As fiduciaries, corporate leaders must understand the legal standards they’re entrusted to uphold.
Corporations are complex legal entities. At the heart of every corporation are two key leadership structures: the board of directors and the officers. Both have important responsibilities to properly manage the corporation for the benefit of the shareholders who own it.
Every state imposes legal duties on both officers and directors. Many of these duties are outlined in state statutes. Others, however, have been developed through the courts. Delaware – the state where many businesses decide to incorporate – is home to a particularly vast body of case law addressing corporate governance.
Shareholders, as the ultimate beneficiaries of the corporation, can stand in the shoes of the corporation to hold the leadership accountable. Officers and directors can be held personally liable for the financial losses that result from failure to uphold their legal duties.
Below are some of the legal standards officers and directors must observe. The exact scope and name of these duties vary by state, but the overarching concepts are the same.
1. Duty of good faith
Officers and directors must always act in the best interests of the corporation. This standard underscores everything they do, from making business decisions to managing corporate assets to identifying and disclosing potential conflicts of interests.
2. Duty of care
Corporate leaders must handle business affairs with the same level of care they would in their own personal dealings. They must exercise the degree of diligence and prudence that an ordinary businessperson would under similar circumstances. This duty is ongoing, and it applies to all business decisions.
In fulfilling this duty, officers and directors must stay reasonably informed about the business. They can rely on the opinions of other professionals – for example, the corporation’s legal counsel, accountants or committee members. However, if additional guidance is needed, they cannot move forward without first obtaining an informed basis for the decision.
Business judgment rule
Business decisions involve a significant degree of discretion and judgment. A decision that seemed prudent at the time may nonetheless turn out to be disastrous. There are rarely clear-cut answers, and hindsight is always 20-20.
Recognizing this reality, many courts will uphold the business decisions of officers and directors so long as:
- They acted in good faith
- They had a reasonable basis for the decision
- There was a business purpose for the decision
This standard, called the business judgment rule, gives leaders greater freedom in exercising their professional judgment without fear of liability.
3. Duty of loyalty
When it comes to business dealings, officers and directors must always place the corporation’s interests above their own. They cannot engage in self-dealing. Nor can they usurp a corporate opportunity for their own financial benefit. Should a potential conflict of interest arise, they must disclose it. Likewise, they must report misconduct and mismanagement on the part of other directors and officers.
Applying these standards
While it’s easy to outline the general standards for corporate fiduciaries, it’s far more difficult to apply them in concrete situations. For this reason, directors and officers should always seek qualified legal counsel regarding the scope of their legal responsibilities.
Keywords: corporate officers, executives, fiduciary duties, breach of fiduciary duty, business law, corporate law, shareholder claims