Strategic Legal and Social Issues
The Board of Directors of a corporation are vested with the authority to exercise corporate powers, conduct all business and control and hold all properties of the corporation. The supreme authority insofar as the management of the business regular and ordinary affairs of the corporation is vested with the Board of Directors. With great power however comes great responsibility. Directors act as fiduciaries to the corporation, and once elected they must serve the best interests of the corporation and the shareholders.
This fiduciary duty arises out of the board’s fiduciary relationship with the corporation and shareholders. (Saboor H. Abduljaami p2) The following are the three-fold duties of a director: duty of obedience; duty of diligence and duty of loyalty. Duty of Obedience The duty of obedience mandates that every director of the corporation must do and perform only those acts designed to achieve its mission. The mission and goals of the corporation are indicated in the articles of incorporation.
Thus, the director must constantly check whether his action is within the scope of his authority and in pursuance of the goals of the company as indicated in its articles of incorporation. (“Role Playing: When do Board Members Step Over the Line”p2) Further, obedience does not only mean compliance with the rules of the corporation but it also means informing the corporation of any act done in violation of the rules of the corporation. This means that every director is mandated to refrain from violating the internal rules of the corporation.
As directors they are also required to inform the corporation of any wrongdoing committed by one director that seriously prejudices the interest of the corporation. Thus, a director who willfully and knowingly votes or assents to patently unlawful acts of another director renders him jointly and severally liable for any damage resulting to the corporation. Duty of Diligence The rule is that every director of the corporation is required to manage the corporate affairs and perform his functions with reasonable care and prudence.
As an officer of the corporation, the responsibility of the director towards the corporation is not limited to willful breach of trust or excess of power but extends to negligence. This means that even if there was no unlawful intent or evil motive in performing a corporate act, he can still be held liable if it can be established that he acted negligently. This liability of a director for his negligent acts rests upon common law rule which renders the agent liable who violates his authority or neglects his duty to the damage of the principal. It must be stressed however that the degree of diligence required of a director is relative.
The standard of diligence is that which an ordinary prudent director could reasonable be expected to exercise in a like position under similar circumstances. The directors are also bound to observe the limits placed upon their powers in accordance with the Articles of Incorporation or charter, and if they transcend such limit and cause such damage, they incur liability. (Ruben Ladia, p. 164) Thus, if a director willfully performs an act which he knows or ought to know to be unauthorized and beyond the scope of his authority, he is clearly liable for any injury.
It is however essential to state that though directors are liable for their negligence which has caused serious prejudice to the corporation, they are not liable for losses due to the imprudence or honest error of judgment. This is the concept of business judgment rule which is a defense on the part of the director to escape any liability for his actions. In principle, this states that questions of policy and management are left solely to the honest decision of the board of directors and the courts are without authority to substitute its judgment as against the director.
It is said that “business judgment rule is purely a case law derived concept whereby a court will not review the management decisions of a corporation’s board of directors absent some sort of showing that the board of directors violated their duty of care or loyalty. ” (Jon Canfield 1) It must be stressed that directors are not insurers of the property of the corporation or guarantors of the success of the corporation. So long as the director exercised reasonable diligence in the performance of its function the courts will not interfere and render it liable for negligence. Duty of Loyalty
It is a general knowledge that there exists a fiduciary relationship between the directors of the corporation and the corporation and its stockholders. As fiduciaries, they are expected to act with utmost candor and fair dealing for the interest of the corporation and without taint of selfish motives. Thus, the directors are not only required to act with reasonable diligence in managing the affairs of the corporation, they are also expected to act with utmost good faith. Thus, the directors of the corporation are expected to first serve the interest of the corporation and their interest later.
They are enjoined not to manipulate the affairs of the corporation to the detriment and disregard of the standards of morality and decency. As corporate insiders, the director cannot utilize any inside information they have acquired for their own benefit. He cannot violate the requirements of fair play by doing indirectly what he cannot do directly. Further as directors of the corporation they are not allowed to obtain any personal profit, commissions, bonus or gain for their official actions. Lastly, a director is prohibited from seizing any business opportunity or developing it at the expense and with the facilities of the corporation.
Thus, the duty of loyalty requires a fiduciary to act in the best interests of the corporation and in good faith. (Jiangyu Zhu 2) Thus, as corporate officers an undivided loyalty is expected of every director. This fiduciary relationship between the director and the corporation imposes a strict duty to act in accordance with the highest standard which a man of the finest honor and reputation might impose upon himself. It must be stressed that the duty to act with utmost good faith is imposed upon all the directors.
The law imposes upon the director liability for violating this duty of loyalty regardless whether the director actually received profit from his undisclosed transaction. This was affirmed in the case of Item Software v. Fassihi. Case of Item Software v. Fassihi. Facts: Item Software entered into transaction with another company. Item Software has a managing director and a marketing director. It specifically provided in its contract with the marketing director that it cannot take advantage of any confidential information it has learned while employed with Item Software.
It appears that while Item Software and the other company were engaged in negotiations, its marketing director had been visiting the other company informing it of his intention to form a new company and his intent to transact directly with the other company. The contract between the two companies did not materialize. Item Software later found out about the actuations of its marketing director. He was eventually summarily dismissed from employment and sued by his own company. Issue: whether the respondent should be held liable by the corporation for its act of disloyalty even if it did not profit from its misconduct.
Held: It is immaterial whether the director profited from his misconduct. The sole factor to be determined here is that the director committed a breach of its duty when it failed to disclose its transactions with the other company. The duties of a director imposed by law are generally higher than those imposed on an employee because he is more than simply a general manager of the company, he is a fiduciary who, with his fellow directors, is responsible for the success of the company’s business.
Section 317 of the Companies Act of 1985 states that: “it is the duty of the director of a company, who is in any way, whether directly or indirectly, interested in a contract or proposed contract with the company to declare the nature of his interest at a meeting of the directors of the company. ” (Section 317 Companies Act of 1985) Thus, the marketing director was in breach of his duties both as an employee and as a director and the Item Software was entitled to recover from him damages for breach of that duty suffered as a result of the termination of the contract.
