Conflicts of Interest and the Director's Duty of Loyalty
| Publication year | 1988 |
| Pages | 1969 |
| Citation | Vol. 17 No. 10 Pg. 1969 |
1988, October, Pg. 1969. Conflicts of Interest and the Director's Duty of Loyalty
Members of a corporation's board of directors frequently find themselves in the unenviable position of being asked to make business decisions for the benefit of their corporation which may have long-term effects on the viability of the corporation. If the effect proves to be positive, it is likely that few if any shareholders will complain. However, if the effect is negative, the value of the corporation's outstanding stock probably will be affected. The shareholders are more likely to question the decisionmaking process and seek to hold one or more members of the board or management liable for their loss.(fn1)
In earlier times, insurance purchased to insure against liability arising from the mistakes of directors and officers provided protection. Recently, however, only the largest corporations have been able to obtain directors and officers ("D&O") insurance on reasonable terms. As a result of the unavailability of such insurance and the reluctance of "outside directors" (as opposed to members of management or large shareholders) to serve on corporate boards and in response to at least one decision from the Delaware Supreme Court holding members of the board liable for "negligent" actions, Delaware adopted a provision allowing for the exoneration of directors for actions which breached the "duty of care" that each director owes to a corporation.(fn2) Shortly thereafter, several other states,(fn3) including Colorado,(fn4) adopted similar statutes.
Because of these statutes, corporations which include appropriate provisions in their articles of incorporation may limit or eliminate the potential liability of their directors for any violation of their duty of care. The Colorado statute(fn5) expressly excludes from its protection any violation by directors of their duty of loyalty.
While the duty of care and the business judgment rule deriving from the duty of care have been discussed in many articles, the duty of loyalty is not widely understood. This article discusses the duty of loyalty, and describes situations in which the duty is placed into question.
Directors unquestionably owe a duty of loyalty to their corporation and its shareholders. Colorado courts have not discussed this duty in the context of a director's duties to his or her corporation.(fn6) They have, however, discussed it in other contexts.(fn7)
The duty of loyalty a director owes to his or her corporation is generally defined as follows:
Stated another way, concern for the stockholders of the corporation must be paramount over any other concern the directors might have.(fn9)By assuming his office, the corporate director commits allegiance to the enterprise and acknowledges that the best interests of the corporation and its shareholders must prevail over any individual interest of his own. The basic principle to be observed is that the director should not use his corporate position to make a personal profit or gain other personal advantage.(fn8)
The duty of loyalty of the director to the corporation is brought into question whenever the director stands to gain, directly or indirectly, from a corporate decision in a different manner than the corporation and its shareholders might gain. An example is where the director is on both sides of the transaction, such as when the corporation contracts with a director or a firm controlled by a director. In Natoli v. Carriage House Motor Home, Inc.,(fn10) a New York federal district court found a brother to have breached his fiduciary duty of loyalty to a corporation in a derivative action brought by his sister where the brother, as director and chief operating officer, used corporate funds for personal expenses without providing security or interest.(fn11)
The duty of loyalty also requires the sharing of information among directors which may affect the corporation's course of business. This was placed into question in a Delaware case, Weinberger v. UOP, Inc.(fn12) Directors of UOP, Inc., a 50.5 percent owned subsidiary of Signal Companies, Inc., approved a cashout merger so that Signal could acquire 100 percent of the outstanding UOP
The Delaware Supreme Court found that the Signal directors owed a duty to UOP to share that information with all UOP directors even though they may also have...
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