Duty Of Care

Directors, officers, and incorporators of a corporation must perform their duties in good faith and in a manner reasonably believed to be in the best interests of the corporation, and with such care as an ordinarily prudent person in a like position would use under similar circumstances.

The fact finder would consider the individual's skill and sophistication and his familiarity with the business.

A director who dissents from a course of action will not be liable if the corporation is damaged by that action.

A director or officer can be liable for negligently selecting subordinates, but is not liable for the negligence of his peers unless he participated or was negligent in not discovering it.

Generally, a director or officer who makes a good-faith error of business judgment will not have breached his duty of care.

A director, or officer, is entitled to rely on information, opinions, reports or records, including financial statements, books of account and other financial records, presented by or prepared by or under the supervision of others qualified to do such.

A director who votes for or assents to the declaration of any dividend or other distribution of the assets of a corporation to its shareholders contrary to statute or restrictions in the articles of incorporation is liable, with other assenting directors, to the corporation for the amount of the distribution.

A director who votes for or assents to the purchase of the corporation's own shares contrary to the statute is liable, with the other assenting directors, to the corporation for the amount of consideration paid for those shares.

A director who votes for or assents to any distribution to the shareholders during liquidation without payment of or adequate provision for known obligations or liabilities of the corporation will be liable, with the other assenting directors, for the value of the assets so distributed.

Any director against whom such a claim is successfully asserted is entitled to contribution from the other directors who voted for, and the other officers who participated in, the wrongful action, and who did not meet the good-faith standard. 

A director may also receive contribution or indemnification  from the shareholders who accepted any improper dividend or distribution knowing that the dividend or distribution was wrongful.

A director or officer can be liable for negligently selecting or supervising subordinates.

Duty Of Loyalty

The fiduciary duty of officers, directors and employees require that they be loyal to the corporation and not promote their own interests in a manner injurious to it.

A conflict of interest occurs whenever a director or officer contracts with the corporation to buy or sell goods or services. These transactions are not void, but at most voidable by or on behalf of the corporation. The action should be approved only by a disinterested majority of the directors or shareholders.

Generally, the contract will stand if an independent corporate fiduciary in an arms length bargain would have bound the corporation to the transaction.

The fiduciary duty of loyalty prohibits directors and officers (and sometimes employees) from taking for their own benefit any business opportunity which properly belongs to the corporation, unless the corporation is first given a chance to pursue the opportunity.

If a director has usurped a corporate opportunity, the court may hold the individual to be a constructive trustee for the corporation, and order him to convey any property, income or profits derived through his misappropriation to the corporation, or may assess any damages suffered by the corporation.

Competition by a director or officer will not necessarily be a breach of fiduciary duty if he acts in good faith.  As a general rule, directors and officers may engage in independent business, but if the independent business competes with the corporation, equitable limitations will apply.

The remedy for such a breach would be the profits earned in competition, a constructive trust on the competitor's property, or damages for injury to the corporation.

In the absence of any contrary agreement or understanding, corporate officers are not precluded, upon the termination of their employment, from entering into competition with their corporate employer, or from using the intangible knowledge and skill they acquired while employed.

Duties Of Controlling Shareholders

The majority stockholders have the right to control, but in doing so they owe a fiduciary duty to the corporation and the minority. They must not act fraudulently or misuse their power to promote their personal interests at the expense of corporate interests.

A majority shareholder's fiduciary duty is usually enforceable by the corporation, by means of a shareholder's derivative action, or by an individual shareholder's action for breach of fiduciary duty to him.

In selling their control, controlling shareholders owe the corporation fiduciary duties and duties of due care because control is a corporate asset in which all shareholders have an interest.  Thus, if a controlling shareholder sells his stock to a person who he knows or has reason to know intends to loot the corporation, he is liable.

Insider Trading

At common law, the majority rule was that a director, officer or other corporate "insider" owed no fiduciary duty to shareholders, and therefore was under no duty to disclose inside information when trading in corporate stock.

At common law, the minority rule is that insider trading constitutes a breach of the fiduciary duties owed to the corporation, on the theory that inside information is a corporate asset and cannot be exploited for personal gain.

SEC Rule 10b-5 (promulgated under Section 10(b) of the 1934 Securities and Exchange Act), the federal anti-fraud rule, prohibits:

• the use of any device, scheme or artifice to defraud;
• the untrue stating of a material fact, or the omission of a material fact which is misleading in light of the circumstances under which they were made; or
• any act, practice or course of business which operates or would operate as a fraud or deceit.

Rule 10b-5 applies to all securities of any corporation, whether or not publicly traded, as long as some means of interstate commerce was used in connection with the purchase or sale of securities.

The SEC may impose fines and seek criminal penalties.  Courts have also implied a private cause of action for money damages where the plaintiff either purchased or sold stock in connection with the alleged fraud.

There is no requirement of privity between the plaintiffs and defendants in Rule 10b-5 actions because identification of buyers and sellers is difficult on the open market.

Section 16(b) provides that any profit made by an officer, director, or beneficial owner of more than 10% of a class of equity security from any purchase and sale of a security within six months is recoverable by the corporation.

16(b) applies to corporations that are listed on national securities exchanges or that are engaged in interstate commerce or whose stock is traded in interstate commerce and that have at least $5,000,000 in assets and a class of equity securities owned by at least 500 shareholders.