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BASIC DUTIES OF A
DIRECTOR IN A CALIFORNIA NON PUBLIC CORPORATION
Introduction:
A corporation is a
small “republic” with the shareholders (owners) electing the directors
who, in turn, appoint the officers who run the day to day operations of
the company. Absent a contract to the contrary, the officers serve at
the pleasure of the Board of Directors and most Boards are elected
annually by the shareholders.
The role of the
shareholders is clear: they own the company, enjoy its benefits, and
elect the directors. The role of the officers is the day to day
operations of the company. The directors are more strategic in nature,
supervising generally the operations of the company and the actions of
the officers. This article shall explore further the roles of the
directors of a California non public corporation.
Basic Duties Imposed by
Statute on Directors:
While officers run
the day to day operations of the corporation, it is the directors who
are concerned with the more strategic operations of the company and who
have a direct duty to the shareholders as to the well being of the
corporation. They supervise the activities of the officers and report
back to the shareholders as reasonably required but no less often than
annually. They have a
fiduciary duty
to the shareholders and the company.
A California non
public owned corporate director’s general duty of care is set forth in
Corporations Code §309.
Corporation Code Section 309 provides as follows:
(a) A director shall perform the duties
of a director, including duties as a member of any committee of the
board upon which the director may serve, in good faith, in a manner such
director believes to be in the best interests of the corporation and its
shareholders and with such care, including reasonable inquiry, as an
ordinarily prudent person in a like position would use under similar
circumstances.
(b) In performing the duties of a director, a director shall be
entitled to rely on information, opinions, reports or statements,
including financial statements and other financial data, in each case
prepared or presented by any of the following:
(1) One or more officers or employees of the corporation whom
the director believes to be reliable and competent in the matters
presented.
(2) Counsel, independent accountants or other persons as to
matters which the director believes to be within such person's
professional or expert competence.
(3) A committee of the board upon which the director does not
serve, as to matters within its designated authority, which committee
the director believes to merit confidence, so long as, in any such case,
the director acts in good faith, after reasonable inquiry when the need
therefor is indicated by the circumstances and without knowledge that
would cause such reliance to be unwarranted.
(c) A person who performs the duties of a director in accordance
with subdivisions (a) and (b) shall have no liability based upon any
alleged failure to discharge the person's obligations as a director. In
addition, the liability of a director for monetary damages may be
eliminated or limited in a corporation's articles to the extent provided
in paragraph (10) of subdivision (a) of Section 204.
The “Business Judgment Rule:”
Corporation Code
Section 309 is a codification of the common law “business judgment
rule”. Will v. Engebretson (1989) 213 Cal. App. 3d 1033, 1040;
Gaillard v. Natomas Co. (1989) 208 Cal. App. 3d 1250, 1264. The
business judgment rule recognizes a long standing policy of judicial
deference to the business judgment of corporate directors who are
presumably better able than the courts to decide whether or not a
proposed transaction is in the best interests of the corporation.
Will, supra. at page 1033; Gaillard, supra. at page 1264
Under the business
judgment rule, as codified, a director is not liable for mistakes
in business judgment, made in good faith, in a manner the director
believes to be in the best interests of the corporation and which were
made with such care, including reasonable inquiry, as an ordinarily
prudent person in a like situation would use under similar circumstances.
A director’s liability may be further limited or eliminated by the
Articles of Incorporation by provisions.
The language of the
statue applies expansively to the “duties of a director”. One authority
summarized, without citation to case authority, that application of the
business judgment rule as codified by §309 arises most frequently in
actions seeking to hold corporate directors liable for corporate losses
resulting from, among other things, the directors’ failure to obtain
adequate insurance on corporate assets, or to protect the corporation
against foreseeable liabilities and claimed diversion or waste of
corporate assets.
The §309 duty of
care includes a duty of “reasonable inquiry. Information that
would cause a prudent business person to make further investigation of
facts requires the director to make that investigation and take
appropriate action or face violation of the fiduciary duty.
The Duty of Loyalty for
Directors and Officers
In addition to the
statutory duty of care, corporate directors and officers, who
participate in corporate management and exercise some discretionary
authority, owe the corporation a
fiduciary duty
of loyalty (Bancroft-Whitney Co. v. Glen (1966) 64 Cal. 2d 327,
345; GAB Business Services, Inc. v. Lindsey and Newsome Claim
Services, Inc. (2000)83 Cal. App. 4th 409,420-424.
A public policy …demands of a corporate officer
or director,
peremptorily and inexorably, the most scrupulous
observance
of his duty, not only affirmatively to protect
the interests of
the corporation committed to his charge, but
also to refrain
from doing anything that would work injury to
the corporation
or to deprive it of profit or advantage which
his skill and
ability might properly bring to it, or enable it
to make in the
reasonable and lawful exercise of his powers.
Bancroft-Whitney, supra. at 345
Both the
Bancroft-Whitney case and the GAB case involved corporate
executives who, while still employed, solicited the most desirable
employees of their present employer to leave with them to take jobs with
their employer’s direct competitor. However, the reasoning and result
in neither case turned on that particular fact pattern. The definition
of the duty, as set forth above by the Bancroft-Whitney court
would certainly seem to encompass the duty to prevent drastic drop in
value and other economic damage or waste to a corporation in the event
of a director’s or key officer’s death or incapacity, prevention of
which is clearly within the lawful exercise of the director’s powers.
The
Corporate Opportunity Doctrine would apply to certain of
the actions and the article on that topic should be reviewed by the
reader.
The fiduciary duty
enunciated by the Bancroft -Whitney
Court is imposed upon corporate
officers as well as directors.
At least one commentator suggests that an officer is held to a higher
standard of care than a director because he/she may be required to be
more familiar with corporate affairs and less able to rely on the
reports or other information supplied by others.
A higher duty of care on the part of corporate officers was confirmed by
the court in Gailliard v. Natomas Company, supra.,
which held that an officer’s liability is not limited by Corporations
Code §309 or the business judgment rule. The Gaillard court
considered the propriety of golden parachutes for various executives
approved by the directors of the corporation, some of whom were also
officers, who the court referred to as “inside directors.” The
Gaillard court reasoned as follows:
We
further conclude, however, that, as a matter of law, our review of the
conduct of the inside directors is not governed by section 309. The
inside directors did not vote on the approval of the golden parachutes
or consulting agreement. In securing the payment of these benefits to
themselves, they were not "[performing] the duties of a director" as
specified in section 309, but were acting as officer employees of the
corporation. The judicial deference afforded under the business judgment
rule therefore should not apply. As stated by Marsh in his discussion of
section 309: "section 309 subdivision (a) does not relate to officers of
the corporation, but only to directors. . . . [An] officer-director
might be liable for particular conduct because of his capacity of an
officer, whereas the other directors would not." (1 Marsh, op. cit.
supra, § 10.3, at p. 576.) This result is in accord with the premise
of the business judgment rule that courts should defer to the business
judgment of disinterested directors who presumably are acting in
the best interests of the corporation. Gaillard, supra at p.1265.
The facts upon which
the Gaillard court distinguished the activities of an
officer/director from the activities of an “outside director” for
purposes of liability are the following. The officer/directors were
active in the negotiation of the favorable employment agreements and the
merger structure that required them. However, when the agreements were
put to the full board of directors the five officer/directors who had
been involved in their negotiation, abstained from voting. Only the
“outside” directors voted.
When determining
director liability under Corporations Code §309 there is a rebuttable
presumption that a director acted in good faith. Katz v. Chevron Corp.
(1994) 22 Cal.App. 4th 1352, 1366; Burt v. Irvine
(1965) 237 Cal. App. 2d 828,845. Since the presumption stems from the
business judgment rule it would not apply to the determination of
liability of an officer. See Burt v. Irvine, supra at p.
845.
Conclusion:
One wag put it
succinctly: a director is allowed to be wrong but not allowed to cheat
or be wrong without a leg to stand on. Courts will give him or her wide
discretion and allow him or her to have made the wrong decision but only
if there was some grounds for making such a decision and dishonesty or
self dealing was not a factor.
It is equally vital
to note that the duty of inquiry does not allow a director to “look the
other way” or fail to make reasonable inquiry as to facts or
developments that a prudent business person would investigate.
”I don’t want to
know” is not a valid defense.
Bylaws can provide
additional protection for a director and limit both the exposure and
provide for indemnity to a director forced to defend him or herself. But
the Courts have been firm that if wrongdoing or gross negligence is
demonstrated that the director will not be able to rely on indemnity or
the business judgment rule for protection.
Thus being a
director requires due care and full understanding of the duties imposed.
It is not merely a ceremonial position or a seat around a large table.
It is an obligation, a duty, and the shareholders have the right to
require compliance with all the obligations of a fiduciary.
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