What are a Board of Directors' Fiduciary Duties? Care, Loyalty, and Obedience (2024)

Fiduciary responsibilities are a matter of regulatory compliance, ethical considerations, and legal requirements.

Corporate governance is one key area in which fiduciary duties play an important role. Directors on a corporation’s board are bound by their fiduciary responsibilities to shareholders. These responsibilities can be summed up in three key duties, which we’ll explore in depth in this article:

1. Duty of Care
2. Duty of Loyalty
3. Duty of Obedience

What is a Fiduciary?

The term “fiduciary” has its origins in the Latin, fudiciarius, denoting the importance of trust and confidence in the fiduciary relationship. In short, a fiduciary is a person who acts on behalf of someone or something else, whether an individual or a corporation, for example.

It’s common to think of fiduciary in financial terms — as in a client placing trust in a financial advisor, for example — but an attorney-client relationship is also a fiduciary one, since the client needs to trust that their attorney is always acting in the client’s best interest.

Three Key Fiduciary Duties

1. Duty of Care

Duty of care describes the level of competence and business judgment expected of a board member. This is commonly expressed as the obligation to provide the level of care that an ordinarily prudent person would exercise in a similar position and under similar circ*mstances.

A “reasonably prudent” person would exercise reasonable care when making business decisions as a company steward. So, a fiduciary is responsible for investigating and asking questions and ensuring that they’re well-informed and fully understand issues surrounding their decisions. In a practical sense, this requires:

• Being interested in, and informed about, the company’s mission, goals, and plans
• Preparation before board and committee meetings (e.g., reviewing agenda, reports, etc.)
• Active participation in meetings
• Remaining alert to potential concerns and problems
• Asking for more information (e.g., from management, accountants, attorneys, etc.) before making decisions
• Investigating irregularities and/or violations in governance of the organization

2. Duty of Loyalty

Duty of loyalty revolves primarily around board members’ financial self-interest and the potential conflict this can create. When a board member is making decisions affecting the organization, the organization must have their undivided allegiance. This means not only in decision-making on behalf of the company, but also that a board member may never use information obtained as a member for personal gain. Rather, they must act in the best interest of the organization.

Directors can face conflict, in fact or in appearance, when they are on both sides of an ESOP transaction. So, how do they satisfy this duty of loyalty?

Every board member’s compliance with the organization’s policy surrounding conflicts of interest starts with full disclosure of any potential conflicts, to avoid the appearance of impropriety. This offers the governance committee or board an opportunity to review and evaluate potential conflicts and resolve any issues that may arise before related decisions come under consideration.

When a conflict of interest does arise, the affected director has an obligation to recuse himself or herself from participating in the discussion and/or decision.

3. Duty of Obedience

Duty of obedience is about respecting the limits of the board’s power, and using that power to help the organization fulfill its mission — while also respecting and obeying the law. The flip side of this is that board members must not act inconsistently with the organization’s mission.

In other words, directors have a duty to make decisions that serve the purpose of upholding and perpetuating the company’s mission. That means guiding decision-making to help keep the company on course toward its stated objectives. So board members need to be ready to question initiatives, investments, or other plans that could degrade or derail the mission.

Who Are an ESOP’s Fiduciaries?

Directors on a company board are corporate fiduciaries, with a duty to company shareholders. Many of the board’s legal fiduciary duties are articulated in state statutes; courts have also weighed in to help define the scope and limits of these responsibilities. Typically, these duties revolve around the corporate bottom line — but they can also relate to the interests of fair employment, surrounding communities, environmental practices, and even customers.

This isn’t much of a stretch, since it’s easy to imagine examples of these areas impacting the bottom line, and therefore the shareholders.

In addition to the board of directors, the ESOP trustee also serves as a fiduciary. Here’s why: The sole legal shareholder of a 100% ESOP-owned company is the ESOP trust, while the employee-owners are beneficial owners of the shares allocated to them. That is to say, employee owners receive the financial benefit of those shares, even though the trust is the legal shareholder.

Also Read: How Can Leadership Address Key Issues Around ESOP Executive Compensation?

The Employee Retirement Income Security Act of 1974 (ERISA) defines the primary ESOP trustee duties as acting solely in the interest of ESOP participants and beneficiaries while defraying reasonable plan expenses. The ESOP trustee takes on the fiduciary duty to look out for the best interests of the company and the plan participants. ERISA also lays out the trustee’s duties to act “care, skill, prudence, and diligence.”

Help Board Members Understand and Meet Their Obligations

When you download our free tip sheet, ESOP Company Board of Directors’ Responsibilities, you can help ensure that all board members understand the main areas of responsibility, the importance of following and documenting established processes, and the board’s relationship and interactions with the ESOP trustee. Just click below to download your copy now.