Directors' Duties and Indemnification

Question 1

What are the two main duties that a director has?

Answer 1

1. The duty of care
2. The duty of loyalty

Question 2

When does the duty of care apply?

Answer 2

When the board is making a decisoin in which a director does not have a self-interest.

Question 3

When a director fails to act, what standard governs whether they satisfied their duty of care?

Answer 3

The “prudent person” standard: you acted with the care of an ordinarily prudent person in a like position (which includes special skills) and similar circumstances

Question 4

When a director acts, what standard applies to determine whether they met their duty of care?

Answer 4

A general standard that considers

1. reliance
2. business judgment rule

Question 5

What type of information can a director rely on in keeping with their duty of care?

Answer 5

Any information and reports provided by

1. Officers and other employees
2. Outside experts AND
3. Committees of the board.

Question 6

What is the business judgment rule?

Answer 6

A rebuttable presumption that a director reasonably believed his actions were in the best interest of the corporation, which can be rebutted if

• the director failed to adequately inform themself before approving the decision;
• the director had a personal stake in the decision OR
• the director did not act in good faith.

Question 7

When does the duty of loyalty apply?

Answer 7

When any of the following circumstances exist:

• Self-dealing transactions
• Corporate opportunity doctrine
• Competition with the corporation

Question 8

What is a self-dealing transaction?

Answer 8

A transaction in which the director (or their relative) has a financial interest.

Question 9

What must a director do to shield themself from liability in a self-dealing transaction?

Answer 9

• Disclose their interest to the board!
• Or, failing that, prove that the transaction was fair to the corporation.

Question 10

When will a self-interested transaction be upheld?

Answer 10

1. If the self-interest was disclosed by a majority of the board’s non-interested directors.
2. If the self-interest was disclosed to and approved by a majority of shareholders without a conflicting interest.
3. If the transaction was fair.

N.B.: It all comes down to fairness. If one of the first two is met, still look to the fairness of the deal.

Question 11

What remedy is available when a self-dealing transaction was not excusable?

Answer 11

• Rescind or enjoin the transaction OR
• Require the interested director to disgorge her excess benefit.

Question 12

When does the corporate opportunity doctrine apply?

Answer 12

When the director does not enter into a transaction with the corporation, but instead takes the opportunity for themself.

Question 13

What must a director do in order to avoid the corporate opportunity doctrine?

Answer 13

Offer the opportunity to the corporation and only pursue the opportunity if the corporation rejects it.

Question 14

What is a “corporate opportunity?”

Answer 14

When

• the opportunity relates to the corporation’s business
  
  • the corporation has an interest or expectancy in the opportunity, or it’s in the company’s line of business
• the opportunity came to the director through the corporation
  
  • the director learned about the opoprtunity because of their position at the corporation OR used corporate facilities or assets to pursue the opportunity

Question 15

What defense can a director raise if they pursue a corporate opportunity for themself?

Answer 15

ONLY that they presented the opportunity to the corporation and the corporation rejected it.

Assuming the corporation’s financial inability to pursue the opportunity won’t suffice.

Question 16

When will a decision that competes with the corporation violate the director’s duty of loyalty?

Answer 16

Just if it’s obviously in direct competition with the corporation.

Question 17

What is indemnification?

Answer 17

The corporation’s promise to pay the cost of a director’s defense of litigation against her.

Question 18

When will indemnification be mandatory?

Answer 18

Whenever the director successfully defends.

Question 19

When will indeminification be prohibited?

Answer 19

When the director is defending against liability for receipt of an improper personal benefit.

Question 20

When is indemnification allowed, but not required?

Answer 20

If the director

1. acted in good faith
2. had the reasonable belief that their actions were not opposed to the interests of the corporation;

AND

1. in a criminal case,
2. the above two and
3. the director did not have reasonable cause to believe the conduct was unlawful.

Question 21

To what extent is indemnification insurance permitted?

Answer 21

To the max: can insure indemnification of the director against costs and liability from any litigation, even if the corporation could not itself indemnify the director.

Question 22

What is the remedy under the corporate opportunity doctrine?

Answer 22

To impose a constructive trust with all profits from the opportunity going to the corporation.