This is such a great summary of the duties of the board of directors from three attorneys at Sidley Austin LLP – Claire H. Holland, Holly J.Gregory and Rebecca Grapsas:

Responsibilities of the board (supervisory)

Board’s legal responsibilities

What are the board’s primary legal responsibilities?

The primary legal responsibility of the board is to direct the business and affairs of the corporation (see DGCL, section 141). While the functions of a board are not specified by statute, it is generally understood, as noted in the ALI’s Principles of Corporate Governance and other codes of best practice, that board functions typically include:

• selecting, evaluating, fixing the compensation of and, where appropriate, replacing the CEO and other members of senior management;
• developing, approving and implementing succession plans for the CEO and senior executives;
• overseeing management to ensure that the corporation’s business is being run properly;
• reviewing and, where appropriate, approving the corporation’s financial objectives and major corporate plans, strategies and actions;
• understanding the corporation’s risk profile and reviewing and overseeing the corporation’s management of risks;
• reviewing and approving major changes in the auditing and accounting principles and practices to be used in preparing the corporation’s financial statements;
• establishing and monitoring effective systems for receiving and reporting information about the corporation’s compliance with its legal and ethical obligations, and articulating expectations and standards related to corporate culture and the ‘tone at the top’;
• understanding the corporation’s financial statements and monitoring the adequacy of its financial and other internal controls, as well as its disclosure controls and procedures;
• evaluating and approving major transactions such as mergers, acquisitions, significant expenditures and the disposition of major assets;
• providing advice and counsel to senior management;
• reviewing the process for providing adequate and timely financial and operational information to management, directors and shareholders;
• establishing the composition of the board and its committees, board succession planning and determining governance practices;
• retaining independent advisers to assist the board and committees;
• assessing the effectiveness of the board, its committees or individual directors; and
• performing such other functions as are necessary.

Board obligees

Whom does the board represent and to whom does it owe legal duties?

Directors are elected by shareholders. They are fiduciaries of the corporation and its shareholders. Directors represent the shareholding body as a whole, and not any particular set of shareholding constituents. If a corporation becomes insolvent, directors continue to owe their fiduciary duties to the corporation, not directly to creditors; however, creditors will have standing to assert derivative claims. See North American Catholic Educational Programming Foundation Inc v Gheewalla (Del 2007).

Enforcement action against directors

Can an enforcement action against directors be brought by, or on behalf of, those to whom duties are owed?

Shareholders can bring suit against the directors on their own behalf or on behalf of the corporation (a derivative suit), depending on the nature of the allegation. To institute a derivative suit, a shareholder must first make a demand to the board of directors that the corporation initiate the proposed legal action on the corporation’s own behalf. However, if the shareholder can show that bringing such a demand would be futile, it is not required.

Directors will not be held liable for their decisions, even if such decisions harm the corporation or its shareholders, if the decisions fall within the judicially created safe harbour known as the ‘business judgement rule’. The rule states a judicial presumption that disinterested and independent directors make business decisions on an informed basis and with the good faith belief that the decisions will serve the best interests of the corporation. If a board’s decision is challenged in a lawsuit, the court will examine whether the plaintiff has presented evidence to overcome this presumption. If the presumption is not overcome, the court will not investigate the merits of the underlying business decision.

This helps courts avoid second-guessing board decisions, and protects directors from liability when they act on an informed and diligent basis and are not otherwise tainted by a personal interest in the outcome. This is true even if the decision turns out badly from the standpoint of the corporation and its shareholders.

Care and prudence

Do the board’s duties include a care or prudence element?

Directors owe duties encompassing both a duty of care and a duty of loyalty to the corporation and to the corporation’s shareholders.

Although grounded in common law, the duty of care has been codified in more than 40 states. Most state statutes require that directors discharge their responsibilities in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director reasonably believes to be in the corporation’s best interests. Conduct that violates the duty of care may also – in certain circumstances – violate the good faith obligation that is a component of the duty of loyalty. For example, a failure to ensure that reliable information and reporting systems are in place to detect misconduct could give rise to a claim for breach of the duty of care and the obligation of good faith. See In Re Caremark International Inc Derivative Litigation (Del Ch 1996) and Stone v Ritter (Del 2006).

The duty of loyalty prohibits self-dealing and misappropriation of assets or opportunities by board members. Directors are not allowed to use their position to make a personal profit or achieve personal gain or other advantage. The duty of loyalty includes a duty of candour that requires a director to disclose to the corporation any conflicts of interest. Transactions that violate the duty of loyalty can be set aside and directors can be found liable for breach. Thus, whenever a board is considering a transaction in which a director has a personal interest, the material facts about the director’s relationship or interest in the transaction should be disclosed to the board and a majority of the disinterested directors should authorise the transaction. Alternatively, the material facts should be disclosed to shareholders, for a vote to approve the transaction.

In 2003, the Delaware Court of Chancery rendered an important opinion concerning the ‘duty of good faith’ of corporate directors (In Re The Walt Disney Co (Del Ch 2003)). In this opinion, the court held that directors who take an ‘ostrich-like approach’ to corporate governance and ‘consciously and intentionally disregard their responsibilities’, adopting a ‘we don’t care about the risks’ attitude may be held liable for breaching their duty to act in good faith. The opinion was rendered on a motion to dismiss for failure to state a claim. The opinion is notable for its sharp focus on the importance of good faith, in addition to due care and loyalty, when considering director conduct. By characterising the alleged lack of attention by directors as a breach of the duty of good faith rather than a breach of the duty of care, the court effectively stripped the directors of the protection afforded by the Delaware Director Protection Statute (which is described in greater detail in question 32).

In 2005, the Delaware Court of Chancery rendered another opinion in connection with the same Disney litigation that further defines the contours of the duty of good faith (In Re The Walt Disney Co (Del Ch 2005)). In this opinion, the court focused on the element of intent in identifying whether a breach of the duty of good faith has occurred. Generally, the court determined, the duty of good faith is not satisfied where a director ‘intentionally acts with a purpose other than [. . .] the best interests of the corporation’; where a director ‘intend[s] to violate applicable [. . .] law’; or where a director ‘intentionally fails to act in the face of a known duty to act’. With respect to the specific case at hand, however, the court ruled that the Disney directors did not, in fact, breach their duty of good faith because they did make some business judgements and, therefore, their conduct did not meet the intent elements enumerated by the court as necessary to constitute a breach of the duty of good faith.

In 2006, the Delaware Supreme Court upheld the Delaware Court of Chancery’s ruling that the Disney directors were not liable.

The Supreme Court also provided guidance with respect to the contours of the duty of good faith, describing the following two categories of fiduciary behaviour as conduct in breach of the duty of good faith: conduct motivated by subjective bad faith (that is, actual intent to do harm); and conduct involving ‘intentional dereliction of duty, a conscious disregard for one’s responsibilities’. The Supreme Court further held that gross negligence on the part of directors ‘clearly’ does not constitute a breach of the duty of good faith.

In late 2006, the Delaware Supreme Court held in Stone v Ritter (Del 2006) that ‘good faith’ is not a separate fiduciary duty. The Supreme Court stated that ‘the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty’ and the fiduciary duty of loyalty ‘encompasses cases where the fiduciary fails to act in good faith’.

Board member duties

To what extent do the duties of individual members of the board differ?

Generally, all board members owe the same fiduciary duties regardless of their individual skills. However, case law suggests that when applying the standard of due care (namely, that a director acted with such care as an ordinarily prudent person in a like position would exercise under similar circumstances) subjective considerations, including a director’s background, skills and duties, may be taken into account. For example, ‘inside’ directors – usually officers or senior executives – are often held to a higher standard because they more actively participate in and have greater knowledge of the corporation’s activities.

Additionally, in 2004, the Delaware Court of Chancery rendered an important opinion concerning the fiduciary duties of directors with special expertise (Emerging Communications Shareholders’ Litigation (Del Ch 2004)). In Emerging Communications, the court held a director in breach of his duty of good faith for approving a transaction ‘even though he knew, or at the very least had strong reason to believe’ that the per share consideration was unfair. The court, in part, premised the culpability of the director (described in the opinion as a ‘principal and general partner of an investment advisory firm’) on his ‘specialised financial expertise, and [. . .] ability to understand [the company’s] intrinsic value, that was unique to [the company’s] board members’. As the court also found that the director in question was not ‘independent’ of management, the Emerging Communications decision should not necessarily be interpreted as a pronouncement holding directors with ‘specialised expertise’ to a higher standard of care in general.

Delegation of board responsibilities

To what extent can the board delegate responsibilities to management, a board committee or board members, or other persons?

State corporate law generally provides that the business and affairs of the corporation shall be managed by or under the direction of the board of directors. The board has wide-ranging authority to delegate day-to-day management and other aspects of its responsibilities both to non-board members and to board committees and even individual directors. Typically, the board delegates wide powers to the corporation’s senior managers. State laws generally make a distinction between those matters a board must address directly and those it may delegate to officers or other agents of the corporation, or to board committees. For example, under DGCL, section 141(c), the board of a company incorporated prior to 1 July 1996 cannot delegate the power to:

• adopt, amend or repeal any by-law of the corporation;
• amend the corporation’s certificate of incorporation (except that a board committee may make certain specified decisions relating to the rights, preferences or issuance of authorised stock, to the extent specifically delegated by the board);
• adopt an agreement of merger or consolidation;
• recommend to shareholders the sale, lease or exchange of all or substantially all of the corporation’s property and assets;
• recommend to shareholders a dissolution of the corporation or a revocation of a dissolution;
• approve, adopt or recommend to shareholders any action or matter that is required by the DGCL to be submitted to shareholders for approval;
• declare a dividend, unless that power is expressly provided for in the certificate of incorporation, resolution or by-laws; and
• authorise the issuance of stock or adopt a certificate of ownership and merger, unless that power is expressly provided for in the certificate of incorporation, resolution or by-laws.

The Sarbanes-Oxley Act and the NYSE and Nasdaq listing rules also require that each listed company has an audit committee comprising independent directors who have responsibility for certain audit and financial reporting matters. As required by the Dodd-Frank Act, NYSE and Nasdaq listing rules also require that each listed company has a compensation committee comprising independent directors who are responsible for certain matters relating to executive compensation. NYSE listing standards require that each listed company has a nominating or corporate governance committee comprising independent directors who are responsible for director nominations and corporate governance. Nasdaq listing rules require independent directors (or a committee of independent directors) to have responsibility for certain decisions relating to director nominations. (See questions 25 and 27.) These committees are permitted to delegate their responsibilities to subcommittees solely comprising one or more members of the relevant committee.

Directors may also reasonably rely on information, reports and recommendations provided by officers, other agents and committees on matters delegated to them (see DGCL, section 141(e)). Nevertheless, the board retains the obligation to provide oversight of its delegates, to act in good faith and to become reasonably familiar with their services or advice before relying on such advice.

Non-executive and independent directors

Is there a minimum number of ‘non-executive’ or ‘independent’ directors required by law, regulation or listing requirement? If so, what is the definition of ‘non-executive’ and ‘independent’ directors and how do their responsibilities differ from executive directors?

NYSE and Nasdaq listing rules require that independent directors comprise a majority of the board. Controlled companies (ie, companies in which more than 50 per cent of the voting power is held by an individual, group or another company) and foreign private issuers are exempt from this requirement.

Under the NYSE rules, for a director to be deemed ‘independent’, the board must affirmatively determine that he or she has no material relationship with the company. A material relationship can include commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships, among others. Under the NYSE rules, directors having any of the following relationships may not be considered independent:

• a person who is an employee of the listed company or is an immediate family member of an executive officer of the listed company;
• a person who receives, or is an immediate family member of a person who receives, compensation directly from the listed company, other than director compensation or pension or deferred compensation for prior service (provided such compensation is not contingent in any way on continued service), of more than US$120,000 per year;
• a person who is a partner of, or employed by, or is an immediate family member of a person who is a partner of, or employed (and works on the listed company’s audit) by a present or former internal or external auditor of the company;
• a person, or an immediate family member of a person, who has been part of an interlocking compensation committee arrangement; or
• a person who is an employee or is an immediate family member of a person who is an executive officer, of a company that makes payments to or receives payments from the listed company for property or services in an amount that in a single fiscal year exceeds the greater of 2 per cent of such other company’s consolidated gross revenues or US$1 million.

In applying the independence criteria, no individual who has had a relationship as described above within the past three years can be considered independent (except in relation to the test set forth in the final bullet point above, which is concerned with current employment relationships only). The Nasdaq listing rules take a different but similar approach to defining independence.

For NYSE and Nasdaq companies, only independent directors are allowed to serve on audit, compensation and nominating or governance committees. Note that the Sarbanes-Oxley Act, section 301, defines an independent director for audit committee purposes as one who has not accepted any compensation from the company other than directors’ fees and is not an ‘affiliated person’ of the company or any subsidiary. NYSE and Nasdaq listing standards require NYSE and Nasdaq companies to have an audit committee that satisfies the requirements of Rule 10A-3 under the Exchange Act. That rule, which embodies the independence requirements of the Sarbanes-Oxley Act, section 301, provides that an executive officer of an ‘affiliate’ would not be considered independent for audit committee purposes. As required by the Dodd-Frank Act, the NYSE and Nasdaq developed heightened independence standards for compensation committee members that became effective during 2014. Under these standards, in affirmatively determining the independence of a director for compensation committee purposes, the board of directors must ‘consider’ all factors specifically relevant to determining whether a director has a relationship to the listed company that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including the source of compensation received by the director and whether the director is affiliated with the company or any subsidiary.