Introduction:
A common misconception is that a corporate officer is always a paid employee in a California corporation or that one must be a corporate officer to be the manager in charge of a company. Neither is the case though it is common to have the person in charge of day to day operations be the President or Chief Executive Officer of the company.
A corporation is akin to a small republic. Shareholders elect, usually annually, the board of directors who, in turn, usually annually, appoint the officers. Normally, each share has one vote for election to the board of directors and the directors vote by majority vote for appointment of officers. Shareholders can be but need not be directors or officers or both; directors can be but need not be officers. And employees, including key employees operating the company, need not be shareholders, directors or officers.
Duties of directors are discussed in detail in other articles on this site. This article shall concentrate on the role and duties of officers.
The Basic Role of Corporate Officers:
The board of directors appoints corporate officers. The corporate officers usually consist of a president, one or more vice presidents, the secretary, and a treasurer. In large companies the number of officers may be myriad, with tens or even hundreds of vice presidents, who are usually employees of the company as well. Most small companies have a president, secretary and treasurer. One person can occupy various positions and the role of “secretary-treasurer” is common in the smaller company.
Officers have a fiduciary duty to be responsible for the management and day-to-day operations of the company. This is true whether they are employees or not and whether they are compensated or not. This does not necessarily mean occupying an office every day of the week, but it normally does mean an ongoing awareness of operations and general supervision of the activities of the company. Failure to perform that duty can result in personal liability of the officer to the company.
The president (also called chief executive officer) reports to the board of directors and oversees day to day operations. He or she normally hires and fires employees, supervises same, and develops strategy for the company. The Treasurer is normally in charge of maintaining the financial records of the company, often working with accountants and bookkeepers. The secretary keeps the corporate minute book, issues shares, and often executes documents on behalf of the company. Vice Presidents are normally assigned specific duties, such as sales, human resources, or locales to supervise.
Fiduciary Duty of Officers:
Directors and officers of corporations owe fiduciary duties to corporate stockholders and to the corporate business entity itself. In the corporate setting, the fiduciary duty requires both directors and officers to apply their best business judgment, to act in good faith, and to promote the best interests of the corporation.
Note that officers usually hire and supervise other employees within a company, acting as senior management, but that such a role is not essential. The officers, themselves, may be the only employees in the company. The key is that the officers are responsible for making the various day to day business decisions of the company with each officer normally responsible for their particular area of expertise (e.g. the treasurer making financial and bookkeeping decisions) and the president in overall charge of day to day operations.
The Business Judgment Rule
Within the limits of their fiduciary duty, both directors and officers can take reasonable business risks, direct corporate business and affairs and make innocent mistakes without incurring the liability of claims of other owners as to their failures and the resultant judicial scrutiny. Most courts will not second guess such decisions. Most judges are aware that operating a business requires some risk taking and that neither directors nor officers guaranty a result from any particular business decision. As one judge wrote the writer, “Being able to make a mistake is one aspect of being in charge. Playing it safe all the time merely guaranties eventual failure.”
But making innocent mistakes is not the same as violating one’s duty by self-dealing, disloyalty or gross negligence. The "business judgment rule" is a rebuttable presumption that directors and officers:
- Made the various decisions on an informed basis and in good faith
- Honestly believed their actions to be in corporation's and shareholders' best interests
Only if the plaintiff is successful in rebutting the "business judgment rule" presumption will relief be granted against an officer or director. The presumption will protect directors and officers from personal liability to corporation and its shareholders absent such showing.
The business judgment rule presumption can be successfully rebutted by showing that at least one of fiduciary duties had been breached. So, what are these different fiduciary duties?
The Three Basic Types of Fiduciary Duties
Most states, including California, maintain three basic fiduciary duties.
1) Duty of Care – directors and officers must use care and be diligent when making decisions on behalf of the corporation and its shareholders (who are the true owners of the corporation). Directors and officers meet their duty of care if they act:
- In good faith
- With the care of a reasonable person in like position
- With reasonable belief their decisions are in best interest of the corporation
These standards may sound like the ones described under the business judgment rule. However, some states, such as Delaware case law, hold that even a careless, negligent director or officer may be protected by the Business Judgment Rule unless the officer or director was "grossly negligent," rather than simply negligent or careless.
2) Duty of Loyalty – directors and officers must have an undivided duty of loyalty to the corporation and shareholders. They must put the interests of shareholders and the corporation above their own interests. To understand the duty of loyalty, let us illustrate several ways it in which can be violated:
- Gaining secret profit belonging to corporation
- Competing with corporation
- Seizing corporate opportunity
- Self-dealing with corporation
- Improperly using corporate assets
- Transferring corporate assets or opportunities to a third party or a relative
- Failing to disclose information of value to the corporation
The reader should review our article on the Corporate Opportunity Doctrine to obtain a more detailed review of this particular law.
The key is full disclosure and informed approval from other disinterested (i.e., without personal stake in transaction) directors, officers or shareholders. Director or officers should disclose any possible conflict of interest or questionable transaction and ask others (i.e., shareholders and directors) for permission to engage in such a transaction and obtain that permission in written form that includes description of the disclosure that was made.
3) Duty of Good Faith – Some states, in addition to duty of loyalty, impose a duty of good faith which is at times defined as "conscious disregard" or "intentional dereliction of duty." California subsumes that duty into the above two duties.
Practical Applications:
When all is said and done, the courts in California essentially allow errors in judgment on the part of corporate officers, but not gross negligence, intentional wrongdoing or conflicts of interest.
If you are a corporate officer, whether salaried or not, you have a fiduciary duty to the entity and you must act with that in mind in all your actions, including business deals involving unrelated third parties. That does not mean you cannot make a mistake; but you cannot act unethically and favor yourself over the corporate interests. Or, as an elderly client who had run a dozen companies put it to the writer, “You have to take care of business and cannot make remarkably stupid mistakes…and keep your hands in your own pockets, not the pockets of the company. What’s so hard to understand about that?”