Fiduciary Duties and Other Responsibilities Sixth Edition 2016
1. Fiduciary Duties and
Other Responsibilities
of Corporate Directors
and Officers
Sixth Edition
Christopher M. Forrester
Shearman & Sterling LLP
Celeste S. Ferber, Esq.
Foreword by John Buley
Professor of the Practice of Finance
Duke University
Fuqua School of Business
2.
3. FIDUCIARY DUTIES AND
OTHER RESPONSIBILITIES
OF CORPORATE
DIRECTORS AND
OFFICERS
Christopher M. Forrester
Shearman & Sterling LLP
Celeste S. Ferber, Esq.
Foreword by John Buley
Professor of the Practice of Finance
Duke University
Fuqua School of Business
Sixth Edition
5. About This Handbook
This Handbook is designed to assist directors and officers of public and private corpo-
rations in fulfilling their duties to their corporate constituents. The Handbook is intended to
provide both an authoritative resource and a practical hands-on tool for addressing various
situations faced by directors and officers. To that end, the Handbook combines a dis-
cussion of the law and case studies and practice pointers that illustrate application of the
law to the real world challenges faced each day by directors and officers of U.S. corpo-
rations.
Given that a substantial majority of publicly traded U.S. corporations are incorporated in
Delaware and that courts in other jurisdictions often look to Delaware court decisions for
guidance, the information provided in the Handbook is premised principally on Delaware
law, unless otherwise noted. This handbook is limited to the laws that affect corporations,
as compared to other forms of business entities, such as partnerships and limited liability
companies.
None of the information contained in this Handbook is intended to constitute legal advice
or establish an attorney-client relationship with the authors or Shearman & Sterling LLP or
any of the attorneys in that firm, and you should not rely on any of the information in this
Handbook without consulting with your legal counsel as to your specific circumstances.
This handbook was prepared and published as of March 2016 and does not reflect develop-
ments or events occurring after that time.
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6. About the Authors
Christopher M. Forrester
As a partner in Shearman & Sterling LLP, Christopher M. Forrester’s practice focuses on the
representation of public and private companies and investment banks in general corporate and
finance matters, with an emphasis on mergers, acquisitions and strategic transactions, public
and private securities offerings and corporate governance and compliance.
Celeste S. Ferber
Celeste Ferber is former counsel in Shearman & Sterling LLP’s Capital Markets Group and
now serves as Associate General Counsel of Aduro Biotech, Inc. Ms. Ferber has extensive
experience representing issuers and underwriters in public and private securities offerings and
on a broad range of transactional, securities and corporate governance matters.
Contributing Authors
The following Shearman & Sterling LLP partners provided assistance in the editorial process
for this work: Robert Evans, Michael Kennedy, Patrick Robbins and Fredric Sosnick.
The following Shearman & Sterling LLP associates provided substantial contributions to the
preparation of this Sixth Edition of the Handbook: Antonio Herrera Cuevas, Chen Ye, Jeremy
Cleveland, Nathan Mee, Patrick Fischer, Scott Lucas and Yian Huang.
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12. FOREWORD
I am honored to write the Introduction to the Sixth Edition of Fiduciary Duties
and Other Responsibilities of Corporate Directors and Officers. I am grateful to my
friends Chris Forrester and Celeste Ferber, and their colleagues at Shearman & Ster-
ling for providing an accessible resource for managers, directors, investors and other
lawyers.
While a business practitioner, I often referred to prior editions of this book for its
concise, comprehensive, jargon-free, practical guide to the roles of officers and direc-
tors. This book’s lessons proved valuable in numerous business combinations, divest-
itures, financings and insolvency and bankruptcy proceedings. As an academic, I better
appreciate its utility in training current and future business leaders. Understanding the
roles and duties of officers and directors to the corporation is critical; and under-
standing the relationship between the corporation and its shareholders is increasingly
important in the current business climate.
It was not always so. Until the late 1980s, corporate governance in general and
the role of officers and directors was not of great interest to academics, business pro-
fessionals or all but very specialized lawyers.
How times have changed. The merger waves of the past three decades, the lever-
aged buyout boom, and the advent of poison pills and other defensive tactics have shined
a spotlight on the duties and responsibilities of officers and directors to their companies
and shareholders. Business practitioners read, “The business and affairs of every corpo-
ration…shall be managed by or under the direction of a board of directors” but needed
better understanding of that phrase in order to hold their positions and exercise their
responsibilities. Directors and officers were well aware that they should “act in the best
interests of the corporation,” but what exactly did that term mean? To some, the term
meant exactly what it said. A few academics invented the phrase “maximizing share-
holder value” in the short term despite long term or potential negative consequences to
long-term interests of corporations, other stakeholders or long term shareholders.
Scandals at Adelphia, Enron, WorldCom, Global Crossing, Tyco and others high-
lighted the need for informed, knowledgeable business professionals who not only
understand their businesses but who also understand the governance framework
against which they are held accountable. Officers and directors of public and private
companies sharpened their understanding of Delaware Corporate Law using prior edi-
tions of this book, not to replace the need for legal advice but to understand the context
in which legal advice is provided. A new federal law, Sarbanes-Oxley, was enacted to
enhance governance and insert specific rules into the corporate governance so that
such scandals, and the judicial rulings discussed in this book, would never again occur.
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13. It was not to be. The Global Financial Crisis of the next decade and failures of
corporate governance at Bear Stearns, Lehman Brothers and many other financial
institutions demonstrated (as if further demonstration was needed) that men and
women engaged in business need to have basic legal principles in a single source as a
reference tool to understand the context upon which their conduct and decisions would
be judged. This book is also helpful in understanding the context of the legal advice
provide by in-house and outside counsel.
We do not know what the next decade will bring, but we do know that nearly all
public company mergers and acquisitions result in litigation claiming officers and
directors were not “acting in the best interests of the corporation.” We can expect that
shareholders and activist investors will continue to fight “the battle for corporate con-
trol” between shareholder democracy and Board of Director independence. We can
also expect the next edition of this book to be longer.
This book is written with a keen eye towards the needs of business practitioners,
senior officers and directors, and persons advising the above. It is an important compi-
lation of relevant, highly readable, indexed chapters on each of the issues facing
corporate managers and directors and those who advise them. Corporate governance is
important and a wealth of academic research demonstrates shareholders will pay a
premium for shares of public companies with good corporate governance.
To you, the reader, I offer the same advice I have given to hundreds of MBA
students who have received this book—When air turbulence hits the plane at 35,000
feet, you know you should have listened to the safety instructions and read the safety
card instead of checking email before the fasten seat belt sign came on. Just as you
instinctively reach for the printed instructions in the seatback in front of you to figure
out where the nearest exit may be, carry this book with you, even if you do not read it
cover to cover. You never know when you will have to excuse yourself from a meeting
to read the clear, specific, precise and practical guidance contained in this book.
John Buley
Professor of the Practice of Finance
Duke University
Fuqua School of Business
January 2016
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14. OVERVIEW OF THE HANDBOOK
Chapter 1 discusses the general relationship of directors and officers with their
corporation, including reviewing the process surrounding election and appointment to
their positions, their general powers, authorities and responsibilities, the rules that
govern their actions, the constituents served by directors and officers and the potential
liabilities that they face.
Chapter 2 provides an overview of the business judgment rule, and the duties of
care, loyalty, good faith and fair dealing and disclosure. The business judgment rule is
a court-developed doctrine that is designed to provide directors and officers with the
latitude to exercise their judgment in furtherance of managing the corporation’s busi-
ness and affairs without fear of having every one of their actions second-guessed by
litigious stockholders and courts.
Chapter 3 provides a more detailed application of the business judgment rule to
specific transactions and other situations, such as mergers and acquisitions, hostile
takeovers and activist stockholder demands.
Chapter 4 addresses fiduciary duties in the context of going private transactions,
which implicate complicated disclosure and conflict of interest considerations.
Chapter 5 discusses how special committees can be used to mitigate against
claims of a breach of the duty of loyalty and to safeguard against potential conflicts of
interest.
Chapter 6 addresses the duties of directors and officers when a business becomes
insolvent and the particular duties that directors owe not only to the corporation and its
stockholders, but also in some cases to the creditors of the corporation.
Chapter 7 provides an overview of the attorney-client privilege and a discussion
of the work product doctrine. It explains the complicated relationships between the
corporation, its counsel and the directors, particularly in the context of derivative suits,
class actions and special investigations.
Chapter 8 introduces indemnification and liability insurance. It provides essential
information on who can be indemnified by a corporation and special issues that should
be considered in selecting director and officer liability insurance.
Chapter 9 discusses the concepts of piercing the corporate veil and agency, two
theories by which stockholders may be liable for any lawsuits brought against the
corporation if the corporate form is not properly respected.
Chapter 10 discusses fiduciary duties and other responsibilities of officers and
directors of non-profit corporations generally.
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15. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
CHAPTER 1
MANAGING THE BUSINESS: THE ROLES OF DIRECTORS
AND OFFICERS
INTRODUCTION
Corporate laws in the United States provide that the board of directors is respon-
sible for the management of the corporation’s business and affairs. In managing the
business and affairs of corporations, boards typically act in a supervisory role, and
delegate the details of the day-to-day management of the business to the officers of the
corporation. This construct provides a balance between the officers who have actual
and apparent authority to direct and control the daily activities of the business and the
board of directors which has the ultimate responsibility for the corporation and the
power and responsibility to supervise the officers. While the officers are agents of the
corporation in the strict legal sense and so have the power individually to bind the
corporation to obligations and take actions, the directors in their capacity as directors
are not agents and generally can act only as a group. The directors are fiduciaries of
the corporation and as a group have the ultimate power and authority over the manage-
ment of the business through their ability to hire,
supervise and replace the officers.1
In addition to having the responsibility to
supervise and, if necessary, replace the officers, the
board is charged by law with the power and
responsibility to approve major corporate actions,
such as issuing securities, entering into a merger,
converting the business from a corporation to a
limited liability company, partnership or other form, disposing of substantially all of
the corporation’s assets or dissolving the corporation. Further, through their super-
visory powers, boards frequently require the officers to obtain board approval for
events that are not fundamental to the business, but are nevertheless sensitive or
material – for example, entering into a significant acquisition, licensing, financing or
other contractual arrangement. In contrast, officers are charged with the daily
management of the business and have the power under the Delaware General Corpo-
1 8 Del. C. §141(a).
The officers are charged
with managing the day-to-
day operations of the
corporation while the board
is responsible for the overall
management of the corpo-
ration and supervision of
the officers.
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16. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
ration Law (the “DGCL”) to bind the corporation; however, they do not have the
authority, acting without board approval, to cause the corporation to take the type of
fundamental corporate actions described above.2
This balance between the directors and the officers is created by the DGCL and
Delaware case law, which together provide that every corporation shall have a board
of directors, and establish the responsibility of that board to manage the affairs of the
corporation. The DGCL also provides for the appointment of certain officers – which
commonly include a president, treasurer, secretary and one or more vice presidents –
to manage the daily activities of the corporation.3 However, the DGCL also provides a
corporation with latitude to customize various aspects of its governance structure
through its charter documents (i.e., its certificate of incorporation and bylaws).4 One
common example is that many U.S. corporations appoint a chief executive officer as
their most senior officer in lieu of, or in addition to, a president pursuant to bylaw
provisions.
It is important to note that each
corporation may approach the roles
of, and interaction between, man-
agement and the board somewhat
differently. The decision as to how
much power and authority to vest in
the management and what level of
involvement the board will have in
the activities of the business is a decision for each board to make, which is then memo-
rialized in the corporation’s charter, bylaws and corporate resolutions, as well as board
practices, committee charters and meeting agendas.
THE INTERACTION AMONG THE BOARD, THE CHIEF EXECUTIVE OFFICER
AND THE OTHER OFFICERS
In general, most boards seek to fulfill their obligation to supervise the managers
primarily by consulting with the corporation’s most senior officer (usually the chief
executive officer) on major decisions affecting the business, and reviewing, guiding
2 See, e.g., 8 Del. C. §§151-52, 251-66, 271-85.
3 8 Del. C. §142.
4 See, e.g., 8 Del. C. §142.
Although the board ultimately supervises
the activities of all of the officers in
managing the business, typically the chief
executive officer reports directly to the
board, and the other “C-level” officers,
including the chief operating and chief
financial officers, and vice presidents,
report to the chief executive officer.
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17. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
and ultimately supervising the performance of the chief executive officer. The chief
executive officer, in turn, generally is charged with the power and authority to super-
vise the other officers, who report directly to the chief executive officer rather than the
board. Notwithstanding this practical chain of command, most corporations’ bylaws
provide that senior officers are selected by the board, meaning that, while the officers
other than the chief executive officer report to the chief executive officer, the board
will remain actively involved in establishing and evaluating the duties and perform-
ance of those officers. Beyond the chief executive officer, typical officer positions and
their general responsibilities are as follows:
• President. The president is responsible for the supervision of the other officers
and the day-to-day management of the business. If an organization does not
have a separate chief executive officer, then the president is generally the most
senior position in the organization. If an organization has both a chief executive
officer and a president, those officers generally work very closely to supervise
the other officers and manage day-to-day operation of the business.
• Secretary. The secretary is the person respon-
sible for keeping the books and records of the
corporation, including the corporate minute
book.5 As such, the secretary attends board
meetings to keep minutes, although the corpo-
ration’s legal counsel is sometimes charged
with preparing the initial draft of the minutes.
As the official keeper of the books and records,
the secretary generally is responsible for
certifying the accuracy of corporate documents
to third parties, for example, banks or financing
sources.
In many companies, this position is held by the General Counsel.
• Treasurer. The treasurer is generally the most senior financial position in the
corporation, although companies often use the title chief financial officer as
the most senior level financial position. The treasurer is charged with main-
taining the corporation’s finances as well as supervising the accounting
functions of the business. In larger companies, it is common not only to have
5 8 Del. C. §142(a).
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Officer positions and
responsibilities are
generally established
by the corporation’s
bylaws and the board
is free, to a large
degree, to customize
those positions under
Delaware law.
18. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
a chief financial officer who serves the role of treasurer, but also to have a
controller who performs the accounting functions and a vice president of
finance who is in charge of the financing aspects of the business.
• Vice President. Vice presidents can be appointed to oversee specific busi-
ness functions, such as sales, marketing, research and development, human
resources, information technology or finance. Although generally vice
presidents are appointed by and report to the board, the bylaws may provide
that certain vice presidents may be appointed by (and report to) other offi-
cers of the corporation, such as the chief executive officer or president.
• Other Officers. The DGCL contemplates that the corporation may create
additional officers and it is quite frequent that companies create such posi-
tions in their bylaws, such as chief technology officer or chief marketing
officer. If these positions are designated by the bylaws as officer positions in
the corporation, then they will have authority as such, and their specific
duties and reporting structure will be specified in the bylaws. However,
many companies draw distinctions between executive officers and non-
executive officers, with executive officers being viewed as the primary
corporate officers while the non-executive officers are considered a class of
junior officers without the same powers or responsibilities. As noted above,
to truly ascertain the power, responsibility and reporting authority of officers
of a particular corporation, it is necessary to consult its bylaws.
• Executive Chairperson. It is notable that although the DGCL contemplates
that non-management directors are not officers and therefore cannot act to
bind the corporation, in some states by law, the chairperson of the board also
is specifically designated as an officer position.6 Also, many companies
specifically create an office of the Executive Chairman in their bylaws, in
which case the Executive Chairman typically is designated an officer.
Executive Chair positions may be created to separate the CEO and Chairman
role, to allow for support of a CEO by a strong Executive Chair, or for other
reasons in the discretion of the board. To ascertain whether the chairperson
of a particular corporation is or is not an officer, and to understand that
officer’s powers and authority, one must consult the bylaws of the corpo-
ration and resolutions of the board.
6 See, e.g., Cal. Corp. Code §312.
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19. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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BOARD DYNAMICS
Just as a president or chief executive officer is responsible for the daily manage-
ment of the business, the chairperson of the board is generally responsible for manag-
ing the affairs of the board. Most corporations provide in their bylaws that the
chairperson of the board is empowered to call board meetings, set the agenda for the
board meetings and preside over board meetings. The specific manner and timing of
calling board meetings is specified in a corporation’s bylaws, but many corporations
use as a default rule that board meetings can be called on some minimum advance
notice (e.g., four days’ notice if the notice is given by mail or 48 hours’ notice if the
notice is given by telephone or other electronic means, such as email). Notice of meet-
ings may always be waived by directors at any
time either in writing or by their presence at a
meeting. The agenda for meetings and support-
ing materials should be distributed in advance
whenever possible so that the directors have an
opportunity to prepare for the meeting and
provide meaningful contributions.
Convening a board meeting requires that a quorum of directors be present at the
meeting. Generally, the specific number of directors required for a quorum will be
specified in the bylaws (but in no event will be less than one third of the total number
of directors); in the absence of a specific quorum requirement, the DGCL provides a
default rule of not less than a majority of the board members.7 Once a board meeting is
duly convened and a quorum is present, in the absence of a specific provision in the
bylaws otherwise, the vote of a majority of the directors present and voting at the meet-
ing will be sufficient to constitute an action of the board.8 In addition to taking action at
a properly convened meeting, a board may take action by written consent, which must
be signed or electronically consented to by all directors. Unanimous written consents
are not effective until all signatures or electronic consents have been obtained.9
7 8 Del. C. §141(b).
8 Id.
9 8 Del. C. §141(f). However, in the case of publicly listed companies, in many cases specific actions
must be approved by a majority of the board’s “independent” directors or a committee comprised solely of
independent directors. In these cases, the definitions of independence are specified by rules of the U.S.
Securities and Exchange Commission or the stock exchange on which such Company’s shares are listed.
The chairperson of the board is
generally responsible for
managing the affairs of the
board, including calling meet-
ings and setting agendas.
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20. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
Not infrequently board members may speak of having the power to vote by
proxy. Unlike stockholders, however, board members cannot vote by proxy.10 The
essence of the board’s effectiveness is its ability to engage in meaningful discussions
and deliberations where all members of the board can express their views and debate
the potential risks and benefits of a particular course of action. The concept that one or
more board members may be individually briefed on a topic privately and then deliver
their vote privately by proxy is contrary to the concept of a robust board deliberation.
Extra care should used to permit the attendance of all or as many of the board
members as possible, particularly for sensitive and important matters. The importance
of directors’ participation and attendance at board meet-
ings is underscored by the fact that the rules and regu-
lations of the U.S. Securities and Exchange Commission
(“SEC”) require that reporting companies under the Secu-
rities Exchange Act of 1934 (the “Exchange Act”) dis-
close if directors have failed to attend 75% of board and
committee meetings.11
In addition to acting as a whole, many boards designate (and in fact, public corpo-
ration boards are required to designate) one or more committees or sub-committees.
The most notable examples of this are the audit committee and the compensation
committee. The rules of the SEC and the listing rules of the national securities
exchanges, such as the New York Stock Exchange and The Nasdaq Stock Market,
specifically require that reporting companies whose stock is listed on a national secu-
rities exchange maintain an audit committee and a compensation committee, each
composed entirely of “independent directors.”12 Independent directors are defined as
directors who, among other things, do not receive compensation from the company
other than in their role as a director, are not part of management and who do not
otherwise have a role or relationship with the corporation that has the potential of
10 In re Acadia Dairies, Inc., 15 Del. Ch. 248 (1927). This rule is commonly misunderstood because
some jurisdictions, such as the Cayman Islands, do permit directors to vote by proxy.
11 17 C.F.R. 229.407; 17 C.F.R. 240.10A; see Commission Guidance on The Use of Company Web-
sites, Release Nos. 34-58288 (Aug. 1, 2008).
12 Nasdaq Listing Rule 5605; NYSE Listing Rules 303A.05 and 303A.06; see also 17 C.F.R. 240.10A-
3 and 17 C.F.R. 240.10C-1.
Attendance at board
meetings is critically
important and board
members may not act
by proxy.
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21. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
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The rules of the SEC and the list-
ing rules of the national securities
exchanges, require a board to
have an audit committee com-
posed of independent directors
and that includes a designated
“audit committee financial
expert.”
The listing rules of the national
securities exchanges require that
a board have a nominating
committee and compensation
committee composed of
independent directors.
creating any conflict of interest. In addition, members of a public company’s audit
committee are expected, through formal education or experience, to have enhanced skills
in reading and understanding financial statements and in accounting matters generally.
The audit committee is charged with
approving the corporation’s auditors, super-
vising the chief accounting officer of the
corporation in the preparation of the corpo-
ration’s financial statements, monitoring
complaints by employees regarding financial
matters, and other important financial and
accounting-related matters.13
The compensation committee is charged with establishing and reviewing the
compensation policies and procedures for the senior officers, as well as administer-
ing the corporation’s compensation and equity incentive plans. In addition, approval
of compensation packages by compensation committees composed of non-employee
directors can provide certain required appro-
vals under the Internal Revenue Code neces-
sary to make certain of the corporation’s
compensation payments tax-deductible. In
addition, many companies utilize a nominat-
ing and/or corporate governance committee
to help manage the affairs of the corporation
(the national securities exchanges also require independent oversight of director nomi-
nations – either through a formal committee, or approval of the independent members
of the board). Nominating committees generally evaluate directors’ performance and
interview and nominate director candidates for board and stockholder consideration.
Boards may also delegate other duties and functions to committees of the board, with
certain limitations specified in the DGCL.
13 Id.; see also 15 U.S.C.S. §78j-m.
22. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
Generally, each committee is managed by a chairperson. Similar to the role of the
chairperson of the board, the chairperson of the committee is charged with calling
committee meetings, setting the agenda, and reporting
back to the board on the business of the committee.
Though directors who serve on one or more
committees or as a chairperson of the board or a
committee take on additional responsibilities in those
roles, they are subject to the same fiduciary duties
applicable to regular directors.14
APPOINTMENT TO POSITIONS
Directors
Directors are elected to hold office by the stockholders of the corporation at an
annual stockholders meeting, or by written consent of the stockholders if not pro-
hibited by the corporation’s certificate of incorporation.15 Vacancies on the board may
also be filled by a vote of the board pending the next annual meeting of stockholders.
Nominees for director can be made by any shareholder or by the board of directors.
Public companies generally do not include directors nominated by shareholders in the
proxy materials that are prepared and filed with the SEC. Given that many share-
holders vote in advance of the meeting by proxy, the fact that the director nominees of
shareholders are not included in the proxy materials can effectively preclude such
nominees from having a meaningful opportunity to be elected. In an effort to modify
this trend, in August 2010, the SEC modified the proxy rules to adopt new
Rule 14a-11 to require, among other things, that a company include in its annual proxy
statement the names of directors nominated by shareholders who have held shares for
at least three years and who hold at least three percent of the company’s outstanding
common stock. Rule 14a-11, however, was vacated in 2011 by a federal court that
found the SEC had exceeded its authority (although Rule 14a-8 remains and provides
14 Lyman P.Q. Johnson, Corporate Compliance Symposium: The Audit Committee’s Ethical and Legal
Responsibilities: The State Law Perspective, 47 S. Tex. L. Rev. 27, 39 (2005). Similarly, although public
companies are required under the Exchange Act to designate at least one member of the audit committee
as the “audit committee financial expert,” such designation is not intended to place additional liability on
the individual designated. 17 C.F.R. 229.407(d)(5)(iv)(B).
15 8 Del. C. §211(b).
Being designated as the
“audit committee finan-
cial expert” is not
intended to place addi-
tional liability on the
individual designated.
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23. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
shareholders some ability to influence matters included in proxy statements).16 The
concept has nonetheless been picked up by shareholders and shareholder rights groups,
and currently many public companies are being pressured to implement, and some are
implementing, policies and procedures that permit shareholder nominees to be
included in company proxy materials even though they are not required to do so by
law. Even if proxy access rules become operative, a company may still require stock-
holders to give advance notice of their intention to propose nominees for director by an
appropriate bylaw provision.
The default rule under the DGCL is that the slate of directors receiving the most
votes (a plurality) at a properly convened meeting of stockholders or by written con-
sent of stockholders, if applicable, will be elected to office. Recently, many public
companies have modified their charters to require that directors must actually receive a
majority of the outstanding votes, or at least a majority of the shares voted at the meet-
ing to be elected or, alternatively, if a director receives fewer votes for reelection than
withheld votes, the director must submit a resignation for consideration by the board.
Although the default rule under Dela-
ware law is that directors hold office for
one-year terms, the DGCL permits the strat-
ification of a board into classes, with each
class having a term that expires in succes-
sive years.17 This is commonly referred to
as a classified or staggered board. The most
frequent example is a board of three classes
with each class having a three-year term and
expiring on successive years. Some believe
that classified boards provide stability by
ensuring that at any one election, only a
portion of the board will be
re-elected. On the other hand, classified boards have been used as a device to resist
hostile takeovers, and many stockholder rights activists believe that classified boards
unduly impair the stockholders’ fundamental right to change the board, if they believe
16 Business Roundtable and Chamber of Commerce of the United States of America v. Securities &
Exchange Commission (D.C. July 22, 2011).
17 8 Del. C. §§141(d), 211.
Although the default rule under
the DGCL is that directors who
receive a vote of the plurality of
the shares voted (i.e., the most) are
elected to office, in response to
shareholder pressure, some public
corporations have modified their
bylaws to specifically require that
directors must receive a specified
minimum number of shares
approving their candidacy before
they will be elected.
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24. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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that the corporation is not being managed appropriately. Use of classified boards in the
context of takeover defenses is discussed further in Chapter 3 of this Handbook.
Officers
As noted above, the board has the power, authority and responsibility under the
DGCL to appoint the officers of the corporation.18 Many boards feel, and rightly so,
that to effectively discharge their duties to manage the business and affairs of the
corporation, they should regularly evaluate, counsel and supervise the entire manage-
ment team to some degree. For this reason, although a board may delegate the
management and performance review of the subordinate officers of the corporation to
the chief executive officer, most boards exercise some level of supervision over the
most senior officers of the corporation including the chief financial officer, chief oper-
ations officer, president and vice presidents.
IDENTIFYING THE CONSTITUENTS
One of the most difficult tasks for a board and management team is to balance the
competing interests of multiple constituents of a business. There are employees, ven-
dors, creditors (and bondholders), contract counterparties, customers, communities,
society and, of course, stockholders to consider. Whom do you serve first? So long as
a particular decision benefits all parties equally, the decision of a board and manage-
ment team is quite easy. The difficulty arises when decisions do not affect all parties
equally.
Although not always easy in application, there is a clear legal answer to the ques-
tion: a corporation’s board and management
owe a fiduciary duty as their primary obliga-
tion, above all others, to the stockholders, to
maximize the value of the equity of the corpo-
ration.19 Fiduciary duty is a core legal concept,
perhaps the most fundamental legal concept
that underlies the manner in which U.S. corpo-
rations are managed. A fiduciary owes an
18 8 Del. C. §142.
19 There is increasing support in the public and various state legislatures for new corporate forms that
allow or require directors to consider the interests of constituencies other than shareholders, such as their
employees, communities and the natural environment, in making decisions.
In a solvent business, directors
and officers of a Delaware
corporation are bound by a
fiduciary duty to manage the
business to maximize the inter-
ests of the stockholders first and
foremost.
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25. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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utmost duty of care, candor and confidence to its constituent. A fiduciary must act with
a high standard of care with respect to its constituent and must avoid conflicts of inter-
ests, including taking actions that would advantage the fiduciary to the disadvantage of
the constituent.
Directors and officers of a solvent corporation are fiduciaries of the common
stockholders. Consequently, decisions made in furtherance of managing the business
should first and foremost focus on what is in the best interests of the stockholders.
Notwithstanding the apparent oversimplification, it is frequently advisable to consider
what might be the impact on other constituents of the business, for example, its
employees, vendors, creditors and contract counterparties, to maximize the long-term
value of the stockholders. Indeed, a daily focus of the managers of a business is to
ensure that the business meets its contractual obligations, satisfies its creditors, cares
for its employees and vendors, and pleases its customers. Fortunately, doing these
things generally will result in building the business for the stockholders, so that the
interests of constituents are aligned.
Unfortunately, as business conditions change, boards and officers may be unable
to make decisions that satisfy all constituents and instead must focus on maximizing
value for the stockholders. These decisions may be difficult and may involve damag-
ing long-standing and important personal relationships – for example, substantial lay-
offs for the benefit of the business and mergers or acquisitions that may result in the
shutdown or wind-up of business units or may otherwise affect the status of employ-
ees. When these challenging decisions must be made,
it is critical to remember the board’s fundamental
obligation to act in the best interest of the stock-
holders. After all, it is the stockholders who have
selected the directors and the directors who have
selected the officers who are entrusted to manage the corporation for the stockholders’
benefit.
The duties of directors and officers to care for the interests of stockholders
change dramatically when a business falters and becomes insolvent. When a business
is insolvent, the creditors become the residual risk-bearers (the position typically held
by stockholders). Therefore, the primary duties of the board and management shift
from protecting the interests of the stockholders to protecting the interests of the
The duties of the board
shift from stockholders to
creditors when a business
becomes insolvent.
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26. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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corporation’s creditors. These situations present boards and officers with some of the
most difficult decisions they face. The specific and complicated duties and demands
placed on boards and officers when a corporation becomes insolvent are discussed in
detail in Chapter 6 of this Handbook.
GOVERNING RULES
In addition to the DGCL, there are myriad rules that must be observed in manag-
ing a corporation. Directors and officers must be aware of federal and state statutes
and regulations as well as local ordinances that may affect the facilities and local
activities of the business. For example, state employment laws can be complex and
provide for substantial penalties and fines if they are disregarded. Federal and state
laws affecting employee benefits and healthcare often are byzantine and implicate
corporate, employment and tax considerations as well as complicated contractual obli-
gations with third-party insurers and administrators.
Some states, such as California, seek to impose their corporate laws on corpo-
rations domiciled in other states but that engage in substantial business activities in the
concerned state.20 Federal, state and foreign income tax and state sales tax laws apply
to corporations in varying degrees and are aggressively enforced. Federal and state
securities laws affect the manner in which a corporation markets and sells its equity
and debt securities to investors. Disclosure laws also affect the manner and extent to
which corporations communicate with their investors.
There are many other federal and state statutes and regulations, as well as court
decisions and local ordinances, that may affect individual businesses, including but not
limited to laws pertaining to environmental, foreign corrupt practices, antitrust, dis-
ability, copyright, trademark, patent, property and criminal matters. Application of
these and other laws varies widely from business to business. It is important that a
corporation familiarize itself with the laws to which it may be subject and tailor its
operations accordingly.
20 See, e.g., Cal. Corp. Code §2115.
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27. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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Beyond the realm of statutes, regulations, ordinances and court decisions, there
are also industry standards and guidelines that have a substantial impact on a corpo-
ration. The books and records of a U.S. corporation typically must comply with Gen-
erally Accepted Accounting Principles or GAAP. Further, many corporations doing
business outside the United States must also maintain their books and records in
accordance with International Financial Reporting Standards or other local require-
ments, and transactions between U.S. corporations and foreign investors or entities
may be subject to national security scrutiny. Stock exchange rules require companies
to establish various committees and promulgate and police procedures and canons. On
top of these demands, many companies also seek to implement best practices that go
beyond what is required.
MITIGATING LIABILITY CONCERNS
Directors and officers face the tough challenge of navigating a path to profit-
ability while making various nuanced business decisions. The last thing that directors
and officers should have to worry about is a court second-guessing their decisions with
the benefit of hindsight, particularly given that such decisions are frequently tough and
must be made under stressful conditions in real time on imperfect information. For-
tunately, there are several protections that have developed to provide directors and
officers with some assurance that their decisions will be respected in the future.
The most fundamental of protections for directors and officers is the business
judgment rule. The business judgment rule is a judicially developed doctrine that
recognizes that directors and officers are generally best situated to make difficult deci-
sions that affect the rights of stockholders, and provides strong deference to the
integrity of those decisions in the face of claims of malfeasance or negligence. Given
the central importance of the business judgment rule, much of this Handbook is
devoted to discussing the applicability of the business judgment rule to various sit-
uations. Directors and officers would be well counseled to learn about the business
judgment rule in some level of detail and to ensure that their actions are best situated
to enjoy the protection of the business judgment rule. The business judgment rule is
discussed generally beginning in Chapter 2 of this Handbook and specifically in sev-
eral further chapters.
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28. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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Additional protections potentially available for directors and officers include cer-
tificate of incorporation provisions that can eliminate or limit directors’ personal
liability to the corporation and its stockholders as permitted by the DGCL, mandatory
and permissive indemnification protections available under the DGCL,
indemnification provisions contained in a corporation’s certificate of incorporation and
bylaws, contractual indemnification agreements, and directors’ and officers’ insurance
policies. These protections are designed to provide further assurance to directors and
officers so that they feel comfortable exercising their business judgment in a manner
that they believe best advances the interests of the corporation’s stockholders, without
unnecessary fear of personal liability. These protections are also discussed in greater
detail in Chapter 8 of this Handbook.
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29. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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CHAPTER 2
GENERAL OVERVIEW OF THE FIDUCIARY DUTIES OF
DIRECTORS AND OFFICERS
INTRODUCTION
The business judgment rule is a judicially developed doctrine that recognizes that
directors and officers generally are best situated to make difficult decisions that affect
the rights of stockholders, and provides strong deference to the integrity of those deci-
sions in the face of claims of malfeasance or negligence.21 The business judgment rule
is a critical component of corporate jurisprudence that is designed to assist companies
in attracting talented directors and officers to operate the corporation by limiting the
circumstances in which those persons can be liable for their actions on behalf of the
corporation.
DETERMINING THE STANDARD OF REVIEW
Generally, so long as directors and officers comply
with their basic fiduciary duties – the duty of care and
the duty of loyalty – they are entitled to the protections
of the business judgment rule.22 The business judgment
rule provides that directors’ and officers’ decisions are
“presumed to have been made on an informed basis, in
21 The business judgment rule historically has protected the actions and decisions of directors and,
while Delaware courts and commentators had extended the protections to officers as well by implication,
no Delaware court decision had explicitly confirmed the application to officers until recently. In 2009, the
Supreme Court of Delaware explicitly extended the scope of the business judgment rule to encompass the
actions and decisions of corporate officers. Gantler v. Stephens, 965 A.2d 695, 708-09 (Del. Sup. 2009)
(“In the past, we have implied that officers of Delaware corporations, like directors, owe fiduciary duties
of care and loyalty, and that the fiduciary duties of officers are the same as directors. We now explicitly so
hold.”). Although corporate officers will receive the protection of the business judgment rule, if they
breach their fiduciary duties, the consequences of the breach will not necessarily be the same as for direc-
tors. Under 8 Del. C. § 102(b)(7), a corporation may adopt a provision in its certificate of incorporation
exculpating its directors from monetary liability for an adjudicated breach of their duty of care. Although
legislatively possible, there currently is no statutory provision authorizing comparable exculpation of
corporate officers.
22 Some commentators describe fiduciary duties as three separate duties – the duties of care, loyalty and
good faith, although the Delaware courts have now clarified that there are two separate duties – the duties
of care and loyalty, with the duty of good faith being a subset of the duty of loyalty. See, e.g., In re Walt
Disney Co. Derivative Litigation, 906 A.2d 27 (Del. 2006).
The business judgment
rule presumes that direc-
tors acted on an informed
basis, in good faith and
with the best interests of
the corporation in mind.
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30. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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good faith and in the honest belief that the action taken was in the best interests of the
corporation.”23 When the business judgment rule applies, a court will not substitute its
own views for those of directors or officers or second-guess the outcome of business
decisions by holding a director or officer personally liable for a mistake in judgment.
Rather, the plaintiff will have the burden of rebutting the presumption and estab-
lishing that a fiduciary duty was breached. This requires the plaintiff to produce evi-
dence and persuade the court that the evidence demonstrates that the board members
or officers breached their fiduciary duties. In contrast, when the business judgment
rule is inapplicable, courts will closely examine the circumstances surrounding any
challenged business decision and require the directors and officers to demonstrate that
the particular challenged action was “entirely fair” to the corporation and the con-
stituents to whom a duty was owed. The entire fairness standard is a much more exact-
ing standard requiring the directors and officers to demonstrate fair price and fair
dealing, as discussed in detail on page 32 under the caption “Entire Fairness
Review.”24 Directors and officers who are unable to meet the applicable standard of
review can be personally liable to the corporation and its constituents for their actions.
In certain instances, the business judgment rule will not apply automatically to
the actions of directors and courts may apply a more enhanced level of scrutiny to
challenged actions, such as when:
• The subject transaction or challenged decision involves interested directors
or stockholders;25
• The subject transaction or challenged item involves a sale of control of the
company or a change of control of the company;
• A company initiates an active bidding process to sell itself;
• A company abandons a long-term strategy and seeks an alternative trans-
action involving a break-up or sale after receiving a takeover offer;
• An unsolicited third-party bid is received after a transaction with respect to
the company has been announced; or
23 Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1341 (Del. 1987).
24 Weinberger v. UOP, 457 A.2d 701, 711 (Del. 1983).
25 See, e.g., Marciano v. Nakash, 535 A.2d 400, 405 n3 (Del.1987); see also In re Southern Peru Cop-
per Corporation Shareholder Derivative Litigation, 30 A.3d 60 (Del. Ch. 2011).
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31. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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• The company adopts defensive tactics or provisions that are not reasonable
in relation to a threat posed to the company or that otherwise constitute an
abuse of discretion.
In these instances, courts may impose a more rigorous standard which may
require the directors to demonstrate the entire fairness of their actions to the stock-
holders, or courts may apply the heightened review standard of Revlon or Unocal. The
Revlon and Unocal standards are discussed in Chapter 3 of this Handbook.
It is also important to note that although directors’ fiduciary duties generally are
described as consisting of two separate duties – the duty of care and the duty of loyalty
– some commentators also consider the duty of good faith and fair dealing to be a
separate duty. However, other commentators and the Delaware courts consider the
duty of good faith and fair dealing to be a subset of the duty of loyalty. Nevertheless,
courts often evaluate the duties more fluidly, and acts that may constitute a breach of
the duty of care may be found to be sufficiently egregious to constitute a breach of the
duty of loyalty as well.
DUTY OF CARE
The duty of care requires directors and officers to act prudently in light of all
reasonably available information in overseeing the corporation’s business and making
decisions on its behalf. Specifically, directors and officers
should employ the following practices, among others, to
the extent appropriate:
• Obtain and consider all relevant information;
• Take time to evaluate corporate actions;
• Consider the advice of experts;
• Ask questions and test and probe assumptions;
• Understand the terms of transactions;
• Make deliberate decisions after candid discussion;
• Understand the corporation’s financial statements and monitor related con-
trols;
The duty of care
requires directors to
fully inform them-
selves and deliberate
carefully before
making corporate
decisions.
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32. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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• Review and monitor the performance of the chief executive and other senior
officers;
• Remain informed about the corporation’s operations, performance and chal-
lenges; and
• Implement and monitor reporting and information systems to check for fail-
ures to comply with laws and regulations.
Breaches of the duty of care typically are not found where directors and officers
merely fail to follow best practices. Rather, breaches of the duty of care occur when
directors and officers engage in conduct that is grossly negligent, such as failing to
review or discuss board materials, act with reckless indifference to stockholder con-
cerns or act in a manner that is completely irrational with respect to their decision-
making process.26 Consider, for example, several prominent cases:
• Breach of Duty of Care Where Directors Take Substantially No Actions to
Inform Themselves Regarding a Potential Merger. In Smith v. Van Gor-
kom, the court found that the directors breached their duty of care in approv-
ing a merger agreement where:
O Before the board meeting approving the merger, most of the directors
were unaware that a merger was even contemplated, although the dead-
line imposed by the proposed buyer for signing the merger agreement
was the next day;
O During the chief executive officer’s short oral report regarding the terms
of the deal, the directors did not question the role that he had played in
orchestrating the sale and were unaware that he had suggested the per
share purchase price to the buyer; and
O The board approved the agreement in a two-hour long meeting, during
which they neither reviewed the agreement nor questioned the determi-
nation of the purchase price.27
26 Smith v. Van Gorkom, 488 A.2d 858, 873 (Del. 1985).
27 Id.
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33. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
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• No Breach of Duty of Care Where Directors Approved a Substantial Sev-
erance Arrangement for an Executive Without Following Best Practices or
Consulting a Compensation Consultant. In In re Walt Disney Co.
Derivative Litigation, no breach of the duty of care was found in connection
with the directors’ approval of an employment agreement that resulted in a
$130 million severance payment to a president terminated after only one
year of employment even though the court found that the board failed to take
actions consistent with best practices, including failing to inform themselves
of the estimated severance payments for each year of employment and fail-
ing to confer with the compensation expert who had assisted in preparing
compensation figures for the president. The court determined that the direc-
tors had acted on an informed basis, in good faith and in the honest belief
that they were taking action in the best interests of the company.28
• No Breach of Duty of Care When Directors Failed to Detect Violations of
Law by Employees Where Directors Had Preventative Systems in Place
and Had No Reason to Know About the Violations. In In re Caremark
International Inc. Derivative Litigation,29 no breach of the duty of care was
found where the directors failed to detect violations of laws by employees of
the corporation – specifically, employees had been compensating health care
practitioners who referred Medicare and Medicaid patients to Caremark
facilities in violation of the law.30 The court noted that generally a director
will be liable only if he or she knew or should have known about violations
of the law, he or she did nothing to address or remedy those violations, and
those violations were the cause of the losses to the corporation complained
of in the lawsuit.31 Further, the court stated that a director may be liable if he
or she failed to ensure that systems were put in place to check compliance
with applicable laws or failed to monitor those systems even where there
were no red flags indicating violations.32 The court determined that, had it
been presented with the question, it would not have found the Caremark
28 906 A.2d 27 (Del. 2006).
29 698 A.2d 959 (Del. Ch. 1996).
30 Id. at 961-62.
31 Id. at 971.
32 Id. at 970.
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34. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
directors liable because they did not and had no reason to know of the viola-
tions and had systems in place to check for violations.33
Further, as noted above, courts increasingly are finding that sufficiently egregious
breaches of the duty of care may also constitute a breach of the duty of loyalty:
• Breach of Duty of Loyalty (as Opposed to Just Duty of Care) Where Direc-
tors Fail to Install and Monitor Systems to Police Legal Compliance. In
Stone v. Ritter,34 the court held that directors may breach their duty of loyalty
where they fail to implement any reporting or information system controls,
or having implemented such a system fail to monitor or oversee its oper-
ations.35 Significantly, the court held that such directors breached the duty of
loyalty (as opposed to their duty of care) by failing to institute a legal com-
pliance system because such failure constituted a failure to act in good
faith.36 This is notable because corporations cannot indemnify directors and
officers for breaches of the duty of loyalty where the director or officer has
acted in bad faith as they can for breaches of the duty of care.
• Potential Breach of Duty of Good Faith When Directors Were Given
Sufficient Notice of Safety Violations and Failed to Act. In In re Abbott
Labs Derivative Shareholders Litigation, the court found facts sufficient to
establish a breach of good faith when the FDA repeatedly served notices of
safety violations over a six-year period and the directors took no steps to
remedy the violations, resulting in large monetary losses to the company.
The court determined that, due to a set of facts indicating their awareness of
the problem, the board’s inaction appeared to be intentional and, con-
sequently, the directors’ decisions were not made in good faith.37 These find-
ings were made in connection with the denial of a motion to dismiss, and
this matter was settled prior to a full evaluation of the facts in a trial.
33 Id. at 971-72.
34 911 A.2d 362 (Del. 2006).
35 Id. at 370.
36 Id. at 373.
37 325 F.3d 795 (7th Cir. 2003).
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35. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
• Breach of Duty of Loyalty Where Directors Abdicated Responsibilities to
Management and Engaged in Rush Sale of Business. In the case In re
Bridgeport Holdings, Inc.,
directors were held to have
breached their duty of loy-
alty by abdicating crucial
decision-making authority in
the sale of the company to an
officer of the company, fail-
ing to monitor the officer’s
execution of an abbreviated
and uninformed sale process,
and ultimately, approving the sale of the business for grossly inadequate
consideration. The court held that the board’s actions were tantamount to an
intentional disregard of their duty of care, and thus constituted a breach of
their duty of loyalty, notwithstanding the fact that the plaintiff did not allege
self-dealing by the board or a lack of independence.38
Reliance on Experts
In discharging the duty of care, directors and officers often are encouraged to
seek the advice of experts, such as accountants, investment bankers and attorneys.
Under Delaware law, directors and officers are entitled to rely on the advice and
recommendations of such experts so long as such
reliance is reasonable and in good faith.39 How-
ever, if a director has reason to know that the
information presented by the expert is incorrect,
then such reliance is not reasonable and the duty of
care may not be satisfied. Accordingly, experts
should be selected with reasonable care – an
expert’s qualifications and experience should be considered in detail. Additionally, an
expert’s independence should be evaluated – experts who stand to earn significant fees
38 In re Bridgeport Holdings, Inc., 388 B.R. 548 (Bankr. D. Del. 2008).
39 8 Del. C. §141(e).
In considering an expert’s
findings, directors should
probe and test an expert’s
assumptions, analysis and
conclusions.
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The decisions in Caremark, Stone,
Abbott Labs and Bridgeport suggest that
if directors have failed to act in good
faith in adhering to their duty of care
obligations, they may also have violated
their duty of loyalty and have personal
liability for which indemnification is not
available.
36. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
based on the success of a transaction may not be able to deliver an unbiased opinion.40
Finally, directors must not blindly rely on experts’ findings. Directors should probe
and test an expert’s assumptions, analysis and conclusions and should probe any con-
flicts the expert may have.
DUTIES OF LOYALTY AND GOOD FAITH
The Duty of Loyalty
Directors owe a fiduciary duty of loyalty to the corporation and to its stock-
holders. The duty of loyalty requires directors and officers to act in good faith, to act in
the best interests of the corporation and its stockholders, and to refrain from receiving
improper personal benefits as a result of their relationship with the corporation.
The duty of loyalty prohibits self-dealing and
usurpation of corporate opportunities by directors
without the informed consent of the corporation,
through either its disinterested directors or stock-
holders. “Essentially the duty of loyalty mandates
that the best interest of the corporation and its share-
holders takes precedence over any interest possessed
by a director, officer or controlling shareholder and
not shared by the shareholders generally.”41
Duty of loyalty issues can arise in various contexts, including:
• A conflict of interest – where any director or officer has an interest in a trans-
action contemplated by the corporation;
40 In its decision in In re Tel-Communications, Inc. Shareholders Litigation, No. 16470, 2005 Del. Ch.
LEXIS 206, *41 (Del. Ch. Dec. 21, 2005), the court specifically questioned whether an investment bank’s
advice to a special committee would be considered independent when the bank’s entire fee was contingent
in nature on the completion of the transaction. Fairness opinion fees generally are bifurcated so that the
fee for the opinion is payable regardless of whether a transaction proceeds. Furthermore, if a board is
aware that a financial advisor may also benefit from fees related to financing an acquisition, careful con-
sideration should be given to any conflict of interest, and thus whether reliance on that financial advisor as
an expert is reasonable. See In re Rural Metro Corp. Stockholders Litigation, C.A. No. 6350-VCL (Del.
Ch. March 7, 2014).
41 Cede & Co. v. Technicolor Inc., 634 A.2d 345, 361 (Del. 1993).
22
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The duty of loyalty
requires directors to put
the corporation’s interests
above their personal
interests in evaluating
opportunities.
37. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
• Misappropriation of corporate opportunities – where a director or officer
exploits an opportunity that should have been made available to the corpo-
ration;
• Competition with the corporation – where the director or officer is compet-
ing with the corporation without the express informed consent of the disin-
terested directors or stockholders;
• Misappropriation of corporate assets – where corporate assets or information
are used by an officer or director for non-corporate purposes; and
• Egregious conduct – conduct that is deemed to be sufficiently egregious to
be viewed as not having been taken in good faith, including completely
abdicating the director’s responsibilities to the corporation.
Unlike the duty of care, liability for breaches of the duty of loyalty cannot be
limited by the corporation’s certificate of incorporation, and directors and officers may
also not have access to contractual indemnification for breaches of the duty of loyalty
that involve bad faith.42
What Defines a “Conflict of Interest”?
A director is “interested” in a particular transaction or corporate decision when
his or her exercise of judgment with respect to such transaction or corporate decision is
compromised by the presence of one or more
external factors relating to the transaction. Such
“interests” most commonly exist when a director
has a material economic interest in a particular
transaction or decision, such as when a director has
a financial stake in another party with whom the
corporation is seeking to do business, when a
director stands to receive a financial payment
arising out of a transaction (such as a finder’s fee) or where a director or officer stands
to benefit from a continuing relationship with the other party to a transaction (such as
an employment relationship following the transaction). Conflicts of interest also can
exist in interlocking or overlapping governance arrangements – for example, when a
42 8 Del. C. §102(b)(7).
One of the most fertile
grounds for breach of fidu-
ciary duty claims are
instances in which directors
have a potential conflict of
interest, and thus their duty
of loyalty is implicated.
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38. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
director approves compensation for a chief executive officer who in turn sits on the
board of a corporation that employs that director. However, interested party trans-
actions are not inherently detrimental to a corporation. As long as a transaction is fair
to the corporation, no protected confidences are betrayed, and there is not a mis-
appropriation of corporate property, the duty of loyalty may not breached, regardless
of whether certain corporate directors and officers will profit as a result of it.
“[The Delaware] Court has never held that one director’s colorable interest in a
challenged transaction is sufficient, without more, to deprive a board of the protection
of the business judgment rule presumption of loyalty. . . . To disqualify a director . . .
there must be evidence of disloyalty. Examples of such misconduct include, but cer-
tainly are not limited to, the motives of entrenchment, fraud upon the corporation or
the board, abdication of directorial duty, or the sale of one’s vote.”43
Mitigating Duty of Loyalty Issues
Duty of loyalty issues can be mitigated if actions involving potential conflicts are
approved by an independent decision-making body, which reduces the risk that the
decision in question is motivated by an improper purpose. The independent decision-
making body can be a majority of disinterested directors (even if less than a
quorum) or a majority of the stockholders. To neu-
tralize duty of loyalty issues, the independent
decision-maker must be fully informed of the conflict
of interest as well as the terms of the corporate action
and must act in good faith.44 Boards commonly uti-
lize disinterested director approval mechanisms or
special committees comprised of disinterested and
independent directors in an effort to mitigate duty of
loyalty concerns and to try to preserve the application of the business judgment rule to
the maximum degree possible. In such an instance, use of a properly formed and func-
tioning independent decision-maker may operate to shift the burden of proof of any
potential breach of fiduciary duty back to the plaintiff. Where no independent
decision-maker is present and where the business judgment rule does not apply, duty
of loyalty challenges can be overcome where the directors and officers can demon-
strate that a challenged transaction was “entirely fair” to the corporation and its stock-
43 Cede, 634 A.2d at 363.
44 8 Del. C. §144.
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Duty of loyalty concerns
can often be mitigated by
obtaining approval of
disinterested directors or
stockholders of a subject
transaction.
39. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
holders.45 However, entire fairness can be difficult, time-consuming and costly to
establish, as discussed in detail later in this Chapter. The use of special committees is
discussed further in Chapter 5 of this Handbook.
The Corporate Opportunity Doctrine
The corporate opportunity doctrine governs the appropriation of business oppor-
tunities by directors and officers of corporations. Generally, the corporate opportunity
doctrine provides that corporate directors and officers are prohibited from exploiting
business opportunities that might be of interest to the corporation that they serve.
Corporate opportunity issues often arise when corporate officers or directors are
involved with multiple corporations, including affiliated entities or entities that com-
pete or operate in related markets; these scenarios can be particularly complicated
because such officers or directors have a duty of loyalty to each entity. Corporate
opportunity issues also arise where an officer or director has personal business inter-
ests that compete with the corporation’s interests in certain business opportunities.
Directors who are industry experts and serve as directors, promoters and principals at
multiple entities must be particularly sensitive to this issue.
What Constitutes a Corporate Opportunity?
In general, a corporate opportunity exists, and a corporate officer or director is
prohibited from taking such business opportunity for his or her own without first offer-
ing it to the corporation, if:
• The corporation has an interest or expectancy in the opportunity;
• The corporation is financially able to exploit the opportunity;
• The opportunity is within the corporation’s line of business; and
• By taking the opportunity for his or her own, the corporate fiduciary will
thereby be placed in a position contrary to his or her duties to the corpo-
ration.
45 Id.
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40. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
The corollary to this rule is that a director or officer may generally take a corpo-
rate opportunity without breaching the duty of loyalty, if:
• The opportunity is presented to the director or officer in his or her individual
and not his or her corporate capacity;
• The opportunity is not essential to the corporation;
• The corporation holds no interest or expectancy in the opportunity; and
• The director or officer has not wrongfully employed the resources of the
corporation in pursuing or exploiting the opportunity.46
Of course, the safest course of action with respect to a transaction involving a
potential conflict over a corporate opportunity is approval of the subject transaction by
the disinterested directors or stockholders after the full disclosure of its terms.
Mitigating Corporate Opportunity Issues
Corporations employ a wide range of practices to mitigate the risk of corporate
opportunity issues. Some alternatives include:
• Limit fields of interest in which directors and officers can participate outside
of their activities on behalf of the corporation to avoid potential overlaps
with the corporation’s business;
• Define the activities and duties of
the affected director or officer. For
example, each of the corporation
and any competing entity with
which an officer or director is
affiliated could adopt a policy
on confidentiality that would release the affected director or officer from any
obligation to disclose overlapping opportunities, and would prohibit mem-
bers of the board of directors of each entity from bringing to the other oppor-
tunities learned of through participation in its meetings and deliberations;
• Renounce the corporation’s interest or expectancy in a particular field or
opportunity as permitted under the DGCL such that directors and officers do
46 See Guth v. Loft, Inc., 5 A.2d 503, 509 (Del. Ch. 1939). See also Broz v. Cellular Info. Sys., 673 A.2d
148 (Del. 1996).
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Many corporations build extensive
guidelines into their employee
conduct codes in an effort to avoid
potential conflicts of interest and
corporate opportunity issues with
their executives and directors.
41. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
not have an obligation to refrain from participating in, or an obligation to
offer the corporation the right to participate in, such activities if presented to
the directors or officers;
• Recuse the director or officer from deliberations with the corporation or the
other entity that implicate any areas of overlap between the competing busi-
nesses; or
• Ask that the affected director or officer step down from his or her position
with the corporation or the other entity.
In all events, whatever limits are placed on a potentially affected director or offi-
cer, or whatever relief such director or officer receives from bringing opportunities to
the corporation or the other entity, there should be full disclosure of the potential con-
flicts to the boards of directors of the corporation and the competing entity.
Duty of Good Faith
The duty of good faith is a subset of the duty of loyalty requiring directors and
officers to act in the best interests of the corporation and its stockholders at all times.47
Bad faith is not simply bad judgment or negligence, but rather implies the conscious
doing of a wrong because of a dishonest purpose or a state of mind affirmatively oper-
ating with furtive design or ill will. Breaches of the duty of good faith have been found
in the following circumstances:
• Directors knowingly or deliberately
withheld information they knew to be
material for the purpose of misleading
stockholders;48
• A transaction was authorized for pur-
poses other than to advance corporate
welfare and in violation of applicable
laws;49
47 Guth, 5 A.2d at 509; Stone v. Ritter, 911 A.2d 362 (Del. 2006).
48 Emerald Partners v. Berlin, 1995 Del. Ch. LEXIS 128 (Del. Ch. Sept. 22, 1995); see also Potter v.
Pohlad, 560 N.W.2d 389, 395 (Minn. Ct. App. 1997).
49 Gagliardi v. TriFoods Int’l, Inc., 683 A.2d 1049, 1051 n.2 (Del. Ch. 1996).
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The duty of good faith is a
subset of the duty of loyalty.
Duty of good faith violations
may occur when directors
blatantly disregard their duty
to act in the best interests of
the corporation and its
stockholders.
42. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
• A director’s decision was primarily motivated by personal interest and not
the best interests of the corporation;50
• Actions were consciously taken with a dishonest purpose or moral obliq-
uity;51 and
• Directors failed to prevent waste or self-dealing by another director or corpo-
rate officer.52
There was some ambiguity surrounding the duty of good faith, including some
confusion regarding whether the duty of good faith is an independent duty or an ele-
ment of the duty of loyalty. Two Delaware Supreme Court cases settled the issue. In In
re Walt Disney Co. Derivative Litigation,53 the court outlined three categories of
behavior that are candidates for bad faith:
• Category 1 – Fiduciary conduct motivated by an actual intent to do harm.
This would include actions taken by the directors with the intent to harm the
corporation or with ill will (subjective bad faith).54
• Category 2 – Grossly negligent conduct, without more.55
• Category 3 – The fiduciary intentionally acts with bad faith dereliction of
duty, a conscious disregard for one’s responsibilities.56 For example, the
fiduciary acts with a purpose other than advancing the best interests of the
corporation; the fiduciary acts with the intent to violate applicable positive
law; or the fiduciary intentionally fails to act in the face of a known duty to
act, demonstrating a conscious disregard for his or her duties.57
50 Washington Bancorp. v. Said, 812 F. Supp. 1256, 1269 (D.D.C. 1993).
51 Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1208 n.16
(Del. 1993).
52 In re Nat’l Century Fin. Enter. Inv. Litig., 504 F. Supp. 2d 287, 313 (S.D. Ohio 2007).
53 906 A.2d 27 (Del. 2006).
54 Id. at 64.
55 Id.
56 Id. at 66.
57 Id. at 67.
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43. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
While the court decided that Categories 1 and 3 described behaviors that would
be classified as bad faith, grossly negligent conduct, without more (Category 2), could
not constitute a breach of the fiduciary duty to act in good faith.58
Following the 2006 Disney decision, the Delaware Supreme Court again
addressed the duty of good faith in Stone v. Ritter.59 In Stone, the court clarified that
the duty of good faith is an element of the duty of loyalty, not an independent fiduciary
duty. Specifically, the Stone court said that “the obligation to act in good faith does not
establish an independent fiduciary duty that stands on the same footing as the duties of
care and loyalty.”60
Consider, for example, the following cases regarding the duties of loyalty and
good faith:
• No Breach of Fiduciary Duty When Decisions Are Made in Good Faith
Without Self-Dealing or Improper Motive. In Gagliardi v. TriFoods
International, no breach of fiduciary duty was found when a shareholder
alleged mismanagement and waste by the corporation. The court held that
without a showing of self-dealing or improper motive, a corporate officer or
director cannot be held liable for losses suffered as a result of a decision
made by the officer or authorized by the director unless the facts indicate
that no person would authorize the transaction in good faith.61
• No Breach of Fiduciary Duty for Losses Due Solely to Errors in Judg-
ment. In Kamin v. American Express, no breach of fiduciary duty was found
when shareholders filed suit to enjoin a distribution of special dividends that
would cause the corporation to lose $8,000,000 in tax savings, claiming
waste of corporate assets. The court held that the directors were protected by
the business judgment rule. The court refused to interfere with the decisions
of the board unless powers had been illegally or unconscientiously executed
or the acts were fraudulent, collusive, or destructive to shareholders’ rights.
58 Id. at 64.
59 911 A.2d 362 (Del. 2006).
60 Id. at 370.
61 683 A.2d 1049 (Del. Ch. 1996).
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44. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
Errors in judgment, without more, were not sufficient grounds for judicial
interference.62
• Breach of Fiduciary Duty When Directors Knowingly Committed Illegal
Activities. In Miller v. AT&T, the court found a breach of fiduciary duty
when the company made an illegal campaign contribution in violation of
federal law. The business judgment rule does not insulate directors from
liability after they knowingly commit illegal activities.63
• Breach of Duty of Loyalty Where Directors Abdicated Responsibilities to
Management and Engaged in Rush Sale of Business. In the case In re
Bridgeport Holdings, Inc., the directors were held to have breached their
duty of loyalty by abdicating crucial decision-making authority in the sale of
the company to an officer, failing to monitor the officer’s execution of an
abbreviated and uninformed sale process, and ultimately approving the sale
of the business for grossly inadequate consideration. The court held that the
board’s actions were tantamount to an intentional disregard of their duty of
care, and thus constituted a breach of their duty of loyalty, notwithstanding
the fact that the plaintiff did not allege self-dealing by the board or a lack of
independence.64
Summary
Delaware courts still recognize a triad of director duties, including care, loyalty
and good faith; however, following Disney and Stone v. Ritter, it appears that the duty
of good faith is viewed as a subset of the duty of care and does not stand on the same
level as the duties of care and loyalty. The Delaware Court of Chancery has observed
that by definition, a director cannot simultaneously act in bad faith and loyally towards
the corporation and its stockholders because “bad faith conduct . . . would seem to be
other than loyal conduct.”65 Today, if considering an action or decision that might raise
duty of loyalty considerations, directors are advised to demonstrate their good faith
62 383 N.Y.S.2d 807 (N.Y. Sup. Ct. 1976).
63 507 F.2d 759 (3d Cir. 1974).
64 In re Bridgeport Holdings, Inc., 388 B.R. 548 (Bankr. D. Del. 2008).
65 In re ML/EQ Real Estate Partnership Litigation, No. 15741, 1999 Del. Ch. LEXIS 238 (Del. Ch.
Dec. 20, 1999).
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45. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
(and loyalty) by documenting the business purposes or stockholder-oriented reasons
for their decisions and/or recusing themselves if there is the potential appearance of
impropriety.
DUTY TO DISCLOSE
Stemming from their fiduciary duties of care and loyalty, corporate directors also
have a duty of disclosure, sometimes referred to as the duty of candor.66 Disclosure
violations constitute a breach of the duty of care when the misstatement or omission
was made as a result of a director’s erroneous judgment, but was nevertheless made in
good faith. If the board lacks good faith in approving or failing to make a disclosure,
the violation also implicates the duty of loyalty.67 When directors do seek to make a
disclosure, such as in seeking stockholder approval, Delaware courts have held that
they need to “disclose fully and fairly all material information within the board’s
control.”68 Further, the court said that when directors recommend stockholder action,
they have an affirmative duty to disclose all information material to the action being
requested and “to provide a balanced, truthful account of all matters disclosed in the
communications with stockholders.”69 Likewise, directors have a duty of candor that
requires that they disclose to the board information known to them that is relevant to
the board’s decision-making process.
Not all information requires disclosure under the duty of candor, but when a
corporation does speak to its investors, the directors need to be sure that any disclosure
of material information is truthful, accurate and complete. Consistent with federal
securities law, information is material if there is a substantial likelihood that a reason-
able stockholder would consider it important in deciding how to vote. In addition,
there must be a substantial likelihood that such information would significantly alter
the ‘total mix’ of information available.70
66 Malone v. Brincat, 722 A.2d 5, 11 (Del. 1998).
67 In re Tyson Foods, Inc. Consol. Shareholder Litigation, 919 A.2d 563, 597-98 (Del. Ch. 2007).
68 Malone, 722 A.2d at 10 (Del. 1998).
69 Id.
70 Shell Petroleum, Inc. v. Smith, 606 A.2d 112 (Del. 1992); Arnold v. Soc’y for Sav. Bancorp, Inc., 650
A.2d 1270, 1277 (Del. 1994).
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46. FIDUCIARY DUTIES AND OTHER RESPONSIBILITIES OF
CORPORATE DIRECTORS AND OFFICERS
ENTIRE FAIRNESS REVIEW
Overview
In situations where the presumption of the business judgment rule is not avail-
able, directors will be required to establish the entire fairness of the transaction or
decision in question. When engaging in an entire fairness review, a court will
determine whether the transaction or decision is entirely fair to stockholders and
should therefore be upheld, notwithstanding any deficiencies on the part of the board.71
This standard of review is rigorous and the board bears the burden of not only provid-
ing the evidence to the court but also persuading the court that the evidence demon-
strates that the directors have met their burden. The practical implication of a rebuttal
of the business judgment rule is that the chances that a transaction may be set aside are
greatly increased. As a result, it is of the utmost importance that boards manage their
actions and the circumstances surrounding them to have the best chance of preserving
application of the business judgment rule.
As noted previously, a rebuttal of the business judgment rule most frequently
occurs when a director may have an interest in the transaction, or when there is
evidence that the directors may have
breached their fiduciary duties. In addition,
the entire fairness test will be applied when
a corporation consummates a transaction
with a controlling stockholder unless the
corporation obtains the approval of disin-
terested directors through a properly
formed, empowered and functioning committee and disinterested stockholders.72
Although such disinterested approval may result in the board receiving the benefit of
the business judgment rule, a court may nonetheless require a defendant controlling
stockholder to demonstrate the entire fairness of the challenged transaction. Absent a
disinterested approval process, the defendant would be required to bear the burden of
providing evidence and convincing the court that the transaction was entirely fair to
the minority stockholders. If a disinterested approval process was used, a court may
shift the burden of proof from the defendant controlling stockholder to the plaintiff
71 See, e.g., Citron v. E.I. Du Pont de Nemours & Company, et al., 584 A.2d 490 (1990).
72 See, e.g., In re S. Peru Copper Corp. S’holder Derivative Litig., 30 A.3d 60 (Del. Ch. 2011).
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The entire fairness test requires
directors to produce evidence that
demonstrates that the subject
transaction was the product of fair
dealing and produced a fair price
for the stockholders.
