In our earlier post on the Duty of Loyalty – Part 1, we discussed conflicts of interest, self-dealing (under California law), and excess benefit transactions. In this post, we’ll examine other aspects of the duty of loyalty: confidentiality and corporate opportunities. This post continues to address these fiduciary issues from the perspective of a director of a California nonprofit public benefit corporation exempt under Section 501(c)(3) of the Internal Revenue Code and described as a public charity.
Duty of Loyalty
Meeting a director’s duty of loyalty generally requires acting in good faith and in the best interests of the corporation. The key to meeting this duty is to place the interests of the corporation before the director’s own interests or the interests of another person or entity.
Inherent in a director’s duty of loyalty to the corporation is a duty of confidentiality. More specifically, a director must keep certain information that she learns about in her capacity as a director confidential. Such information may include information identified as confidential pursuant to a contract between the corporation and another party; trade secrets of the corporation, which commonly include donor lists; certain employee-, beneficiary/client-, and donor-related records (particularly if they include personally identifiable information like social security numbers or health or financial information); and attorney-client privileged communications. In addition, board meeting discussions should often also be treated as confidential.
It’s important for directors to be able to communicate about matters before the board without fearing that their words are going to be shared with others who are not on the board. If directors are uncertain that their communications will be kept private, they may not feel they can safely express their thoughts, particularly if they are critical of someone in or related to the organization or of any existing policy or practice. In such an environment, frank discussions that may be of great value to the effective governance of the organization will be chilled. Imagine how a director might refrain from contributing her thoughts on an executive’s performance, the value of a prospective major donor, or the little known problems of a popular program because of fear of backlash from outsiders who learn of her thoughts, particularly without the context in which they may have been offered. Moreover, the uncertainty of the privacy of board communications would deter a director who might otherwise play the role of devil’s advocate to spur more critical board deliberations.
The corporate opportunity doctrine prohibits a director from seizing an opportunity for herself or himself if:
- The corporation is financially able to undertake it;
- It is within the corporation’s line of business and is of practical advantage to the corporation; and
- The corporation is interested, or has a reasonable expectancy, in the opportunity.
It therefore follows that a director may take a corporate opportunity if:
- The opportunity is presented to the director in her or his individual capacity;
- The opportunity is not essential to the corporation;
- The corporation holds no interest or expectancy in the opportunity; and
- The fiduciary has not wrongfully employed the resources of the corporation pursuing or exploiting the opportunity.
Accordingly, a director who, in her or his capacity as a director, learns of a prospective transaction that might be considered a corporate opportunity should first present the opportunity to the board and allow the corporation sufficient time and first right to exploit the opportunity before taking advantage of the transaction in her or his individual capacity.