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Philip Touitou Authors Article, "Directors and Officers: The Role of Motive in Defining the Line Between Good Faith and Bad," in Bloomberg Law Reports

February 7, 2011

A collateral effect of the downturn in the economy and the credit crisis of the last two years has been a heightened focus by the courts on activities of corporate directors and officers. Increasingly, in such cases, the courts have sought to discern the often opaque line between good faith activities necessitated by circumstances and excessive and self-serving conduct. In doing so, they have upheld board actions compelled by sudden cataclysmic financial circumstances where the courts have found the challenged activity made in the heat of the moment need not be perfect, as long as the course taken was one of several reasonable alternatives. However, they have also responded critically where board members have acted with a motive that appears self-interested or inconsistent with the objectives of the corporation and its shareholders.

Fiduciary Duty Standard

Under well-developed bodies of law in New York and Delaware, members of a corporate board of directors are fiduciaries and, as such, are held to an elevated standard of care. In New York, the duty has been famously been described as requiring a level of behavior that is "stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive . . ." A "special duty" arises from a relationship that imposes an obligation to "protect the interests of another." In the corporate context, an officer’s fiduciary duty includes discharging corporate responsibilities "in good faith and with conscientious fairness, morality and honesty in purpose and displaying ‘good and prudent management of the corporation.’" The "core duties" are those of "loyalty and due care."

The Business Judgment Rule

Despite the heightened standards to which directors and officers are held, their activity is, under most circumstances, insulated from personal liability by the "business judgment rule." The business judgment rule presumes that a business decision has been made on an "informed basis," in "good faith" and with an "honest belief that the action taken was in the best interests of the company." The rule "bars inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance or corporate purposes." The central premise behind the rule is to prevent a court from "second-guessing corporate decision-making in the event the corporate decision was made in good faith and after reasonable investigation." Where a director’s decision can be attributed to "any rational business purpose," it will remain undisturbed.

To rebut the presumption of good faith requires evidence that the directors engaged in acts constituting a "[breach of] their duty of care or of loyalty or acted in bad faith." Where such evidence compels the conclusion that "no person of ordinary sound business judgment would say that the corporation received fair benefit," the presumption of the business judgment rule is overcome. In such circumstances, the burden shifts to the directors "to demonstrate that the challenged act or transaction was entirely fair to the corporation and its shareholders." Where the directors establish that they have acted in the best interest of the corporation, liability will not be imposed, even where hindsight reflects that the action fell short of the goal intended.

© 2011 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 2 edition of the Bloomberg Law Reports—Director & Officer Liability. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P.

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