The ‘North Star’ for Directors in Executing Good Governance

Amid the revival of stakeholder capitalism and the continuing rise of the environmental, social and governance (ESG) movement, directors’ fiduciary duties are even more pivotal in protecting not only the company and its investors but also its employees, suppliers, and customers. Three critical laws guide the conduct of directors, setting the ‘North Star’ for good corporate governance, according to John Zecca, Chief Legal and Regulatory Officer at Nasdaq, and Joan Conley, Senior Advisor on Corporate Governance and ESG Programs at Nasdaq. The business judgment rule helps to ensure that directors act in the best interest of the company and its stakeholders, while duty of care and duty of loyalty establish essential obligations for directors when making business decisions.

“The question that I think is first and foremost with the directors should be, what is their duty to the company and ultimately the shareholders,” said Zecca and Conley. “It sets the North Star for a director’s thinking when they go through their own obligation to stay informed and their obligation to shareholders to act in the best interests of the company, their stockholders, stakeholders and employees, and make decisions that are unbiased to avoid conflicts.”

Under the General Corporation Law in Delaware, where many public companies are incorporated, duty of care requires directors to make informed business decisions based on all available material information. Duty of loyalty, on the other hand, requires directors to act in good faith to advance the best interests of the corporation and to refrain from conduct, such as self-dealing, that harms the corporation. Meanwhile, at the center of Delaware General Corporation Law is the business judgment rule, which affords directors making business decisions a set of presumptions that, so long as a majority of the directors have no conflicting interest in the decision, their decision will not later be second-guessed by a court if it is undertaken with due care and in good faith.

“It's an attempt by the law to create a structure that encourages what we all know are just good principles for life—things you would expect if you were doing it yourself,” they said. “If you are loyal, if you have care, then you will exercise care. You are more likely to contribute to overseeing a well-run organization.”

To ensure that directors comply with these laws, it is critical that there is adequate director training on their duties. Conley and Zecca noted that Nasdaq provides its directors with training on the duty of loyalty and duty of care, as well as the business judgment rule, on an annual basis.

“Understanding the obligations under Delaware law, receiving updates on Delaware Chancery Court decisions and reviewing these concepts in light of the board’s strategy and plans is critically important for every director,” said the duo, emphasizing that “directors need to think about and understand these concepts prior to facing them in the boardroom.”

Some of the essential elements for directors to learn about the duty of loyalty are identifying perceived conflicts and having a process in place at the board level to communicate those conflicts with the corporate secretary and the general counsel, receiving guidance and potentially recusing oneself if necessary.

“For example, you may have a general discussion of strategy or M&A, and you may sit on boards, but you may not know the full import of their businesses. Discussing it with the general counsel of the company where you sit on the board can help you understand whether there's a real conflict and where management intends to go in the discussion, and whether you're getting information that may be hard for you to compartmentalize your business models,” Zecca and Conley said.

Under the duty of care, a director must be able to commit to their role fully and become engaged with the company. A director has to devote the time and the care to ask questions and feel empowered to weigh in on business decisions.

“That's about corporate culture,” said Conley and Zecca. “It is about the board collectively, the chair and the directors coming together and establishing what they feel their culture is—and it should be inclusive. It should welcome diverse opinions. It should welcome some level of ability to disagree. The resolution process to get to an outcome is, at the end of the day, the company requires a decision.”

Part of the board culture includes continuing training, taking the time and effort to stay current on the information needed to make strategic business decisions that benefit all stakeholders. That education could mean taking classes to become more proficient in finance, reading material information or engaging external experts regarding an acquisition. That, in turn, plays a key role in the business judgment rule.

“As long as you’ve met those standards [of duty of care and duty of loyalty], the courts will not second-guess your decisions as long as you have a reasonable basis for your decision,” they said. “Because they know that there’s a range of outcomes based on the input, and reasonable minds can differ.”

Should a director either neglect or violate the standards of those duties, they can be individually liable in situations.

“These duties are there because society has determined that those are important values for a company. But I don't think that is what creates a sufficient ecosystem for good governance to occur. It could set the minimum expectations, but it's only about how you employ them and how the individual directors and then the board comes together to implement them,” concluded Zecca and Conley.

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Corporate Governance Culture Leadership Public Companies

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