Chapter 1:Directors’ Fiduciary Duties Flashcards
Divided Loyalties
Directors who are dual fiduciaries—for example, directors appointed by a VC firm to sit on a portfolio company board—may also encounter conflicts of interest during a transaction when the interests of the VC firm diverge from those of the portfolio company. In this case, directors should consider the interests of all shareholders and consult advisors as needed.5
Inside Director
An inside director refers to someone who is also employed in a managerial capacity by the corporation or who is a majority or controlling shareholder of the corporation. For example, a CEO or CFO serving on the board would be considered an inside director.
Outside director
An outside director is a director who is not also employed as a member of management at the company. An outside director may or may not also qualify as an independent director
Related-party transaction
This is a transaction involving two parties that had a preexisting relationship prior to the transaction. Item 404(a) of Regulation S-K—a US Securities and Exchange Commission (SEC) regulation that covers textual disclosures by public companies— requires that public-company transactions involving related parties (i.e., directors, executive officers, owners of more than 5% of the company’s stock, or family members of one of the aforementioned) be disclosed under certain conditions.
Shareholder vs. stakeholder
A shareholder is an individual, company, or other organization that owns stock in a company. In contrast, a stakeholder is anyone that has an interest in the company, including shareholders, customers, employees, creditors, suppliers, and vendors, among others.
Business judgment rule
The business judgment rule, also called the business judgment presumption, is a legal concept that shields directors from being held liable for their reasonably informed decisions, even if the outcomes of those decisions are negative, as long as the decisions were made in good faith, without conflicts of interest, and with a reasonable level of care. When a company invokes the business judgment rule and the court finds that the presumption applies, then the burden of proof is on the plaintiff to prove that the business judgment rule does not apply due to bad faith, conflicts of interest, or gross negligence. Otherwise, the board may need to provide proof that its process was fair and its decisions were informed.
Conflict of interest
Directors have a conflict of interest when they participate in a company matter involving a party with which they are affiliated—often matters involving financial or familial interests. In such a case, the director’s personal interest may conflict with the interests of the organization for which the director serves as a fiduciary.
Controlled company
A controlled company is one that is controlled through a person, group of people, or entity that holds a certain percentage of the stock’s voting power. For the NYSE and Nasdaq, the level is more than 50 percent.
Entire fairness standard
The court will apply the stricter entire fairness standard, instead of the business judgment rule, when one of the parties in a transaction is interested (e.g., owns controlling shares). This standard requires both a fair price and a fair process but may be waived when a transaction includes protection for minority shareholders.
Fiduciary
A fiduciary is an individual or institution obliged to act in the best interests of another individual or institution when engaging in any matter within the context of their relationship.
Independent director
An independent director, as defined by US standards, generally has no links to the organization beyond his or her role as a director. For example, the director must have no ties to the company’s management, no financial interest in the company (aside from compensation for service as a director), and no familial or business relationship with the company. For a director to be considered independent by the NYSE and Nasdaq, the director must not have been a company employee or have had any other relationship with the company (such as a family member working for the company) within the last three years. Institutional Shareholder Services, a proxy advisory firm, does not have such a cooling-off period, and will never consider a former company CEO or executive to be independent.
Duty of Loyalty
Part (a) of this section of the MBCA describes the duty of loyalty. Under the duty of loyalty, directors must place the interests of the corporation above their own interests and those of their friends, family members, and any other associated entities. Additionally, directors cannot take advantage of their positions to benefit themselves, even if it would not harm the corporation, such as using confidential information.
Duty of Good Faith
The duty of good faith is a component of the duty of loyalty. The duty of good faith states that directors must make decisions honestly and in the best interests of the corporation.
Duty of Care
Part (b) of this section of the MBCA describes the duty of care. The duty of care instructs directors to make informed, rational, and prudent decisions through a highly analytical decision-making process.
