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Fiduciary Memo: Duties and Obligations of Directors | Mitchell A. Dix & Associates

Fiduciary Memo: Duties and Obligations of Directors

In furtherance of your request, this memorandum will serve to provide you with a general overview of the primary fiduciary duties and obligations of the Board of Directors. While a careful consideration of the points raised herein should assist you in the proper discharge of your responsibilities as directors, its purpose is to formally make all present and future Board members aware of the important legal responsibilities you have to your shareholders.

As you are aware, the authority of the Board of Directors to perform its functions and legal obligations derives principally from the Corporation’s by‑laws, Certificate of Incorporation and from relevant statute and case law.  Every Director should read the by‑laws carefully, because you are charged with the legal responsibility for knowing its contents and to seek legal advice in areas where you don’t.  Essentially, the by‑laws serve as the “rule book” for the Board of Directors.

 

More specifically, the by‑laws create the legal obligations from which your fiduciary duties are derived by providing in Article II, Section 7 thereof that “the affairs and business of this Corporation shall be managed by its Board of Directors, except with respect to the powers which are herein delegated to the officers.” Some of those responsibilities can, by proper Board resolution and in accordance with the requirements of your by-laws, be delegated to one or more committees. Committees are, in effect, an “extension” of the Board, with limited authority that is established solely by the Board (not by the committee members themselves). The Board should always supervise the actions of its committees since, as an “extension” of the Board, both committee members and directors can be held legally accountable for the acts of committee members that exceed their authority or which violate the directors’ fiduciary responsibilities to their shareholders.

 

There are several areas in which a director (and, by extension, in certain circumstances a committee member), is likely to be held accountable if he or she fails to fulfill these legal responsibilities.

 

DIRECTORS HAVE A FIDUCIARY OBLIGATION TO THE CORPORATION

 

Directors have a fiduciary obligation to the members of the cooperative, and their position is therefore somewhat analogous to a trustee’s relationship to a trust and its beneficiaries.  If a director does breach his fiduciary obligation, he may be personally liable for any loss resulting to the corporation.

 

Directors must exercise the utmost good faith in their dealings with the corporation’s business and its property.  They must act to protect the interests of all of the shareholders of the corporation and to preserve the value of its assets.

 

One important aspect of a director’s fiduciary duty is that the director must not, of course, divert or otherwise misappropriate corporate assets or funds.  Any monies received by a director from the corporation’s operations are held by him as trustee for the benefit of the corporation and its members.

 

Directors should be always be careful to fully disclose to each other and to the shareholders of the corporation all material facts concerning corporate transactions, and must ensure the accuracy of all statements in corporate documents such as annual reports. However, not all information discussed among directors is always appropriate to disclose, as it may be in the interests of the corporation and its shareholders that it be kept confidential. Some examples would be matters pertaining to ongoing or potential lawsuits, matters discussed at meetings that the Board determines cannot be effectively discussed without an understanding of confidentiality, and matters which, if revealed to third parties without proper authorization, could subject the directors and/or their shareholders to liability. Provided the directors are not otherwise under a legal obligation to disclose these matters, it is the Board’s prerogative to determine which of the matters before it should be treated as confidential. A director’s breach of this “duty of confidentiality” could not only adversely affect the interests of the corporation and its shareholders, but could subject that director to personal liability.

 

Another important aspect of a director’s fiduciary duty is that a director is not generally permitted to benefit financially by virtue of his position, without disclosure to the other directors.  In fact, a director has a duty to reveal any conflict of interest between the affairs of the corporation and his own personal interests that may arise. The most important practical implication of this is that a director must reveal his own interest in a transaction to the other members of the Board as soon as possible after becoming aware of an actual or potential conflict of interest. For example, a director must not knowingly permit the corporation to enter into a transaction with a business in which he has an ownership interest without first disclosing his involvement to those involved in approving the transaction and obtaining the necessary approval of the Board.

 

A related requirement is the duty to comply with the “business opportunity doctrine.” That doctrine states that a director who becomes aware of a business opportunity in his capacity as a director in which the corporation would be interested may not divert the opportunity to himself.  If he does divert the opportunity to himself, then he may be accountable for the profit he gained in the transaction and/or the profit lost by the corporation.

Finally, directors may be liable for breach of their fiduciary duty if they retain in a responsible position a person who has been shown to be unworthy of trust.  It is therefore important to investigate the actions of an employee or other director if those actions appear to violate the law or constitute fraud, bad faith or gross negligence.

 

ACTS OF MISMANAGEMENT OR NEGLIGENCE BY A DIRECTOR

 

Ordinarily, a director who acts honestly and performs his or her duties in good faith, using ordinary diligence and care, will have little to fear if accused of mismanagement or negligence.  The criteria used to determine if a director has met this standard is whether or not a reasonably prudent person would have made the same decision or taken the same action in the same circumstances.

 

It is well settled that, ordinarily, directors of a corporation are not liable for mere mistakes or errors of judgement when they act in good faith and without corrupt motive. In other words, they will not normally be held liable for “honest mistakes” that a person exercising ordinary common sense and attention might have made.  This is known as the “business judgment rule.” In order to benefit from the rule, directors must not act fraudulently or illegally, and must be diligent and careful in performing their duties.

 

Some of the acts described above as being breaches of fiduciary duty may also be classified as acts of mismanagement or negligence. Some examples would be concealment of facts when discussing corporate transactions, the making of false statements in reports, and retaining a person in a position of responsibility who is known not to be trustworthy.  Injuring the good will of the corporation, and failing to supervise adequately the affairs of the corporation and its officers and employees may also be regarded as acts of mismanagement or negligence.  Financial matters are at the heart of any corporation. It is therefor of particular importance for directors to keep themselves adequately informed regarding the corporation’s financial affairs.

 

One important point to make in this area is that a director who does not participate in or votes against a measure of the Board that later is deemed to have evidenced misconduct or negligence may nevertheless be held accountable for that decision.  In order to ensure that he or she is not held responsible for the consequences of that decision, a director must create a written record of the fact that he or she does not agree with the decision.  If a director is actually present at a meeting, the most appropriate method to achieve this may be by ensuring that a statement is included in the minutes of the meeting.  If the director does not attend the meeting at which the decision was made, he or she must ensure that his or her disapproval is recorded, for example, by the delivery of a letter by registered mail to the Secretary of the corporation.

 

 

ACTS PERFORMED OUTSIDE THE SCOPE OF A DIRECTOR’S AUTHORITY

 

The limits of a director’s authority are addressed both in the provisions of the Business Corporation Law and in the by‑laws of the corporation.  Directors may be held personally liable to the corporation for any loss incurred if they act or attempt to act outside the bounds of their authority.  Therefore, if directors are in doubt as to whether a particular course of action is within their power, they should first consult the corporation’s by‑laws. If still in doubt, legal advice should be sought before going any further.

 

TORTIOUS ACTS BY DIRECTORS

 

Tortious activity can include negligence, the intentional infliction of injury to persons, or property, libel or slander and interference with contractual rights. In addition, increasing numbers of suits based upon certain federal, state and city statutes which preclude discrimination are being brought against the directors of cooperative corporations.

 

Generally, a director is not personally liable for the tortious acts of the corporation, and only becomes personally liable if he personally voted for or participated in them. Likewise, directors are not personally liable for the torts of employees of the corporation unless the directors participated in or permitted the tortious activity.  Directors may, however, be in breach of their fiduciary duty if they permit the tortious act to occur.

 

DIRECTORS’ FAILURE TO COMPLY WITH THE LAW

 

Directors of a corporation are responsible for performing acts that are required by law, such as the payment of taxes and the obtaining of appropriate permits and licenses. Directors may also expose themselves to personal liability if they perform acts which are prohibited by law.

 

Generally, applicable law regulating cooperative corporations provides specific sanctions rather than personal liability for noncompliance, such as the failure to file permits, failure to appoint a registered agent, and failure to deliver a statement of change of registered office or registered agent.  Some of those sanctions could, in some extreme circumstances, even lead to the involuntary dissolution of the corporation.  Although most laws do not specifically provide that directors can be made personally liable in such circumstances, there is nevertheless the possibility that shareholders of the corporation could allege mismanagement or negligence when such failures take place. Directors should therefor pay particular attention to the timely filing of all corporate documents.

 

SIGNATURE OF DOCUMENTS BY DIRECTORS

 

Directors should exercise care in signing letters and other documents when acting on behalf of the corporation.  Directors should always ensure that it is clear to anyone who may read the document that the director is signing in his or her capacity as a director, and not in his or her personal capacity.  Prudence, therefore, dictates that a statement making that fact clear always appears next to one’s signature when acting in one’s capacity as a director. Of even greater importance is the fact that no one director can unilaterally act on behalf of the corporation unless authorized to do so by proper Board vote or by the provisions of the corporation’s by-laws.

SUMMARY OF STEPS DIRECTORS SHOULD TAKE TO MINIMIZE POTENTIAL PERSONAL LIABILITY

 

Periodically review the corporation’s by‑laws and Certificate of Incorporation.

Always be diligent and careful in performing one’s duties as a director, and exercise

good faith in dealing with the corporation’s business and property.

Attend board meetings regularly, and carefully review minutes of meetings.

Keep informed of corporate affairs, particularly those involving the finances of the

corporation.  Carefully review all financial reports of the corporation.

Be sure that statements in all corporate documents are accurate.

Ensure that all corporate documents which are required to be filed with a third party are

filed in a timely manner.

Reveal any actual or potential conflict of interest to the other members of the board at the

earliest possible opportunity.

Do not divert corporate opportunities.

Ensure that the corporation does not retain any employees who are unworthy of trust.

Insist that Board meeting minutes accurately reflect any comments or votes in opposition to

matters acted upon at meetings.

Never act unilaterally. As a director, you must always obtain Board approval for your

actions.

If in doubt about whether directors have the power to take a particular course of action,

consult the by‑laws.  If still in doubt, ensure that the Board takes legal advice.

 

Kindly acknowledge that you have read and hereby agree to comply with the obligations set forth herein by signing a copy of this memorandum on the signature line provided below and returning an executed original to the managing agent upon the commencement of your term(s) as a Director.