Directors and officers have a fiduciary relationship with the corporation, resulting in a duty of care to avoid harm to the corporation, a duty of loyalty by placing the corporation’s interests ahead of their own as well as a duty of good faith and in some states a duty of candor. In accordance to the duty of care, corporate officers have a duty to inform themselves, prior to making a business decision, of all material information reasonably available to them. They then are to act with requisite care in the discharge of their duties. This duty of care is judged under a gross negligence standard.1 Courts have defined gross negligence as “reckless indifference to or a deliberate disregard of the whole body of stockholders” or actions that are “without the bounds of reason.”2 The courts look at whether the directors have acted with reasonable diligence and in good faith and whether any conflict of interest was involved. The business judgment rule insulates an officer or director from liability for a business decision. The decision must be made in good faith, she must be informed to the extent she reasonably believes appropriate under circumstances, and rationally believe that the decision is in the best interests of a corporation.3

If a conflict of interest exists, the issue no longer is whether the action is a breach of the duty of care, but rather of the duty of loyalty. An officer or director is precluded from exploiting her position for personal gain when the benefit or gain properly belongs to the corporation. The duty of loyalty is analyzed with a conflict of interest approach. The model business act requires approval by disinterested directors, approval by the shareholders or proof that the transaction is fair.

The breach of a duty by a director or officer results in a cause of action for the corporation against that officer or director. An inherent conflict exists, however, in the corporation bringing an action against directors or officers. The breach can have been committed by all the directors or officers, leaving no person in management left to bring the suit on behalf of the corporation. Other issues such as loyalty to fellow directors and/or officers also come into play. To remedy this situation, the courts allow for derivative shareholder suits to be brought by which a shareholder can sue on behalf of the corporation. The cause of action still is the corporation’s, and the recovery usually goes to the corporation.

Excerpted with permission of the author from: American Business Law A Civil Law Perspective, Laura Carlson, J.D. (USA), LL.M. (Sweden)