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Corporations • Directors and Officers
CORP#030
Legal Definition
The duty of loyalty is a director's obligation not to place their own interest ahead of the corporation and its shareholders, and to avoid: (1) engaging in self-dealing, (2) usurping corporate opportunities, and (3) insider trading, unless there has been material disclosure and independent ratification.
Plain English Explanation
Directors are like captains of a ship, and they have an obligation to steer the ship. More importantly, they are obligated to steer the ship towards a path that benefits the ship and not only themselves. There are three ways a director can breach their duty of loyalty to their company:
(1) The first one is pretty obvious: no self-dealing, which occurs when director of a company uses their position and authority to engage in some sort of transaction that either benefits them directly (like if a Director sells themselves a $1,000 company asset for $1), or indirectly (like if a Director allows their family member to purchase a $1,000 company asset for $1). Such actions would be disloyal to the company and put the Director's interests and benefits above those of the company.
(2) The second one has to do with usurping corporate opportunities, which means intercepting an opportunity that should belong to the company, but taking it for yourself.
(3) The third way is insider trading. You'll learn more about that in other cards, but in general it means when people who have an unfair amount of access to valuable, non-public information use that information to buy or sell shares of a company.
(1) The first one is pretty obvious: no self-dealing, which occurs when director of a company uses their position and authority to engage in some sort of transaction that either benefits them directly (like if a Director sells themselves a $1,000 company asset for $1), or indirectly (like if a Director allows their family member to purchase a $1,000 company asset for $1). Such actions would be disloyal to the company and put the Director's interests and benefits above those of the company.
(2) The second one has to do with usurping corporate opportunities, which means intercepting an opportunity that should belong to the company, but taking it for yourself.
(3) The third way is insider trading. You'll learn more about that in other cards, but in general it means when people who have an unfair amount of access to valuable, non-public information use that information to buy or sell shares of a company.
Hypothetical
Hypo 1: HypoCorp specializes in importing fabrics from India and reselling them in America. Bob is a Director of HypoCorp and has been for more than 10 years. He knows the business like the back of his hand. One day, while at a company mixer, he meets Sam, a fashion designer in New York. Sam is in need of a substantial amount of fabric and has a budget of $300,000. Bob decides to give Sam his personal cell phone number and personally contracts with Sam to get him the fabric he needs without going through HypoCorp. Result: Bob has breached his duty of loyalty by usurping a corporate opportunity. Here, Bob was at a company mixer and used his knowledge and connections within the fabric industry as a result of his HypoCorp position to, instead, intercept a deal that should have been handed over to HypoCorp.
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 care?
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?
