Standard of Conduct and Standard Term Paper

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A lot of critical information on the duty of care and its itinerant duties is located on every Secretary of State website in each state's corporation statute regarding the duties of care and loyalty.

But the discussion until now has dealt (in a lot of practical matters) with large corporations. In a small corporation, the directors, officers, and shareholders may all be the same.

In larger corporations with a larger Board of Directors, it may not be possible for all directors to participate in certain Board decisions. In that case, the Board of Directors may appoint an Executive Committee to handle certain matters.

The grant of power from the Board to an Executive Committee is included in the Bylaws. The grant of power to an Executive Committee can be fairly extensive and can authorize the Committee to act on behalf of the Board and with the authority of the Board. However, Executive Committees typically may not take the following acts without the approval of the full Board of Directors:

The filling of vacancies on the Board of Directors or vacancy on any committee;

The fixing of compensation of the directors for serving on the Board or any committee;

The amendment of the Articles of Incorporation;

The amendment or repeal of the Bylaws or the adoption of any new Bylaws;

The amendment or repeal of any resolution of the Board of Directors which by its express terms is not so amendable or repealable;

distribution to the shareholders of the corporation, except at a rate, in a periodic amount or within a price range set forth in the Articles of Incorporation or determined by the Board of Directors;

The appointment of any other committees of the Board of Directors or the members thereof;

Adopting an agreement of merger or consolidation of the corporation;

Recommending to shareholders the sale, lease, or exchange of all or substantially all of the Corporation's property and assets; or Recommending to the shareholders either a dissolution of the corporation or revocation of the dissolution of the corporation.

Most concretely, the Bylaws will include the authority and limitations for Executive Committee.

A major issue impacting duty of care for directors is conflict of interest. A conflict of interest is defined as a financial transaction of such significance that it could influence the director or officer's judgment. A director is often required to disclose any and all conflicts of interests so that there is no chance that he or she might violate them down the road.

Delaware sets the standard for the American director's duty of care, since so much American corporate law is based on Delaware codes and case law. Delaware corporate jurisprudence has for decades recognized that corporate directors are charged with a "triad" of fiduciary duties: loyalty, due care and good faith. See, e.g., Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001). Cases explicating the fiduciary duties of loyalty and care are legion. By contrast, the boundaries of the fiduciary duty of good faith remain amorphous. This is the same in Australian corporate law as well.

For instance, here is the general basis of Australian directors' duties:

Directors should at all times employ a reasonable degree of skill, care and diligence in the exercise of their powers and the discharge of their duties.

To ensure that the appropriate levels of care and diligence are met, it is strongly advised that directors:

keep fully up-to-date on what the company is doing;

investigate the impact of any business proposal on their company's business performance and financial standing;

seek outside professional advice when they do not have sufficient information to make a properly informed decision;

question management and staff about how the business is going; and take an active part in business transacted at directors' meetings.

It is unwise for directors to simply agree to proposals put forward by other directors without obtaining some information about the effect of the proposals on the company's business.

The convergence of the American duties as dictated in Delaware case law and the Australian duties is somewhat surprising, since there are potentially significant consequences under the Delaware General Corporation Law ("DGCL") to a finding that a director did not act in good faith.

For instance, under Section 102(b)(7) of the DGCL, a director who did not act in good faith (or who breached his duty of loyalty, engaged in intentional misconduct, knowingly violated the law or derived an improper personal benefit - one of the elements of scienter) is not entitled to be exculpated from monetary liability, whereas he would be so entitled if he breached his duty of care. Similarly, under Section 145 of the DGCL, a director who did not act in good faith is not entitled to indemnification of legal fees or judgments in litigation.

Recent cases from this Court seem to be split over whether the so-called "duty of good faith" is really an independent duty at all, and also over whether it is truly a subset of the duty of loyalty or the duty of care.

Because much of the discussion regarding "good faith" is geared around whether directors may call upon Section 102(b)(7) exculpatory certificate provisions to avoid personal liability, it is worth briefly noting the history behind that section of the DGCL - the Delaware Code.

In the landmark case of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), the Delaware Supreme Court decided that directors who approved a merger transaction were simply not entitled to the presumptions of the business judgment rule where they spent a very negligible time considering the transaction, had no meaningful financial advice or analysis in doing so, completely allowed the negotiation process to be controlled by one of the company's executives, and did not even have the merger agreement before them when they approved it. Under these extenuating circumstances, the Supreme Court concluded that the directors breached their duty of care and could be held personally liable for the breach, explaining as follows:

A] director's duty to exercise an informed business judgment is in the nature of a duty of care, as distinguished from a duty of loyalty. Here, there were no allegations of fraud, bad faith, or self-dealing, or proof thereof. Hence, it is presumed that the directors reached their business judgment in good faith, and considerations of motive are irrelevant to the issue before us.

We think the concept of gross negligence is... The proper standard for determining whether a business judgment reached by a board of directors was an informed one." Id. At 872-73 (citations omitted).

Under that standard, the Supreme Court discovered that the directors had acted in a grossly negligent fashion in failing to inform themselves adequately about the merger, even though they were presumed to have acted in good faith, and that they therefore breached their duty of care. Australian cases have held very similarly, putting directors in both countries on guard with regard to their duties.

In 1986, Section 102(b)(7) was enacted by the Delaware General Assembly, following a "directors and officers insurance liability crisis and the 1985 decision [of the Supreme Court] in Smith v. Van Gorkom.'" Emerald Partners v. Berlin, 787 A.2d 85, 90 (Del. 2001) (citations omitted).

Without a doubt, Section 102(b)(7) contained "carve-outs" from exculpation for actions or omissions that simply were not in good faith or from which directors received an improper personal benefit, based upon the language of Van Gorkom singling out "bad faith" and "self-dealing" as examples of improper directorial conduct.

But when one jumps in time to 2003, the result is different. In re the Walt Disney Co. Derivative Litig., 825 A.2d 275 (Del. Chapter 2003), the Delaware Court of Chancery ruled that a board of directors acted in bad faith when it approved an executive's employment contract and later approved the termination of that same contract, with the result that the executive received $140 million for just over one year's performance -- performance that was viewed as poor at best.

Australian law agrees on this subject as well: Good faith means that the directors must at least reasonably see that the corporation gets value for its money. Once again, the board devoted very little time to the decisions, lacked any financial advice or analysis, did not have all of the material terms of the contract before it, and left the negotiation of the contract to a long-time friend of the executive. The Court explained its holding as follows:

These facts, if true, do more than portray directors who, in a negligent or grossly negligent manner, merely failed to inform themselves or to deliberate adequately about an issue of material importance to their corporation. Instead, the facts alleged in the new complaint suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a "we don't care about the risks" attitude concerning a material corporate decision. Knowing or deliberate indifference by a director to his or her duty to act faithfully and with appropriate care is conduct,…[continue]

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