Corporate Directors and Officers Are ‘Discretionaries’—Not Fiduciaries

In my long career as a corporate and securities attorney and academician, I recognize that it is a truism that corporate directors and officers are identified as fiduciaries. But, as I focus on the statutes and case law, I say to my students ‘is that really accurate?’ After further reflection and analysis, the answer is ‘certainly not.’ This thought-process resulted in the authoring of my most recent book published in June by Oxford University Press entitled Director and Officer Liability —‘Discretionaries’ Not Fiduciaries.

That is not to say that fiduciary duties never apply to directors and officers. Indeed, they do in certain situations. For example, a director or officer engaging in a self-dealing transaction with the corporation that is neither approved by disinterested directors nor independent shareholders must prove that the transaction is entirely fair to the corporation. Fairness includes all material aspects of the transaction, including the making of sufficient disclosure, the company’s need for the transaction, and the terms of the transaction, including price.

There are far more situations, however, where fiduciary standards are absent. Take, for example, the business judgment rule which is one of the fundamental concepts of US company law. To rebut the presumption of the business judgment rule, it must be shown that either a disabling conflict of interest existed or that the decision made was grossly negligent. As interpreted, this culpability level requires proof that the officer or director acted with reckless indifference. Perhaps Delaware Vice Chancellor Laster said it best by recently opining: ‘To hold a director liable for gross negligence requires conduct more serious than what is necessary to secure a conviction for criminal negligence.’ (291 A.3d 652, 690) Thus, it is easier for a prosecutor to obtain a criminal conviction resulting in imprisonment than it is for a shareholder-plaintiff to rebut the presumption of the business judgment rule. Although application of the business judgment rule may make good policy in certain contexts, it is not consonant with fiduciary norms.

Outdoing the business judgment rule are the director and officer exculpation statutes that have been enacted throughout the United States. The ‘mild’ version of these statutes exculpates director and officer monetary liability unless there is a breach of the duty of loyalty or intentional misconduct. Many other state statutes are even more lax, exculpating duty of loyalty breaches unless these breaches involve fraud, intentional misconduct, or knowing violation of law. Shielding directors and officers from monetary liability unless they engage in such egregious misconduct belies the status of these individuals being deemed fiduciaries.

As another example, many states permit companies to waive the duty of loyalty for directors and officers in situations involving corporate opportunities. For example, the Delaware statute allows a corporation to authorize its directors and officers to take ‘specified business opportunities or specified classes or categories of business opportunities.’ (Del. Gen. Corp. L. § 122(17)). Eliminating this aspect of the duty of loyalty does not require a shareholder vote. The adoption by the board of directors of a bylaw amendment is sufficient under the statute. In effect, therefore, these statutes entitle a corporate director and officer to secure a lucrative financial benefit by taking an attractive business opportunity that otherwise would have belonged to the corporation. Clearly, fiduciary standards are deficient in this context.

My book provides many more examples of situations where standards of liability for corporate directors and officers lack fiduciary content.  Identifying corporate directors and officers as fiduciaries is a misnomer. But the question may be asked: ‘Why does it matter? After all, corporate directors and officers have been viewed as fiduciaries for centuries. Why should this terminology be changed?’ The answer is that the law should be truthful. The substance of a term should be consistent with its accepted meaning. A fiduciary is viewed as one who owes due care, good faith, and loyalty. As applied to director and officer liability, the term ‘fiduciary’ therefore conveys a false portrayal. Moreover, uninitiated investors, particularly many retail investors, may rely on this portrayal to believe that their investments are protected to some degree by the application of meaningful liability standards in the event of director and officer misconduct. Retaining the term fiduciary in this setting is detrimental to the rule of law, adversely affects the transparency of the financial markets, and contravenes reasonable investor expectations.

This book hopefully will make a significant contribution to the development of the law. It thus far has received excellent reviews from two former Delaware Supreme Court Chief Justices, a current Delaware Vice Chancellor, leading practitioners, and preeminent academicians from law schools globally, including the United States, England, and Singapore. The continued embracement of directors and officers as fiduciaries impedes both investor trust and legal clarity. The solution is that a neutral and accurate term should be adopted—corporate directors and officers are ‘discretionaries.’

Marc I. Steinberg is the Radford Chair in Law and Professor of Law at SMU School of Law.

The author's book can be found here.