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Board of Directors

by Jim Slaughter

Originally published as "Board of Directors Duties and Liabilities" in The Business Weekly of the Greensboro News & Record

 

Congratulations!  You've just been made a member of the board of directors.  Your new position, whether of a for-profit corporation or a non-profit entity, is both prestigious and well respected.  By the way, did anyone describe your duties or the fact that you may be financially liable for your actions?

Standards of Conduct

Boards of directors must have the authority and discretion to manage a business successfully.  At the same time, however, wrongdoing by directors must be prevented.  As a result, a balance must be made between a board of director's protection and its accountability.

The North Carolina Business Corporation Act gives guidance on both the duties and liabilities of directors.  Specific standards of conduct are provided.  According to the Act, a director must discharge his duties "(1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the director reasonably believes to be in the best interests of the corporation."  Although these standards are vague, they can be generally described as a duty of good faith and a duty of due care.

Good Faith

The primary duty of a director is good faith.  This means that a director must perform his duties honestly, conscientiously, and fairly.  A corporation must be managed in the best interests of all shareholders and not for the particular benefit of any group or individual.  An important element of good faith is undivided loyalty to the corporation.  Directors are prohibited from using their positions for their own personal gain to the detriment of the corporation or its shareholders.  Obviously, certain transactions between a director and a corporation are often necessary and even advisable.  However, a director should not be involved in such transactions unless "he reasonably believes [them] to be in the best interests of the corporation."

Generally, a director cannot compete with the corporation.  For example, a director cannot usurp a corporate opportunity to the detriment of the corporation.  To avoid liability in such instances, the director must establish that the transaction was "just and reasonable" to the corporation because it did not involve an opportunity that the corporation would have wanted.  Even the purchase of shares in the corporation by directors can raise the issue of corporate opportunity.  Questions of undivided loyalty can also arise when a director is on the boards of two different corporations that have dealings with each other or compete against each other.

Duty of Due Care

Though the duty of good faith prohibits misconduct, the duty of due care creates an obligation to direct and supervise the corporation.  The specific language from the Act is that a director must conduct himself "with the care an ordinarily prudent person in a like position would exercise under similar circumstances."  Inherent in such language is the possibility that some directors are held to higher standards than other directors.

At the very least, a director is required to see that the corporation is operated according to the terms of its articles of incorporation and to law.  Directors are also under a "duty of reasonable inquiry" to inform themselves as to the condition of the corporation and the conduct of its affairs.  Thus, a director cannot claim that he didn't know about mismanagement or fraud when reasonable attention would have disclosed the misconduct.  This principle has been used to hold directors liable when they delegated their management functions to a committee that mismanaged the corporation.

The duty of due care could place an overwhelming burden upon directors, in that it obligates the board both to what they know as well as to what they should know.  Because board positions are usually part-time, directors seldom have the ability to research every issue themselves.  To prevent this problem, the Act allows directors to rely upon the advice of others under certain circumstances.  A director can rely upon information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by any of the following:

arrow Officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented;
arrow Outside advisers such as lawyers, accountants, investment bankers, appraisers, consultants and others as to matters the director reasonably believes to be within their professional or expert competence;
arrow A committee of the board of directors of which the director is not a member if he reasonably believes the committee merits confidence.

There is no right of reliance if the director has actual knowledge of information that makes reliance unwarranted.

Liabilities

As long as a decision is made in good faith and with due care, directors are usually protected from claims that they should be held personally responsible for mistakes.  The idea that management should be protected from unfair retrospective reviews of their mistakes is known as the "Business Judgment Rule."  According to the Rule, a court will not invalidate or hold directors liable for

arrow a business judgment
arrow made by disinterested directors
arrow within the scope of their authority
arrow in good faith
arrow with reasonable care and
arrow not for their own self-interests.

A director held individually liable for an act may have a right to indemnification from the corporation.  The Business Corporation Act requires that a corporation indemnify a director who is wholly successful in the defense of any proceeding to which he was made a party because of being a director. In other circumstances, a corporation may, but is not required to, indemnify a director.  A director should examine corporate documents to determine under what circumstances a right to indemnification exists.

A director should not sit idly by while action is taken at a meeting that violates either the duty of good faith or reasonable care.  Indeed, a director who is present at a board meeting is deemed to have assented to any action from which he does not clearly and promptly dissent or abstain.  As a result, the director could be personally responsible for such actions. A director should express his opposition (in the minutes, if possible) to action that he believes is a breach of the required standards of conduct.

 

Articles are intended to provide general information and are not legal advice or a legal opinion. Specific questions should be directed to an attorney at Black, Slaughter & Black, PA., or to another lawyer.