Board of Directors' Fiduciary Duties to Shareholders

Board of Directors' Fiduciary Duties to Shareholders

Source: CNBC

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),

Conclusion

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.

Douglas Y. Park

Twitter: @DougYPark

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  • http://twitter.com/DrRLeblanc Richard Leblanc

    Doug if you get a moment could you please quote the statutory language that the duty from the board is to shareholders, or to maximize shareholder value? Thanks, Richard

  • http://www.dypadvisors.com Douglas Y. Park

    Hi Richard,

    Thanks for your message. Whether the board's duty to shareholders come from statute or case law is an interesting questions. In Delaware, the duty to shareholders comes from case law, not statute. In addition to the Ghewalla case cited in the post, the Revlon discussed the board's duty to shareholders in the mergers and acquisitions context. Revlon v. MacAndrews & Forbes Holdings Inc., 506 A.2d 173, 179 (Del. 1986). Directors of a solvent corporation who favor a constituency over its shareholders may violate their duty of loyalty. Revlon, 506 A.2d 173 (Court held that the Board breached duty of loyalty by entering into a lockup agreement on the basis of impermissible considerations of the creditors' interests at the expense of the shareholders).

    Similarly, Delaware courts have held that directors of solvent corporations do not owe fiduciary duties to other constituencies whose rights are purely contractual (e.g., creditors). Katz v. Oak Indus., 508 A.2d 873, 879 (Del. Ch. 1986).

    By contrast, California statute requires directors to consider the best interests of the corporation and its shareholders. Cal. Corp. Code § 309(a).

    Some states have adopted “other constituencies” statutes which allows directors to consider the interests of non-shareholder constituencies, including creditors, in their decision making. These laws are usually permissive, as in Oregon. Or. Rev. Stat. § 60.357(5) (1997).

    Doug

  • http://twitter.com/DougYPark Douglas Park

    Hi Richard,

    Thanks for your message. Whether the board's duty to shareholders come from statute or case law is an interesting question. In Delaware, the duty to shareholders comes from case law, not statute. In addition to the Ghewalla case cited in the post, the Revlon discussed the board's duty to shareholders in the mergers and acquisitions context. Revlon v. MacAndrews & Forbes Holdings Inc., 506 A.2d 173, 179 (Del. 1986). Directors of a solvent corporation who favor a constituency over its shareholders may violate their duty of loyalty. Revlon, 506 A.2d 173 (Court held that the Board breached duty of loyalty by entering into a lockup agreement on the basis of impermissible considerations of the creditors' interests at the expense of the shareholders).

    Similarly, Delaware courts have held that directors of solvent corporations do not owe fiduciary duties to other constituencies whose rights are purely contractual (e.g., creditors). Katz v. Oak Indus., 508 A.2d 873, 879 (Del. Ch. 1986).

    By contrast, California statute requires directors to consider the best interests of the corporation AND  its shareholders. Cal. Corp. Code § 309(a).

    Some states have adopted “other constituencies” statutes which allows directors to consider the interests of non-shareholder constituencies, including creditors, in their decision making. These laws are usually permissive, as in Oregon. Or. Rev. Stat. § 60.357(5) (1997). 

    Doug

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  • http://twitter.com/DrRLeblanc Richard Leblanc

    Doug this is an excellent and very thorough and understandable answer. Thank you! (And also for your ongoing very good contributions to the Board Advisors group). Collegially, Richard

  • http://twitter.com/DougYPark Douglas Park

    Thanks, Richard, for moving this important conversation along here and through the Board Advisors group.

    Best,
    Doug

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  • Aaron K. Heath

    Doug,

    Thanks very much for this post, it is very helpful for a law student in Business Associations! I am getting hung up on a BoD's duties to shareholders versus the corporation when the Board is put in a situation where the existence of the corporation is at stake.  For example, where there is a high priced tender offer but which, if carried out, will result in the death of the corporation.  How do BoD's duties flesh out as a general matter in that situation?   If they have a viable company at the time, who do they owe their fiduciary duties to- the company or shareholders?

    Thanks very much in advance!

    Aaron

  • http://www.dypadvisors.com Douglas Y. Park

    Hi Aaron,

    Keep in mind the general principle. The board should take actions that benefit the corporation; shareholders gain when the corporation is better off, and the standard measure of corporate health is stock price.

    In the specific situation that you mention, the answer depends on what you mean by death of the corporation. If you mean that the corporation will be acquired and merged into the acquirer, then the answer is the duties run to the corporation. Yet, the shareholders benefit from the tender offer because the corporation is worth under the tender offer than under the current stock price. Unless accepting the tender offer has some counterbalancing negative consequences for the corporation, the board can approve the tender offer.

    Maybe I misunderstand your question. Feel free to send me a follow up through the contact form.

    Best,

    Doug

  • moy Last

    I Have a Question
    The Taro's case ;Taro is incorporated in Israel but is listed and traded only on the NYSE.  Sun Pharma controls %66 of Taro's outstanding shares, and %77 of its voting rights. Sun Pharma is listed in India and traded on the Mumbai Stock exchange. Sun Submitted an offer of $39.5/share (for about 5 times Taro's EBITDA) to buy the remaining %34 shares it does not own. Based on similar mergers offers (in the dermatology segment) consummated at an average of 15xEBITDA Taro's and Taro's stellar performance (deserving even more) the minority thinks that Taro's share is worth $140-$180. No wonder Taro's minority feels it is being squeezed out by its own board whose  directors were actually  appointed by Sun and by what they consider a pseudo 'independent" director. Add to that many grievances  of fiduciary duty issues the minority has against its own board and immediately the possibility of derivative lawsuit pops up. The question is, in principle, which venue and what other remedies are available to Taro's minority?
    Are Israel, NY and India all possible venues for a derivative lawsuit.?
    Can one complain to the SEC about a company fiduciary duty and expect them to take an action ?
    anything else ?

  • Herve Nsingi

    Thank you Mr. Park for your post on the Board's Fiduciary Duties to its shareholders. As a law student in mercantile law i have understood that, the board owes the fiduciary duties to the corporation and to its shareholders. So, California Statute requires directors to consider the best interest of the corporation and its shareholders. That interesting, i will quote it with reference in my Master research in 2014.