Fiduciary Duty Of Directors And Officers

The legal requirements for the duties of directors and officers of a corporation in Michigan are not well understood by business owners. This article explains these requirements, known as fiduciary duty, and briefly details common requirements of directors or officers of corporations.  There are similar rules that apply to members and managers of limited liability companies in Michigan.
 
It is important to note that under Michigan law, all fiduciary duties are applicable to both officers and directors of the corporation.
 
What is a “Fiduciary?”
A corporate fiduciary is an individual who is employed as an officer of the corporation or has been elected by the shareholders as a director to hold and exercise power on behalf of the shareholders. Under Michigan law, officers and directors have a basic obligation to act only in the best interest of the shareholders.
 
What Duties Are Owed?
Although fiduciary duties stem from common law principles, they are found in Michigan’s corporation law, which is the Michigan Business Corporation Act. These duties include: 1) the duty of loyalty to shareholders to only act in their best interest; 2) the duty of care; and 3) the duty of good faith. Corporate fiduciaries are protected by the “Business Judgment Rule” in the absence of a breach of one of the above-mentioned duties in their day-to-day operation of the company.
 
The Business Judgment Rule
The fiduciary rules do not provide that a director or officer of a corporation will be liable for all bad decisions they make while serving the corporation, since this would produce an absurd result, making any risk-taking by officers or directors off limits. The solution to this is the Business Judgment Rule which states that when a corporation suffers a loss from a lawful transaction, a director or officer is not liable when he or she acted in good faith, on an informed basis, and under the honest belief that the action was taken in the best interest of the company.
 
Duty of Loyalty
The duty of loyalty is one of the most common fiduciary pitfalls for directors and is especially magnified in the case of a closely-held corporation where directors are often also shareholders. The duty of loyalty is most commonly breached when the director either: 1) engages in a transaction on behalf of the corporation that constitutes “self-dealing”; 2) engages in a transaction that constitutes self-interest; or 3) engages in a personal transaction that rightfully belongs to the corporation.
  • Self Dealing - Self-dealing occurs when a director has a financial interest in both sides of a transaction. An example of this would be having the corporation purchase another company that the director personally holds stock in. Self-dealing essentially creates automatic liability for the director unless his or her financial interest in the transaction is disclosed prior to its acceptance by the rest of the board of directors.
  • Self-Interest - A director engages in self-interest when he or she will receive a personal benefit from a transaction that is not equally shared by the shareholders. This is not the same as self-dealing. An example of self-interest would be a director obtaining a large bonus from the company every year the corporation is extremely profitable, but engaging in an extremely risky transaction to attempt to reach the profit goal. This is known as the “Enron Pattern”.
  • Corporate Opportunity - Under the Corporate Opportunity Doctrine, a director breaches his/her duty of loyalty when he or she personally seizes a business opportunity for personal gain, which the corporation could have taken. This includes any opportunity the director learns of from his/her position in the company or any opportunity to engage in a business in which the company is engaged or expects to engage. Again, disclosure is the solution to potential corporate opportunity issues.
 
 
Duty of Care
Generally, a director has a duty to keep him/herself informed of the activities of the corporation. The duty of care is not often included in a lawsuit against a director because a corporation may indemnify its directors for breach of the duty of care under Michigan corporate law.
 
 
Duty of Good Faith
Since the duty of care is often subject to indemnification, the duty of good faith has somewhat replaced it in lawsuits against directors. The duty of good faith may be breached either by objective or subjective bad faith. This means that an officer or director must either consciously disregard his or her responsibilities or act with an intent to harm the company or its shareholders.
 
Action Step:
In order to ensure you are meeting your duties as a director or officer, or as a member of a limited liability company, you should ensure your business has a corporate/business attorney to advise you and make sure you understand your fiduciary duties in the context of your particular situation. In addition, you should consult with your insurance agent to make sure you have directors and officers liability coverage under your business general liability insurance policy.