Corporate Leaders’ Duty of Loyalty and Conflicts of Interest in California

This article outlines the duty of loyalty imposed on corporate leaders, how the business judgment rule provides protection against liability for directors if they act with reasonable care, and how conflicts of interest should be handled by corporate leaders.

I. Duty of Loyalty

California law imposes certain fiduciary duties on officers and directors of a corporation, duties which are owed to the corporation’s shareholders and to the corporation itself. One such duty is referred to as the duty of loyalty, which requires that officers and directors act in the best interests of the corporation and its shareholders. Any breach of this duty by corporate leaders exposes them to civil liability, and can expose them to criminal charges as well, depending on the circumstances.

Guidance on how to interpret this duty of loyalty is provided by the California Corporations Code, which provides, in part, that a director of a corporation operating in California has a duty to act “in good faith…in the best interests of the corporation and its shareholders,” with a level of care, “including reasonable inquiry, that an ordinarily prudent person in a like position would use.” Cal. Corp. Code § 309(a). See also Small v. Fritz Companies, Inc., 132 Cal.Rptr.2d 490, 499 (2003).

II. Conflicts of Interest

Self-dealing, such as when an officer or director has a conflict of interest with the corporation and acts in his or her own interest, and against the corporation’s interests, is a frequent example of a breach of the duty of loyalty. California law states that an interested director can avoid violating the Corporations Code if he or she discloses to the other directors the material facts of any transaction in which they have a conflict of interest, and a majority of the non-conflicted directors approves the transaction. Cal. Corp. Code § 310. It is important to note that the fact that a conflict of interest is present does not prevent a director from fulfilling his or her obligations to the corporation, but the director should act with the utmost candor concerning the facts of such transactions and abstain from voting on such matters.

III. Business Judgment Rule

Where a conflict of interest is alleged to have occurred, the business judgment rule will often come into play as well. Courts will not typically intervene in corporate decisions if the decision-makers acted in good faith and with the reasonable belief that their actions were in the corporation’s best interest. However, pursuant to long-standing legal precedent, this protection is NOT extended to corporate officers, who must act with a higher level of prudence and should carry adequate insurance to protect against the possibility of civil liability being imposed for their business decisions. See Gaillard v. Natomas Co., 208 Cal.App.3d 1250 (1989)

For further discussion on the business judgment rule, both statutory and common law, see our article:How Does the Business Judgement Rule Protect Corporate Executives?

Summary

In determining whether a decision-maker has violated his or her duty of loyalty or otherwise engaged in conduct for which legal action may be instituted, the interplay between the various legal duties and protections often involves a complex analysis in applying the law to the facts of each case. As such, it is important to reach out to an experienced business attorney to assess such situations. The trusted team of lawyers at Gehres Law Group, P.C. has the expertise to advise corporations of all sizes on such matters. Contact us today for a complimentary consultation.

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