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DIRECTOR'S DUTY OF LOYALTY

AN OVERVIEW

Corporate directors1 are fiduciaries of the company and occupy positions of trust and confidence. Directors are obligated to remain loyal to the corporation by protecting the corporation's best interests in all circumstances and by refraining from acts that could injure the corporation or breach the trust and confidence bestowed upon them. Generally, any act that places the director's self-interest above that of the corporation's legitimate best interests may constitute a breach of the duty of loyalty.

A director is prohibited from self-dealing and cannot derive a personal benefit from a corporate transaction. A director must refrain from placing herself in a position where her personal interests conflict with her directorial obligations to the corporation.

A director cannot personally take advantage of a business opportunity that the corporation could undertake. It can be a breach of the duty of loyalty if a director appropriates a commercial opportunity for herself in an area in which the corporation has a business interest or has a reasonable expectation of conducting business. In line with this concept, a director is prohibited from competing with the corporation.

The director cannot protect the status quo or promote entrenchment. For example, if a deal contemplates action that would result in the removal of the director, the director cannot thwart the deal if it would ultimately inure the corporation's and shareholders' benefit. It is also a breach of the duty of loyalty if a director "rubber stamps" an executive decision in order to curry personal favor or to maintain her position.

If a plaintiff provides sufficient proof that a director has a personal interest in a corporate transaction, the burden of proof shifts to the director to demonstrate the overall fairness of the transaction2 and to show that the transaction benefitted the corporation and its shareholders. The director's good faith does not preclude a finding that the director breached the duty of loyalty. A self-dealing transaction will typically be upheld only if it is objectively or intrinsically fair to the corporation and the shareholders. If shareholders or the board of disinterested stockholders has ratified a self-dealing director's action, the ratification is merely a defense to a claim for breach of the duty of loyalty and does not disprove the breach.

While the majority of states (Delaware, for example) allow corporations to limit a director's personal liability for a breach of the duty of care, they typically do not limit a director's personal liability for breach of the duty of loyalty. Liability can be personal or joint and several. Equitable remedies are available, and a successful plaintiff typically is compensated by the amount of money that the corporation would have received but for the director's breach of the duty of loyalty.

1 The duty of loyalty also applies to officers of the corporation and the dominant shareholders of the corporation.

2 Two basic components of fairness are fair dealing and a fair price.

Copyright 2010 LexisNexis, a division of Reed Elsevier Inc.