Oct. 14, 2020

This paid piece is sponsored by Woods, Fuller, Shultz & Smith PC.

By Sander Kline, attorney

When you agree to serve on a corporate board, you may not realize that you need to observe rules and undertake responsibilities beyond simply attending meetings and voting or offering input on important business matters. Board members and certain corporate officers are fiduciaries and owe duties of loyalty and care to their corporation and shareholders. The same is often true of managers in a limited liability company.

This duty of loyalty requires that board members act in good faith with an honest belief that all their actions are in the best interest of their corporation and that they be both disinterested and independent. Board members who fail to live up to their fiduciary duties may incur personal liability. The threat of potential liability makes it important for board members to understand the scope of their duties.

Board members are generally shielded from personal liability by the “business judgment rule.” The business judgment rule starts from the assumption that board members are acting in compliance with their duty of loyalty. Unless presented with information or evidence to the contrary, a court will not second-guess a decision of the board, even if that decision turns out to be unwise or unsuccessful. Courts understand that risky decisions are sometimes part of running a business and that occasional bad outcomes can be a normal part of doing business. Courts have little desire to tell corporate leaders how to do their jobs.

However, courts do have both a responsibility and a desire to protect corporations and their shareholders, who are not involved in the day-to-day operation of the business, from board members who do not respect the duties they owe to their corporation.

A board member can lose the protection of the business judgment rule if he or she breaches his or her fiduciary duties. Courts will deny board members the protection of the business judgment rule when they find any of these situations:

• Conflicts of interest on the part of the board member.
• Preferential treatment of certain shareholders or other constituencies represented by a particular board member.
• The failure of a board member to disclose fully certain material aspects of a transaction, including their relationships with the principals in the transaction, board member contacts with interested third parties or information tending to show a benefit to a particular board member or shareholder.
• Action taken without the information or deliberation expected of a reasonable person or that otherwise violates the duty of care.

A board member in one of these situations should advise his or her fellow board members. Then, the board as a whole can make an informed decision about whether to take necessary actions such as excluding a conflicted member or obtaining additional information. Of course, a board member can always choose to recuse himself or herself and avoid any conflict.  If you find yourself in one of the situations above, consider the duties you owe to the corporation and the potential consequences of not observing those duties. And as always, if you are in doubt, consult your attorney for further advice.

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