DIRECTOR’S DUTIES

Fiduciary duties
- Directors owe fiduciary duties to the corporation and to the shareholders

- We may distinguish:
o The duty of care, i.e., the duty to act diligently in the best interest of the
corporation
o The duty of loyalty, which includes different aspects:
 The duty not to act in conflict of interest
 Management of transactions with related parties
 The business opportunity doctrine
- Directors do not have fiduciary duties toward creditors, since creditors have contractual
rights toward the corporation (but there are some exceptions, e.g. in the “zone of
insolvency”)

The duty of care

- The duty of care is the duty of directors to manage the corporation diligently

- It is an obligation of means, not an obligation of result, whereas:

o Obligations of means are obligations that are performed simply by being diligent
o Obligations of result are obligations that are performed only if a specific result is
achieved
- In fact, directors must manage the corporation in compliance with the law and the
governing documents of the corporation, and act diligently, while the negative results of
the corporation are not per se a source of liability
- The care required by directors is primarily a "procedural” care, i.e. it pertains to the “way”
in which a decision has been reached, rather than to the merits of the decision itself
o Directors must: act on an informed basis, devote sufficient time to their decisions,
acquire - when necessary - opinions from independent experts on a business
decision
o If they do so, they are generally not liable for an honest error of judgment.
- Courts are not business experts, so it would be difficult for them to review the merit of the
decision > it would even be unfair to do so once the outcome of the decision is known
(hindsight bias)
o Still, completely irrational decisions are generally deemed to violate the duty of
care regardless of how they were taken
- Standard of diligence: directors should exercise the same care that ordinarily careful and
prudent persons/directors would use in similar circumstances
o This does not mean not taking risks but being aware of and considering (and maybe
reducing) the existing risks
o Is the diligence standard objective or subjective? = if somebody is an expert in the
field in which they’re taking decisions, the level of responsibility is higher
- The business judgement rule
o = a presumption that the directors or officers of a corporation acted on an informed
basis, in good faith, and in the honest belief that the action taken was in the best
interest of the company
  > courts assume they should not review director decisions absent fraud,
illegality, or conflict of interest (self-dealing)
 Unless this can be proved, courts will not take the case
o In the US, the business judgement rule can be rebutted if the plaintiff demonstrates
that the decisions of the directors are tainted by fraud, illegality, or conflict of
interest
 The following circumstances may be proved to rebut the business
judgement rule:
 The director breached his duty of loyalty, acting in conflict of interest
> had a personal interest in the decision when it was taken
 The director was completely passive and failed to inform himself on
the business of the corporation
 Knowing violation of criminal law > courts will review how the
decision was taken
 A reasonable investigation (by the BoD) was missing
 The decision was completely irrational and wasteful
 A legal case is open in these circumstances (does not necessarily mean that
the director is responsible > investigation will be carried out)
o The business judgement’s rule traditional justification is that courts are not business
experts
o An explanation for the business judgement rule focuses on decision-maker
incentives
 Judges necessarily have less info about the needs of a particular firm than
do that firm’s directors > a fortiori, judges will make poorer decisions than
the firm’s board
 Rational shareholders might prefer the risk of managerial error to that of
judicial error > but this only extends to decisions motivated by a desire to
maximize shareholder wealth
 Where the director’s decision was motivated by considerations other than
shareholder wealth, the question is no longer one of honest error but of
intentional misconduct
 Despite the limitations of judicial review, in such cases rational
shareholders would prefer judicial review with respect to board
decisions so tainted
o Why hindsight review of business decisions is inconsistent with shareholder
interests?
 Limited liability substantially insulates shareholders from the downside risks
of corporate activity
 Portfolio theory teaches that shareholders can eliminate idiosyncratic risk (=
firm-specific) by holding a diversified portfolio
 On the contrary, managers will be avers to risks shareholders are perfectly
happy to tolerate (managers are completely involved in the corporation)
 The diversion of interests as between shareholders and managers
will be compounded if managers face the risk of legal liability, on top
of economic loss, in the event a risky decision turns out badly
 Knowing with the benefit of hindsight that a business decision turned out
badly could bias judges or juries towards finding a breach of the duty of care
  Rational shareholders therefore should prefer a regime that encourages
managerial risk-taking by, inter alia, pre-committing to a policy of not
litigating the reasonableness of managerial business decisions

The duty of loyalty

- A director breaches their duty of loyalty when they act in conflict of interest with the
corporation
o Typically happens when a gain of the director implies a loss or a lower gain for the
corporation
o But it happens also when the interest of the directors, although not in conflict with
the one of the corporation, might still taint their ability to exercise independent
judgement in the best interest of the corporation
o Indirect interests are also usually relevant
- The duty of loyalty includes different aspects:
o The duty not to act in conflict of interest
o Management of transactions with related parties
o The business opportunity doctrine
- 3 typical regulatory strategies:
1. All conflicted transactions are prohibited
2. Conflicted transactions are not regulated at all
3. Conflicted transactions may be approved subject to some procedural protections, such
as to delegate the decision to independent and non-conflicted directors fully informed
on the situation, or to require that the transaction is entirely fair to the corporation
- Business opportunities
o When a director becomes aware of a business opportunity that could benefit the
corporation, but rather than offering it to the corporation, takes advantage of it
 There is not a BoD influenced by an interest (as when there is conflict of
interest), but still there could be a problem of loyalty
o Two problems regarding the business opportunity doctrine:
 Any info acquired by a director, also when they are not acting in their
capacity as director, should be relevant?
 What constitutes a business opportunity?
 Line-of-business-test: to be subject to the rule, the business
opportunity should fall within the activities in which the corporation
is involved and/or is potentially interested in
- Related parties transaction
o When the corporation entertains transactions with related entities (not only
directors), such entity could be unfairly advantaged to the detriment of the
corporation and its shareholders
 Related parties = entities with a strong connection to the corporation
(executive, relative of a member of the BoD, relevant shareholder, lender...)
 This could also happen with groups of companies
 One company controlling others > giving directives in its interest
(maybe even damaging the controlled companies)
o There is an issue of fiduciary duties because of the BoD might favor another subject
with which there is a relationship (e.g. a controlling shareholder)
- Fiduciary duties: remedies
o Remedies for violations of the duty of loyalty are usually restitutionary: rescission of
the unfair contract, accounting, or constructive trust in the corporation’s favor in
case of violation of the business opportunity doctrine
o VS remedies for a breach of the duty of care are generally monetary