In California, directors and officers have fiduciary duties, or legal obligations, that they must adhere to when making decisions for the corporation and the shareholders. If they do not fulfill their fiduciary duties, the directors and officers can be sued. Therefore, in order to minimize their risk, directors and officers may try to convince shareholders… Read More
In California, directors and officers have fiduciary duties, or legal obligations, that they must adhere to when making decisions for the corporation and the shareholders. If they do not fulfill their fiduciary duties, the directors and officers can be sued. Therefore, in order to minimize their risk, directors and officers may try to convince shareholders to release them of these duties, but such efforts are illegal under California law.
Background on Fiduciary Duties
Fiduciary duties imposed on directors and officers of corporations generally fall into one of two categories: duty of loyalty and duty of care. The duty of loyalty requires directors and officers to always act in the corporation’s best interest and forbids them from engaging in “self dealing,” or taking advantage of their position in the corporation to benefit their own interests. The duty of care obligates directors and officers to carry out their duties as a normal prudent person would do under the circumstances, including making sure that they are completely informed before making decisions.
If a director or officer makes decisions for the shareholders or the corporation in a manner that does not meet these obligations, then the shareholders can bring a lawsuit against the director or officer for breach of a fiduciary duty. Additionally, in small, non-public corporations, majority shareholders can generally control the corporation by electing themselves as directors and officers, thereby “freezing out” minority shareholders. Therefore, directors and officers of small or close corporations are generally held to a higher standard for fiduciary duties.
Waiver of Fiduciary Duties is Void
California statutory law and common law expressly prohibit the waiver of fiduciary duties for directors and officers. In particular, section 204(a) of the California Corporations Code states that a corporation’s Articles of Incorporation may not “eliminate or limit the liability of directors” for acts or omissions that violate the directors’ fiduciary duties to the corporation and shareholders. Furthermore, section 1668 of the California Civil Code provides that any contracts (such as a shareholders agreement) that “exempt any one from responsibility for his own fraud, or willful injury to the person or property of another” are against public policy. Based on these statutes and prior court cases, the California Court of Appeals in Neubauer v. Goldfarb held in 2003 that “waiver of corporate directors’ and majority shareholders’ fiduciary duties to minority shareholders in private close corporations is against public policy and a contract provision in a buy-sell agreement purporting to effect such a waiver is void.” As a result, directors and officers cannot limit or avoid their fiduciary duties through the company’s incorporation documents or another contract.
Minimizing Risks for Directors and Officers
Although directors and officers cannot obtain a waiver from shareholders of their fiduciary duties, there are a number of ways to minimize the risk of a shareholder lawsuit:
- Fulfill duty of loyalty – Directors and officers should make sure that all decisions made are in the best interests of the corporation and the shareholders, not just one or a small number of shareholders. Robust, detailed written board and/or shareholder resolutions or minutes documenting the reasons for a decision are recommended so these reasons can be provided to the shareholders and also as evidence in the event of a lawsuit.
- Fulfill duty of care – Directors and officers should obtain and review all information necessary for making a decision and, when helpful, either include this information in board resolutions or refer to it. Again, the more detailed the board and shareholder resolutions or minutes, the better the historical and legal record that is created. All shareholders, even minority shareholders, have the right to request information from and about the corporation with reasonable cause. Therefore, while directors may not want to include confidential company information in a resolution that is being freely circulated, otherwise it is prudent to add whatever supporting information was used for a decision to a resolution since it is open to shareholders anyway.
- Sign indemnification agreements between the company and the directors – In the event that a director acts in good faith and is still sued, the company is then agreeing to pay for the lawsuit.
- Provide E&O (“Errors and Omissions”) insurance for directors – The financial viability of this option generally depends on the size of the company and can be discussed with a business insurance broker.
In conclusion, although shareholders cannot waive their right to sue directors and officers for breach of fiduciary duties, directors and officers can protect themselves from such a lawsuit by making all decisions in the best interests of the corporation, being properly informed before making any decisions, and documenting all decisions and reasoning in writing thoroughly.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this articleRead Less