Magazine article Business Credit

Discriminating Directors' Domain Features Fiduciary Responsibilities

Magazine article Business Credit

Discriminating Directors' Domain Features Fiduciary Responsibilities

Article excerpt

A fundamental rule in the law of corporations is that ultimate authority for managing the affairs of the corporation is vested in the board of directors. Because the law grants directors such authority, it imposes on them the obligation to act in the best interests of the corporation, to manage its affairs with the same care, diligence, and prudence that they would to manage their own businesses.

This, in essence, is what is meant by the fiduciary obligations of members of boards of directors. With some adaptations, the rules are the same for non-profit and for-profit corporations.

Management Is Vested in Directors

Every state has a corporations' law and many states have separate statutory schemes for for-profit and not-for-profit corporations, although many provisions are similar or identical to each other. In every state, the corporations' statute will provide that "the management of the affairs of the corporation shall be vested in a board of directors."

A director must act in the best interests of the corporation, or at least in a manner not opposed to its best interests. A director owes a "duty of care" to the corporation he or she serves, which the law states as acting with that same prudence and diligence as a reasonable person would use in his or her own affairs.

Ultimate Authority Rests with Directors

Directors may delegate authority and rely on the advice of others, but the ultimate responsibility remains theirs. Although in most situations, directors will not be held personally liable if the corporation is found to be at fault, there are situations in which directors may be held personally liable for the actions of the board or of the corporation.

The power of the directors to delegate their legal obligation to manage the affairs of the corporation is not absolute. Every state statute will expressly say that some powers of the board cannot be delegated.

Directors may rely on the information and advice of others, such as executives and employees or its outside experts, such as attorneys, accountants, bankers, and pension plan administrators. Here, too, however, there are limits on the extent to which the directors can "pass off" responsibility to others.

A good illustration of this is in the selection of plan administrators who are covered by the Employee Retirement Income Security Act of 1974 (ERISA). Rulings have held that where the board of directors selected a plan administrator without sufficient investigation into the competency and expertise of the administrator, but on the basis of personal friendship or favor, the directors could be held liable for any harm suffered by the plan participants due to the mismanagement of the plan administrators. The basis of liability is not that the directors chose a friend, but that the firm chosen wasn't competent.

Another excellent example, because it seems to occur with some regularity, is the obligation to file tax returns. Under federal law, if an association has at least $25,000 in annual income, it must file tax returns. The directors must see to it that these returns are filed; they cannot simply rely on the representations of staff employees or tax accountants or preparers. Otherwise, the association can be subject to daily fines for failing to file, which can result in having to pay thousands of dollars to the IRS. The same applies to almost any other type of tax that must be paid, whether federal or state. This holds especially true for employment taxes and workers' compensation and unemployment compensation taxes.

Nor can directors remain willfully ignorant of the affairs of the association. A director chosen as treasurer, for example, with no knowledge of finance, could not simply rely on the representations and reports of the staff or the auditors that "all is well." The directors do not have to verify the work themselves but they cannot abdicate their responsibility to manage the association by totally delegating this task to others. …

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