Generally, corporate officers and directors have a fiduciary obligation to the corporation and its shareholders that requires them to act in good faith, use their best judgment, and do their best to promote the corporation’s interests. Collectively, this set of obligations is known as an officer or director’s fiduciary duty and arises from the legal relationship between the individual and the corporation or shareholder.
An officer or director’s fiduciary obligations under California law can generally be distilled into two duties: the duty of loyalty and the duty of care. With regard to corporate directors, both of these duties have been codified in California Corporations Code section 309(a) which provides:
“A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.”
Generally, officers have the same fiduciary duties as directors.
The Duty of Loyalty
The duty of loyalty requires a corporate officer or director to always act in the corporation’s best interest, and forbids the officer or director from engaging in “self-dealing.” Self-dealing is conduct by a corporate officer or director that involves taking advantage of his or her position in the corporation to benefit his or her own interests rather than those of the corporation or shareholders.
For example, assume John is the CEO of a major computer corporation, ABC, Inc. ABC needs to buy a considerable amount of computer chips to install in its computers, so it begins shopping for a manufacturer. John happens to own a large amount of stock in XYZ, Corp., a manufacturer of computer chips.
John, without notifying anyone of his personal interest in XYZ, uses his authority as CEO to ensure that ABC hires XYZ to produce the necessary computer chips, giving XYZ’s share price a significant bump and, in the process, earning John a nice return on his investment in XYZ.
The type of transaction will not always necessarily amount to self-dealing. Had John disclosed to the board of directors that he held an interest in XYZ, and the board elected to contract with XYZ anyway, John would not have violated any fiduciary duty to ABC or its shareholders. However, because John failed to disclose his personal interest in XYZ, his conduct constituted a breach of his duty of loyalty.
The Duty of Care
The duty of care requires a corporate officer or director to carry out his duties as would any ordinarily prudent person in similar circumstances. For example, a corporate officer or director might violate his duty of care by contracting to buy a company without first conducting due diligence to find out if it is an economically sound decision.