Fiduciary Duty

Fiduciary duty is the legal obligation that directors and officers owe to a corporation and its shareholders to act with care, loyalty, and good faith. The foundation of corporate governance, it is the basis on which directors and officers can be personally sued for breach of duty. Under Delaware corporate law, the two primary duties are the duty of care (informed decision-making) and the duty of loyalty (acting in the corporation's best interest, not personal interest). It is one of the most-important and least-understood concepts in startup governance, and the legal doctrine that determines how board members behave when shareholder and company interests conflict.

The two primary fiduciary duties under Delaware corporate law:

• Duty of Care: Directors must make informed decisions, exercising reasonable diligence (reviewing relevant materials, asking questions, seeking expert advice when needed, taking adequate time to deliberate). The standard is gross negligence, not ordinary negligence; minor procedural mistakes generally don't breach the duty. The famous case: Smith v. Van Gorkom (1985, Delaware), where directors of Trans Union were held liable for approving a merger after a two-hour board meeting without reviewing the agreement; the case became the touchstone for board-process discipline.
• Duty of Loyalty: Directors must act in the best interest of the corporation and its shareholders, not their own personal interest. The duty prohibits self-dealing transactions, usurpation of corporate opportunities, and conflicts of interest without proper disclosure and approval. Conflicted transactions require disclosure and approval by disinterested directors or shareholders, or must be entirely fair (fair price + fair process).

The business judgment rule is the legal shield that protects directors who fulfill their fiduciary duties: courts will not second-guess business decisions made by informed, disinterested directors acting in good faith, even if those decisions turn out poorly. This is why board minutes and corporate-formality documentation matter: they establish the procedural record that triggers business-judgment-rule protection. Famous cases reshaping fiduciary doctrine: Revlon, Inc. v. MacAndrews & Forbes Holdings (1986) established that when a sale is inevitable, directors must seek the highest price. eBay v. Newmark (2010, the Craigslist case) confirmed that directors can't pursue purely philosophical or non-pecuniary interests at the expense of shareholder value. The 2020s evolution: public benefit corporations explicitly modify fiduciary duty to allow directors to balance stakeholder interests with shareholder value, providing a legal shield not available to standard C-corp directors.

What founders get wrong: Failing to formally disclose conflicts of interest in board decisions. Self-dealing transactions need disclosure and disinterested-director or shareholder approval; otherwise they can be unwound years later. A founder negotiating a deal with their own related entity needs to recuse from the board vote and ensure disinterested directors evaluate the transaction; otherwise the duty-of-loyalty exposure is real.

Related: Board of Directors · Officers · Corporate Formalities · Bylaws

FAQ

What is fiduciary duty?
The legal obligation that directors and officers owe to a corporation and its shareholders to act with care, loyalty, and good faith. The foundation of corporate governance and the basis on which directors and officers can be personally sued for breach. Two primary duties under Delaware law: duty of care and duty of loyalty.

What is the business judgment rule?
A legal shield protecting directors who fulfill their fiduciary duties: courts will not second-guess business decisions made by informed, disinterested directors acting in good faith, even if those decisions turn out poorly. Why board minutes and corporate-formality documentation matter: they establish the procedural record that triggers protection.

What happens when fiduciary duty is breached?
Directors and officers can be personally sued by shareholders for breach. Damages can be substantial. Famous cases: Smith v. Van Gorkom (1985, duty-of-care breach in approving a merger after a 2-hour board meeting), Revlon (1986, duty to seek highest price in inevitable sales), eBay v. Newmark (2010, duty not to pursue purely non-pecuniary interests at shareholder expense).