Part of Bricker & Eckler’s Board and Executive Series

Your Responsibilities as a Director1

October 6, 1999

Introduction2

Under most states’ laws3, the board of directors of a corporation is responsible for oversight of the business and affairs of the corporation. The purpose of this discussion paper is to provide directors with an overview of their general obligations to the corporation. Because the protections afforded officers and employees, including directors who are also officers and employees, of the corporation are less than those afforded to those who are independent directors, directors who are also officers and employees are encouraged to review a companion paper entitled "Your Responsibilities as an Officer."

Authority of the Board

Generally under most states’ laws, all of a corporation’s power and authority are vested in its board of directors except to the extent otherwise reserved to or vested in stockholders.4 Corporate law recognizes that a board does not directly exercise all of that power and authority, but it is exercised "under the direction" of the board.5 In reality, the board exercises that authority under its direction by delegating to others, such as:

  • committees of the board,6
  • officers or senior management,7 and
  • professionals or other experts including legal counsel and public accountants.

Ohio corporate law reflects this reality by entitling the board as well as individual directors to rely upon information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by those committees, officers or senior management, and professionals or other experts.8

Exercise of Its Authority

Directors exercise their authority only as a board and not as individuals. Under Ohio law, authority is exercised only by action of a majority of the directors present at a meeting at which a quorum is present, unless the act of a greater number is required by the articles, the regulations, or the bylaws.9 For this purpose, a majority of the whole authorized number of directors is necessary to constitute a quorum for a meeting.10 A board can also exercise authority by unanimous consent in writing of all directors.11

Standard of Conduct for Directors

Directors have Fiduciary Duties

Under Ohio law, the board as a whole and you as an individual director owe certain fiduciary duties to the corporation as an entity and to the stockholders as a whole. This is generally expressed under Ohio law as acting "in the best interests of the corporation,"12 and in so doing Ohio law requires the board and individual directors to "consider the interests of the corporation's stockholders" and may consider other interests.13

These fiduciary duties include the duty of care and the duty of loyalty.

Duty of Care

In simplest terms, the duty of care requires that a director exercise the care that an ordinarily prudent person in a like position would use under similar circumstances.14 Under most states’ laws, a director must perform his duties as a director, including his duties as a member of any committee of the directors upon which he may serve:

  • in good faith;
  • in a manner he reasonably believes to be in or not opposed to the best interests of the corporation; and
  • with the care that an ordinarily prudent person in a like position would use under similar circumstances.

The duty of care requires that a director inform himself of all material information reasonably available before making a business decision. This duty also requires directors to inform themselves of alternatives to a proposed business decision. The more important the decision, the greater the need to consider additional information and alternatives. Once a director has become adequately informed, the director must act with the requisite care in performing his duties. A claim of "good faith" alone is no defense if a director fails to exercise the duty of care in order to arrive at an informed business decision.

Duty of Loyalty

Under many states’ laws, the duty of loyalty requires that a director in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation.15 There are three components to the duty of loyalty.

This first is that a director should act to the extent possible in a disinterested manner. That means not being influenced by any financial or personal interest in the matter under consideration.16

The second is full disclosure of possible financial or personal interests in any matter under consideration. In common law before statutory corporate law, courts often treated as void or voidable any contract or transaction approved by a board if a director had a financial or other personal interests in the contract or transaction. Many states’ statutory laws provide that any contract, action, or transaction considered by the board or one of its committees is not void or voidable because of a financial or personal interest of a director if the material facts regarding that interest are disclosed or otherwise known to the board or the committee before the consideration.

The third is substantive "fairness." Under many states’ statutory laws, no contract, transaction or other action of a board is void or voidable, even if there is a financial or personal interest which is not fully disclosed, if the action is "fair to the corporation" as of the time it is authorized or approved.17 However, because what is "fair to the corporation" is a question of fact upon which reasonable minds may differ, directors should rely on full disclosure.

The Business Judgment Rule

In evaluating a director’s compliance with his fiduciary duties, courts generally follow the so-called "business judgment rule." Under the business judgment rule, courts do not inquire into the wisdom of actions taken by directors in the absence of fraud, bad faith, or abuse of discretion. The business judgment rule specifically applies to any situation in which directors make a decision which, in retrospect, was or is argued to be a bad one. If the directors are thereafter sued because of that decision, a court applying the business judgment rule will not second guess the merits of the decision as long as the court finds all of the following to be true:

  • The directors made a business decision (the rule does not apply to acts of directors which do not constitute business decisions);
  • The directors were disinterested (that is, they are not "on both sides of the transaction" and will not derive any personal benefit from their decision);
  • The directors exercised "due care" (as noted above, this means acting like an ordinarily prudent person would act);
  • The directors acted in good faith; and
  • The directors did not abuse their discretion.

If one or more of these factors is not satisfied, the court will interpose its own judgment to determine whether the transaction in question is in the best interests of the corporation.

Reliance on Experts, Special Committees, and Officers

At times directors are faced with decisions that require special knowledge or expertise which the directors themselves do not possess. Additionally, directors may not have the time or resources to investigate personally every matter that comes before the board. Because of these limitations, directors are permitted to rely reasonably upon information presented by officers, employees, board committees, and independent professional advisors in making their decisions.18

The following standards apply when determining whether a director’s reliance on information, opinions, reports, or statements (including financial statements and other financial data) prepared or presented by others is appropriate:

Source of Information Presented to the Director:

Reliance is Appropriate if:

Other directors, officers, or employees of the corporation

The director reasonably believes such persons are reliable and competent in the matters prepared or presented.

Legal counsel, public accountants, or other experts

The director reasonably believes that the matters prepared or presented are within the person’s professional or other competence.

A committee of the board on which the director in question does not serve

The committee has been duly established in accordance with the corporation’s governing documents, is acting within its delegated authority, and the director reasonably believes that the committee’s decision merits his confidence.

Consideration of Non-Stockholder Interests

In determining what he reasonably believes to be the best interests of the corporation, a director should always consider the interests of the stockholders of the corporation. However, some states recognize that a director may in his discretion also consider the interests of other corporate constituencies, including the following:

  • The interests of the corporation’s employees, suppliers, creditors, and customers;
  • The economy of the state and nation;
  • Community and societal considerations; and
  • The long-term as well as the short-term interests of the corporation and its stockholders, including the possibility (in the context of a takeover proposal) that these interests may be best served by the continuing independence of the corporation.19

While some states permit directors to consider the interests of other constituencies in making decisions, the interests of the stockholders are always of paramount importance.

Indemnification and D&O Insurance

Corporations may indemnify, or agree to indemnify, directors against liabilities, and directors may in certain circumstances be entitled to indemnification as a matter of right. However, in most states there are limits on indemnification. For example, in most states indemnification is precluded if a court finds a director did not act in good faith or in a manner reasonably believed to be in the best interests of the corporation.20 Some states preclude indemnification in a derivative action if the liability involves negligence or misconduct by the director in the performance of a duty to the corporation.21

Accordingly, errors and omissions insurance is important for directors. Most states’ laws do not prohibit insurance giving broader coverage of director liability than permitted by indemnification. By reviewing and comparing coverages of the insurance products of different insurers, directors can usually find this broader coverage at reasonable rates.

Practical Application of Fiduciary Duty Principles

The practical "tips" listed below will help to ensure that you satisfy your fiduciary duties as director of the corporation:

  • Stay informed. Read all materials sent to you before board and committee meetings.
  • Never act on behalf of the corporation unilaterally. Directors only have the power to act collectively, as a board.
  • Attend and participate in meetings of the board and in any committee on which you serve. If you cannot physically be present at a meeting, arrange in advance to attend the meeting via teleconference. Failing that, make sure you read the minutes of any meeting you missed.
  • If you have questions, ask them. If you have concerns, express them. Remember: When a court is assessing whether or not you have satisfied your fiduciary duties, there is no safety in numbers and ignorance is no excuse. You are responsible for, and should be able to justify under the standards set forth above, your own decision on any given matter.
  • Never disclose confidential information presented or discussed at board or committee meetings except when and as expressly authorized or directed to do so by a vote of the board or committee. Disclose confidential information to officers and employees only on a "need to know" basis. When in doubt as to whether particular information is "confidential," it is always best to err on the side of maintaining the confidentiality of information.
  • Remember: Confidential information is not limited to "trade secrets." It includes (a) information discussed at meetings of the board or committees; (b) plans and proposals relating to the corporation’s business and prospects; (c) information regarding the corporation’s unique corporate structure; and (d) information regarding existing or proposed contracts and arrangements to which the corporation is or may be a party. For this purpose, the term "corporation" includes all subsidiaries and affiliated entities.
  • If you (or any of your relatives or affiliates) have any personal or business interest (financial or otherwise) in any matter before the board, whether or not you personally believe that the interest is material, you should disclose that interest at the board meeting (so that the disclosure is reflected in the board minutes) and abstain from voting on the matter in question.
  • Finally, a caution about note taking. A board should speak through its minutes. The only purpose for taking notes of board proceedings is to verify the accuracy and completeness of the minutes evidencing that proceeding. Once you have done that, the best practice is to thrash the notes. The official minutes should speak for the proceedings, and your obligation is to assure that they do.

footnotes:

1.    This paper is intended for discussion purposes only and does not constitute legal opinion or advice. Directors, officers, employees, or other representatives of corporate entities should seek the advice of their personal or independent legal counsel on their actual circumstances under the laws of applicable jurisdictions before acting or relying upon any of the statements made herein.

2.    Laurie A. Briggs, Esq. and Alexander M. Brown, Esq. of Bricker & Eckler LLP, made substantial contributions to this paper.

3.    Because it is impossible within one paper to discuss the laws of all jurisdictions, this paper will refer where appropriate to the laws of the states of Delaware and Ohio. All references to Delaware statutory law is the Delaware Annotated and to Ohio statutory law is the Ohio Revised Code.

4.    See 8 Delaware Laws Annotated §141(a) which provides that "The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. See also, Ohio Revised Code §1701.59(A) which provides that "Except where the law, the articles, or the regulations require action to be authorized or taken by shareholders, all of the authority of a corporation shall be exercised by or under the direction of its directors."

5.    See 8 Delaware Laws Annotated §141(a) which provides that "The business and affairs of every corporation... shall be managed by or under the direction of a board of directors." (Emphasis added.) See Ohio Revised Code §1701.59(A) which provides that "the authority of a corporation shall be exercised by or under the direction of its directors." (Emphasis added.)

6.    See 8 Delaware Laws Annotated §140(c) which provides that the board "may designate 1 or more committees... [that] to the extent provided in the resolution of the board of directors, or in the bylaws of the corporation, shall have and may exercise all the powers and authority of the board of directors in the management of the business and affairs of the corporation." See also, Ohio Revised Code §1701.63(A) which provides that a board may create "an executive committee or any other committee of the directors, to consist of one or more directors, and may authorize the delegation to any such committee of any of the authority of the directors …"

7.    See 8 Delaware Laws Annotated §142(a) which provides that a corporation "shall have such officers with such titles and duties as shall be stated in the bylaws or in a resolution of the board of directors which is not inconsistent with the bylaws." See also, Ohio Revised Code §1701.64 which requires each Ohio corporation to have "officers" consisting of at least a president, secretary and treasurer having, respectively, "such authority and perform such duties as are determined by the directors .…"

8.    See 8 Delaware Laws Annotated §142(e) which provides that "A member of the board... or a member of any committee... shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports, or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation." See also, Ohio Revised Code §1701.59(B) which provides "In performing his duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by:

(1) One or more directors, officers, or employees of the corporation who the director reasonably believes are reliable and competent in the matters prepared or presented;

(2) Counsel, public accountants, or other persons as to matters that the director reasonably believes are within the person's professional or expert competence;

(3) A committee of the directors upon which he does not serve, duly established in accordance with a provision of the articles or the regulations, as to matters within its designated authority, which committee the director reasonably believes to merit confidence."

9.    See 8 Delaware Laws Annotated §141(b) which provides that "The vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the board of directors unless the certificate of incorporation or the bylaws shall require a vote of a greater number." See also, Ohio Revised Code §1701.62 which provides that "The act of a majority of the directors present at a meeting at which a quorum is present is the act of the board, unless the act of a greater number is required by the articles, the regulations, or the bylaws."

10.    See 8 Delaware Laws Annotated §141(b) which provides that "A majority of the total number of directors shall constitute a quorum for the transaction of business unless the certificate of incorporation or the bylaws require a greater number." See also, Ohio Revised Code §1701.62 which provides that "Unless the articles or the regulations otherwise provide, and subject to the exceptions, applicable during an emergency,... a majority of the whole authorized number of directors is necessary to constitute a quorum for a meeting of the directors, except that a majority of the directors in office constitutes a quorum for filling a vacancy in the board."

11.    See 8 Delaware Laws Annotated §141(f). See also, Ohio Revised Code §1701.54.

12.    See 8 Delaware Laws Annotated §145(b) which provides, in order for there to be indemnification of a person in a derivative action brought by or in the right of a corporation, such person must have "acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." See also, Ohio Revised Code §1701.59(B) which expressly requires that "A director shall perform his duties... in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation…."

13.    See Ohio Revised Code §1701.59(E) which provides that a director, "in determining what he reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation's shareholders and, in his discretion, may consider" other interests enumerated in the statute.

14.    In Delaware and many other states, this duty is judicially-made common law. In Ohio the standard is also statutory. See Ohio Revised Code §1701.59(B) which provides that "A director shall perform his duties as a director... with the care that an ordinarily prudent person in a like position would use under similar circumstances."

15.    In Delaware and many other states, this duty is also judicially made. Delaware statutory law requires compliance with a duty of loyalty in order for there to be indemnification of a person in a derivative action brought by or in the right of a corporation. See 8 Delaware Laws Annotated §145(b) requiring that "such person must have acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." See Ohio Revised Code §1701.59(B) which provides that "A director shall perform his duties... in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation…."

16.    See 8 Delaware Laws Annotated §144(a) which provides that "No contract or transaction... shall be void or voidable solely [director's relationship or interest therein], if... [t]he material facts as to the director's... relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee." See also, Ohio Revised Code §1701.60(A)(1)(a) which provides that "No contract, action, or transaction shall be void or voidable... for the reason that... one or more of its directors or officers... have a financial or personal interest... if [t]he material facts as to his or their relationship or interest and as to the contract, action, or transaction are disclosed or are known to the directors or the committee and the directors or committee, in good faith reasonably justified by such facts, authorizes the contract, action, or transaction by the affirmative vote of a majority of the disinterested directors, even though the disinterested directors constitute less than a quorum of the directors or the committee…."

17.    See 8 Delaware Laws Annotated §144(a) which provides that "No contract or transaction... shall be void or voidable... if... [t]he contract or transaction is fair as to the corporation as of the time it is authorized, approved, or ratified…." See also, Ohio Revised Code §1701.60(A)(1)(c) which provides that "No contract, action, or transaction shall be void or voidable... if... [t]he contract, action, or transaction is fair as to the corporation as of the time it is authorized or approved by the directors, a committee of the directors, or the shareholders."

18.    See 8 Delaware Laws Annotated §142(e) which provides that "A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member's duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation's officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation." See also, Ohio Revised Code §1701.60(B) provides that "a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by:

(1) One or more directors, officers, or employees of the corporation who the director reasonably believes are reliable and competent in the matters prepared or presented;

(2) Counsel, public accountants, or other persons as to matters that the director reasonably believes are within the person's professional or expert competence;

(3) A committee of the directors upon which he does not serve, duly established in accordance with a provision of the articles or the regulations, as to matters within its designated authority, which committee the director reasonably believes to merit confidence."

19.    See Ohio Revised Code §1701.59(E)(1) – (4).

20.    See 8 Delaware Laws Annotated §145(b) which provides that indemnification is only available "if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." See also, Ohio Revised Code §1701.13(E) which provides that indemnification is only available "if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation."

21.    See 8 Delaware Laws Annotated §145(b) which provides that "no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity…." See also, Ohio Revised Code §1701.13(E)(2) which provides that except that "no indemnification shall be made in respect of any... [a]ny claim, issue, or matter as to which such person is adjudged to be liable for negligence or misconduct in the performance of his duty to the corporation unless, and only to the extent that, the court of common pleas or the court in which such action or suit was brought determines, upon application, that, despite the adjudication of liability, but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity…."

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