August 2019

By Kelly Knotts and Ladd Hirsch

Fiduciary. The term applies broadly to cover all types of companies, as well as spouses in marriage, and is defined as “of, relating to, or involving a confidence or trust.” In the private business context, the company’s shareholders or members trust that their directors, managers and officers will make good faith decisions and act with loyalty to the business. When company leaders breach this trust and violate their fiduciary duties, however, they may become personally liable for any damages resulting from their improper conduct. This post focuses on the fiduciary duties that apply to private company leaders and reviews the legal guideposts that will help these company leaders, as well as the company’s shareholders and members better understand what constitutes compliance with these fiduciary obligations.

The Core Fiduciary Duties

Regardless of the entity structure, Texas law imposes fiduciary duties on company directors, managers and officers, which they owe to their company. Apart from Texas law, the fiduciary duties owed by company leaders are also typically addressed in the company’s bylaws, agreements, or regulations. What precisely are the fiduciary duties that Texas law imposes on business leaders, and do they vary based on the role as director, officer, or manager? The remainder of this post takes a closer look at these fiduciary duties.

  1. The Duty of Care

When making decisions for the company, the directors, managers, and officers are expected to exercise and adhere to the standard for the “duty of care.” Under Texas law, this duty is generally described as the obligation to use the amount of care an ordinarily careful and prudent person would use in similar circumstances. Gearhart Indus., Inc. v. Smith Intern., Inc., 741 F.2d 707, 720 (5th Cir. 1984). The decisions that company directors, manager, and/or officers make on behalf of the company involve a certain amount of risk as they seek to act for the benefit of the company. Recognizing that directors, managers and officers must make decisions for the company that cannot be fairly judged with the benefit of hindsight, Texas law applies the “Business Judgment Rule” to protect company leaders in their decision-making process. The Business Judgment Rule specifically precludes directors, managers, and officers from being held liable for business decisions that turn out poorly provided that they acted in an informed manner an on a good faith basis. To overcome the Business Judgment Rule as a defense, a shareholder or member who desires to assert a claim against a governing person at the company is typically required to show that this company leader engaged in self-dealing or other bad faith conduct. “. . . the Texas business judgment rule precludes judicial interference with the business judgment of directors absent a showing of fraud or an ultra vires act. If such a showing is not made, then the good or bad faith of the directors is irrelevant.” Gearhart Indus., Inc. v. Smith Int’l, Inc., 741 F.2d 707 (5th Cir. 1984);

The Texas Business Organizations Code does permit a company to limit or even eliminate a director’s personal liability for money damages to the company or its shareholders or members for breaches of their duty of care. Tex. Bus. Orgs. Code § 7.001. These so called “exculpation clauses” do not eliminate the fiduciary duty of care, but by limiting or eliminating the remedy of a cash payment for the breach of this duty, the practical effect is the same (a breach of the duty of care could give rise to non-monetary damages even when the company’s governing documents include an exculpation provision).
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By Zack Callarman and Mark Johnson

Our previous posts have stressed the critical importance of buy-sell agreements for both majority owners and minority investors in private companies (Read here). For majority owners, securing a buy-sell agreement avoids the potential of becoming “stuck” in business with a difficult co-owner without the ability to force