Fiduciary Duties and Business Judgment in the Business Divorce

Robert Royal,  |  March 16, 2017

When business owners are in conflict, they must be aware of their fiduciary duty obligations to the company and the other owners.As conflict builds, an owner’s management is more critically reviewed, decisions questioned, and unpopular results criticized.Many business decisions are protected by the Business Judgment Rule.It is important for business owners to know and distinguish their fiduciary duties and understand the application of the Business Judgment Rule.

The fiduciary duty arises out of a confidential business relationship of trust.Owners who are employed and/or manage the business are put in a position of trust by all owners and the company.This trust duty encompasses acting in the best interest of the company and its owners, protecting the assets of the company, and making the most of those assets for the benefit of the owners. Because fiduciaries are in the position of control, they are charged with the highest duty recognized in law, the fiduciary duty.

The fiduciary duty requires the exercise of utmost good faith, fair dealing, disclosure and avoiding even the impropriety of self-interest or self-dealing.If you owe to another a fiduciary duty you must exercise honesty, fairness, and be reasonable, and recognize the reasonable expectations of those to whom you owe that fiduciary duty.

Generally speaking, the fiduciary duty is divided between the duty of loyalty, the duty of care and the duty of disclosure.This duty of care is well set forth in the Arizona Business Corporations Act which requires directors and officers to exercise their duties in good faith, in what they believe to be in the best interests of the company, and as a reasonable director or officer would act.Thus, a duty of care does encompass a “negligence” standard subject to the Business Judgment Rule discussed below.

The duty of loyalty requires that the fiduciary put the interests of those to whom the duty is owed ahead of their own interests.When a fiduciary is faced with a choice to benefit themselves or the company/owners, the fiduciary must choose the company/owners.Corporate opportunities must be preserved for the company.Conflicts of interest must be avoided where the fiduciary may have an interest in a company transaction.But if certain disclosures are made and approvals obtained, safe harbors exist for fiduciaries to participate in conflicting interest transactions.If the fiduciary faces accusations of self-interest or self-dealing, the Business Judgment Rule does not apply.

The duty of disclosure requires, with some limitations, the fiduciary to be open, forthright, and disclose to whom a fiduciary duty is owed all important and relevant information.This follows from the fact that a person who puts trust and confidence in their fiduciary should be advised on material matters so that fiduciary actions are well known and proper decision making is made. But disclosure could be avoided if the proprietary information passed on would be used for an improper purpose.

Courts will not interfere with the decision making of company management if the duty of due care is properly exercised by those making an informed, reasonable decision in the best interests of the company.If directors and officers in an Arizona corporation demonstrate that they met the standard of care in A.R.S. ยงยง 10-830 and 10-842 of good faith, acting in what they believe to be in the best interests of the corporation and as a reasonable director and officer would do, a decision will likely be protected by the Business Judgment Rule.In fact management has the right to rely on knowledgeable experts to assist them in making good business judgment decisions.An objecting party is required to demonstrate by clear and convincing evidence the director or officer failed to discharge their duties, rebutting the presumption such duties were properly discharged.

If the business decision is questioned as not being in the best interests of those to whom the fiduciary duty is owed, the business decision may not be protected by the Business Judgment Rule.If the decision is being attacked because the fiduciary has arguably made a decision in his or her best interest, ignoring others, protections of the Business Judgment Rule vanish.

The fiduciary duty and Business Judgment Rule are actively utilized in business divorce.Currently these legal principles are entrenched in corporate law where directors and officers owe fiduciary duties to the corporation and its shareholders.In the partnership context, a managing partner owes fiduciary duties to the partnership and the partners.It is generally accepted that fiduciary duties exist between shareholders in a corporation and partners in a partnership.In Arizona there is no statute nor published case establishing a fiduciary duty in an LLC. The fiduciary duty concept and Business Judgment Rule create leverage for negotiation, potential liability or liability avoidance.With leverage and potential liability, economic decisions causing alleged economic losses, perhaps protected by the Business Judgment Rule, assist the practitioner in arguing a settlement when owners conflict.These legal principles are essential in settling the business divorce.

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