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The Directors of a corporation serve a vital role with the Corporation. They run the company and are responsible for the company's overall management. The Directors are responsible for major business actions in the company, such as election of officers, the issuance of stock, the establishment of corporate policies' and the setting of their own and key officers' salaries and compensation packages.
Directors have certain fiduciary responsibilities to the company. They must be loyal to the company; they must make informed, independent decisions as Board members; they must not act in bad faith, such as self-dealing or fraudulent dealings; and they must act in the best interests of the company and its shareholders.
Subject to certain requirements, discussed below, a director of a Delaware corporation is “fully protected” from liability for a breach of his or her duty of care, provided he or she acts (or chooses not to act) in good faith in relying on the information presented to him or her by corporate officers, employees, and third-party experts in making decisions or voting on issues before the board.
While the board is responsible for the overall management of the corporation, a director cannot be an expert in every area relevant to a corporation. The company’s officers, employees, as well as other experts in various fields, are more engaged with the day-to-day operation of the corporation, making their input and guidance important in informing the Directors before taking actions.
Directors often rely on experts in making decisions, to comply with their fiduciary duty of care in becoming adequately informed. This article discusses when a director may successfully claim reliance on experts in avoiding liability for a breach of his or her fiduciary duty of care.
Under Section 141(e) of the Delaware General Corporation Law, a director may rely on an expert so long as:
The protection given to directors reflects their practical need to rely on experts’ knowledge and experience in making complex business decisions.
A director must actually rely on an expert’s recommendations in order to claim the protection of such reliance under Section 141(e). While not acting in accordance with an expert’s advice does not necessarily mean that the director breached their duty, it prevents the director from claiming reliance on the expert’s conclusions later on.
A director must rely on expert advice in “good faith,” which often becomes a test of belief in the quality of the advice of the provider. A director with “knowledge that makes reliance on an expert unwarranted” for instance, cannot avoid liability based on Section 141(e).
Although a director is not required to conduct an independent inquiry into materials, calculations, financial statements and other material presented to the board before relying on them, but, as the court stated in the seminal Delaware Supreme Court case Smith v. Van Gorkom, directors are “entitled to good faith reliance, not blind reliance.”
In relying on the advice of an expert, a director must believe the advice was within the area of the expert’s field. For example, it would be difficult for a director to rely solely on a tax account for purposes of determining a value for the company, such as in the case of a merger, perhaps. Instead, the board would want to consult the accountant for tax questions, but would need to hire a firm to properly ensure that they are speaking to an expert with enough experience and knowledge in the valuing of a company to provide information for the directors to make an informed decision.
The basis of the test for reliance is self-explanatory. Where there are significant red flags in a service provider’s record, a board of directors may not be able to rely on the expertise of a service provider. Failing to conduct even a quick background examination of a provider’s credentials, claims, and history could be looked at as searching without diligence.
Finding a director liable for relying in good faith on the information of a carefully selected expert would undermine a board’s ability to prepare and consider all options.
Even where a decision proves to be a bad one, Delaware courts look to the intent of the process of considering an issue, rather than the result. Therefore, even if relying on an expert led a director to a bad decision, the expert is a vital part of looking into a matter. By encouraging directors to access the information and insight of experts in boards’ decisions, the Section 141(e) furthers the importance on the quality of the decision-making process, with less worry for the correct or incorrect decision.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such sourceâ€™s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.