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A Breach of Fiduciary Duty

Wed, 01 Apr 2009 01:59:02 GMT

Boards of Directors have legal, and arguably moral, responsibilities to the shareholders who depend on them to run a business. Those duties are called fiduciary duties and include the duties of care and loyalty. When a Board member breaches those duties and shareholders are harmed as a result the shareholders have the right to recover damages.

When A Breach of Fiduciary Duty Occurs

Before a plaintiff can recover damages for an alleged breach of fiduciary duty, a plaintiff must prove the elements of a breach of fiduciary duty case. Specifically, the plaintiff must prove that a fiduciary relationship existed between the plaintiff and the defendant. If the plaintiff is a shareholder in a company where the defendant is on the Board of Directors then this element of the case has likely been met. Next, the plaintiff must prove that the defendant breached his or her fiduciary duty. If, for example, the defendant acted on his own behalf and not in the best interest of the company or if the defendant failed to give proper consideration to a business decision then the defendant may have breached his or her duty of loyalty or duty of care. If this element of the case has been satisfied then the plaintiff must show that the defendant’s breach of his or her duty caused the plaintiff damage and the plaintiff must specify the nature and extent of his or her damages. So, for example, if the plaintiff is a shareholder in the company and the plaintiff can prove that the defendant’s actions caused the stock price to plummet then the plaintiff may have proven his or her damages. This is often the hardest part of the case for the plaintiff to prove since many factors can be involved in a decrease in stock price.

It is important to note that plaintiffs in breach of fiduciary duty lawsuits need not be shareholders and that defendants are not always on the Board of Directors. For example, employees may have a successful breach of fiduciary duty claim against employers who fraudulently or negligently handled employee retirement accounts or 401(k) investments.

Possible Remedies for a Breach of Fiduciary Duty

The possible remedies for a breach of fiduciary duty lawsuit depend, in part, on state law. A plaintiff may recover for actual damages incurred and, in many states, the plaintiff can also recover for punitive damages, particularly if the plaintiff proves that the defendant’s breach was due to malice or fraud.

For many plaintiffs, and other people who are in a fiduciary relationship, one of the most important benefits of bringing a breach of fiduciary duty lawsuit is the deterrent effect it may have on Boards of Directors at other companies and on future Boards of Directors at the company involved in the lawsuit. With each lawsuit that is brought, other members of Boards of Directors may grow more aware of the possible damages that may be awarded against them and more careful in the exercise of their duties of loyalty and care.

The Board of Directors Duties of Care and Loyalty

Wed, 01 Apr 2009 01:59:57 GMT

The stock market gives many Americans a chance to have a small ownership share in publicly traded companies. Stock holders, as partial owners of the company, share in the company’s profit and loss. However, they often have little, if any, say in the business decisions of the company and they have no control over the everyday operations of the company. Instead, it is the company’s Board of Directors that is charged with the decision making responsibility and operational control.

Over the years, the courts have been in the often difficult position of having to decide if a company’s Board of Directors acted appropriately in certain situations. The courts have been reluctant to second guess the business decisions of Boards of Directors, even if those decisions are disastrous. However, the courts have recognized that Boards of Directors have certain duties or responsibilities to company shareholders. Those duties are called the Board’s fiduciary duties and include the duty of care and the duty of loyalty.

The Duty of Care

Each publicly traded company’s Board of Directors has a duty of care to its shareholders. That means that in making business decisions the Board must exercise reasonable care in the decisions that it makes for the company. Reasonable care has two elements. First, the Board must be acting in good faith for the benefit of the company. They must believe that the actions they are taking are in the company’s best interest. Second, they must believe that the actions are in the best interest of the company based on a reasonable investigation of the options available. In other words, they must carefully consider the available options within the time and financial constraints presented before they make a decision or take a particular action on behalf of the company.

The Duty of Loyalty

In addition to the duty of care, the Board of Directors owes a duty of loyalty to company shareholders. That means that the Board of Directors must be loyal to the company and its shareholders and act in their best interest. The Board and its individual members may not act in their own best interest or engage in self-dealing while making decisions or taking actions on behalf of the company. The duty of loyalty is sometimes known as the business judgment rule because the Board is required to make its judgments in the best interest of the business.

Shareholders must remember, however, that even if the Board of Directors strictly adheres to both of its fiduciary duties of care and loyalty, business decisions may still be made that hurt that company. That is because many business decisions are inherently risky. The courts recognize this risk and do not engage in the business of second guessing business decisions that were carefully made in what was honestly believed to be the company’s best interest. That said Boards of Directors are in unique positions of trust. They must, therefore, carefully exercise their duties of care and loyalty in their furtherance of their business goals. Then the shareholders, the Board members and the business will be protected.

Are There Any Limits on Executive Compensation?

Wed, 01 Apr 2009 02:04:48 GMT

Business executives are often among the most well paid individuals in our society. They have a lot of responsibility and they are experts in their field. However, business executives often do not have full ownership of their businesses. Instead, the businesses are owned by a variety of stockholders. Accordingly, the appropriate compensation for business executives is a topic that is often considered and hotly debated.

Generally, the law did not impose a limit on the compensation of business executives. Instead, executive compensation is a matter that is left to the private sector. Instead of legal and governmental involvement in determining the salaries, bonuses and stock options that were appropriate for individual executives, it was thought that individual companies should work out individual compensation agreements with executives. Companies could best determine the value of an executive’s skills and how much the company was willing to pay for that executive. As long as the executives acted in accordance with their fiduciary duties and in good faith then the agreements were generally outside of the court’s jurisdiction.

Regulation Without an Imposed Maximum Wage

While compensation is usually a matter that is left to the private sector, as described above, the government has attempted to put some regulation on executive compensation without setting a maximum wage limit. For example, public companies may be required to disclose the salaries, bonuses and other compensation received by their executives to their shareholders who may object to excessive compensation.

It is also possible to regulate maximum wages through taxes. The government could, for example, institute a tax plan that would create a high tax on incomes over a certain level. While this would not prevent an executive from receiving excessive compensation it might make excessive compensation less desirable and reduce compensation plans to levels that prevent the high tax rate. There are, of course, criticisms of such a tax plan in that it creates too much government interference with the free market and that it unfairly taxes the income of certain individuals.

The Bailout Exception

The general rule, that executive compensation is a matter for the private sector, is still applicable to the majority of business executives in the United States. However, in February 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 which introduced compensation limits on some of the high paid executives whose companies were receiving federal bailout money. Recipients of federal Troubled Assets Relief Program (TARP) money (also known as bailout money) must have appropriate standards for executive compensation. The U.S. Treasury Department will provide guidance on what will define appropriate standards. One standard, for example, may be to limit bonuses of the top executives in companies receiving TARP money to one third of their annual salary.

The Obama Administration is still debating whether additional regulations are needed on executive compensation in certain industries, such as the banking industry. It is, therefore, important to watch for any new laws or regulations regarding excessive compensation that may occur in the future.

The Sarbanes Oxley Act: Success or Failure?

Wed, 01 Apr 2009 02:05:51 GMT

After the Enron scandal shocked the world and created doubt about the accounting principles of public companies, the United States Congress passed the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act created new standards that had to be met by publicly traded companies and accounting companies. It was designed to protect shareholders from fraud that could ultimately destroy their investments and it was meant to provide certainty to financial markets that were left jittery from the series of scandals that annihilated corporate giants.

The Sarbanes – Oxley Act created certain financial reporting procedures for both public companies and their auditors. Senior executives and auditors were given specific responsibilities to ensure that the financial reporting from public companies would be truthful in the future. Financial reporting has to happen according to certain procedures and at certain time intervals. The penalties for not complying with the requirements of Sarbanes – Oxley include both civil and criminal charges that can result in significant fines and prison sentences.

Applicability to Private Firms

The Sarbanes – Oxley Act created the Public Company Accounting Oversight Board. The purpose of the Board is to oversee the auditors of public companies. Accounting firms that are not registered with the Board cannot audit public companies in the United States. However, for many years after the creation of the Sarbanes – Oxley Act the Securities and Exchange Commission (S.E.C) waived the requirement for privately held firms. This wavier allowed the accounting firm that was responsible for auditing Bernard L. Madoff Investment Securities to avoid registering with the Board and to avoid the type of governmental oversight that Sarbanes – Oxley was designed to create.

After news of Bernard Madoff’s Ponzi scheme broke and its devastating effects on individuals and financial markets become apparent in December 2008, the S.E.C. allowed the waiver to lapse and as of January 2009 it now requires auditors of privately held firms to register with the Board and to be held accountable for the ethical and professional standards set forth by the Board.

Has the Sarbanes – Oxley Act Been a Success?

The success of Sarbanes – Oxley is often debated. Those who criticize the Act claim that the Act is unnecessary and too expensive to implement. The most ardent criticizers of the bill claim that not only has Sarbanes – Oxley failed in its mission to ensure honest financial recordkeeping and disclosure but that it has also stifled new business development in the United States. Some criticizers point to the Madoff scandal as an example of the failure of the Sarbanes – Oxley Act.

Yet, not all analysts share in this type of criticism. Many analysts believe that more precise financial statements are now being prepared for public companies and that shareholders have greater confidence in their investments as a result of Sarbanes – Oxley. In order for these benefits to be realized, however, the S.E.C. must ensure that all of the requirements of the Act are carefully and universally followed and that exceptions, such as those for certain accounting firms, are not permitted.

Choosing your Business Entity Structure

Fri, 06 Jun 2008 00:09:36 GMT

Businesses can operate in a variety of structures, such as a sole proprietorship, partnership, limited partnership, corporation, or limited liability company. Each of these forms of incorporation provides certain benefits and also certain limitations. The legal structure of a business determines how it is managed, how it is taxed, and what regulations it must follow.

So how do you know what form of entity is the right one for your business? Things to take into consideration include:

Company Size– Do you plan on keeping your business small or do you plan on expanding by adding employees and locations? How many existing employees do you currently have and how many owners will there be, does every owner own an equal share? Some corporate structures require additional formalities. For instance the corporate form requires a board of directors, annual meetings, shareholder approval, etc. Smaller companies may consider more flexible forms of business, such as an LLC or even a sole proprietorship.

Business Purpose– Will your business make and sell a product or will you provide a service? Some states only allow personal services providers to register as LLCs or LLPs.

Liability –Some forms of doing business offer the protection of limited liability, which eans the owners are not personally responsible for the debts of the business. Business structures offering limited liability protection include corporations, limited liability companies (LLCs) and limited liability partnerships (LLPs). Sole proprietorships and partnerships do not have limited liability.

Taxes – Profits and losses for businesses are treated differently for each type of business entity. Profits from sole proprietorships and partnerships pass through to the owners and are treated as personal income. This means the profits are taxed one time. Profits from corporations and limited liability companies do not necessarily go directly to the owners, but are taxed when the company distributes dividends to the owners. There are some exceptions and alternatives depending on the entity structure.

The main types of business entities are:

1) A Sole Proprietorship is a business which is completely owned by one person and which the business does not have a separate legal identity. The owner personally owns all of the assets and profits and may not be required to register with the state.

2) A Partnership is a business that has two or more owners who agree to share the profits and has not formally registered as a corporation, LLC or other entity type. The general rule in a partnership is that each partner owns an equal share of the business unless there is a written partnership agreement giving one of the partners a majority interest. In most states formal steps may not be required to create a partnership, but complying with certain formalities is usually recommended.

3) A Limited Liability Partnership (LLP) is a business that is organized and run just like a partnership but limits the liability of each partner. Some states only allow licensed professionals to form an LLP, like architects, accountants or lawyers while other states allow anyone to form an LLP. Most states require LLPs to register and pay a registration fee, and include “limited liability partnership” or “LLP” in the business name.

4) A Corporation is a business that has a separate identity from its shareholders, and may be organized for any business purpose. The general requirements are that there must be at least one shareholder and the corporation must have a director(s), president, secretary and treasurer, though in some states the same person may hold all of those positions. Unlike a partnership or sole proprietorship, a corporation continues to exist even when its ownership changes hands.

5) A Limited Liability Company (LLC) is a hybrid of a corporation and a partnership. Unlike a corporation the owners of an LLC are called members, and LLCs. LLCs offer limited liability, while requiring fewer formalities than a corporation. Other features which may be provided for include continuity of life if a member dies or sells their interest, centralization of management, and free transferability of an owner’s shares.

To determine what the best structure for your business is you should consult a business law attorney today.