Role of fiduciary duty in US corporate law

Fiduciary duty is a duty to act for someone else’s benefit while subordinating one’s personal interest to that of the other person. It is the highest standard of duty implied by law. The fiduciary duty of loyalty operates to constrain directors and officers of a corporation in their pursuit of self interest. It is an actionable wrong for an officer or director to compete with his corporation or divest to personal use the assets or opportunities belonging to the corporation. In directing and managing the business affairs of the corporation the relevant factor is the director’s official conduct. Fiduciary duty includes not only a duty of loyalty but also a duty of care.

Business judgement rule

An essential element of the director’s authority and power is the business judgement rule. Where the directors have acted in accordance with their fiduciary duties of care, loyalty and good faith, their actions are protected. The protection provided by the business judgement rule lies in pleading an evidentiary burden that it places on plaintiff’s seeking to hold directors liable for allegedly breaching their fiduciary duties while engaged in official conduct.

Fiduciary duty has traditionally operated as a shield to protect directors from liability for their decisions. If the directors are entitled to the protection of the rule, then the courts may not interfere with the affairs of corporation. The one who challenges director’s actions bears the burden of rebutting the presumption that the decision was a proper exercise of the business judgement. A derivative suit can allow shareholders too impartially and in good faith to control a particular law suit. 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.

Core of fiduciary duty

The core of fiduciary duty is the requirement that a director favour the corporation’s interests over her own whenever those interests conflict. As with the duty of care, there is a duty of candor aspect to the duty of loyalty. Thus, whenever a director confronts a situation that involves a conflict between her personal interests and those of the corporation, courts will carefully scrutinise not only whether one has unfairly favoured one personal interest in that transaction, but also whether one has been completely candid with the corporation and its shareholders.

Both the corporate opportunity and conflicting interest transaction settings raise concerns about whether a director has fairly treated the corporation. A trustee is held to something stricter than the morals of the market place. Not honesty lone, but the punctilio of an honour the most sensitive, is then the standard of behaviour. There has developed a tradition that is unbending and inveterate. (Meinhard)

Conflict of interest rule

Directors must disclose and not withhold relevant information concerning any potential conflict of interest with the corporation, and they must refrain from using their position, influence, or knowledge of the affairs of the corporation to gain personal advantage. (Rosenthal v. Rosenthal)

If there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake from its nature, in the line of the corporation’s business and is of practical advantage to it, the same is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself. (Guth)

Business test

The line of business test suffers from some significant weaknesses. First, the question whether a particular activity is within a corporation’s line of business is conceptually difficult to answer. Second, the Guth test includes as an element the financial ability of the corporation to take advantage of the opportunity. The courts 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 will unduly favour the inside director or executive who has command of the facts relating to the finances of the corporation. Reliance on financial ability may also act as a disincentive to corporate executives to solve corporate financing and other problems.

True basis of governing doctrine rests on the unfairness in the particular circumstances of a director, whose relation to the corporation is fiduciary, taking advantage of an opportunity for a personal profit when the interest of the corporation justly calls for protection. This calls for application of ethical standards of what is fair and equitable in particular sets of fact is a relevant factor. (Durfer)

ALI test

The ALI test was applied by the Oregon Supreme Court in Klinicki v. Lundgren. According to this case, “full disclosure to the appropriate corporate body is an absolute condition precedent to the validity of their actions on the ground of fairness. A good faith but defective disclosure by the corporate officer may be ratified only by an affirmative vote of the disinterested directors or shareholders.

(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)