Board of Directors: Duty of Care and Duty of Loyalty
Jim Lejeal and I have worked together for almost a decade – I was one of the investors in his last company – Raindance Communications (now part of West Corp) and am an investor in his new company, Oxlo Systems. Jim also has a lot of experience as an angel investor and a board member for startup companies. In response to my other posts on boards, Jim suggested that we co-author a “Board of Director” series similar to several other series – such as the Term Sheet series, the Letter of Intent series, and the 409A series that Jason Mendelson and I have written. A few emails later, we had a rough outline. We hope you enjoy it (and feel free to suggest topics.)
In understanding the role of a board and blogging about good board meeting practices – we thought it would be beneficial to start by reviewing some basics surrounding the notion of “being a board member”; specifically a board member’s fiduciary duties.
A board member’s fiduciary duties are based in or upon what’s called the business judgment doctrine. This is a case law derived concept that, through time (a long time actually) has declared two primary duties: the duty of care and the duty of loyalty. Recently, there has been some discussion around two more duties (specifically – the duty of candor and the duty of good faith) which we’ll cover in a later post.
The business judgment doctrine is essentially a concept in business law that outlines the notion that a court won’t review the actions of a corporation’s board of directors in managing the corporation unless someone suggests that the directors 1) violated their duty of care or their duty of loyalty or 2) made an irrational decision.
In direct terms – this means a court won’t play 20/20 hindsight and rethink a board’s actions or decision if it’s reasonably clear that the board made rational decisions and acted within the notions of their fiduciary duties. Implied in this are standards of conduct that, having been broadly explored in many courts, are generally well understood (although this doesn’t prevent endless shareholder lawsuits around directors responsibility, especially in situations where a public company fails and there is a meaningful director & office insurance policy in place.)
We decided to start here because being a board member means doing work. And it’s work that has real risk associated with it. Taking a board set without being familiar with these fundamentals is sort of like performing a laproscopic gall-blader removal procedure after two years of medical school – you might be able to get through it, but it won’t be pretty, and the patient will probably be miserable. While the fundamental risk dynamics – especially today with the legal and regulatory overhand of Sarbanes Oxley – differ between public and private companies, the responsibilities are the same. That said, our perspective and experience derives primarily from private companies (although both Jim and I have been on public companies boards) – that will be the focus of this series.