February 10, 2017
Officers and directors in a corporation are legally bound by fiduciary duties. In a clear example, directors owe a fiduciary duty to the shareholders of the corporation to make profits. Defining the nature of a fiduciary with duties to a beneficiary, “A fiduciary duty is the highest standard of care. The person who has a fiduciary duty is called the fiduciary, and the person to whom he owes the duty, is typically referred to as the principal or the beneficiary. If an individual breaches the fiduciary duties, he or she would need to account for the ill-gotten profit.[i]”
The fiduciary duty and relationship with beneficiaries exists in several different business entity formations such as corporations, limited liability companies and general partnerships including limited liability partnerships. This legal resource article is focused on corporations and their directors’ duties of obedience, care and loyalty.
- A Director’s Duty of Obedience
A corporate director has a duty of obedience and may not engage in acts that are considered ultra vires, meaning beyond the limits of authority. The authority, or scope, of a director is identified in corporate laws and in bylaws. In general, Texas courts have been reluctant to hold directors personally liable for breaching duties of obedience, unless there is a clear showing of knowledge and intent. There are legal defenses that may apply to questions of a corporate director’s obedience.
- A Director’s Duty of Care
In most contexts, a director has a duty of care to act prudently and with diligence in managing corporate business. A director must act as an ordinarily prudent individual would act under similar circumstances. While a corporate director may make innocent errors and omissions in conducting business, the focus becomes whether the director acted in good faith or was negligent or reckless. Litigating and defending duty of care issues is fact-driven and involves comparisons to similarly decided Texas cases and a comparison of facts.
- A Director’s Duty of Loyalty
Corporate directors owe a duty to guard against conflicts of interest between the corporation and the individual interests of the director. Examples of a breach of a duty of loyalty may be decisions where the individual director would personally benefit, known as self-dealing, and usurping (avoiding) opportunities for the betterment of the corporation. Determining whether a corporate director has acted with loyalty to the corporation can be determined on a case by case basis. Consistent with other corporate duties, determinations of legal liability are a function of current law, controlling legal decisions and individual facts and occurrences.
In addition to the fiduciary duties identified in case law and statutes, an organization can modify its duties and liabilities in its bylaws and operating documents. In creating a customized set of legal duties and expectations, one must be careful to not stray too far from existing case law and statutory requirements, so that the corporation’s bylaws and operating agreements remain valid and enforceable.
One of the worst things a corporate director can do is ignore their awareness or suspicion of a breach of a legal corporate duty. There are effective ways to clean up a corporate mess without risking the potential outcomes of sweeping that mess under a rug.
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