When acting on behalf of a corporation, you have a duty to put the company’s interests above your own.
When corporate officers, directors, or employees act on behalf of a corporation, they must put the company’s interests above their own and make responsible, informed decisions. The obligation to put the company’s interests first is known as a fiduciary duty. If you fail to follow your fiduciary duties, you might be personally liable for your actions or inactions.
What is a Fiduciary?
In a corporation, a fiduciary is someone who acts on behalf of the company, including directors and officers. The board of directors set policies, oversee the corporation, and appoint the officers. Officers include the executive director, secretary, treasurer, and others who manage the day-to-day affairs of the business. In some corporations, the directors and the officers are the same individuals.
Shareholders and stockholders are the owners of the business. Unless shareholders are also directors or officers, they are not responsible for managing the corporation beyond electing the board of directors. Because shareholders do not act on behalf of the company, they are not fiduciaries and do not owe the corporation the same duties as directors and officers.
However, the rules are different for controlling shareholders—those who own a majority of the business. Controlling shareholders have more control over the business than an ordinary shareholder because they decide who will be on the board, and they could sell the majority of the business to a third party. As a result, controlling shareholders also owe fiduciary duties to the corporation and the other shareholders.
Types of Fiduciary Duties
People who owe a corporation a fiduciary duty must act in its best interests in the following ways:
- Duty of Care: Fiduciaries must use care and diligence when acting on behalf of the corporation. When making decisions, fiduciaries should stay informed of all the pertinent information, and when necessary, use the advice of experts. An example of breaching this duty would be hiring an executive director without asking for a resume, doing a background check, or calling references.
- Duty of Good Faith: Fiduciaries must exercise good faith and honesty in all business dealings. While the duty of care requires fiduciaries to investigate the situation before acting, the duty of good faith requires fiduciaries to make decisions that best serve the interests of the company. For example, if a background check on an executive director candidate revealed a criminal history of embezzlement, it would be a breach of good faith to hire that individual.
- Duty of Loyalty: Fiduciaries must put the interests of the corporation above their own interests. This rule prohibits “self-dealing,” which occurs when a fiduciary acts or makes a recommendation for the company that will benefit the fiduciary personally instead of the business. If there’s a reasonable possibility that a course of action might benefit the fiduciary as well as the corporation, the fiduciary must disclose their personal interests to the corporation, and allow the directors or officers to decide whether to move forward with the deal without the interested party’s vote. For example, if an officer decides to engage the services of an insurance broker who happens to be the officer’s brother, the relationship must be disclosed before the deal is closed. Fiduciaries may not compete with the business, either by providing the same services to the same customers or by usurping business opportunities for their own gain.
The Business Judgment Rule: Protections for the Fiduciary
Fiduciaries are not responsible for every decision that turns out to be a bad move for the company. When fiduciaries are sued for breaching their duties, courts will defer to the business judgment of the fiduciaries, even where the corporation loses money. The courts will presume that the fiduciary did not breach his duties, so long as the fiduciary made the decision:
- in good faith,
- with the same care a reasonable person in the same person would use, and
- with reasonable belief that the decision was in the best interests of the company.
The party who brings the lawsuit against the fiduciary has the burden of proving the director acted with gross negligence, bad faith, or had an undisclosed conflict of interest. If the party does not meet this burden, the court will not find a breach.
Consequences for Breach of Fiduciary Duty
If a fiduciary breaches a duty and someone suffers financial harm as a result, the harmed individual may sue the fiduciary. Typically, the harmed individuals are the shareholders who lost money as a result of the breach. If successful, the fiduciary will be personally responsible for the corporation’s estimated lost profits, and for repaying profits the fiduciary realized from self-dealings.
In cases where the breach was intentional, the court might award punitive damages, which serve to punish the fiduciary. Depending on the state law on the circumstances, punitive damages might be much higher than lost profits.
How to Avoid Breach of Duty
To avoid breaching your fiduciary duties, understand the responsibilities involved in serving as a director, officer, or controlling shareholder. Take time to attend all meetings and research the decisions you make on behalf of the company. When in doubt about whether a transaction could benefit you personally, err on the side of disclosing more information and abstaining from voting on the decision. Keep copious records to document how you made decisions for the company, including what information you consulted.
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