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A Board Member's Legal Duties

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The state laws in which the company is incorporated, and the company's charter documents (the Articles of Incorporation and Bylaws) establish the legal duties of a board member. Federal securities laws and the Securities and Exchange Commission (SEC) add bonus rules for public companies.

A fiduciary duty is an obligation to act in the best interest of another party and is the highest standard of care the law can impose on someone. A fiduciary is expected to be completely loyal to the person or entity they owe the duty, who is also called the “principal.” Specifically, the fiduciary mustn't put their interests before the interests of the principal and must not profit from their position as a fiduciary unless the principal consents. Every board member has a fiduciary duty to the shareholders unless the company is a Public Benefit Corporation (PBC), where, under Delaware law, the fiduciary duty is to the stakeholders as defined in the company's charter.

My attitude when I'm on a board is to be supportive of management teams, to be a sounding board, and to offer constructive criticism at times. The board shares the responsibility to the company and the shareholders and we're not just cheerleaders—there are legal and fiduciary responsibilities that are often cut-and-dried. For instance, our board was contacted by an employee who said, “I'm quitting, and I want you to know that some of the numbers that you're being shown at the board meetings aren't really accurate.” As a board we need to get to the truth of that; is it a parting shot from a disgruntled employee or do we have a management team that isn't representing things accurately? We hired an internal audit firm to look at the books and tried to understand how it added up to what we were being shown. It turned out that the numbers were accurate, but that situation was cut-and-dried: we were given information that we had to investigate.

Legal and fiduciary responsibilities to me are in some ways easy, but the more difficult decisions for a board are the ones that are not legal or fiduciary, but ethically important. For example, we had a member of a firm where we were investors post comments that were homophobic on Twitter. That's not a legal or fiduciary issue, but we asked if we could coach that person. Being on a board is more than legal and fiduciary responsibilities but also involves ethical responsibilities. You need to make sure that the right thing happens.

Rebecca Kaden, Union Square Ventures, Partner

The duty of care and the duty of loyalty primarily define board members' fiduciary duties.

 Duty of Care: A board member needs to be attentive and prudent in making board-level decisions, acting in good faith, and conducting enough business investigation and supervision to provide an informed basis for decisions. A board member breaches their duty of care when they act negligently or know that the consequences of an action could be harmful to the company.

 Duty of Loyalty: A board member should ensure that the company's interests are always on their mind. Loyalty to the company supersedes any other vested interests the board member might have. A board member breaches their duty of loyalty when they put their interests ahead of the company, conduct inappropriate transactions which benefit the board member (“self-dealing”), or benefit personally from confidential information shared in the boardroom.

VC board members, especially when they are major shareholders, are also focused on making a financial return for their fund, which can generate a conflict of interest in certain situations. Jon Callaghan (True Ventures, Managing Partner) says, “As long as you are a board member, you have to focus on what is best for all shareholders. This can be difficult for VCs. Afterward, you can go home and fret all you want about your fund not making a better return.” In actual conflict situations, a VC should explain the conflict and either recuse themselves or honor their fiduciary duty to the company in a board vote, while reserving the right to vote differently as a shareholder.

Additional legal obligations include the duty of confidentiality and the duty of disclosure. While linked to the duty of care and duty of loyalty, they're just as important.

 Duty of Confidentiality: A subset of the duty of loyalty, the duty of confidentiality requires a board member to maintain the confidentiality of nonpublic information about the company.

 Duty of Disclosure: A subset of both the duties of care and loyalty, the duty of disclosure requires a board member to take reasonable steps to ensure that a company provides its stockholders with all material information about a matter for which stockholder action is sought.

While these duties may sound conceptually straightforward, in practice, they're subject to judgment and interpretation based on the specific situation. In legal disputes over board action, courts apply a legal construct, called the business judgment rule, which gives deference to the decisions of boards where the directors acted in good faith and in an informed manner. Courts generally apply the business judgment rule and uphold the decisions of boards if:

1 The directors don't have any personal interest in the outcome.

2 The directors have reviewed all relevant information before deciding.

3 The directors believe that the decision is in the best interests of the company.

This rule helps protect a director from personal liability for bad business decisions by essentially shifting the burden of proof to a plaintiff to demonstrate that the director didn't satisfy this test. On the other hand, if directors have an interest in the decision or fail to adequately inform themselves about the decision to be made, courts may apply a more rigorous standard to the board's conduct.

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