devices, including market sanctions.⁸

The fiduciary duty literature is rich and fruitful, and thus it is surprising that one important question within fiduciary law-a question that bears upon many of the others-has been virtually ignored. Directors, of course, do not operate in isolation; they are capable of acting only by majority vote.⁹In practice, they usually act unanimously.¹⁰ Yet each director is an individual, and each will either comply or not comply with the standards set by fiduciary law. For example, one director may have a conflict of interest, while the remaining board members do not. Also, different directors may have exercised different levels of carefulness in reaching their decisions. Given these differences (or potential differences) among directors, what impact does one director's fiduciary duty breach have on the liability of the remaining directors? Or, flipping the question, what impact does the compliance of the remaining directors have on the liability of the one breaching director? More broadly, the unexplored question within fiduciary duty law is this: how are outcomes affected when, although all directors vote Page 933 the same way,¹¹ some do so in compliance with their fiduciary duties while others do not? Should director liability be assessed individually or collectively?

An individual focus does not allow a director to hide behind her fellow directors' compliance, but instead deems her singular breach of sufficient gravity to jeopardize the board's functioning and warrant legal sanctions. A collective focus, on the other hand, will serve to insulate any one director's wrongdoing provided the remaining directors complied with their fiduciary duties.¹² Therefore, how courts answer the individual/collective question can have important practical ramifications. Although the choice between treating directors individually or treating them collectively is only one of the variables in fiduciary duty suits, it has the potential to be the difference between a director's liability and her exoneration. As a result, it carries significant financial implications for directors, shareholders, insurers, and attorneys. Moreover, how courts answer the individual/collective question can affect how directors interact with one another and can provide important insights into the judicial view of fiduciary duty liability as a corporate governance mechanism.

This Article favors a duty-specific answer to the individual/collective question on both descriptive and normative grounds. First, it shows that courts generally have focused on the board as a whole in duty of care cases, and on directors as individuals in duty of loyalty cases. Second, this Article argues that courts have been correct in drawing this duty-based distinction because it strikes the proper balance between the board's authority and its Page 934 accountability in each case.¹³ It contends that loyalty breaches, if committed by even a single director, are likely to impact the board's functioning in a meaningful way, and therefore those breaches warrant greater accountability through an individual director focus. On the other hand, due care breaches committed by only one director are unlikely to jeopardize the board's functioning in the same way, and therefore these breaches call for a more deferential collective focus. Because good faith now appears to be a subset of the duty of loyalty,¹⁴ and because it too involves intentional wrongdoing as presently defined,¹⁵ allegations of bad faith also warrant an individual director focus. This Article does not extend the individual/collective analysis to the so-called enhanced or intermediate scrutiny cases found in the takeover context, which present a more difficult question because it is unclear whether a board that enacts takeover defenses is acting intentionally to serve its own interests by staying in power or acting in the best interests of shareholders by thwarting an inadequate bid.¹⁶

After contending that courts are properly oscillating between a collective and individual focus to director liability depending on whether the duty of care or the duty of loyalty is at issue, this Article asks what broader lessons we might take away from this. It suggests that this duty-based distinction reveals a further splintering between the duties of care and loyalty, and by only adopting the stricter individual approach in duty of loyalty cases, courts are further de-emphasizing fiduciary duty liability as a corporate governance mechanism. On the other hand, that courts have only implicitly adopted the more lax collective approach in duty of care cases suggests that the duty of care is still important as an aspirational "standard of conduct," if not a "standard of liability."¹⁷

This Article proceeds as follows. Part II discusses the existing law on the collective versus individual treatment of directors in fiduciary duty suits. This law is comprised of cases that explicitly address the question, cases that implicitly address it, and statutes from Delaware and the Model Business Corporation Act ("MBCA"). Existing law reveals a preference for an individual director focus in duty of loyalty cases and a preference for a collective focus in duty of care cases. Part III first sets forth the normative criteria that should inform the choice between the two assessment approaches on corporate governance policy grounds and then applies those criteria to different types of fiduciary duty claims that a plaintiff may bring. It concludes that courts are creating good corporate governance policy Page 935 through their duty-based distinction. Part IV draws broader implications about fiduciary duties from the courts' resolution of the individual/collective question. Part V concludes.

II The Individual/Collective Question: Existing Law

Existing law on the individual/collective question is difficult to decipher. Forming any sort of a coherent picture about how the law views this question requires piecing together case law that explicitly addresses the question, case law that implicitly addresses it, and relevant statutory provisions from Delaware and the MBCA. Engaging in this exercise reveals a focus that shifts between an individual or collective approach depending on the type of fiduciary breach being litigated. Duty of loyalty claims tend to be analyzed using an individual approach, while duty of care claims tend to be analyzed using a collective approach.¹⁸

This Section begins by examining three high-profile Delaware cases that have explicitly addressed the individual/collective question, albeit briefly and inadequately. It then touches on case law that could be said to implicitly answer the question. Finally, it introduces a Delaware statute and a provision from the MBCA that speak to this question. While other statutes may also be relevant, the two provisions chosen for illustration are important provisions that provide support for the duty-specific framework that emerges from the case law.

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