The Fiduciary Duty of the Boards of Directors

The board of directors of any corporation represents a number of responsibilities. Generally, each director is chosen to fulfill some need within the organization, but they’re expected to all work together in order to help the corporation succeed. While this should seem obvious enough, there’s actually a legal mandate that requires them to do so. It’s known as their fiduciary duty and is an essential component of their position.

The Basics

Fiduciary duty is an easy enough concept to understand. It simply means if someone is contractually obligated to represent another person or party, they must fulfill their duties as opposed to looking for opportunities of personal interest.

A lawyer is a good example of this. If a lawyer represents you during divorce, they can’t tell your spouse information you relay to them, even if it would mean a large profit. In many ways, the laws surrounding fiduciary duties are very much about enforcing contracts. However, they serve to cover those areas that may otherwise be considered vague or unspoken.

The Board of Directors

Those on the board of directors have a fiduciary duty to their corporation. So they’re mandated to do what’s in its best interest even if they can find opportunities for personal gain if they were to act against it. So if a director is offered a higher paying job with Corporation A if they’ll help vote down a deal their current company, Corporation B, is working on, they’d have to decline (and, actually, they’d be bound to report this espionage) because of their fiduciary duties.

Taking it a step further, the board of directors has, by extension, fiduciary duties to their shareholders as well. So, they could conspire to help each other out in a way that would hurt their shareholders. A director couldn’t pencil a deal for themselves wherein they’d sell some asset, which the corporation would “buy” at an inflated price. The board of directors may not feel the pain, but the shareholders certainly would.

Acting against Their Own Self-Interest

You can probably understand how things can quickly enter a gray area though. No director is supposed to sacrifice their own wellbeing to assist the corporation or its shareholders either.

For example, you’d have a hard time making the case that a director had a fiduciary duty to sell off some or all of their own shares to help the corporation.

When a Corporation Goes Insolvent

Not all corporations succeed, obviously. Many actually become insolvent. At that point, it’s generally understood that the board of directors now have fiduciary duties to the creditors. This means, upon becoming insolvent, they can’t start selling things off or taking unnecessary risks because they know it will soon be over.

The same usually goes for corporations who know they will soon be insolvent. Obviously, it would hurt shareholders if a board thought they’d soon be in too much debt to survive and decided to start playing with shareholder money.

The laws surrounding fiduciary duties differ by state, can be complicated and, sometimes, even a bit contradictory. If you need help clarifying them or picking board members who will honor their duties, my experience can help.