3.6.2 Distinction between duties and liabilities, best practice codes

In the US a clear distinction is made between best practice duties and duties based on law. The Model Business Corporation Act (MBCA) of 2002 makes the distinction between "standards of conduct" in § 8.30 and "standards of review" in § 8.31.1 Standards of conduct include conduct that is required of directors and aspirations for what is expected of directors. Standards of review, on the other hand, govern whether directors will be held liable. The Dutch terras for standards of conduct and standards of review are respectively "gedragsnormen" and "toetsingsnormen".2 Although this distinction is implied in Delaware case law and has been mentioned in speeches and articles, it has not been developed in liability cases.3

A review of standards of conduct in general can best start with the duties and responsibilities of directors. Directors must direct the management of the corporation. They also have a duty of oversight — the American word for supervision — while confusingly the British meaning of the word oversight is the opposite: "an unintentional failure to notice something". They have the duty to monitor management, albeit without going into micromanaging. They must carry out their responsibilities in accordance with principles of fiduciary duty. Although the business judgment rule applied by the courts is the standard of review, these fiduciary duties are embodied in the rule itself. That is, directors are expected to act — and are presumed to act, unless the presumption is rebutted — "on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company” 4

As mentioned before basic responsibilities of the board of directors stem from the Delaware General Corporate Law, which requires that "the business and affairs of ... [the] corporation ... be managed by or under the direction of the board of directors".5 One of the meanings of the noun "direction", and the verb "direct", is defined in Webster's dictionary, besides "control of operations", "tell or show someone the way". Both meanings when applied to corporations "strategie control and goal orientation". Webster's dictionary expresses the meaning of the noun "direction" even more forcefully: "guidance or supervision of action, conduct, or operations", and "something that is imposed as authoritative instruetion".6 The meaning of the verb "direct" follows from these definitions. The root "direct' in this statutory mandate for directors has two components: (1) to determine policy in their decision making role of "telling the way" and "imposing authoritative instruction", what the law calls "managed by" and (2) to guide and supervise in their oversight function what the law expressed with "under the direction". Thus, directors "manage and are not merely the supervising group that hire and fire the CEO and advise management."7 This is an essential point for a one-tier board. The board members, including the independent directors, are involved in decision making.

In a two-tier board system the supervisory directors are not involved in the development of decision making. They only veto or give consent.

The marketplace is developing the expectation that directors will engage in best practices, i.e. an extra-legal standard of conduct or "soft law". This expectation is, for now, primarily an aspirational standard of conduct. Failure to adhere to the standard of conduct reflected in aspirational best practices may not necessarily result in liability, as the Delaware Supreme Court made clear in the Disney case.8

This is a good example of Delaware judges expressing their views about better corporate governance, but at the same time making clear what the law on liability is.

The Disney cases10 have had a huge impact on corporate governance counselling, especially on proper board procedures and on the use of external advisors by nomination and compensation committees. It is often repeated by Delaware judges and retired judges that, as a matter of prudent counselling, the directors' conduct may be measured not only by evolving expectations of directors in the context of Delaware common law fiduciary duty but also by other standards, such as standards from the Sarbanes-Oxley Act, rules of the SEC, Listing Requirements of the NYSE and NASDAQ and even the best practice codes of all private institutions. These corporate governance codes set a high standard of board behaviour that most boards aim to comply with, but this standard is not identical to the standard of review required by the courts, which is lower.

The difference between preaching by Delaware judges and immediate judgments about transactions is described clearly by Professor Ed Rock:11

"These opinions illustrate a striking feature of the Delaware fiduciary duty cases, specifically, the multivalent character of the outcomes. In these cases, and in the ones that follow, the courts avail themselves of one of three options: denying the request for an injunction and blessing the behaviour; denying the motion for an injunction and criticizing defendants' behaviour; or granting the injunction. The intermediate position plays three roles. First, it provides guidance applicable to future cases, that is, what kind of behaviour the courts are likely to find to be a breach of fiduciary duty. Second, in these intermediate cases, although the court denies plaintiffs' motion for a preliminary injunction, it also typically denies defendants' motion to dismiss, leaving defendants with some substantial damages exposure. Finally, and perhaps most importantly and certainly least noticed — it tells directors, who we may suppose are generally trying to do a good job, what they should do."