Quick facts
- The two core duties: care and loyalty
- Default standard of review: the business judgment rule
- Heightened review: Unocal for defensive measures, Revlon on a sale
- Strictest review: entire fairness, where directors are conflicted
- Exculpation: 8 Del. C. § 102(b)(7) covers care, never loyalty
Fiduciary duty is the obligation directors owe to the corporation and its shareholders. In Delaware it resolves into two duties: care, meaning decide on an informed basis, and loyalty, meaning decide in the company's interest rather than your own.
Most disputes are not really about whether a duty exists. They are about which standard of review a court will apply, because that choice usually determines the outcome before the facts are argued.
In plain English
Directors are allowed to be wrong. They are not allowed to be careless, and they are not allowed to be self-interested. A board that makes a bad decision through a good process is generally safe. A board that makes a defensible decision through a conflicted process usually is not.
Process is the product here.
Duty of care
Directors must inform themselves before deciding: read the materials, ask questions, take advice, attend the meetings, and oversee management.
The liability threshold is high. It is gross negligence, not ordinary negligence. A merely unwise decision does not breach the duty of care.
Duty of loyalty
Directors must act in the company's interest, not their own. That means no self-dealing, disclosing conflicts, standing aside from conflicted decisions, and not taking for yourself an opportunity that belonged to the company.
Loyalty is the more serious of the two, for a structural reason covered below: it cannot be contracted away.
The business judgment rule
The default standard, and a generous one. Delaware treats a board decision as protected by a presumption "that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company," a formulation from Aronson v. Lewis that later cases quote directly.12
If the presumption holds, a court will not second-guess the decision. To get past it, a plaintiff must show the directors were uninformed, conflicted, or acting in bad faith.
This is why so much corporate litigation is about process rather than merits. Attacking the decision is hard. Attacking how it was reached is the way in.
Enhanced scrutiny when the board is defending itself
A board resisting a takeover has an obvious problem: refusing an offer may protect shareholders, and it may protect the directors' own jobs. Delaware does not resolve that by trusting them.
Unocal Corp. v. Mesa Petroleum Co. set an intermediate standard. The directors carry an initial burden, and "must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed," satisfying that burden "by showing good faith and reasonable investigation." The defensive measure must also be reasonable in relation to the threat posed.23
Unocal is why a poison pill is reviewable at adoption and reviewable again at use.
Revlon, and the moment the duty changes
Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. addressed what happens when a company is going to be sold and a change of control is inevitable. At that point the board's role changes. Preserving the company as an independent entity stops being the objective, and obtaining the best value reasonably available for shareholders becomes it.4
Practitioners call this being "in Revlon mode." The point is that the duty is not static. It depends on what the board is doing.
Entire fairness
The strictest standard, applied where directors or a controlling shareholder sit on both sides of a transaction. The defendants must prove the deal was entirely fair, across two dimensions:
- Fair dealing: how the transaction was timed, structured, negotiated, disclosed and approved
- Fair price: whether the economic terms were fair
The burden can shift back toward the plaintiff where real protections were used, in particular an independent committee with genuine bargaining power, or approval by a majority of the minority shareholders. These protections are the reason special committees exist.
Oversight, and the duty to actually look
Directors also have an obligation to make a good-faith effort to ensure the company has reporting systems capable of surfacing problems. In re Caremark International Inc. Derivative Litigation is the origin of this line of cases.5
The claim is hard to win because it requires something close to conscious disregard, not simply a failure that was missed. But it is the theory under which directors are pursued for what they did not notice rather than what they decided.
What can and cannot be waived
Delaware lets a company include a charter provision "eliminating or limiting the personal liability of a director or officer... for monetary damages for breach of fiduciary duty." The statute then carves out what cannot be eliminated: liability "for any breach of the director's or officer's duty of loyalty," and liability for "acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law."6
Nearly every Delaware company adopts this provision. The consequence is that duty of care claims for damages are largely foreclosed, which is precisely why serious fiduciary litigation is fought on loyalty and good faith.
Which standard applies
| The situation | The standard | What decides it |
|---|---|---|
| Ordinary business decision | Business judgment rule | Were the directors informed and disinterested? |
| Defensive measure against a bid | Unocal | Reasonable grounds to perceive a threat, proportionate response |
| Sale or change of control | Revlon | Was the best value reasonably available obtained? |
| Controller or conflicted transaction | Entire fairness | Fair dealing and fair price |
What this means for a founder
You are probably a director of your own company, and these duties are owed to the corporation and its stockholders, not to you personally and not to the investor who appointed you.
Three situations should make you slow down: a financing where you are also an investor, a sale where your payout differs from common holders generally, and any transaction with an entity you have an interest in. In each, the useful instincts are the same. Disclose early, stay out of the decision, let disinterested directors run it, and keep a record that shows they did.
The record is not paperwork. In a dispute years later it is the evidence.
Related reading
- Poison Pill covers the defensive measure Unocal review was built for
- Appraisal Rights covers the remedy where process quality decides the price
- Staggered Board covers a structure that changes how quickly directors answer for any of this
- Proxy Fight covers the shareholder route when duties are contested