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An Introduction to the Law of Corporations: Cases and Materials

Duty of Loyalty

The business judgment presumption presumes, among other things, that directors act “in the best interests of the corporation.” When a plaintiff can plead facts to suggest that director does not act in the best interests of the corporation, then the defendant director will lose the deferential business judgment presumption and will be required to prove at trial that notwithstanding the facts pleaded by the plaintiff that the challenged decision was nevertheless entirely fair to the corporation (the entire fairness standard).

Factual situations that commonly call into question whether a director acted in the best interests of the corporation include some of the following factual scenarios:

  1. A director engages in a commercial transaction with the corporation (a director is “on both sides” of a transaction with the corporation).
  2. A director uses his or her position to obtain a benefit for the director rather that the corporation.
  3. A director acts secretly acts as an adverse party or in competition with the corporation.
  4. A director gets a material personal benefit from a third party in connection with a transaction between the corporation and third party.

In each of these factual situations, a plaintiff can reasonably plead that a director's decision was not in the best interests of the corporation and the director can lose the presumption of business judgment.

Unlike violations of the duty of care, violations of the duty of loyalty are not exculpable. That is to say, if a director violates her duty of loyalty to the corporation, the director may be personally liable to the corporation and its stockholders for damages. Violations of the duty of care, as you will remember, are exculpable. The availability of a monetary remedy consequently draws the attention of plaintiffs' counsel who can be expected to engage in a high degree of scrutiny of interested director transactions.