The Delaware General Corporation Law’s central mandate appears in Section 141(a); it provides that the business and affairs of every Delaware corporation are managed by or under the direction of the corporation’s board of directors. In discharging their duty to manage or oversee the management of the corporation, directors owe fiduciary duties of loyalty and care to the corporation and its stockholders.
Business judgment rule: Although some major transactions require the consent of stockholders as well as the approval of the board, the board generally has the power and duty to make business decisions for the corporation. These decisions include establishing and overseeing the corporation’s long-term business plans and strategies, and the hiring and firing of executive officers. Delaware law affords directors making such decisions a set of presumptions—known as the “business judgment rule”—that, so long as a majority of the directors have no conflicting interest (see “duty of loyalty” below) in the decision, their decision will not later be second-guessed by a court if it is undertaken with due care and in good faith. The business judgment rule, which applies even if the business decision later turns out to have been unwise, is the centerpiece of Delaware corporation law.
Duty of loyalty: Broadly stated, 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.
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. A director therefore cannot cause a Delaware corporation to violate the law in order to make a profit. Rather, directors must exercise good-faith efforts to ensure that the corporation has policies to ensure compliance with the regulatory laws applicable to its operations (such as environmental, labor, and criminal laws) and to monitor senior management’s adherence to those policies. Although Delaware law gives directors wide discretion to decide how a corporation should seek profit, the duty of loyalty requires them to consider as well what legal, ethical course of action will produce the best outcome for the corporation’s stockholders.
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. Thus, the duty of loyalty prohibits directors from, for example, causing the corporation to engage in an unfair transaction in which the director has an interest, taking unreasonable action to keep their director positions, or profiting from the use of confidential corporate 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.
If a majority of the board has a conflicting interest in a transaction challenged in court, the board’s decision may not be protected by the business judgment rule. Rather, Delaware courts will generally require the directors to demonstrate that a self-dealing transaction was entirely fair to the corporation. For that reason, the Delaware courts encourage interested directors to adopt procedural protections—like impartial and independent decision-makers—to help ensure that the transactions are fair. 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.
Duty of care: In managing and overseeing a corporation’s business and affairs, directors must both make decisions and rely on subordinates. The duty of care requires directors to make informed business decisions, but recognizes that directors must make decisions constantly and cannot spend forever on each one. Thus, directors are not required to review all information in making their decisions—only the information that is material to the decision before them. Nevertheless, in evaluating information provided to them by management, directors are expected to review the information critically and not accept it blindly.
Whether directors have satisfied their duty of care typically depends on the specific circumstances. The Delaware courts will generally consider how much time the directors had to review the information, what information they reviewed, how critically they reviewed that information, and whether they sought expert financial or legal advice. Because rational stockholders would not want directors to fear that good-faith, but unavoidably risky, business decisions would later be second-guessed as a lapse in care, Delaware law typically applies a “gross negligence” standard to determine whether directors have satisfied their duty of care. In other words, although directors are expected to act with reasonable diligence, Delaware courts will only intervene if the directors have drastically departed from what would be expected of a careful fiduciary. Further, Delaware law allows corporations to include in their charters a provision immunizing directors from personal monetary liability for violating their duty of care—such a provision may not, however, shield directors from liability for violating their duty of loyalty. This provision, Section 102(b)(7), is designed to facilitate management creativity and good-faith risk taking to enhance stockholder wealth.
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Related Topics: business, business judgment, businesses, corporate, corporations, Delaware, Delaware Corporate Law, Delaware Courts, directors, duty of loyalty, State of Delaware