fiduciary duty board of directors

Fiduciary Duties of Officers and the Board of Directors

The fiduciary duty on the board of directors and on corporate officers arises from their legal relationship with the corporation, which is  fiduciary in nature. These duties are creatures of state common law. Officers, directors, and controlling shareholders owe fiduciary duties of utmost good faith, scrupulous honesty, and loyalty to the corporation and to its shareholders collectively.

The board of directors' fiduciary duty includes the duty to exercise care in the management of corporate affairs, the duty of obedience, and the duty of loyalty to the corporation. The standard to which officers are held may vary from the stringent obligations of a managing officer, who may have the same fiduciary obligations as a director, to those based simply on the principles of agency in the case of the subordinate officer. The fiduciary duty of both officers and directors requires that they exercise the powers of their offices solely for the benefit of the corporation and its stockholders collectively.

Board of Directors' Fiduciary Duty of Due Care

The board of directors of a corporation have a fiduciary duty to exercise the same due care in the management of the corporation’s business as a prudent man would exercise under similar circumstances. Corporate officers and directors must use their uncorrupted business judgment for the sole benefit of the corporation. The fiduciary duty is to exercise same care as prudent man usually exercises in the management of his own affairs. Texas requires a director to exercise his unbiased or honest judgment in pursuit of corporate interests with undivided loyalty and in utmost good faith.

In determining whether the standard has been met, courts may consider such factors as (a) the character of the corporation; (b) the condition of its business; (c) the usual method in which such corporations are managed; and (d) any and all relevant facts that tend to throw fight upon the question of the proper discharge of one's duty as director. As a general rule, a director may be liable to the corporation, and occasionally to its shareholders, creditors, or other persons, for losses caused by his failure to exercise the proper care.  A director breaches his duty if (i) he commits overt acts constituting mismanagement or (ii) his inaction amounts to a failure to direct.

Recovery for Board of Directors' Breach of Fiduciary Duty of Care

The directors' liability for mismanagement ordinarily runs to the corporation, not to third party creditors.  As a result, the directors liability may be enforced only by any person who is seeking to assert the claim on behalf of the corporation, rather than as his own individual claim. Thus, the director may be brought to task by a receiver or trustee in bankruptcy of the corporation or (a shareholder bringing a derivative action to recover for the loss suffered by the corporation. Id. If the duty of due care is breached, the directors and/or officers are liable to the corporation for any loss it may have suffered as a result of their neglect. A creditor who sues solely on his own behalf cannot maintain a personal action against directors who, by negligent mismanagement of the corporation’s affairs, have breached their duties to the corporation to the consequent damage or injury of the creditor.

By statute, Texas has eliminated the "trust fund" theory, which was an equitable doctrine that allowed holders of pre-dissolution claims against a dissolved corporation to trace the assets that were distributed by the corporation to its shareholders and to recover those assets to the extent of the claims. To impose liability on directors for payment, or on shareholders for receipt of illegal distributions from Texas corporations, the remedies now are exclusively contained in statuory.

The duty of directors and officers to distribute the assets of a dissolved corporation for the benefit of its creditors is codified in BOC 11.052-054, which require the corporation, before filing articles of dissolution, to pay all its debts, or to the extent possible, make adequate provision for payment. Directors, however, do not become personally liable to corporate creditors under the "trust fund doctrine" unless they have received corporate assets of the defunct corporation or the assets are untraceable, in which event the directors are personally liable up to the value of the assets. Shareholders who receive corporate assets are similarly at risk.

The Business Organizations Code allows directors to rely on opinions of professionals or the financial statements of persons who assume the obligations of the corporation by becoming contractually obligated to pay them. BOC 21.316. The effect of this amendment is to allow directors and officers of a corporation that has voluntarily dissolved to sell the assets to a third person who assumes the liabilities associated with those assets and then to distribute the proceeds of the sale to the shareholders in final liquidation. If the directors and officers in the exercise of ordinary care rely in good faith upon financial or other reliable information that supports the ability of the third person to satisfy those liabilities assumed, they may do so without the risk of being held jointly and severally liable or the proceeds distributed to shareholders to the extent they would otherwise be required to meet the liabilities assumed./p>

Certain other kinds of wrongful acts may make a director liable to third parties, including direct participation in tortious act. One case has held that dissolution of a corporation did not end the corporation's liability on a personal consulting contract and the corporation's sole director and shareholder was personally liable for the dissolved corporation’s debt to the extent of distributions received after dissolution.

Business Judgment Rule Limits Enforcement of the Board of Directors Fiduciary Duty of Care

Actions against officers or directors of a corporation for breach of their fiduciary duty of due care almost inevitably trigger the response that management is not liable for ordinary mistakes of business judgment. The so-called "business judgment rule" shields a corporate director who acts in good faith and without corrupt motive from any liability for mistakes of business judgment that damage corporate interests.  In Texas, it is generally held that the business judgment rule protects non-interested directors from liability unless the challenged action is ultra vires or tainted by fraud or self-dealing. Gross negligence on the part of directors is not protected by the business judgment rule. Further, a director who abdicates responsibilities or fails to exercise any judgment similarly cannot use the business judgment rule to avoid liability.

Fiduciary Duty of Loyalty

The universal rule of directors and officers of a corporation is that they occupy a fiduciary position and, as such, owe a duty of loyalty to the corporation. This duty is to act only in the best interests of the corporation and its collective shareholders.

Breach of Fiduciary Duty by the Board of Directors

A breach of fiduciary duty involves a willful violation of the duty imposed by law on the fiduciary in the particular relationship. A cause of action does not require as one of its elements a showing of fraud. 

Interested Director Transactions

Transactions between a director and his corporation, or between corporations with common directors, often raise the question of whether the interested director has complied with his fiduciary obligation to place the interests of the corporation ahead of his own. Early common law rules governing this relationship have been supplemented with statutory directives.

Traditional case law held that contracts between a corporation and its officers or directors were not void, but were voidable for unfairness or fraud. The burden was on the fiduciary to prove fairness, and transactions in which a corporate fiduciary derived a personal profit were subject to intense scrutiny. The duties of the officers and directors were not viewed as identical to those of other fiduciaries; rather, they were defined on a case by case basis in Texas courts. In the past this duty has been described as one which holds the fiduciary to an "extreme measure of candor, unselfishness, and good faith." The director of a corporation must act fairly and honestly and make full disclosure of all pertinent information in relation to subject matter of any contract he would negotiate with the corporation in which he has a personal interest. 

The Code provides a safe harbor for interested director transactions. Section 21.418 provides that a contract or transaction involving an interested director or officer shall not be void or voidable solely for that reason, nor because the interested director or officer was present at the meeting in which the transaction was authorized or his vote was counted in authorizing the transaction, if, after full disclosure, the transaction was (1) authorized by a majority of the disinterested directors (even if they constitute less than a quorum); or (2) approved by the shareholders; or (3) fair to the corporation. The provision codifies the rule of fairness traditionally applied by Texas courts, but additionally insulates transactions that have been properly authorized after full disclosure of the director's interest without further inquiry by the courts into the substantive fairness of the transaction.

Section 21.418 does recognize that an officer or director will be guilty of self-dealing if the plaintiff demonstrates (1) unfairness of the transaction to the corporation, including giving reasons it was unfair, (2) the board of directors did not authorize the transaction by an affirmative vote of the majority of disinterested directors after disclosure of material facts; and (3) the shareholders did not approve of the transaction by a vote after a disclosure of the material facts. 

Self-dealing is only deemed to have occurred if the director is "interested." A director is considered to be "interested" if he or she (1) makes a personal profit from a transaction by dealing with a corporation; (2) usurps a corporate opportunity; (3) buys or sells assets of the corporation; or (4) transacts business in his or her capacity as a director, either with a second corporation of which he or she is also a director or is significantly financially associated, or with a family member. The burden of proving that the transaction was fair to the corporation falls upon the defendant. The plaintiff does not have to prove that the corporation would in fact have taken advantage of the opportunity allegedly usurped by the defendant.

Multiple Fiduciary Duties

A special problem is presented when a director sits on multiple boards and the corporations do business with
one another.  Since each common director has a duty of loyalty to both corporations, the courts are suspicious of any dealing that might favor one corporation over the other.  The burden of proof is on the party wishing to validate the transaction to show that each corporation was dealt with fairly in all respects.  At the time of merger of one corporation with another, the director stands in a fiduciary relationship to both corporations.  Therefore, he must ensure that any actions he takes are fair to both corporations.