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3.1 The Board’s Responsibilities: The Legal Framework

From a legal perspective, the board of a public corporation is charged with setting a corporation’s policy and direction, electing and appointing officers and agents to act on behalf of the corporation, and acting on other major matters affecting the corporation. In this context, individual directors’ duties and responsibilities are described in the American Bar Association’s Corporate Director’s Guidebook, Fourth Edition (2004) with language, such as the following:

  • in good faith. Acting honestly and dealing fairly. In contrast, a lack of good faith would be evidenced by acting, or causing the corporation to act, for the director’s personal benefit or for some purpose other than to advance the welfare of the corporation and its economic interests and may also include acting on a corporate matter without making a reasonable effort to be appropriately informed.
  • reasonably believes. Although the director’s honest belief is subjective, the qualification that it must be reasonable (i.e., based upon a rational analysis of the situation understandable to others) makes the standard of conduct also objective, not just subjective.
  • best interests of the corporation. Emphasizing the director’s primary allegiance to the corporate entity.
  • care. Expressing the need to pay attention, to ask questions, to act diligently to become and remain generally informed, and, when appropriate, to bring relevant information to the attention of the other directors. In particular, these activities include reading materials and engaging in other preparation in advance of meetings, asking questions of management until satisfied that all information significant to a decision is available to the board and has been considered, and requesting legal or other expert advice when appropriate to a board decision.
  • person in a like position. Avoiding the implication of special qualifications and incorporating the basic attributes of common sense, practical wisdom, and informed judgment generally associated with the position of corporate director.
  • under similar circumstances. Recognizing that the nature and extent of the preparation for and deliberations leading up to decision making and the level of oversight will vary, depending on the corporation concerned, its particular situation, and the nature of the decision to be made.See the Corporate Director’s Guidebook (4th ed., 2004), the American Bar Association.

This language provides guidance about how directors should comply with the underlying duty of care, the business judgment rule, and the duty of loyalty, briefly introduced in Chapter 2 "Governance and Accountability", which I restate here more formally:This book focuses on the most important laws aimed at guiding directors’ behavior. The reader should be aware that the law includes additional duties for directors such as “the duty not to entrench” and “the duty of supervision.”

  • Duty of Care. The Duty of Care is the most important duty owed by a director to a corporation. A typical (state) corporation statute defining a director’s Duty of Care provides that a director’s duties must be performed “with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” This Duty of Care is very broad and requires directors to diligently perform their obligations.
  • Business Judgment Rule. The Business Judgment Rule works in conjunction with the director’s Duty of Care. Under this rule, a director will not be held liable for mere negligence if exercising his or her Duty of Care. The rule can be stated as, “A director who exercises reasonable diligence and who, in good faith, makes an honest, unbiased decision will not be held liable for mere mistakes and errors in business judgment.” The rule protects directors from decisions that turn out badly for their corporation, even when the directors acted diligently and in good faith in authorizing the decision.
  • Duty of Loyalty. The Duty of Loyalty exists as a result of the fiduciary relationship between directors and the corporation. A fiduciary relationship is defined as a relationship of trust and confidence, such as between a doctor and patient, or attorney and client. The nature of the relationship includes the concepts that neither party may take selfish advantage of the other’s trust and may not deal with the subject of the relationship in a way that benefits one party to the disadvantage of the other. A director must perform his or her duties in good faith and in a manner in which the director believes is in the best interests of the corporation and its shareholders. Essentially, this duty means that while serving a corporation, the director must give the corporation the first opportunity to take advantage of any business opportunities that he or she becomes aware of and that are within the scope of the corporation’s business. If the board of directors chooses not to take advantage of a business opportunity brought to its attention by a director, the director may then go forward without violating his or her duty.

LiabilityThe state of being legally responsible for causing harm. can exist for officers and directors when they cause financial harm to the corporation, act solely on their own behalf and to the detriment of the corporation, or commit a crime or wrongful act. Certain acts may subject an officer or director to personal liability, and other acts, although they would otherwise subject them to liability, may be either indemnified by or insured against by the corporation.Indemnification of officers and directors means that the corporation will reimburse them for expenses incurred and amounts paid in defending claims brought against them for actions taken on behalf of the corporation. Insurance policies can cover matters that cannot be indemnified under state law or in instances where the corporation does not have the financial resources to pay for the indemnification. Most state corporation statutes allow corporations to purchase insurance to cover matters resulting from acts taken by officers and directors. The goal of directors and officers insurance is to protect directors and officers of a corporation from liability in the event of a claim or lawsuit against them asserting wrongdoing in connection with the company’s business.