Corporate Directors’ Fiduciary Duty to Monitor – Failure to Comply Could Result in Personal Liability
THE DUTY TO MONITOR
Corporate directors should be aware of recent developments in Delaware corporations’ law. Directors of businesses that operate in California, but which are incorporated in Delaware, may have a fiduciary duty to monitor the corporation for any violations of law. Failure to do so could result in personal liability.
What are Fiduciary Duties?
Officers and directors of a corporation owe fiduciary duties to the corporation including a duty of care, and a duty of loyalty. The duty of care requires fiduciaries to act in an informed manner. It requires fiduciaries to review all relevant information reasonably available to them before making company decisions. The duty of loyalty requires fiduciaries to act in a disinterested manner, in good faith, and to avoid self-dealing or actions that would benefit themselves at the corporation’s expense.
The Duty to Monitor
Delaware Courts have recently recognized that as part of their fiduciary duties, directors owe their corporation a “duty to monitor.” The duty to monitor requires directors to monitor the corporation’s compliance with laws, standards and internal protocols. Directors can be held personally liable for breaching the duty to monitor if: (1) they knew or should have known that the corporation was violating the law, (2) they took no steps in good faith to prevent or remedy the situation, and (3) their failure to monitor caused harm to the plaintiff.
The Internal Affairs Doctrine
California has not imposed a duty to monitor on corporate directors. However, Delaware corporations that operate in California may be bound by Delaware law on the issue.
Under the “internal affairs doctrine,” the internal affairs of a corporation are governed by the laws of the state in which it was incorporated. (See Cal. Corp. Code § 2116). Some examples of conduct falling within the internal affairs doctrine includes:
- the election or appointment of directors and officers;
- the adoption of by-laws;
- the issuance of shares;
- methods of voting including any requirements for cumulative voting; and
- shareholders rights to examine corporate records.
The internal affairs doctrine is limited to matters that are peculiar to the relationships among or between the corporation and its officers, directors and shareholders. Other matters such as the making of contracts, the commission of torts, the transfer of property any other issues where California has a “more significant relationship” to the corporation will be governed by local California Law.
Corporate boards of directors should implement comprehensive compliance procedures to assist them in monitoring the corporation. When a potential violation is discovered, directors should take action quickly to bring the corporation in compliance with the law.
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