Striking a Balance on Due Care Liability of Corporate Directors in Delaware

Abstract

Under the corporate statutes, a board of directors is vested with the power to manage the business and affairs of a corporation. The directors' statutory authority is tempered with fiduciary duties of loyalty and care rooted in the common law. Courts impose the duties of loyalty and care to protect the interests of a corporation and its shareholders from unfaithful and irresponsible directors. The duty of care is in place to assure that directors diligently attend their responsibilities. Directors are personally liable for the entire amount of damages suffered by a corporation as a result of a breach of the duty of care. Directors often make large-scale business decisions, and they may face draconian monetary liability for a breach of the duty of care. This may deter competent people from serving on corporate boards and may undermine responsible corporate risk-taking. Section 102(b)(7) of the Delaware General Corporation Law permits a certificate of incorporation to include a provision eliminating personal monetary liability of directors for a duty of care violation. After the enactment of section 102(b)(7), the duty of care virtually exists as an unenforceable legal standard. Section 102(b)(7) eliminates any meaningful threat of personal liability for "mere" inattentive director conduct. This may cause suboptimal director behavior in corporate decision-making or oversight. Behavioral psychology research indicates that the threat of punishment or even just the awareness of having one's behavior monitored is an important motivator of actor behavior. Accordingly, there should be an efficient enforcement mechanism for the duty of care. Directors should not be afforded a free-pass to ignore their due care responsibilities. Section 102(b)(7) pushes the fulcrum point between authority and accountability too far in favor of director authority. This runs counter to the traditional wisdom that authority should be accompanied by accountability. Therefore, there is a need for a balanced approach to revive an enforceable the duty of care while protecting directors from draconian monetary liability. Directors should not be afforded ex ante protection from personal liability for a duty of care violation. Where directors fail to act with due care, they should justify the challenged conduct in a court room on the basis of good faith. If directors are able to justify their due care failure on the basis of good faith, they should not be held liable for money damages. Under this middle-ground approach, the viability of a duty of care action would be maintained, and directors would be protected from draconian monetary liability.