The Leading Role a Director’s Fiduciary Duty Plays in Minimizing D&O Claims
Directors of corporations, non-profit associations/organizations, community associations, etc., are fiduciaries. What does that mean? In short, a fiduciary is one in a special capacity in which he or she has control of and responsibility for the property of another. Where a fiduciary relationship exists, the law imposes the highest standard of responsibility that our legal system provides.
The duties of a fiduciary can generally be broken down into three parts: (1) a duty of care, (2) a duty of good faith, and (3) a duty of loyalty. The duty of care requires fiduciaries to invest time and attention to make informed and careful decisions that are not wasteful, arbitrary, or capricious. The duty of good faith requires directors to be honest. Conscious disregard to a director’s duty that results in a failure to act in accordance with a director’s responsibilities is a lack of good faith. Lastly, there is the duty of loyalty. The duty of loyalty requires directors to act in good faith and in the best interest of the corporation, organization, or association. In other words, directors shall not take advantage of their positions to advance their own personal or financial interests, or the interests of someone else.
Failure of a director to abide by the above duties will get a director into trouble. So what happens if a director finds him/herself in hot water? Usually, the corporation, association, or organization has Directors and Officers (D&O) insurance which is a source of protection for directors against liability. D&O insurance can cover defense costs from criminal, civil, administrative, and regulatory investigations and trials. The most frequent D&O claims are related to employment issues arising from discrimination, harassment, failure to comply with workplace laws, wrongful termination, invasion of privacy, and defamation. In fact, most D&O claims come from dissatisfied employees as opposed to shareholders.
While D&O insurance is vital, it does not always protect directors from liability. There are instances where directors may not be protected by D&O insurance and could be held personally liable for their acts and omissions. For example, D&O insurance typically does not cover intentional illegal acts such as criminal fraud or insured versus insured lawsuits where both parties are covered under the same D&O policy. Therefore, while having D&O coverage provides some level of security to directors, the best protection is for directors to be cognizant of their fiduciary duties so they are proactive in avoiding D&O claims.
To do this, a director must be informed and exercise due diligence. Decisions by directors based on insufficient facts can get the director into trouble. Directors should also be aware of their fiduciary duties in specific jurisdictions, as many states have articulated duties of directors into corporate statutes.
As stated above, directors must understand the need to be well informed for their own protection. Each director has a duty to exercise reasonable care in the performance of his/her responsibilities. If a director does not understand the scope of the director’s authority, that director may do something that is clearly outside of his/her authority which may result in a D&O claim. This is why it is imperative that a director understand the bylaws of his/her corporation, organization, or association, as well as any applicable ethical obligations or codes of conduct. In addition, a director should not be hesitant to contact the appropriate professionals for guidance on certain matters such as legal or financial affairs. Directors should document and keep detailed records of meeting minutes and decisions in the event a decision is challenged. Finally, directors should avoid doing anything that creates an actual or perceived conflict of interest.
Directors have a hefty burden when it comes to corporate governance, but with knowledge and due diligence, they can responsibly fulfill their roles and minimize the potential risks of D&O claims.
For more information on this topic, contact Tiffany Releford