Ask a MoFo: What Fiduciary Duties Do I Have as a Director of a Delaware Corporation?

The following article is part of our "Ask a MoFo" series, where we address some of the frequently asked questions our MoFo startup team is asked during the course of business. These questions span the entirety of the startup lifecycle – from questions relating to incorporation, to tips for a successful exit. We encourage you to submit questions you would like to see answered as part of this series to ECVCevents@mofo.com.

You’re an entrepreneur, you form your first company, and suddenly you carry the title of founder, director, officer, and/or employee all at once. When running your business, it may feel like all of your roles blur together. However, it’s important to remember your different roles when taking action on behalf of the corporation in order to protect yourself from liability.

A fiduciary is someone who is required to act for the benefit of another person on all matters within the scope of their relationship.[1] Directors and officers of a corporation are fiduciaries. Under Delaware law, the general rule is that a director owes fiduciary duties of loyalty and care to the corporation and its stockholders.[2]

The Duty of Care

The duty of care mandates that a director act in good faith, with the care that a reasonable person in a similar position and circumstance would exercise and in a manner the director reasonably believes to be in the best interests of the corporation and its stockholders. Put simply, directors must inform themselves of all reasonably available material information and deliberate carefully prior to making business decisions. For example, directors should take appropriate time to evaluate corporate actions, take advice from experts, actively ask questions, take the time to understand the terms of transactions, and monitor and review management’s performance.

It is important that directors deliberate and properly approve and document certain corporate actions in order to avoid liability for breaching their duty of care as well as to ensure corporate records are adequately maintained and readily available for potential investors.

The Business Judgment Rule

If you are sued for breaching your duty of care, the default standard is that your actions will be evaluated under the Business Judgment Rule (or, as the cool kids say, the BJR). Aptly named, the BJR protects directors from lawsuits that challenge their business judgment.

The BJR is a presumption that, in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and with the honest belief that the action taken was in the best interests of the corporation.[3] When the BJR applies, a court will not substitute its judgment for that of the board if the decision has a rational business purpose.[4] Thus, even bad decisions may be protected under the BJR, so long as they were made by informed directors.

The BJR also protects good-faith reliance on the records of the corporation and on information, opinions, reports, or statements presented to the corporation by its officers or employees, committees of the board, or other people reasonably selected and believed to have professional or expert competence.[5]

However, the BJR presumption is rebuttable, meaning it doesn’t always save the day. If a plaintiff can show certain conditions, such as fraud, illegality or wrongful conduct, a conflict of interest, bad faith, an egregious decision, or waste, the BJR will not apply.

Even if the BJR does not apply, a plaintiff must still prove a breach of the duty of care by showing that the board acted with gross negligence. In one case, a board breached its duty of care where, in deciding to accept a merger proposal, the board based its decision on one uninformed person’s representations without reviewing any documentation or inquiring about the adequacy or method of determining the proposed price per share.[6] Thus, gross negligence can be found where a board fails to inform itself of all readily available material information before acting.[7] Therefore, in order to avoid liability for breaching your duty of care, you should keep informed about the business and its financial status, receive input from management and advisors, consider alternatives and adequately deliberate before making decisions.

The Duty of Loyalty

The duty of loyalty mandates that a director act in good faith and with a reasonable belief that what she does is in the corporation’s best interests. A director must refrain from self-dealing and place the interests of the corporation and its stockholders ahead of her own.[8] Duty of loyalty issues often arise in conflict-of-interest situations, such as transactions between two corporations when a director sits on the board of each or transactions between the corporation and a director, where a director usurps a corporate opportunity without first offering it to the corporation, or where a director is involved in setting her own compensation.

Therefore, in order to avoid liability for breaching your duty of loyalty, it is important to refrain from self-dealing and/or in certain circumstances possibly to recuse yourself from board decisions on matters in which you are self-interested or where there is an appearance of a conflict of interest, absent adequate disclosures to the other non-interested members of the board.

Defenses to Liability

While the BJR applies to evaluate duty of care claims, it does not apply to conflict-of-interest transactions. However, a conflict-of-interest transaction can be “cleansed” if the transaction is approved by a vote of the majority of the fully informed and disinterested directors or the fully informed and disinterested stockholders or if the transaction is shown to have been fair to the corporation in all respects (a high standard).[9]

Are my fiduciary duties waivable? Can I opt out?

The short answer is: No. As a director of a corporation, your fiduciary duties cannot be disclaimed or modified by agreement. Note, however, that Delaware law allows a corporation to indemnify directors for certain breach of fiduciary duty claims, as well as to provide for a waiver that allows a director to take otherwise impermissible actions, such as corporate opportunities. This isn’t true for all jurisdictions or entity types.

What corporate actions under Delaware law “must” a corporation’s board approve?

As a director, you are responsible for managing and directing the business and affairs of the corporation.[10] While the board can delegate management of the day-to-day affairs of the corporation to officers, fundamental corporate changes and most material transactions must be approved by the board. This includes amending the charter or bylaws, granting equity, adopting or amending employee equity or benefit plans, making material expenditures outside of the budget, and entering into mergers and acquisitions.

There is no hard and fast rule about which actions must be approved by the board, and the above list is not exhaustive; always check with your legal counsel to determine if your proposed action requires board and/or stockholder approval.

Disclaimer – This article has been prepared for informational purposes only and does not constitute legal or other professional advice. You should consult a legal professional for questions pertaining to your specific situation.

Originally posted as a client alert on www.mofo.com.

[1] FIDUCIARY, Black’s Law Dictionary (11th ed. 2019).

[2] Guth v. Loft. Inc., 5 A.2d 503, 510 (Del. 1939).

[3] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

[4] Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971).

[5] 8 Del. C. § 141(e).

[6] Smith v. Van Gorkom, 488 A.2d 858, 875 (Del. 1985).

[7] Id. at 872–4.

[8] Guth, 5 A.2d at 510.

[9] 8 Del. C. § 144.

[10] 8 Del. C. § 141(a).