CHAPTER 2 Officer and Director Business Decisions and Fiduciary Duties

JurisdictionUnited States

CHAPTER 2: Officer and Director Business Decisions and Fiduciary Duties

1. Breach of Fiduciary Duty Generally

Corporate officers and directors are common targets of deepening insolvency claims. Plaintiffs frequently allege that one of these parties breached a fiduciary duty by making a decision or taking an action that deepened the insolvency of the corporation. Thus, an understanding of the breach of fiduciary duty action and the various fiduciary duties owed to corporations will help elucidate the connection to deepening insolvency actions.14

2. Nature of Fiduciary Duties Outside of Bankruptcy

A. Historically

Ownership and management can be, and often are, separate roles in a corporate entity. Applicable nonbankruptcy corporate codes require a corporation's business affairs to be managed or directed by a board of directors. Directors, acting on behalf of and for the benefit of the corporation, are thus fiduciaries of their corporation, which benefits the shareholders as the residual owners. While directors are not involved in the daily operations of the corporation, they guide and monitor the corporation's senior management, make strategic policy decisions and promote the corporation's growth. The separation of ownership (by the shareholders) and control (by the board of directors) of the corporation creates a tension between the two constituencies. The tension between ownership and control of a corporation served as a catalyst for the creation of fiduciary duties and continues to develop those duties today. Directors must thus act with care, loyalty, good faith and candor when making decisions for the corporation.

B. Definition of Fiduciary Duties

In Meinhard v. Salmon, the court observed:

Many forms of conduct permissible in a workaday world, for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.15

Implementing this imperative has confounded many authorities.16 Notably, courts fail to reach agreement on an exclusive list of fiduciary duties in the corporate context. However, there is consensus that among these duties, one would normally find the duty of care and duty of loyalty. Authorities have also recognized the duty of good faith, duty of disclosure, duty of impartiality and, in some circumstances, the duty of obedience. Originally, these duties were designed simply to prevent abuse of position. Presently, these duties construct the private regulatory framework for corporate governance and potential liability in the context of corporate responsibilities in and out of bankruptcy.

Generally, applicable nonbankruptcy law (usually state law for U.S. corporations, but with more regularity, the law of foreign nations) vests the responsibility for management of the corporation in a board of directors or a similar body.17 State law generally provides that the directors of a corporation owe a fiduciary duty to the corporation that redounds to the benefit of its shareholders. Outside of contractual provisions and specific statutory limitations,18 the directors generally do not owe a fiduciary duty to creditors of a corporation.

C. Types of Fiduciary Duties

i. Generally

Officers and directors must be mindful of a variety of fiduciary duties in the corporate relationship, which include the duty of care, the duty of loyalty, the duty of good faith, the duty of disclosure, the duty of impartiality and the duty of obedience.19

ii. Duty of Care

The duty of care requires that a director exercise the care that a reasonable person in a like position would exercise under similar circumstances.20 The duty of care requires that management act in an informed and considered manner. To fulfill the duty of care, directors "have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. Having become so informed, they must then act with requisite care in the discharge of their duties."21 In short, the duty of care requires that a director act with a reasonable amount of attention and skill, is well-informed, and exercises reasonable oversight.22

iii. Duty of Loyalty

The duty of loyalty springs from the central principle of placing the interest of the beneficiary first, thus avoiding self-dealing and conflicts of interest.23 In Guth v. Loft, the Delaware Supreme Court offered the classic formulation of the duty of loyalty:

Corporate officers and directors are not permitted to use their position of trust and confidence to further their private interests. While technically not trustees, they stand in a fiduciary relation to the corporation and its stockholders. A public policy, existing through the years, and derived from a profound knowledge of human characteristics and motives, has established a rule that demands of a corporate officer or director, peremptorily and inexorably, the most scrupulous observance of his duty, not only affirmatively to protect the interests of the corporation committed to his charge, but also to refrain from doing anything that would work injury to the corporation, or to deprive it of profit or advantage which his skill and ability might properly bring to it, or to enable it to make in the reasonable and lawful exercise of its powers. The rule that requires an undivided and unselfish loyalty to the corporation demands that there shall be no conflict between duty and self-interest. The occasions for the determination of honesty, good faith and loyal conduct are many and varied, and no hard and fast rule can be formulated. The standard of loyalty is measured by no fixed scale.24

Even though corporate directors owe a duty of loyalty to the corporation, "fiduciary management entails taking action in which the decision-makers have personal interests and conflicts."25 The law does not require that a director serve as a disinterested trustee for a single beneficiary:

The duty of loyalty can still be met in such circumstances through full disclosure and approval or ratification of the decision by disinterested persons. A common example of this rule is the approval of corporate transactions with a board member by a vote of other disinterested board members.26

Thus, corporations, through their directors, address potential conflicts of interest by creating and carefully implementing several constructs, including approval of certain actions by disinterested directors, recusal of interested directors from board discussions or votes, submitting certain proposals to shareholder approval after full disclosure, ensuring extensive deliberation, and recording more vigorously than in general practice.

iv. Duty of Good Faith

The duty of good faith is the cornerstone of the relationship between directors and the corporation.27 Directors must make "a good faith effort to be informed and to exercise appropriate judgment."28 Because of the protection of the business judgment rule, a court may not review the content of a board's decision under a due care analysis, but the court may review the content of a board's decision in determining whether the decision was made in good faith.29

v. Duty of Disclosure

The duty of disclosure requires that directors truthfully and candidly disclose to shareholders all facts material to a transaction involving shareholder approval.30 When a board of directors seeks shareholder action, it has a duty "to disclose fully and fairly pertinent information within the board's control."31 The board's communications must be unambiguous in order to allow shareholders to make an informed vote.32 This is the case whether shareholder approval is mandatory or is voluntarily sought by the directors.33

vi. Duty of Impartiality

The duty of impartiality governs how a fiduciary manages the duty of loyalty among all beneficiaries where the beneficiaries' interests may conflict.34 "When there are two or more beneficiaries of a trust, the trustee is under a duty to deal impartially with them."35 Generally, at least outside of bankruptcy, directors of a corporation may not have a duty of impartiality because the beneficiary of a director's fiduciary duty is the corporation and not any particular shareholder or shareholder group.36

vii. Duty of Obedience

The duty of obedience is often a forgotten duty, frequently subsumed in the duties of care and loyalty. In the appropriate context, it requires that a director obey the directions of its corporation. Of course, a corporation is a legally recognized bundle of relationships, not itself an actor, and can no more shout instruction or convey direction than any other legal fiction. Thus, corporate law, the charter, articles of incorporation, the bylaws and shareholder resolutions dictate the architecture of obedience.

3. Fiduciary Duties in Bankruptcy

While corporate governance and the concomitant fiduciary duties discussed above remain intact in bankruptcy, additional and shifting fiduciary duties come into play. A chapter 11 debtor has fiduciary duties to the "estate" as opposed to, or at least ahead of, its fiduciary duties to creditors and...

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