Advice for Corporate Directors

In managing the business and affairs of a corporation, directors stand in a fiduciary relationship to the corporation, which requires that they act prudently and in the best interest of the corporation, rather than in their own interest. Directors owe the corporation complete loyalty, honesty and good faith. Generally, in accordance with the business judgment rule, courts will not second-guess directors’ decisions as long as the board has conducted an appropriate process in reaching its decision. In certain circumstances, however, including in the context of mergers and acquisitions and where there is a conflict of interest, the court will examine the board’s decision with “enhanced scrutiny.”Following the financial events of the past year, many rules have changed, and new regulations adopted. Reassuringly for fiduciaries, the Delaware courts in 2009 applied the business judgment rule to allegedly faulty fiduciary actions and failures to act that were at the heart of the economic crisis. For example, the Delaware Chancery Court refused to extend liability to the board of directors of Citigroup for participating in the subprime lending market and required that the directors be shown to have acted in bad faith. On the other hand, where directors act in bad faith, they will be held liable, as was the case for certain directors of American International Group which were aware of misconduct that should have been brought to the attention of AIG’s independent directors but chose to conceal their knowledge. Directors will be held liable if they know of fraudulent schemes such as fraudulent reinsurance transactions, the misstatement of accounts and failure to correct accounting problems. This article accordingly sets forth the fiduciary duties directors owe to shareholders, and in certain cases creditors, under Delaware law and how the courts have applied these duties in the context of the recent economic crisis. Delaware law on fiduciary duties is in turn followed by many courts and corporate statutes in other U.S. states.