Officers, directors, managers, controlling stockholders and other control persons of corporations and other entities frequently have responsibilities to minority owners set forth in their companies’ organizational documents (charters, bylaws, operating agreements, etc.). For example, a control person may be required to give investors access to a company’s books and records. In addition, state law imposes specific responsibilities on control persons for the benefit of minority owners, such as a requirement to convene an annual meeting of stockholders.
However, beyond these fairly straightforward responsibilities, controls persons may also have a responsibility to subordinate their own interests to the interests of minority owners. Known as “fiduciary duties,” these duties exist where one person reposes special trust in and reliance on the judgment of another, as in a director-shareholder relationship. In fact, they almost always exist if you are a director, officer or controlling shareholder of a corporation. In the context of an LLC or partnership, however, such duties may be limited or waived entirely through the company’s organizational documents.
Assuming they apply, the primary fiduciary duties** consist of:
- the duty of care
- the duty of loyalty and
- the duty of good faith.
In addition, if you’re selling your company, a heightened standard of conduct known as “Revlon duties” may apply. I discuss Revlon duties in a separate post.
** This post assumes your company is organized in Delaware, the leading jurisdiction for corporate law. The law of Delaware is generally, though not always, a good indicator of standards that will apply in other States.
For now, here’s a brief description of each of the three primary duties:
The Duty of Care
The duty of care requires you to act on an informed basis after due consideration of all information. The duty includes a requirement that you reasonably inform yourself of alternatives. In doing so, you may rely on employees and other advisers so long as you do so with a critical eye and do not unquestionably accept the information and conclusions provided to you. Under normal circumstances, your actions are accorded the protection of the business judgment rule, which presumes that you acted properly, provided that you act on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company.
The Duty of Loyalty
The duty of loyalty requires you to look to the interests of the company and its other owners and not to your personal interests. In general, you cannot use your position of trust, confidence and inside knowledge to further your own private interests or approve an action that will provide you with a personal benefit (such as continued employment) that does not primarily benefit the company or its other owners.
Generally speaking, there are two types of disabling conflicts of interest:
“Interestedness,” where you stand on both sides of a deal and will receive a benefit from the transaction that isn’t shared by the company and its other owners.
Lack of Independence, where you derive an indirect benefit from a transaction, or you derive a benefit from, or are beholden to, another control person who will benefit from a transaction.
A court will not automatically deem a control person “interested” but will determine whether the benefit is material to the control person and would therefore affect his or her objectivity. The mere presence of control persons who are interested or not independent will not undermine the validity of a decision if a majority of the other control persons are disinterested and independent.
The Duty of Good Faith
The duty of good faith requires you to exercise care and prudence in making business decisions—that is, the care that a reasonably prudent person in a similar position would use under similar circumstances. Control persons fail to act in good faith, even if their actions are not illegal, when they take actions for improper purposes or, in certain circumstances, when their actions have grossly inequitable results. The duty to act in good faith is an obligation not only to make decisions free from self-interest, but also free of any interest that diverts the control persons from acting in the best interest of the company. Your duty to act in good faith may be measured by your particular knowledge and expertise. The higher your level of expertise, the more accountable you will be (e.g., a finance expert may be held to a more exacting standard than others in accepting a third party valuation).
At one time, courts seemed to view the duty of good faith as an independent obligation. However, more recently, courts have treated the duty of good faith as a component of the duty of loyalty.
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For a more detailed discussion of control person fiduciary duties, here‘s an excellent 2012 article published in Penn State Law Review.
Got questions or need help with a deal? Contact Erik at email@example.com or +1-214-601-1887.