United States: Fiduciary Duties In Family Business M&A Transactions

This is the eighth article in our series on selling the family business. Our previous articles include advance planning, preliminary diligence, marketing, letters of intent, indemnification provisions, backstopping the deal, and dispute resolution mechanisms.

A company's board of directors has legal duties to act in the best interest of its shareholders. These duties (generally referred to as "fiduciary duties") apply to family business boards just like any other board. A well-advised board should know its fiduciary duties and the best practices for how to satisfy them, both as a general matter and particularly in the context of an M&A transaction.

What Are the Primary Fiduciary Duties?

There are two primary fiduciary duties that a board must satisfy in an M&A transaction: the duty of care and the duty of loyalty.

The duty of care requires the board of directors to act as reasonable, prudent people given the circumstances. Directors must act deliberately, consider all available options, and ensure that they are informed of all relevant information before making decisions.

The duty of loyalty requires that the directors put the interests of the corporation and its shareholders above their own. If, for example, an outside director owns a real estate brokerage, that director is obligated to refrain from unfairly encouraging the company to engage that real estate firm's services.

However, the duty of loyalty does not categorically prohibit the company from engaging that real estate firm. It may still choose to employ the firm if that choice is "entirely fair" and would make good business sense from a third party's perspective. Most jurisdictions have their own laws regarding how boards make decisions where one or more directors have conflicts of interest.

What Are the Consequences of Violating Fiduciary Duties?

A violation of a fiduciary duty can result in significant legal liability, usually by way of derivative shareholder litigation. Yes, even in family businesses, shareholders can-and do-bring litigation in the name of the company against the board.

Dealing with shareholder litigation is expensive, threatening, and the last thing a company that is about to close a sale or has just closed a sale wants to think about. Shareholder litigation in the family business context is divisive and may even be viciously irrational when the family history and culture are components of the dispute.

How Do You Satisfy the Primary Fiduciary Duties?

To avoid violations of fiduciary duties, prevention is the most important strategy. Educating and training directors about their fiduciary duties and the types of behavior that they should encourage and prohibit will mitigate the chances of claims or liability. A company's legal counsel should be well equipped to perform that task and should do so as soon as new directors assume their roles.

Next, it is important that the directors establish internal systems that ensure the board will be provided with all relevant information before they make decisions for the company. It is also important that directors actually absorb and process the information provided to them. Even if the company's internal systems ensure that the directors are consistently sent memos to keep them updated, the directors will still have breached their duties if those memos simply collect dust on their desks.

Finally, taking clear and effective minutes at board meetings can go a long way towards proving that directors' fiduciary duties were satisfied. When determining whether directors have satisfied their fiduciary duties, courts are primarily interested in the process that the board took to reach their decision rather than the substantive outcome of that decision.

As such, the company's meeting minutes should provide written evidence of the information considered by the board, the board's discussion, and even the debate that occurred at board meetings. The minutes should reflect that sufficient time was provided for discussion and consideration and that decisions were not made hastily or arbitrarily. Good meeting minutes create a solid base of evidence that the directors can use to show that they carefully considered all available options and ultimately picked what they genuinely believed was the best course of action for the company and its shareholders.