Fiduciary Duties of Corporate Officers and Directors – Utmost Good Faith

If you are an officer or director of a corporation, you are a fiduciary. If you are an officer or director of a corporation, you have fiduciary duties to the corporation and to the shareholders (including to minority shareholders). In some cases, corporate officers and directors may even owe fiduciary duties to creditors of the corporation. By virtue of being an officer or director of a corporation, you have fiduciary duties irrespective of the fact that you may never have expressly agreed to assume the duties, responsibilities and potential liabilities of a fiduciary. Because officers and directors of corporations have such a strong influence over the conduct of the affairs of the corporation, the law has deemed it necessary and just to impose fiduciary duties upon them.

What Level of Duty Does a Fiduciary Have?

A phrase used by the courts very frequently to describe the fiduciary duty of a corporate officer or director is “utmost good faith.” Corporate officers and directors, as fiduciaries, have an obligation to refrain from acting in their own best interests, with respect to decisions made in their fiduciary capacity, where doing so would conflict with the interests of the corporation or its shareholders. The responsibilities of corporate officers and directors are unlike, for example, the responsibilities of mere parties to a contract, or parties doing business with one another, who can, and indeed, are expected to act in their own best interests (even if doing so directly conflicts with the other party’s interest).

I. When Corporate Officers and Directors Compete

Fairly frequently, corporate officers and directors part ways with a corporation and establish or become involved with another business which is in direct competition with their former corporation. Broadly speaking, officers and directors confront three potential pitfalls when they compete with their former corporation:

1. Potential liability resulting from a non-competition/non-disclosure agreement;
2. Potential liability resulting from the interference with the former corporation’s contracts or prospective business advantages;
3. Potential liability resulting from the breach of fiduciary duties owed to the former corporation

This article focuses on the third potential pitfall only. Under Tennessee law, whether a corporate officer or director has breached his or her fiduciary duty to a “former” corporation by engaging in competitive acts requires an analysis of the unique facts of each case. As with what seems to be just about every other area of the law, there are no distinguishing bright lines, but a multitude of grey areas which comprise the boundaries between permissible competition, on the one hand, and competition in violation of a fiduciary duty, on the other hand. That being said, here are some general rules as to what does and does not amount to a breach of a fiduciary duty:

Allowed

• Generally, a corporate officer or a director of a corporation can “prepare to compete” with that corporation, even before resignation or termination, by, for example, leasing office space; leasing and buying equipment; connecting utilities; or filing a corporate charter for his or her new corporation.
• Generally, a corporate officer or a director, pre-resignation or pre-termination, can notify customers of the simple fact that he or she will be leaving the current corporation and competing with it.
• Generally, even after the corporate officer’s or director’s relationship with the corporation is terminated, he or she can use, to the advantage of the new business, information which the officer or director remembers from his or her former position. For example, a former officer or director could use pricing information, and knowledge and insights resulting from relationships which the officer or director established with the former corporation’s customers or clients.

(The existence of a non-competition or non-disclosure agreement may prevent some or all of the above).

Not Allowed

• Generally, a corporate officer or a director cannot begin competing with the former corporation, before his or her relationship with the former corporation is terminated by actually beginning the operations of a competing business.
• Before his or her relationship with a corporation is terminated, the officer or director cannot “actively solicit” customers of the corporation by, for example, informing the customers that he or she will be leaving the corporation and assuring the customers that he or she can supply the same services or goods at the same prices as those offered by the corporation.
• Generally, before a corporate officer’s or director’s relationship with the corporation is terminated, he or she cannot solicit other valued or key employees of the corporation for employment positions with the new corporation.

II. The Fiduciary Duties of Corporate Officers and Directors to Creditors of the Corporation

As a general rule, corporate officers and directors do not owe fiduciary duties to creditors of the corporation. Creditors are expected to protect themselves from the influences and decisions of corporate officers and directors by relying on contract law, bankruptcy law, fraudulent conveyance law, and other common law and statutory legal grounds other than the laws governing fiduciaries. When, however, the corporate “ship is sinking,” so to speak, corporate officers and directors may be deemed to have fiduciary duties to creditors. In Tennessee, a creditor to an insolvent corporation, or to a corporation on the brink of insolvency, may assert an action for breach of fiduciary duty against officers or directors of the corporation who have given themselves preference in the payment of debt or who have engaged in “self-dealing” conduct.

III. Joint and Several Liability of Corporate Officers and Directors

Where corporate officers or directors breach a collective fiduciary duty by, for example, approving a transaction, those officers and directors may well be held jointly and severally liable. Where a court applies the principle of joint and several liability, which can only happen in a case where there are multiple defendants, each defendant is held liable for all of the damages awarded by the court. Joint and several liability does not allow a plaintiff to “double-dip” and to recover more than the damages which the plaintiff sustained, but it does allow the plaintiff to collect those damages from any of the defendants who are jointly and severally liable.

IV. Statute of Limitation for Actions Against Corporate Officers and Directors for Breach of Fiduciary Duty

A cause of action for breach of fiduciary duty against a corporate officer or director must be commenced within one (1) year from the date of the breach of the fiduciary duty or it will be barred by the statute of limitation applicable to those types of actions. If the breach of fiduciary duty is not discovered and reasonably could not have been discovered within one (1) year of such breach, a party has one (1) year from the date of the discovery of the breach to file a legal action. In no event, however, can a claim for breach of fiduciary duty be brought later than three (3) years from the breach unless the defendant fraudulently concealed the breach. T.C.A. §48-16-101.