By Andreas Koutsoudakis and Karen Canales-Reyes
Despite its relatively small population, the state of Delaware’s footprint in the world of corporate governance organization and laws is both prominent and dominant. Due to its relatively broad protection of directors and officers, many corporations choose Delaware as their place to incorporate.[1] Officers and directors have a duty to oversee the day-to-day operations of the corporation and its respective stockholders. In discharging their duty to manage or oversee the management of the corporation, Delaware directors and officers owe fiduciary duties of loyalty and care to the corporation and its stockholders.[2] This article highlights the duty of care and loyalty associated with directors and officers and discusses what to be weary of when protecting oneself from liability.
Duty of Care
One of the two chief fiduciary duties that directors and officers owe to the corporation and shareholders is called the duty of care. The duty of care requires directors and officers to exercise care and act in an informed manner when acting for the corporation and making decisions on its behalf. [3] In managing and overseeing a corporation’s business and affairs, directors must both make decisions and rely on subordinates.[4] The duty of care requires directors to make informed business decisions, but likewise takes into consideration the fact that directors must make decisions constantly, rapidly and without taking an unlimited amount of time on each decision. Therefore, directors are not required to review all information in making their decisions—only the information that is material to the decision before them. Regardless, in evaluating information provided to them by management, directors are expected to review the information diligently and not accept it blindly.
Whether directors have complied with their duty of care typically depends on the specific circumstances at hand. Delaware courts will generally consider (1) how much time the directors had to review the information, (2) what information they reviewed, (3) how critically they reviewed that information, and (4) whether they sought expert financial or legal advice. Delaware law typically applies a “gross negligence” standard to determine whether directors have satisfied their duty of care; this standard expects directors to act with reasonable diligence. Delaware courts will only intervene if the directors have significantly departed from what would be expected of a reasonable fiduciary in a similar position. Furthermore, Delaware law allows corporations to include in their charters a provision immunizing directors from personal monetary liability for violating their duty of care. [5] Until recently, such a provision only protected directors from personal liability to the corporation and its stockholders for money damages resulting from a breach of the fiduciary duty of care. [6] However, as of August 1, 2022, Delaware corporations are now allowed to protect their officers as well from personal liability for money damages.[7]
Nonetheless, it is important to note that both officers and directors may not be protected against claims made against them for (1) a breach of the fiduciary duty of loyalty to the corporation or its stockholders, (2) acts or omissions not made in good faith, or which involve intentional misconduct or a knowing violation of law, or (3) a transaction resulting in an improper personal benefit.[8] Moreover, unlike directors, officers are not protected against lawsuits made by or on behalf of a corporation. This means that, although a stockholder may not file a direct lawsuit against an officer for breach of the fiduciary duty of care, a stockholder may file a derivative lawsuit against the officer on behalf of the corporation.[9] Therefore, officers are protected against direct claims, but not against claims made by the corporation or derivative claims made by a stockholder on behalf of the corporation. Directors are protected against both direct and derivative claims.
Duty of Loyalty
The second chief fiduciary duty that directors and officers owe to the corporation and shareholders is called the duty of loyalty. The duty of loyalty requires directors to act in good faith to advance the best interests of the corporation and, similarly, to refrain from conduct that injures the corporation.[10] Fundamentally, the duty of loyalty begins with ensuring that the corporation acts consistently with its charter from Delaware – a charter that typically permits the corporation to undertake any lawful business by any lawful means. Although Delaware law gives directors wide discretion to decide how a corporation should seek profit, the duty of loyalty requires them to consider what legal, ethical course of action will produce the best outcome for the corporation’s stockholders as well.
The duty of loyalty also prohibits directors from using their positions to advance their own personal interests. Delaware law requires directors to devote their loyalty to the corporation and its stockholders, without consideration to their self-interest.[11] Thus, the duty of loyalty prohibits directors from engaging in an unfair transaction in which the director has an interest or may profit from the use of confidential corporate proprietary information. Generally, the duty of loyalty forbids any action that subordinates the best interests of the corporation and its stockholders to a director’s personal motive.[12]
To address these instances of potential self-dealing, Delaware courts will generally require the directors to demonstrate that a self-dealing transaction was entirely fair to the corporation. With this, the Delaware courts encourage interested directors to adopt procedural protections, such as impartial and independent decision-makers, to help ensure that the transactions are fair.[13] Further, because Delaware law seeks to protect minority investors, major corporate transactions with controlling stockholders are subject to this searching fairness review, even if procedural protections have been put in place.
It is important to be wary of your duties as a director or officer of a Delaware corporation. For more information on the topics covered here today, or for services related to your specific situation, contact our knowledgeable corporate governance attorneys at (646) 766-8308 or email info@kilegal.com to get the help you need.
[1] https://whyy.org/articles/why-do-so-many-corporations-choose-to-incorporate-in-delaware/
[2] GCL Section 141(a)
[3] Id.
[4] Id.
[5] GCL Section 102(b)(7)
[6] https://www.wolterskluwer.com/en/expert-insights/delaware-corporations-can-now-limit-the-liability-of-senior-officers
[7] Id.
[8] Id.
[9] https://www.lockelord.com/newsandevents/publications/2021/10/delaware-clarifies-its-rules-governing-stockholder
[10] Id.
[11] https://www.skadden.com/insights/publications/2020/02/directors-fiduciary-duties
[12] Id.
[13] https://corpgov.law.harvard.edu/2015/02/03/delaware-in-2014-increasing-deference-to-directors-decision/
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