Exploring Fiduciary Duties in Corporate Governance

Corporate governance is the framework of rules, relationships, systems, and processes within and by which authority is exercised and controlled within corporations. At the heart of corporate governance lies the concept of fiduciary duties, which define the responsibilities of directors, officers, and sometimes controlling shareholders toward the corporation and its stakeholders. Understanding the nature and scope of fiduciary duties is essential for lawyers advising clients in corporate transactions, governance disputes, and compliance matters. 

What Are Fiduciary Duties?

Fiduciary duties are legal obligations that require individuals in positions of trust to act in the best interests of the entity they serve. In the corporate governance context, fiduciary duties primarily apply to directors and officers, but they may also extend to controlling shareholders in certain circumstances.

Fiduciary duties arise from the relationship of trust and confidence that directors and officers have with the corporation and its shareholders. Courts have long recognized that the unique nature of this relationship creates a heightened obligation to act with care, loyalty, and good faith. The primary fiduciary duties in corporate governance are:

Duty of Care

The duty of care requires directors and officers to act with the care that an ordinarily prudent person would exercise under similar circumstances. This includes:

• Staying informed about the corporation’s business and affairs.
• Diligently reviewing corporate documents and financial statements.
• Asking questions and seeking clarification when necessary.
• Making decisions based on a reasonable belief that they are in the best interests of the corporation.

Directors are generally entitled to rely on information provided by officers, employees, and outside advisors, such as accountants and legal counsel, provided that reliance is reasonable under the circumstances. The business judgment rule often protects directors from liability for decisions that turn out poorly, as long as they were made in good faith, with due care, and without conflicts of interest.

Duty of Loyalty

The duty of loyalty requires directors and officers to act in the best interests of the corporation and avoid conflicts of interest. This duty includes:

• Refraining from using corporate opportunities for personal gain.
• Avoiding self-dealing and transactions that benefit themselves at the corporation’s expense.
• Fully disclosing any conflicts of interest and obtaining appropriate approval before proceeding with any conflicted transactions.

Self-dealing and corporate opportunity cases are the most common contexts in which the duty of loyalty is tested. Directors who engage in self-dealing transactions must demonstrate that the transaction was entirely fair to the corporation, a high standard that includes both fair dealing and a fair price.

Duty of Good Faith

While the duty of good faith is often viewed as a subset of the duty of loyalty, some courts have treated it as an independent obligation. The duty of good faith requires directors to:

• Act honestly and with a genuine intent to advance the corporation’s best interests.
• Avoid intentional misconduct and knowing violations of the law.
• Make decisions with the belief that they are acting in the corporation’s best interests.

Evolving Standards in Fiduciary Law

While the core principles of fiduciary duty have remained relatively stable, recent developments in corporate law have shaped how these duties are interpreted and enforced.

Heightened Scrutiny for Conflict Transactions

Courts have increasingly scrutinized transactions involving conflicts of interest, particularly in the context of mergers and acquisitions. In In re Trados Inc. Shareholder Litigation (2013), the Delaware Chancery Court emphasized that directors who stand on both sides of a transaction must demonstrate that the transaction is entirely fair.

The “entire fairness” standard is the most stringent level of judicial review and requires proof of both fair dealing and a fair price. This is in contrast to the business judgment rule, which presumes that directors acted in good faith and with due care.

Increased Focus on Board Oversight

The duty of oversight—often viewed as part of the duty of care—has gained prominence in recent years. In Marchand v. Barnhill (2019), the Delaware Supreme Court held that directors of Blue Bell Creameries could be held liable for failing to implement and monitor food safety compliance programs, which resulted in a deadly listeria outbreak.

The decision reinforced the principle established in In re Caremark International Inc. Derivative Litigation (1996), which requires directors to implement reasonable information and reporting systems to ensure legal and regulatory compliance. A failure to establish such systems, or to act on known compliance issues, can constitute a breach of fiduciary duty.

Expansion of Fiduciary Duties to Controlling Shareholders

While fiduciary duties traditionally apply to directors and officers, courts have extended them to controlling shareholders in certain circumstances. A controlling shareholder who engages in a conflicted transaction with the corporation may be subject to the entire fairness standard.

For example, in Kahn v. M&F Worldwide Corp. (2014), the Delaware Supreme Court held that a controlling shareholder-led merger could receive business judgment rule protection if it was conditioned upon:

• Approval by an independent special committee of the board.
• A fully informed vote of the minority shareholders.
  

This framework has provided guidance for structuring transactions to minimize the risk of fiduciary duty claims.

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