Under what circumstances can shareholders find themselves in litigation? What are the duty of loyalty and the duty of care, and what does it mean if company leadership is in breach of these duties? Bernstein-Burkley, P.C. Partner, Kirk B. Burkley, answers these questions and more in this week’s 5 Minute Legal Master Series episode: SHAREHOLDER LITIGATION.
Shareholder Litigation (5:31)
Welcome to the 5 Minute Legal Master series where expert legal attorneys help you master important legal topics. Today, board certified creditors’ rights and business bankruptcy attorney Kirk B. Burkley discusses shareholder litigation.
One of the things we see a lot more these days are shareholders or disgruntled shareholders involved in litigation and that can come in many forms. It can come in just a disgruntled shareholder suing the other shareholders, a shareholder seeking to file derivative action against other shareholders, derivative action meaning on behalf of the company itself or it might also come out in the context of a bankruptcy where a creditor’s committee or a trustee seeks to file a derivative action against other shareholders or potentially even the board of directors for breach of their fiduciary duty. So what are the duties that board of directors and the officers of a company owe to that company? There are 2 primary duties owed to the company: 1, the duty of loyalty and 2, the duty of care.
Let us talk about those each for a second. The duty of loyalty means that if you serve on the board of directors of a company or if you are an officer of a company, you owe the duty of loyalty and that means that you cannot be disinterested in the decisions you are making, you loyalty is the company. For example, if you have a propriety interest in some external transaction outside the company that causes you to make a bad decision on behalf of the company you could be liable for breach of the duty of loyalty. Let me give you a very specific example, if I were an officer or director of a company and I was going to enter into a contract for the purchase of widgets to supply my company, and I owned the company supplying the widgets then there is a good chance I am breaching my duty of loyalty. That is not always the case. For example, if the company that I own supplying the widgets just happens to be the lowest cost provider and in fact it would be a good business transaction for the company to buy the widgets from my other company, then the first thing I should do is disclosure. Make sure the other board members are aware of my interest in the supplier, then I should in fact recues myself from any voting on that transaction and the non interested or disinterested board members, if you will, in that transaction should make the decision without interference or voting from me.
Sometimes it is good practice for a company to form a committee of independent directors to analyze the situation and issue a report and recommendations to the rest of the board but that might depend on how large the company is or how large the transaction is. But the duty of loyalty really comes down to am I exercising and discharging my duties for the company with loyalty to the interest of the company which I serve or is my loyalty to some other external entity, person or transaction.
The duty of care can be a little bit more complicated. When exercising the duty of care that requires the board members and officers be informed about the decision they are making. That means reading reports, let us say I am talking about a financial transaction, if I am a board member I should be reading financial reports related to the decision, I should be that the CFO supply information so we can make informed decisions. It might be getting information from outside legal counsels or outside accountants but it means gathering information so that you can make an informed decision.
If in fact you are then informed, exercising your duty of care and are disinterested from the transaction, you do not have some personal gain, so you are exercising your duty of loyalty then you will be afforded what is called the protections of the business judgment rule. The business judgment rule says that the courts will not second guess business decision in hindsight. Just because a business decision turns out to be the wrong 1, you will be afforded the protections of the business judgment rule and cannot be held liable for a bad business decision, so long as you exercise you duty of loyalty and care.
This has been another installment of the 5 minute Legal Master series where expert attorneys help you master important legal topics. For more information on this and other topics please visit 5minutelegalmaster.com