Individual or Collective Liability for Corporate Directors?

Associate Professor, University of Arizona James E. Rogers College of Law. I thank my colleagues at Arizona for their many helpful comments and Arizona law students Jennifer Roth, Susan Schwem, and Jesse Showalter for their excellent research assistance. Larry Ribstein, Usha Rodrigues, Bill Sjostrom, and Brad Wendel also provided valuable feedback, as did participants at the 2007 AALS Section on Business Associations, where this paper was presented. My special thanks go to Deborah DeMott, Hillary Sale, and Gordon Smith, who were instrumental in helping me think through these ideas. All errors, of course, are my own.

I. Introduction

Efforts to improve corporate governance routinely focus on the board of directors, which enjoys almost unfettered control over the corporation.1Given the board's broad authority,2 policymakers, courts, and legal scholars constantly look for ways to improve board functioning, especially in the wake of scandals at Enron, WorldCom, and other corporations.3 Making directors independent of management is a popular theme,4 as are calls for subjecting directors to more robust fiduciary duties. Fiduciary duties are meant to reduce agency costs between shareholders and directors. Currently, however, fiduciary duties are generally a weak impetus for motivating directors to act in the best interests of shareholders, at least to the extent that fiduciary law would seek to impose liability for director wrongdoing. This recognition has led some corporate law scholars to call for stricter fiduciary duties, which could take the form of an explicit duty to act in good faith5 or a revival of the duty of care, which is now on life support.6 Other corporate law scholars (and, judging by the recent Disney case,7 Delaware courts) take a more pessimistic view of fiduciary duty liability as a potential cure for what ails boards, preferring to leave corporate governance to other devices, including market sanctions.8

The fiduciary duty literature is rich and fruitful, and thus it is surprising that one important question within fiduciary law-a question that bears upon many of the others-has been virtually ignored. Directors, of course, do not operate in isolation; they are capable of acting only by majority vote.9In practice, they usually act unanimously.10 Yet each director is an individual, and each will either comply or not comply with the standards set by fiduciary law. For example, one director may have a conflict of interest, while the remaining board members do not. Also, different directors may have exercised different levels of carefulness in reaching their decisions. Given these differences (or potential differences) among directors, what impact does one director's fiduciary duty breach have on the liability of the remaining directors? Or, flipping the question, what impact does the compliance of the remaining directors have on the liability of the one breaching director? More broadly, the unexplored question within fiduciary duty law is this: how are outcomes affected when, although all directors vote the same way,11 some do so in compliance with their fiduciary duties while others do not? Should director liability be assessed individually or collectively?

An individual focus does not allow a director to hide behind her fellow directors' compliance, but instead deems her singular breach of sufficient gravity to jeopardize the board's functioning and warrant legal sanctions. A collective focus, on the other hand, will serve to insulate any one director's wrongdoing provided the remaining directors complied with their fiduciary duties.12 Therefore, how courts answer the individual/collective question can have important practical ramifications. Although the choice between treating directors individually or treating them collectively is only one of the variables in fiduciary duty suits, it has the potential to be the difference between a director's liability and her exoneration. As a result, it carries significant financial implications for directors, shareholders, insurers, and attorneys. Moreover, how courts answer the individual/collective question can affect how directors interact with one another and can provide important insights into the judicial view of fiduciary duty liability as a corporate governance mechanism.

This Article favors a duty-specific answer to the individual/collective question on both descriptive and normative grounds. First, it shows that courts generally have focused on the board as a whole in duty of care cases, and on directors as individuals in duty of loyalty cases. Second, this Article argues that courts have been correct in drawing this duty-based distinction because it strikes the proper balance between the board's authority and its accountability in each case.13 It contends that loyalty breaches,...

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