Directors of corporations have a fiduciary duty to act in good faith and in the best interests of the company. It is often called a duty of care and loyalty and is also owed to the corporation’s shareholders. The standard of care of a director is how a reasonable or ordinarily prudent person in a similar position would act under similar circumstances and in a way that the director believes would be in the corporation’s best interests.
Directors may not use the corporation to enhance their own self-worth or to receive personal benefits that were not authorized or approved. Any decisions made by directors, if made after due diligence and if informed, and in the reasonable and sincere belief that they were made in the best interests of the corporation, are protected under the “business judgment rule.”
The Insolvent Corporation
At times, a corporation may find itself unable to pay its creditors and its assets are worth less than the company’s outstanding debts or liabilities. If the corporation files for bankruptcy or is forced into it, the directors’ fiduciary duties may include the creditors as well as the shareholders, at least under Delaware corporate law.
California corporate law, however, does not shift a director’s fiduciary duties to include creditors whether the corporation is solvent or not. In any event, directors cannot worsen the corporation’s insolvent condition or risk having breached their fiduciary duty by self-dealing. They also cannot use their judgment or make decisions that favor one group of creditors over another under the “trust fund” doctrine.
If a Delaware corporation, creditors may bring derivative actions only against the corporation and not direct or personal lawsuits against the directors. In these cases, the business judgment rule is the standard under which the directors’ decisions are judged.
Since the bankruptcy court oversees the administration of the corporation in a Chapter 11, the directors should get court approval for any major decision to avoid any personal or derivative action filed against them or the corporation.
In many cases, corporate charters will insulate directors from personal liability for any breach of their fiduciary duties or will have insurance to indemnify them for any expenses incurred for litigation. These policies or clauses can be limited if the director commits a criminal act or acts to his or her own benefit.
Directors can protect themselves by knowing beforehand their fiduciary duties as defined by the laws of their jurisdiction. They should review their corporate bylaws, articles, insurance and contracts to ensure they are current. Also, directors should carefully document and record in the minutes all significant decisions and, of course, consult with corporate counsel if they have any questions regarding their legal duties if bankruptcy is contemplated.