The fiduciary duty of loyalty operates to constrain directors and corporate officers in their pursuit of self interest. It is an actionable wrong for an officer or director to compete with their corporation or divest to personal use of the assets or opportunities belonging to the corporation. In directing and managing the business affairs of the corporation, the relevant factors include the director’s official conduct.
Fiduciary duty includes not only a duty of loyalty but also a duty of care. Where the directors have acted in accordance with their fiduciary duties of care, loyalty and good faith their actions are protected.
An essential element of the director’s authority and power is the business judgement rule. The protection provided by the business judgement rule lies in pleadings and burden of proof is placed on plaintiff’s claim to hold the directors liable for breaching their fiduciary duties while engaged in their official conduct. Fiduciary duty has traditionally operated as a shield to the directors to protect them from liability arising out of their decisions. Where the directors are entitled to protection under fiduciary rules, the courts in such cases do not interfere with the affairs of corporation.
The one who challenges director’s actions bears the burden of rebutting the presumption that their decisions were a proper exercise of the business judgment.1 The directors are chosen to take decisions in good faith and their judgement is not questionable unless shown to be tainted with fraud. Directors are required to consider the interest of the suppliers, employees, customers and affected communities.
Where a director compromises the corporation’s interests over his own, his act violates the requirements of fiduciary duty. In case of conflict of interests, a director has to show that he discharged duty of care and duty of loyalty properly. Where a conflict between director’s personal interests and those of the corporation stands at variance, the courts generally scrutinise such an event carefully to determine whether one has unfairly favoured a transaction for personal gains and whether or not one has been completely candid and loyal to the corporation and its shareholders.
The corporate opportunity and conflicting interests in a transaction raise concerns and probing question like whether a director has fairly treated the corporate affairs. Directors being trustees of the corporation are held responsible and a stricter test to judge their conduct in terms of the market place is applied. The standard of behaviour in this regard rests not only on morality but also on the punctilio of an honour being the most sensitive element. This tradition or practice is unbending and inveterate.2
Directors are supposed to disclose and not to withheld relevant information concerning any potential conflict of interest with the corporation, and they must refrain from using their position, influence, or knowledge over the affairs of the corporation to take personal gains.3
Where a corporation can handle business opportunity financially and technically and the same corresponds to its abilities, and a competitive edge exists in its line of business, the same offers a corporate officer or director an opportunity which they must seize on behalf of the corporation. At the same time one must remember that the burden to take a fair decision falls within the mischief of loyalty and reasonable expectancy, and where such opportunity is compromised, the self-interest of the officer or director becomes obvious and it brings an element of conflict of interest with the corporation.4
However, there are some significant weaknesses in the application of business test. These include:
(i) Whether or not a particular activity is within a corporation’s line of business, and the fact is conceptually difficult to answer.
(ii) The element of financial ability of the corporation to take advantage of the opportunity, the courts generally rely on the corporation’s supposed financial incapacity as a basis for excusing director’s conduct. Often, the injection of financial ability into the equation may lead to an undue favour to an insider including director or executive who commands and controls the corporation’s finances.5
True basis of governing this doctrine rests on the unfairness of a director in the particular circumstances, since the director’s relationship with the corporation is fiduciary, and where the interest of the corporation justly calls for an advantage of the opportunity, any decision made by directors for their personal profits violates the principles governing fiduciary duty.
Events which call for application of ethical standards are also dependent on fair and equitable decision making.6
For the validity of director’s actions on the ground of fairness truthful disclosure to the corporate body is an absolute condition.7 A defective disclosure even with a good faith by a corporate officer conflicts with the concept of loyalty and can only be ratified by an affirmative vote of a disinterested board of directors or shareholders.
Whether or not a board of directors has acted in good faith, bears the burden to demonstrate a good faith.8 Good faith contains an element of loyalty towards the corporation. Where a corporation is on sale, defensive measures are not reasonable since there is nothing to protect.9
In many cases officers and directors of the corporation act in self interest and loyalty to the corporation is absent. For example in a hostile take-over, following issues require decision to be based on loyalty, due care and good faith.
(i) Whether or not offered prices correctly determined?
(ii) Was it a bargain?
(iii) Were the requirements of GCL. §202 (a) were met?
(iv) Was the price offered fair?
A take-over plan gives rise to following policy tensions:
(a) Short-term vs. long-term investments.
(b) Board’s power to manage long term issues.
Strategy versus incentive planning is made by directors to entrench themselves at the expense of other shareholders. The courts in such circumstances have laid down that –
— Board has to show good faith.10
— Decision to treat one shareholder differently than the others is not acceptable.11
— A right plan should not violate the legal principles laid down in Unocal case.12
Where director’s conduct lacks good faith, loyalty and care, their actions violate the law since their decisions are dependent on their personal interest.
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates Karachi. To see author’s other areas of interest visit Zafars Blog on International Studies http://blogoninternationalstudy.blogspot.com/)
1. For example, a derivative suit can allow shareholders to control a particular law suit impartially and that too in good faith.
2. See Meinhard’s Case.
3. See Rosenthal v Rosenthal.
4. See Guth’s Case: The law will not permit directors to seize such an opportunity for their personal gains.
5. Reliance on financial ability may also act as a disincentive to corporate executives to solve corporate financing and other problems.
6. See Durfer Case.
7. See Klinicki v Lundgren.
8. See Cheff v Mathes.
9. See Revolon’s Case.
10. See Cheff v Mathes.
11. See Unocal Case.
12. See DGCL § 151/157.Zafar Azeem, "Role of fiduciary duty in US corporate decision-making," Business recorder. 2014-03-27.
Keywords: Economics , Economic issues , Economic planning , Interests , Transparencies , Business , Scrutiny , America