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Corporations • Directors and Officers
CORP#028
Legal Definition
Directors must act (1) in good faith, (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances, and *(3)* in a manner the director reasonably believes is in the best interests of the corporation.
Plain English Explanation
You've probably run into a "prudent person" before while studying torts. The idea behind a prudent person is that it creates an achievable—though fictional—standard of care to allow us to compare whether or not someone else acted "good enough." In other words, the law doesn't expect people to act perfectly in every situation, but it does expect some people to genuinely try their best to not only make the right decisions, but be proactive in learning about the world around them to help make better decisions.
With that in mind, a director must act:
(1) in good faith, which means they are trying their best to do the right thing;
(2) with the same care as a prudent person would provide in a similar position, under similar circumstances. This is an important qualifier, because it allows for flexibility. For example, when there is plenty of time to make a decision, then a prudent person would likely take their time to consider a lot of factors. In contrast, if a decision must be quickly made, then a prudent person would do their best within those constraints. The key is always to look at what the director did, and then imagine someone like Mr. Rogers being put in the same position and deciding whether or not they acted similarly; and
(3) in a manner that the director reasonably believes will benefit the corporation in some way.
With that in mind, a director must act:
(1) in good faith, which means they are trying their best to do the right thing;
(2) with the same care as a prudent person would provide in a similar position, under similar circumstances. This is an important qualifier, because it allows for flexibility. For example, when there is plenty of time to make a decision, then a prudent person would likely take their time to consider a lot of factors. In contrast, if a decision must be quickly made, then a prudent person would do their best within those constraints. The key is always to look at what the director did, and then imagine someone like Mr. Rogers being put in the same position and deciding whether or not they acted similarly; and
(3) in a manner that the director reasonably believes will benefit the corporation in some way.
Hypothetical
Hypo 1: Sam is a director for HypoCorp. One day, 1 minute before Sam is about to leave the office and meet his wife for their anniversary dinner, Sam receives an email from Bob, the President of one of HypoCorp's largest customers. The subject line said, "URGENT: Need Help Immediately!" Sam looks at his watch and decides, "I don't have time to deal with this. I'll look at it tomorrow." The next day, when Sam comes to work, he finds out that Bob's company was experiencing an issue with HypoCorp's product and, when no one responded to his email, Bob cancelled their contract. Result: Sam breached his duty of care. Even though Sam had an important, personal meeting to tend to, a prudent director that received an urgent email from one of the company's most important customers would have at least told someone else about it to make sure it was handled. Here, Sam didn't even bother to open the e-mail, which would have enabled him to learn what was going on and either (a) call Bob while driving to meet his wife, or (b) instruct someone else to follow up.
Related Concepts
Can a corporation indemnify an officer or director who is held liable to their own corporation?
Can a corporation indemnify an officer or director who successfully defends themselves against a lawsuit from another party?
How can a director defend against a claim that they breached their duty of loyalty?
What are some common examples of permissive indemnification?
What are the statutory requirements of board of directors meetings?
What are the statutory requirements of directors?
What duties do directors have to the corporation and shareholders?
What duties do officers have to the corporation and shareholders?
What is the business judgment rule?
What is the duty of loyalty?
What is the duty to disclose?
What is the duty to manage?
When do officers and directors often seek indemnification?
Who decides whether a corporation will indemnify a director or officer?
