What Are Fiduciary Duties In The Context Of Corporate Officers And Directors?
Black's Law Dictionary defines "fiduciary duty" as " . . . a duty to act for someone else's benefit, while subordinating one's personal interests to that of the other person. It is the highest standard of duty implied by law (e.g., trustee, guardian)."
In the context of corporate leadership, fiduciary duties are governed by state law, and generally include:
1. Duty of Loyalty: This duty requires corporate officers and directors to act in the best interests of the company and its stakeholders. Pursuant to the duty of loyalty, officers and directors must avoid conflicts of interest and refrain from using their positions for personal gain or advantage.
2. Duty of Care: This duty requires corporate officers and directors to exercise reasonable care, skill, and diligence in carrying out their responsibilities. Pursuant to the duty of care, officers and directors must make informed and prudent decisions, act in good faith, and use the level of care that a reasonably prudent person would use in similar circumstances.
Corporations are governed by the laws of their state of formation and their governing documents (Articles of Incorporation and Bylaws). As a result, it's important to note that fiduciary duties and the interpretation thereof will vary depending on the jurisdiction and the terms of the applicable governance documents.
Duty Of Loyalty
The duty of loyalty encompasses the following key aspects:
1. Avoiding Conflicts of Interest
Corporate officers and directors must avoid situations where their personal interests conflict with the interests of the company. They should not engage in transactions, relationships, or activities that compromise their ability to act impartially and in the company's best interests. If a conflict of interest arises, they must disclose it to the Board of Directors and, in some cases, seek approval or recuse themselves from relevant decision-making processes.
2. Acting in Good Faith
Officers and directors are expected to act honestly, in good faith, and without self-dealing or personal bias. They should make decisions and take actions based on the best available information, independent judgment, and with the primary goal of benefiting the company and its applicable stakeholders as a whole.
3. Maintaining Confidentiality
Officers and directors have a duty to protect and maintain the confidentiality of the company's sensitive and proprietary information. They must not use such information for personal gain or disclose it to unauthorized individuals, except when required by law or when other exception applies.
4. Prohibiting Usurpation of Corporate Opportunities
Officers and directors must not usurp corporate opportunities that rightfully belong to the company. They must refrain from personally benefiting from business opportunities that arise in the course of their positions, unless the company has explicitly declined to pursue such opportunities.
5. Avoiding Competition
Officers and directors must not compete with the company directly or indirectly, unless they have obtained proper authorization to do so. They should not engage in activities that undermine the company's interests or divert business opportunities away from the company.
Duty of Care
The duty of care involves the responsibility to exercise reasonable care, skill, and diligence in carrying out their roles and responsibilities as company management. Key aspects of the duty of care include:
1. Informed Decision Making
Officers and directors are expected to make informed decisions based on adequate information and careful analysis. They should actively participate in board and management meetings, review relevant materials, and ask questions to ensure they have a comprehensive understanding of the matters at hand.
2. Prudent Judgment
Officers and directors should exercise prudent judgment in their decision-making process. This involves considering the potential risks and benefits associated with various courses of action and making choices that are reasonably expected to promote the best interests of the company and its stakeholders.
3. Expertise and Skill
Officers and directors are not required to be experts in all areas of the company's operations, but they are expected to possess the knowledge and skills necessary to fulfill their duties effectively. If they lack specific expertise, they should seek advice from qualified professionals or colleagues with relevant knowledge.
4. Monitoring and Oversight
They have a duty to monitor the company's activities and implement appropriate systems and controls to ensure compliance with laws and regulations, as well as the company's policies and procedures. They should stay informed about the company's financial performance, risk management, and legal compliance.
5. Reasonable Reliance
Officers and directors may rely on information, reports, and expert opinions provided by reliable sources within the company, external consultants, or professionals, as long as they have a reasonable basis to believe in their competence and integrity. However, they cannot blindly rely on such information if there are red flags or indications of potential inaccuracies.
6. Ongoing Engagement
The duty of care requires officers and directors to actively engage in their roles and to dedicate sufficient time and effort to fulfill their responsibilities diligently. They should attend board meetings, review materials, and stay updated on relevant industry trends and developments.
Do Fiduciary Duties Apply To Limited Liability Companies?
In many jurisdictions, pursuant to applicable statutes and case law, fiduciary duties apply to managers and controlling members of limited liability companies comparably to the application of fiduciary duties to corporate officers and directors. That said, in many jurisdictions, subject to certain limitations, fiduciary duties may be affirmatively waived or modified pursuant to the terms of an LLC's operating agreement. As a result, in cases where LLC fiduciary duties have been waived or modified, different (typically lower) standards may apply.
The ability to waive or modify fiduciary duties is one reason why some choose to operate their business under an LLC as opposed to a corporation. By crafting and clearly spelling-out alternative fiduciary standards in the operating agreement, LLC managers and controlling members have greater flexibility on how to conduct their business and can reduce risk of disputes or unclear standards of oversight later.
Consequence Of Breach Of Fiduciary Duty
If an officer or director breaches its fiduciary duty, there can be several consequences, including reputational (to the individual and to the company itself), removal from office (by the company's Board of Directors or court order), potential civil liability including an order to pay the company or its shareholders damages caused by the harm, and potential criminal lability, especially if the matter involved intentional misconduct such as theft or fraud.
Given the seriousness of these matters, it's important for officers and directors to receive training regarding their fiduciary duties. Fiduciary duty training may include a combination of board training programs, third-party speakers and consultants, written materials, case studies and continuing education. Training can be done when a new officer or director is on-boarded, and periodically thereafter.
Ensuring that officers and directors are properly trained will help ensure that they understand their legal and ethical obligations and are equipped to make sound decisions that are in the best interests of the company and its stakeholders.
Fiduciary duties exist to ensure that individuals in positions of trust and authority, such as corporate officers and directors, act in the best interests of those they serve. These duties help to protect the stakeholders who rely on the fiduciaries to make sound and ethical decisions.
Fiduciary duties provide a framework for long-term success and upholding ethical standards within organizations.
They also help foster accountability, transparency and sound decision-making.
The Law Office of Jennifer M. Settles advises companies on best practices in corporate governance, including fiduciary duty training. Call us today to discuss. The initial consultation is free.
Jennifer M. Settles, Esq. is a corporate lawyer at the Law Office of Jennifer M. Settles. She advises clients on corporate governance matters, M&A transactions, commercial contracts, real estate matters, financing transactions and more. To schedule a free consultation with Jennifer, please call 602-617-3938, or email us through the Contact Form on our website, www.jsettleslaw.com