LAW 401 SEU The Duty of Care and The Business Judgment Rule Case Study

Case Study

You are the Chairman of the Board of a well-known, publicly traded corporation. You are personally responsible for convincing the Board to fund a new product design that ultimately failed when it was placed on the market, causing extreme losses for the corporation. The shareholders now want to hold you personally responsible for all the losses to the corporation and have filed a derivative lawsuit in the name of the corporation in which you are the defendant. Please describe how you would defend yourself using the Business Judgment Rule. Create and describe any facts you think will support your position under this Rule. Limit your facts to only those that will support your position under this Rule and no others.

Chapter 8
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Introduction
• The book defines fiduciary relationship as:
“created when one is give the power that carries a duty to
use that power to benefit another.1”
• Fiduciary relationships include:
➢ Trustee relationships
➢ Beneficiaries of trusts
➢ Partners or agents to principals
• Enforcement of fiduciary duty is used to reduce
mismanagement of the company or unfair self-dealing.
• Fiduciaries are accountable to shareholders and directors
of the company.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
• “The characterization of someone as a fiduciary generally
means that the individual has to obey certain duties and
look out for the interests of whoever is owed the duty.”
• Fiduciaries are bound by a duty of care and duty of
loyalty.”
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of care:
❖ Directors perform their duties with care and
diligence.
❖ Can be liable for both malfeasance and
nonfeasance.
❖ Protected under business judgment rule (limits
court questioning business decisions).
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
➢ Duty of loyalty:
❖ Act in the best interests of the company and in
good faith.
❖ A lack of duty loyalty involves intent to harm the
company and dereliction of duty.
▪ Can occur when the person responsible for the
fiduciary duty puts his/her own interests over
the interests of the company.
❖ Courts will get involved in cases where the person
in charge of fiduciary duty puts their personal
interests over loyalty of duty.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Care and loyalty
The textbook states the difference between duty of loyalty
and duty of care is as follows:
“Thus, in duty of loyalty cases involving a conflict of
interest, there is more judicial involvement and scrutiny
than in duty of care or good faith cases.11 The difference
is justified because in a duty of care case, the courts want
to protect business decisions that are intended to enhance
corporate gain, while in a duty of loyalty involving a
conflict of interest case the directors may be motivated by
personal gain.12”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• “The fiduciary duty of those who manage or control is to
the corporation and shareholders and the shareholders
have the right to enforce it through litigation.”
• Publicly traded companies have outside directors to
monitor the inside directors.
• Company representatives disagree on the involvement of
litigation to enforce fiduciary responsibility:
➢ Shareholders want judicial scrutiny.
➢ Managers who have fiduciary duties do not want judicial
scrutiny.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Policy issues
• Law and economics approach
➢ View the relationship between shareholders and
managers as a contract.
➢ The duties of the fiduciary manager are included in the
terms of the contract.
➢ Detractors of this approach include shareholders who
would not be able to negotiate the contract.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Duty of care
• Liability under duty of care requires:
➢ Finding duty
➢ Breach
➢ Proximate cause and loss
• “Issues of breach of duty of care can arise in two kinds
of situations; when
➢ There is a failure to act or monitor where a loss
could have been prevented (i.e., nonfeasance)
➢ There is a decision made in a negligent manner
(i.e., malfeasance).”
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Malfeasance occurs when directors are accused of making
ill-advised decisions or negligence of duties.
• The ill-advised decisions are subject to judicial review and
can be protected under the business judgment rule.
• Even if malfeasance is found, finding causation may be
required.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Malfeasance and the business judgment rule
• Business judgment rule
➢ “limits judicial inquiry into business decisions and
protects directors who are not negligent in the decision
making process.”
➢ Courts defer to the director’s decision and do not infer
that they have more knowledge over business
decisions than the director’s.
➢ Under this rule, courts will review the process of the
process, not the decision.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Causation
• Breach of duty does not necessarily end the inquiry.
• The actual cause of the breach of duty must be found.
• Plaintiffs have the burden of proof and must prove
themselves free of negligence.
• Plaintiffs must also show the amount of damages.
Introduction to Fiduciary Duty: The Duty of
Care and the Business Judgment Rule
Good faith
• “Lack of good faith would include
➢ Conduct motivated by subjective bad intent
➢ By an actual intent to harm the corporation
➢ An intentional dereliction of duty and a conscious
disregard for one’s responsibilities would also constitute
a lack of good faith because it shows more culpability..”