Are Loyalty and Care Distinct Duties?
Codifying the scope of directors’ and officers’ fiduciary duties has long proven to be a difficult task for both professionals and the Courts alike. Justice Frankfurter immortalized this conundrum in his wartime ruling on Securities and Exchange Commission v. Chenery Corp.: “[T]o say that a man is a fiduciary only begins the analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obligations?”
While early American corporate law sought to liken the relationship of directors and officers to that of trustees and agents, it soon became apparent that the ultimate functions and obligations of corporate directors and officers diverged significantly from that of the agent or trustee. Nevertheless, the “fiduciary” title abides; as the fiduciary element is penultimate and remains constant for directors and officers via the obligations owed to a corporation’s ownership base.
The multi-dimensional duty of care is primarily process-oriented, and focuses on the channels by which directors and officers are to reach decisions and (more generally) fulfill their obligations as overseers. Challenges to the duty of care, therefore, tend to focus on the obligations of directors and officers to be attentive, make reasonable inquiry and have a rational basis for decision making. In its current state, however, the duty of care operates only as a mild substantive constraint on director conduct due to the statutorily reduced remedies available to shareholders claiming a breach of the duty of care.
After a group of high-profile directors were held personally liable to shareholders for a breach of the duty of care in Smith v. Van Gorkam, Delaware lawmakers quickly created a statutory cushion for corporate directors by allowing the charters of Delaware corporations to limit or eliminate director liability for monetary damages arising from fiduciary duty breaches. Of the four specified exceptions to this limitation on personal liability, none include the duty of care; thus allowing directors to be exculpated from monetarily liability for a breach of this “baseline duty”. Although judicial attacks on such statutory weaknesses have mounted since the most recent financial crisis, the duty of care still lies drained of any genuinely arduous demands. This erosion of the duty of care places greater emphasis on the importance of the duty of loyalty as a means of shareholder protection, and makes calls for the expansion of the duty of loyalty all the more necessary in light of the current economic climate. It is, ironically, the very thinness of the term “care” in modern corporate law that leaves the richer, more demanding dimensions of that core norm fully available for importing into corporate law via the doctrine of loyalty.
Unlike the duty of care, the duty of loyalty pertains neither to monitoring nor the decision making process at all. Conceptually, the duty of loyalty runs deeper than the duty of care by focusing on the director or officer’s motives, purposes and/or goals. It is for these reasons that the duty of loyalty can affect a legal stance beyond the mere corrective and extend into an affirmative duty not currently contemplated by the Courts.
In order to proceed, we must look closer at the definitional character within rulings that have thus far substantiated a breach of the duty of loyalty to interpret and, ultimately, analogize and apply it to our foregoing hypothetical. The conflict-of-interest transactions occupy the largest portion of our yield in this analysis – reinforcing the echoed sentiment of applying the duty of loyalty to strictly combat the director and officer self-dealing that has persisted through the past decade. Although breaches to the duty of loyalty have regularly been found in instances of usurping corporate opportunities, violating corporate confidentiality (insider trading) and inappropriate leaks of information to the press, the conflict-of-interest transactions dominate the landscape of judicial rulings on the duty of loyalty. As discussed later in this analysis, it is precisely because the majority of cases (and thereby, the majority of rulings) address only “minimal” issues of director loyalty (such as conflict-of-interest) that the common conception of the duty of loyalty has eroded from its original affirmative thrust.
In an effort to locate a new, affirmative vantage on fiduciary duties, one must first risk dirtied hands by sifting through the thick, Delaware judicial mud that has at once both blurred and demarcated the lines between the fiduciary duties of loyalty and care. Despite the Courts’ countless elucidatory attempts, the lack of clear judicial delineation between the duties of loyalty and care creates a haze that goes unaided by the Delaware decisions on these competing obligations.
Like many other similarly substantial concepts in our social milieu, the words “care” and “loyalty” may, at first, appear to have clear and distinct meanings. However, when pressed to etch a more gospelled definition of these terms, or determine whether in a particular instance one or the other was or was not present, the intangibility of these concepts becomes truly appreciable. As evidenced by the near schizophrenic definitional lineage in its case law, such is the paradox for the Delaware bench regarding the duty of loyalty in particular.
Notably, there are indeed many decisions that evidence a tight circumscription of the duty of loyalty and a clear demarcation from the duty of care. For example, “[a]n allegation that properly motivated directors, [acted] for no improper personal reason…does not state a claim for breach of the duty of loyalty.” “[T]he essence of a duty of loyalty claim is the assertion that a corporate officer or director has misused power over corporate property or processes in order to benefit himself rather than advance corporate purposes.” Without an “attempt to show that the directors received any personal benefit as a result of [their conduct]… the alleged disclosure violations simply cannot implicate the duty of loyalty.” Therefore, because care and loyalty are “distinct duties…without some factual basis to suspect [director] motivations, any subsequent finding of liability will, necessarily, depend on finding breaches of the duty of care, not loyalty or good faith.” Accordingly, these judicially clear definitional provinces have led commentators to draw analytically distinct boundaries between the coverage of these two duties: “When there is no adverse financial or personal interest, a question as to whether the directors have exercised good faith and requisite care implicates only the duty of care, not the duty of loyalty.”
Conversely, commentary and case law also supports Judge Easterbrook’s conclusion that “[u]ltimately…there is no sharp line between the duty of care and the duty of loyalty.” This is most evident in Delaware cases involving director oversight and disclosure. “The Delaware Supreme Court has characterized the conduct of disinterested directors who abandon their oversight responsibilities as a breach of the duties of care and loyalty.” These muddled and inconsistent assessments on what the duty of loyalty entails reveal a definitional difficulty that, perhaps, indicates there is more to the complex duty of loyalty than is currently held. Courts tend to focus on particular aspects of the duty of loyalty in the context of the individual case at bar, and the subsequent categorical rhetoric accurately reflects that myopic efficiency. This “practice of generalizing from the particular” tends to result in declamatory carelessness; thus leaving our judicial landscape on the subject both awkwardly incompatible and unclear. What appear to be discordant statements on the duty of loyalty are actually incomplete statements; resulting from many years of the analytical dilution that comes with addressing only the minimum aspects of the duty (such as preventing director self-interest transactions) and not the full scope of the duty (such as the maximum, affirmative obligations).
Accepting how this unfortunate byproduct of judicial logistics can erode important legal concepts over time is not difficult given the especially complex subject matter of corporate law, the particular sophistication of the Delaware bench and the amount of money at stake for the high-powered litigants involved. That is, because modern corporate law is at once, both hugely expansive and intricately complex, cases that survive a motion to dismiss must naturally have tightly circumscribed issues as they proceed to litigation. Accordingly, the overwhelming majority of cases that contemplate duty of loyalty breaches exclusively consider issues tightly circumscribed around the conflict-of-interest/director malfeasance aspect of the duty.
Next, because Delaware is unquestionably the most sophisticated jurisdiction for corporate legal disputes and, moreover, because litigants arguing cases in Delaware are keenly aware of this distinction, these already tightly circumscribed issues are presented to the Court with a myopic intensity that omits discussion of contextual or historical considerations for the benefit of the Court; certainly no corporate litigator wins favor by presuming the need to educate a Delaware judge on broader matters of corporate law not presently before the Court. Finally, because the individual value of these actions (for the corporate or class-action litigants at bar) and their resulting precedential value (for the multi-trillion dollar corporate industry as a whole) are extremely high, the high caliber of lawyering (in briefs and oral arguments) thus presents these already minutely-focused issues with surgical precision. As a result, the bulk of Delaware decisions on the duty of loyalty become veritable singularities in their intense weight and extreme focus on particular aspect(s) of the duty of loyalty that include neither discussion nor dicta on the affirmative aspects of this duty.