What fiduciary duties does the board of directors have to shareholders? Where do these duties come from? Are these duties particular to Delaware corporate law?
In a recent post, I discussed the board's fiduciary duties to the corporation. In response, Alex Todd (Twitter handle:@TrustEnabler) asked the three questions above. These questions raise important issues about how disputes in corporate governance will be addressed.
The Board’s Fiduciary Responsibility to Shareholders
Just as board members owe a duty of care and duty of loyalty to the corporation, they owe the same duties to shareholders because they are considered to be fiduciaries of the shareholders. In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, 930 A.2d 92, 99 (Del. 2007), the Delaware Supreme Court described the duties of directors to shareholders:
It is well established that the directors owe their fiduciary obligations to the corporation and its shareholders. While shareholders rely on directors acting as fiduciaries to protect their interests, creditors are afforded protection through contractual agreements, fraud and fraudulent conveyance law, implied covenants of good faith and fair dealing, bankruptcy law, general commercial law and other sources of creditor rights.
Thus, the source of the directors’ responsibility to shareholders is the fiduciary relationship.
A few points are important to note. Delaware courts, neither here nor in other cases, do not describe the directors as agents of the shareholders. Nor do Delaware courts state that the shareholders’ interests take primacy over all others. As Professor Lynn Stout of UCLA Law School astutely explains, the common belief that the board must always strive to maximize shareholder wealth is not supported in corporate law.
The Distinction Between the Corporation and its Shareholders
In some writings, the distinction between duties to the corporation and its shareholders is blurred. In Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334 (Del. 1987), Gheewalla, and other cases, the court explicitly discussed directors’ obligations to the corporation and its shareholders. That language clearly differentiates between the two.
The distinction is supported by the existence of shareholder derivative lawsuits that shareholders can bring against board members for breach of fiduciary duty.
It is well settled that directors owe fiduciary duties to the corporation. When a corporation is solvent, then those duties may be enforced by its shareholders, who have standing to bring derivative actions on behalf of the corporation because they are the ultimate beneficiaries of the corporation's growth and increased value. Gheewalla, 930 A.2d at 101.
The reasoning behind derivative suits is that the corporation itself is unwilling to bring the claim for the plaintiff shareholders, usually because the directors, officers, or other shareholders are alleged to be at fault. Officers of the corporation, who like the directors presumably also have responsibilities to shareholders, can be held liable in a derivative action.
The Fiduciary Responsibility to Shareholders is Broadly Recognized
Delaware is not the only US state to recognize the board’s responsibility to shareholders. In any state that permits shareholder derivative suits, directors implicitly owe a duty to shareholders. That duty is the basis for such suits, as shareholders have standing to bring the derivative suit on behalf of the corporation. Examples of other states that permit derivative suits are:
- California (See, e.g., Bancroft-Whitney Co. v. Glen (1966) 64 Cal.2d 237, 345; Small v. Fritz Companies, Inc. (2003) 30 Cal.4th 167; Professional Hockey Corp. v. World Hockey Assn. (1983) 143 Cal.App.3d 410; all allowing derivative suits),
- Florida (Florida Corporations Statute FS 607.07401 describing requirements for shareholder derivative lawsuit), and
The board has duties to the corporation and its shareholders. Why? Because of the fiduciary relationship between the board and shareholders. When directors breach their duties, shareholders can bring a derivative suit against the directors. In additional circumstances such as change of control transactions, mergers and acquisitions, and insolvency, directors also owe shareholders duties, including Revlon duties to achieve the best price for shareholders and to disclose material information and potential conflicts of interest.
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