California law gives the directors and officers of a corporation principal authority over the corporation’s ordinary affairs. It also identifies certain fiduciary duties that the directors and officers owe to the shareholders and to the corporation itself. Under the “duty of loyalty,” directors and officers must always act in the best interests of the corporation and its shareholders. Breaches of this duty may result in civil liability to the shareholders. An ongoing scandal involving a major media company offers a demonstration, of sorts, of the duty of loyalty, based on allegations against the former chairman and chief executive officer. These allegations also demonstrate how a director might be able to avoid liability by showing a good-faith belief that their actions benefited the corporation.
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 that “an ordinarily prudent person in a like position would use.” Cal. Corp. Code § 309(a). This is considered a fiduciary duty to the corporation’s shareholders. Small v. Fritz Companies, Inc., 132 Cal.Rptr.2d 490, 499 (2003).
Self-dealing, such as when an officer or director has a conflict of interest with the corporation and acts both in their own interest and against the corporation’s interests, is a common example of a breach of the duty of loyalty. California law states that an “interested” director can avoid liability if they disclose 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 approve the transaction. Cal. Corp. Code § 310. A breach of the duty of loyalty occurs when a conflicted director fails to disclose or actively conceals material information from the corporation.
The “business judgment rule” provides an important form of protection for directors and officers. Courts generally will not 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. Id. at § 309(c). California law applies “a presumption that directors’ decisions are based on sound business judgment.” Gaillard v. Natomas Company, 208 Cal.App.3d 1250, 1263 (1989). See also Aronson v. Lewis, 473 A.2d 805 (Del. 1984). A shareholder claiming a breach of the duty of loyalty has the burden of overcoming this presumption.
A series of lawsuits are currently alleging sexual harassment against the company that owns and operates Fox News. The former Chairman and CEO is at the center of these claims, and allegations of other possible misconduct have surfaced. One claim alleges that he misappropriated corporate funds and property to run “negative PR campaigns against [his] personal and political enemies.” The source making this claim argues that this “was more about advancing his own agenda than Fox’s,” which would suggest a violation of the duty of loyalty.
These allegations, it is important to note, remain largely unexamined. They raise an interesting question, however, about the business judgment rule. Could the former CEO justify these alleged acts on the grounds that he believed that they were in the corporation’s best interest, or that they actually did benefit the corporation? We might never know the answers, but they present an interesting scenario.
Since 1976, Bay Area business litigation attorney James G. Schwartz has represented the interests of businesses and business owners. To schedule a free and confidential consultation with a knowledgeable and skilled business advocate, contact us today online or at (925) 463-1073.
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California Court of Appeals Finds that Business Judgment Rule Will Not Protect Board Decisions that Contravene Corporation’s Private Contractual Obligations: Scheenstra v. California Dairies, Inc., Pleasanton Business & Commercial Law Blog, February 25, 2013