Date: May 18, 2016
Corporate directorial duties comprise a body of rules or standards of care owed by directors and officers of a corporation to the corporation itself. Enacted by state statute, they are designed to protect the interests and investments of shareholders. Accordingly, they serve as the basis of derivative lawsuits—litigation brought by shareholders, on behalf of the corporation, against a specific officer or director. It is crucially important that directors understand the components of these directorial duties, in order to appreciate their exposure to legal liability and the presence of potential causes of action.
While much has been written about the various duties imposed on directors of corporations governed by Delaware law, few online resources specifically address those of Pennsylvania entities. Approximately half of the states have adopted the Model Business Corporation Act, which is a model set of state laws created by the American Bar Association that includes model directorial duties. However, Pennsylvania is one of the states which has refrained from adopting the model rules.
Pennsylvania’s corporate laws (the Business Corporation Law of 1988 or BCL) are codified in Title 15 of the Statutes of Pennsylvania. These laws contain specific rules governing the conduct, rights and duties of officers, directors, and shareholders. Similar to other American jurisdictions, Pennsylvania’s BCL on corporate directorial duties focuses on two major, foundational responsibilities owed to shareholders; (i) the duty of care; and (ii) the duty of loyalty.
Duty of Care
Pennsylvania’s duty of care rules require officers and directors of corporations to exercise business decisions with adequate information and reasonable diligence when considering all available information. Specifically, the statute requires that officers and directors render their services “in good faith” and “with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.”
However, most of the components of the duty of care can be circumvented or otherwise limited through specific language in the corporation’s By-laws. By-laws are the internal operating rules for any corporation, specifically tailored to meet the needs and purposes of those persons who create and control the corporation, like the shareholders. Thus, for example, By-laws can eliminate a directors or an officers personal liability for breaches of the duty of care, but only to the extent that the director or officer does not engage in: recklessness, willful misconduct, or self-dealing. Essentially, an officer or director will likely always be liable for intentionally failing to adequately exercise control over the corporation, regardless of the sufficiency of By-law provisions.
For directors and officers without By-law protections, the “business judgment rule” serves as the primary defense to a shareholder derivative suit. Pennsylvania courts will review causes of action alleging a violation of the duty of care under the business judgment rule, which creates a presumption that the director or officer exercised due care if the business decision was made with adequate information, and in good faith. As part of the business judgment rule, directors and officers are permitted to rely on information, opinions, reports or statements which have been prepared by employees, counsel, accountants, or corporate committees which do not include the officer or director in question.
Duty of Loyalty
Pennsylvania also requires officers and directors of corporations to maintain loyalty to the corporation they serve. Specifically, the statute stipulates that directors and officers act “in a manner [they] reasonably believe to be in the best interests of the corporation.” This duty of loyalty tasks officers and directors with acting, in good faith, for the benefit of the corporation and its shareholders. Where a breach of the duty of loyalty is shown, the underlying transaction may be voidable by the harmed corporation. An example of a breach of loyalty would be one in which a directors personal involvement with a separate entity where that separate entity is a party to a transaction with the corporation, or with an entity directly competing with the corporation. Additionally, where a director unilaterally conducts a transaction which harms the corporation, or where the officer personally engages in a transaction with the corporation, a conflict of interest emerges.
Finally, a director or officer may be held liable for a violation of the duty of loyalty by intentionally or negligently usurping a corporate opportunity. When an officer or director becomes aware of an opportunity which is relevant to the interests of the corporation, or is within the line of business of the corporation, the officer or director must make that opportunity known to the corporation. An officer or director who fails to inform the corporation, or takes the opportunity personally, will have breached the duty of loyalty.
When involved in a corporation as a director or shareholder, it is paramount to understand the potential liability one can face if he or she does not understand the duties of care and loyalty that an officer or director is required to uphold. If there is a question or concern as to whether such duty is being properly exercised, it is best to consult with an outside attorney.