Fiduciary Duties of the Board of Directors in Texas

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Fiduciary Duties of the Board of Directors in Texas

A corporation operates through its board of directors. All corporate powers must be exercised by or under the direction of the board.[1] In Texas, the Texas Business Organizations Code (TBOC) provides certain provisions regarding the management of a corporation’s business and affairs.[2]

A board of directors may delegate the day-to-day business of the corporation to officers as long as the corporation’s business and affairs are managed under the ultimate direction of the board.[3] Directors of a Texas corporation should understand their fiduciary duties in the context of managing corporate affairs. Fiduciary duties are not codified in the TBOC; rather, they have developed through Texas case law and generally include the duties of loyalty, due care, and obedience (also known as the duty to follow the law).[4]Directors generally owe fiduciary duties to the corporation only and not to individual shareholders.[5]

Duty of Loyalty

Under the duty of loyalty, a director must act in good faith and not allow personal interests to prevail over corporate interests. This requires an extreme measure of honesty, selflessness, and good faith by the director.[6]

The duty of loyalty generally prevents the directors from usurping corporate opportunities, engaging in interested director transactions (also known as self-dealing transactions) to the detriment of the corporation, and otherwise taking unfair advantage of the corporation to benefit themselves, such as using confidential information for their own benefit.

Usurping Corporate Opportunities

As a fiduciary, a director may not usurp corporate opportunities for personal gain. Transactions in which a director personally profits are subject to the closest scrutiny. To show that a director has improperly taken a corporate opportunity, a corporation must prove that the director misappropriated a business opportunity that rightfully belonged to the corporation.[7]

Whether a particular venture is the corporation’s business opportunity can be difficult to establish because it involves questions of fact. Texas courts use a variety of tests, and ultimately the determination will depend on the specific facts of each case.

Interested Director Transactions

The BOC sets forth specific conditions under which interested director transactions are deemed to be valid and enforceable. An interested director transaction is defined as a contract or transaction between a corporation and: (1) one or more of the corporation’s directors; (2) one or more affiliates or associates of any of the corporation’s directors; or (3) an entity or other organization in which one or more of the corporation’s directors or any affiliate or associate of a director is a managerial official or has a financial interest.[8]

An interested director transaction is permitted if it is approved using one of the methods set forth in the TBOC. After disclosure, or with knowledge of the material facts of the contract or transaction and the director’s interest, the contract or transaction must be approved in good faith by either: (1) the board or a board committee by a majority of the disinterested directors[9] or committee members, even if the disinterested directors or committee members do not constitute a quorum; or (2) a vote of the corporation’s shareholders entitled to authorize the transaction. The BOC does not require a shareholder vote by disinterested shares, but the safest course is to obtain such a vote.[10]

Even if approval of an interested director transaction does not meet the statutory requirements (for example, if the shareholders or board voted without knowledge of the material facts), the transaction is not voidable if it was fair to the corporation when it was authorized, approved, or ratified.[11]

A board’s liability for breaches of the duty of loyalty cannot be limited or eliminated.[12] A corporation may, however, renounce its interest in specified business opportunities presented to the corporation or any of its directors, officers, or shareholders by either: (1) a statement in its certificate of formation; or (2) action of the board of directors.[13]

Duty of Care

Under the duty of care, a director must perform the director’s duties with the care that an ordinarily prudent person would use under similar circumstances.[14] A director’s conduct may be protected from claims of breach of the duty of care by: (1) the business judgment rule; or (2) a director’s right under the TBOC to rely on certain information prepared by officers, employees, or other professionals or experts.

The Business Judgment Rule

The business judgment rule may protect a director from liability arising from a claim of breach of the duty of care.[15] Courts generally do not intervene in management decisions made by the board of directors because courts are reluctant to substitute their business judgment for the directors’ judgment or question business decisions with the benefit of hindsight.

Although the business judgment rule is described as a defense to a breach of fiduciary duty claim, it is a substantive rule requiring the plaintiff to plead and prove that the director’s conduct is outside of the rule’s protection.[16]

Under the business judgment rule, a director acting in good faith is not liable for mistakes in business judgment that damage the corporation’s interests.[17] The rule protects directors from liability for actions within the honest exercise of a director’s business judgment and discretion, even if the actions are negligent, unwise, inexpedient, or imprudent.[18] In Sneed v. Webre, the Texas Supreme Court noted that the business judgment rule protects directors from liability for actions within the honest exercise of a director’s business judgment and discretion, even if the actions are negligent.[19]

Whether the business judgment rule applies is fact-dependent, but in general, the business judgment rule is not a defense for a director’s: (1) grossly negligent acts; (2) ultra vires acts; (3) fraudulent acts; (4) self-dealing; (5) failure to exercise any judgment at all; or (6) uninformed decisions made without reviewing reasonably available material information.[20]

Right to Rely on Certain Information

A director can, in good faith and with ordinary care, rely on information, opinions, reports, or statements, including financial statements and other financial data, prepared or presented by: (1) the corporation’s officers or employees; (2) legal counsel, certified public accountants, investment bankers, or other persons that the director reasonably believes to have professional expertise in the matter; or (3) a board committee on which the director does not serve.[21] A director may not rely in good faith on the information, opinions, reports, or statements if: (1) the director knows that the reliance is unwarranted; or (2) the conduct forming the basis of the breach of duty is illegal.[22]

Limitation of Liability for Breach of the Duty of Care

A Texas corporation’s certificate of formation can reduce or eliminate a board’s liability for monetary damages to the corporation or its shareholders for certain acts or omissions that are a breach of the duty of care, but cannot limit liability for: (1) an act or omission not in good faith that (a) is a breach of the director’s duty to the corporation, or (b) involves intentional misconduct or a knowing violation of law; (2) a transaction in which the director receives an improper benefit, regardless of whether the benefit results from an action taken within the scope of the director’s duties; or (3) an act or omission for which the liability is expressly imposed by statute.[23]

Duty to Follow the Law

The duty to follow the law, or duty of obedience, prohibits a director of a Texas corporation from acting beyond the scope of the corporation’s powers (also known as an ultra vires act) as defined by its certificate of formation. Under Texas law, a director will be personally liable for an ultra vires act that is either a statutory violation or against public policy.[24] A director will not be held personally liable for the illegal or ultra vires acts of an employee or other corporate agent unless the director either participated in the acts or had actual knowledge of the acts.[25]

A Texas corporation (acting directly or indirectly through a representative) may bring a proceeding against a current or former director to assert an ultra vires claim that the director exceeded his or her authority.[26]

Best Practices for Performing Fiduciary Duties

Although the specific acts required to fulfill a director’s duties may vary depending on the circumstances, examples of fiduciary duties include:

  • Attending and participating in board meetings.
  • Ensuring that the organization’s officers are qualified to perform required duties.
  • Supervising the organization’s officers.
  • Ensuring that the officers prepare adequate reports before board meetings.
  • Carefully reviewing all reports and following up with any relevant questions.
  • Staying up to date on the corporation’s business issues and policies.
  • Maintaining schedules to review and approve the strategic direction of the organization, executive compensation, legal compliance, and budget.
  • Ensuring that dissent or disagreement with any board action is documented.
  • Carefully reviewing potential mergers or takeovers by learning about all aspects of the transaction, studying experts’ reports and other documents, making additional inquiries about the transaction when necessary, and exploring and pursuing other viable alternatives as necessary for the corporation’s best interests.
  • Creating board minutes or other record of any merger, takeover, or other major transaction documenting that the directors’ personal interests did not motivate the transaction and that the directors diligently and sufficiently informed themselves about the transaction.
  • Avoiding participating in business transactions that may rightfully be the corporation’s business opportunity without first presenting the opportunity to the board for consideration.
  • Ensuring compliance with the BOC provisions for interested director contracts or transactions by presenting and explaining the material facts of the contract or transaction to the board, including the interested director’s role in the contract or transaction, and obtaining approval by the vote of a majority of the disinterested directors.

[1] Tex. Bus. Orgs. Code Ann. § 21.401(a).

[2] Id. §§ 1.001 et seq.

[3] Id. §§ 3.101 and 3.103(b).

[4] Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707, 719-23 (5th Cir. 1984) (addressing Texas law); see also Ritchie v. Rupe, 443 S.W.3d 856, 868 (Tex. 2014); Loy v. Harter, 128 S.W.3d 397, 407 (Tex. App.-Texarkana 2004, pet. denied).

[5] Somers ex rel. EGL, Inc. v. Crane, 295 S.W.3d 5, 11 (Tex. App-Houston [1st Dist.] 2009, pet. denied).

[6] Loy, 128 S.W.3d at 407; see also Int’l Bankers Life Ins. Co. v. Holloway, 368 S.W.2d 567, 577 (Tex. 1963), superseded by statute on other grounds, Tex. Civ. Prac. & Rem. Code Ann. § 16.004(a)(5).

[7] Loy, 128 S.W.3d at 408.

[8] Tex. Bus. Orgs. Code Ann. § 21.418(a).

[9] Id. § 1.003(a) (A director approving a contract or transaction is disinterested if the director: (1) is not a party to the contract or transaction; and (2) does not have a material financial interest in the outcome of the contract or transaction).

[10] Id. § 21.418(b)(1).

[11] Id. § 21.418(b)(2).

[12] Id. § 7.001(c)(1).

[13] Id. § 2.101(21).

[14] Gearhart, 741 F.2d at 720.

[15] See Sneed v. Webre, 465 S.W.3d 169, 179 (Tex. 2015).

[16] See Matter of Estate of Poe, 591 S.W.3d 607, 640-41 (Tex. App.-El Paso 2019, pet. filed).

[17] Gearhart, 741 F.2d at 721.

[18] Sneed, 465 S.W.3d at 178 (quoting Cates v. Sparkman, 11 S.W. 846, 849 (Tex. 1889)).

[19] Id.at 178.

[20] Harrington, 844 F. Supp. at 306; Gearhart, 741 F.2d at 721; Voskamp v. Arnoldy, 749 S.W.2d 113, 121 (Tex. App.-Houston [1st Dist.] 1987, writ denied); Lowry v. Tarbox, 537 S.W.3d 599, 616 (Tex. App.-San Antonio 2017, pet. denied; see Resolution Trust Corp. v. Norris, 830 F. Supp. 351 (S.D. Tex. 1993); Pace v. Jordan, 999 S.W.2d 615, 624 (Tex. App.-Houston [1st Dist.] 1999, pet. denied).

[21] Tex. Bus. Orgs. Code Ann. § 3.102(a).

[22] Id. § 3.102(b); see also Esse v. Empire Energy III, Ltd., 333 S.W.3d 166, 179 (Tex. App.-Houston [1st Dist.] 2010, pet. denied)(noting that Texas common law does not provide a defense to liability for a fraudulent transfer based on the debtor’s reliance on counsel’s advice).

[23] Tex. Bus. Orgs. Code Ann. § 7.001(b), (c)(2)-(4).

[24] Gearhart, 741 F.2d at 719.

[25] Norris, 830 F. Supp. at 357.

[26] Tex. Bus. Orgs. Code § 20.002(c)(2).