Delaware is one of the most popular jurisdictions in the United States for opening a new company. Whether that is a limited liability company (LLC), corporation, limited partnership (LP), or other business entity, the state has a longstanding history of advantageous corporate laws, low taxes, privacy & asset protections, and a strong court system.

Opening a Delaware Corporation

An incorporator is the person responsible for creating a corporation. The incorporator files a Certificate of Incorporation with the Delaware Division of Corporations to open the corporation. After formation, the corporation appoints individuals to serve on the corporate board.

These individuals are referred to as directors or board members. Under Delaware law, a corporation can have one or more directors serve on the board.

The corporation’s shareholders elect corporate directors, which is generally done once per year at the annual shareholder’s meeting. When a corporation files its annual report with the state, it must disclose the names and addresses of each corporate director.  

Core Responsibilities of Board Members

At the heart of corporate governance is the board of directors, who are tasked with overseeing the company’s management and overall direction of the company. Under Delaware statutes and related case law, directors must uphold specific legal duties and responsibilities to properly govern the company.

Corporate directors in Delaware have broad responsibilities, and the courts hold them to a high standard of conduct. Their role can be summarized by several core duties, which include the duty of care, loyalty, good faith, and adherence to the business judgment rule.

What is the Duty of Care?

The duty of care requires each board member to make informed decisions and act with the diligence and prudence that a reasonably careful person would exercise in similar circumstances. Under Delaware law, the board of directors must be reasonably informed of the issues, facts, and other information related to the corporation, but they are not expected to be aware of every fact imaginable.

The Delaware courts have applied a gross negligence standard when they assess whether a board member has satisfied his duty of care. Gross negligence can mean different things depending upon the context. For example, in a personal injury context, gross negligence can mean a “lack of care that demonstrates reckless disregard for the safety or lives of others, which is so great it appears to be a conscious violation of other people’s rights to safety.”1 In the context of a corporate director’s duty of care, the Delaware courts have defined gross negligence as a “reckless indifference to or deliberate disregard of the whole body of stockholders or actions which are without the bounds of reason.”2

The courts look at various factors on a case-by-case basis to determine whether a director has breached their duty of care. Those elements may include, but are not limited to, the following:

  • Have the Necessary Qualifications & Expertise. The board members don’t necessarily need experience within the same sector as the corporation; however, they should have the relevant business experience and acumen to make informed decisions.
  • Receipt and Review of Materials Most corporations will have a board meeting four times each year, which occurs once every quarter. Before the board meeting, the company should prepare materials and provide them to the board members to review in advance of the meeting. Board members should be well prepared to discuss all of the relevant issues before attending the meeting.
  • Attending Meetings. The corporation and its shareholders expect every director to attend all board meetings. Ideally, each director should be physically present for the board meeting. Sometimes, it may be appropriate for a director to join the meeting virtually. Many corporations that are domiciled in tax-free jurisdictions require their board members to attend in person because remote attendance could create tax consequences in other jurisdictions.
  • Actively Participate in Discussions. Each director should be an active participant in the board discussions and making decisions. If a board member attends a meeting but sits quietly without engaging with the other participants, they fail to meet their responsibilities as a director.

Duty of Loyalty to the Corporation

The duty of loyalty mandates that directors act in the best interests of the corporation and its shareholders, placing these interests above their own personal or financial interests.

Conflicts of Interest. When a director accepts a board position, they are often still working for other companies or have other investments. Directors must avoid creating any conflicts of interest. If a director engages in a transaction where their interests conflict with the corporation’s, it may breach their duty of loyalty to the corporation.

For example, assume Jane Doe owns a marketing consulting business. Company ABC is a furniture manufacturer in Florida, and the company asks Jane Doe to serve on its board. Company ABC is looking to hire a marketing business to promote its products. Although Jane Doe owns a marketing agency that could take the project, the relationship would create a conflict of interest.

Under some circumstances, the corporation can waive the conflict of interest. If a director discovers a conflict of interest, he must fully disclose the circumstances to the board and the shareholders. The corporate board and its shareholders have the opportunity to waive the conflict; otherwise, the board member must take further action to remedy the conflict, which often requires the director to resign from the board or take the necessary steps to remove himself from the transaction.

Directors will spend significant time in board meetings, reviewing materials, and conducting research to stay up-to-date on company affairs and make the most informed decisions. Therefore, it is permissible for the corporation to compensate directors for their time and efforts. Directors are usually not treated as employees but instead treated as independent contractors.

For example, assume John Smith is one of 9 corporate board members. The members are required to attend meetings once per quarter. Each director is paid $15,000 per quarter for their services. The corporation reports the $60,000 paid to each director on Form 1099-NEC (Nonemployee Compensation).

Duty of Good Faith

Directors must act in good faith and with honesty to not deceive or defraud the corporation or its shareholders.  

This duty of good faith emphasizes the need for directors to:

  • Act with honesty and without any hidden motives or agenda that conflicts with the best interests of the corporation
  • Avoid conduct that is knowingly illegal, unethical, or nefarious
  • Ensure corporate decisions are made with the goal of benefiting the corporation and not the directors’ own personal interests

Delaware courts are particularly strict in enforcing the duty of loyalty, and directors who breach this duty are subject to more severe scrutiny. In a recent Delaware court case, the court determined that a director violates their duty of good faith when he “intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.”3

What is the Business Judgment Rule

The principal purpose of the business judgment rule is to protect the judgement and decision-making authority of directors. The rule shields directors from personal liability for decisions made in good faith as long as they act with due care and loyalty.

There is a lot of inherent uncertainty when making business decisions. It’s impossible for directors and company management to always have every fact and detail in front of them and to foresee every possible outcome and consequence. The business judgment rule presumes that a director’s decisions are informed, made in the best interest of the company, and based on a rational business purpose.

As long as these conditions are met, courts will respect the decision of the directors and not second guess their actions, even if it turns the board’s decision was a bad one.

Directors are only human. As long as directors comply with their duties of care, loyalty, and good faith, they are protected from personal liability for business risks that did not turn out as expected.

Final Take on Fiduciary Duties

Corporate directors under Delaware law are entrusted with the significant responsibility of overseeing the company’s affairs while acting in the best interest of the corporation. Directors must adhere to their duties of care, loyalty, and good faith, and their decisions are generally protected by the business judgment rule if made in good faith and with reasonable care.

  1. https://www.law.cornell.edu/wex/gross_negligence ↩︎
  2. Tomczak v. Morton Thiokol, Inc., No. 7861, 1990 WL 42607, at *12 (Del. Ch. Apr. 5, 1990) ↩︎
  3. In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 67 (Del. 2006) ↩︎