Chapter 2-2 Officer and Director Liability—Breach of the Duty of Loyalty

• Jurisdiction: United States

2-2 Officer and Director Liability—Breach of the Duty of Loyalty

2-2:1 Overview

Corporate officers and directors owe a fiduciary duty of loyalty to the corporation which they serve. The duty encompasses mismanagement as well as wrongful distributions. This subtopic solely discusses mismanagement.

2-2:1.1 Related Causes of Action

Shareholder Derivative Suits, Breach of Duty of Care, Wrongful Distribution of Dividends, Breach of Partnership Duty

MUST READ CASES

Gearhart Indus, Inc. v. Smith Int'l, Inc., 741 F.2d 707 (5th Cir. 1984)

International Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567 (Tex. 1963).

2-2:2 Elements

2-2:2.1 Mismanagement

(1) The defendant is an officer or director of a corporation

• Officers and directors owe their corporations duties.²⁶

(2) The defendant owes a duty of loyalty to the corporation

• Generally, all officers and directors owe their corporations a duty of loyalty.²⁷

(3) The defendant breaches that duty of loyalty

• The Texas Supreme Court has never directly addressed the applicable standard of care. However, the majority of courts have held the applicable standard of care to be gross negligence.²⁸
• The Texas Supreme Court has generally defined gross negligence as conduct that involves an extreme degree of risk, and the defendant was aware of the extreme risk created by his or her conduct.²⁹
• The plaintiff must affirmatively negate the business judgment rule, which insulates an officer or director who acts in good faith, despite how mistaken those actions might later be.³⁰
• The business judgment rule is not a defense, but rather a substantive rule of law.³¹

(4) Which proximately causes damages to the corporation

• The officer or director's gross negligence must proximately cause the corporation damages.³²

2-2:2.2 Wrongful Distribution of Dividends

For elements, damages and remedies, and defenses of a Usurpation of Business Opportunity cause of action, see Wrongful Distribution of Dividends.

2-2:3 Damages and Remedies

2-2:3.1 Actual Damages

Actual damages are an appropriate remedy.³³

2-2:3.2 Special Damages

Special damages are an appropriate remedy if the plaintiff proves fraud.³⁴

2-2:3.3 Exemplary Damages

Exemplary damages are available if the defendant acts:

• Maliciously;
• Fraudulently; or
• With gross negligence.³⁵
• Willful breaches suffice for the imposition of exemplary damages.³⁶
• Exemplary damages may be predicated upon an equitable remedy alone.³⁷

2-2:4 Defenses

2-2:4.1 Statutory Safe Harbor

In discharging a duty, a director may, in good faith and with ordinary care, rely on information prepared or presented by:

• An officer or employee of the entity;
• Legal counsel;
• A certified public accountant;
• An investment banker;
• A person who the officer or director reasonably believes possesses professional expertise in the matter; or
• A committee of the board of directors of which the director is not a member.³⁸
• The Statutory Safe Harbor for Directors might not be an affirmative defense.³⁹

2-2:4.2 Interested Transaction/Corporate Opportunity Validity Procedures

Interested-director transactions will be deemed valid notwithstanding the director's interest in the transaction or participation in the meeting at which the transaction is approved when the director fully...