Duty of loyalty by the corporate directors

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Published — July 28, 2017

The following post does not create a lawyer-client relationship between Alburo Alburo and Associates Law Offices (or any of its lawyers) and the reader. It is still best for you to engage the services of your own lawyer to address your legal concerns, if any.

Also, the matters contained in the following were written in accordance with the law, rules, and jurisprudence prevailing at the time of writing and posting, and do not include any future developments on the subject matter under discussion.

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Having a disloyal corporate officer is worse than having an incompetent one. While incompetence may often lead to flawed business management and ineffective results, disloyalty on the other hand breeds corruption, which can destroy even established businesses in a blink of an eye. Thus, it becomes crucial for owners of any corporate enterprise to prevent breeding disloyalty among its ranks.

Certainly, it becomes especially dangerous if disloyalty resides in the corporation’s board of directors. It is so because under Philippine laws, all corporate powers shall be exercised, all business conducted, and all corporate property shall be held by the board of directors. It is therefore clear how powerful and sensitive corporate directorship is, as control of a corporation is lodged in the said board [Sec. 23, Corporation Code].

Considering the vast powers and extensive authority of the board of directors over the business and the property of the corporation, it stands to reason that the position of director should assume a fiduciary character. It is a position of trust for which the board and the individual directors are accountable to the ultimate owners of such enterprise, which is, the stockholders [See: IBP Journal, Vol. XXVIII, pp. 27].

Conflict of interest situations involving a director

To be qualified as director, a person must possess the following qualifications:

1. Every director must own at least one (1) share of the capital stock;
2. The share of stock held by the director must be registered in his name on the books of the corporation;
3. Every director must continuously own at least a share of stock during his term;
4. A majority of the directors must be residents of the Philippines [Sec. 23, Corporation Code].

Given the level of sensitivity of the position, the law allows corporations to provide additional qualifications of directors in its by-laws, on top of those mentioned above to achieve a legitimate objective. This includes prescribing such other qualifications that would ensure the loyalty of a director to the corporation.

This finds support in the ruling in Gokongwei Jr. vs. Securities and Exchange Commission [G.R. No. L-45911], where our Supreme Court confirmed that it is valid for a corporation’s by-laws to prescribe additional qualifications (or disqualification) for a director in order to prevent conflict of interest situations from arising. As a preventive measure, it would be so much better to require in the by-laws that anyone aspiring for directorship must not be a director of another competitor corporation. This is in line with a corporation’s inherent power to adopt its by-laws to regulate the conduct and prescribe the rights and duties of its members towards the corporation and among themselves in reference to the management of its affairs.

It cannot be denied that a member of the board of directors, for being among the persons who have direct hand in the management and control of the corporate business, has access to sensitive and highly confidential information, such as but not limited to marketing strategies and pricing structure, budget for expansion and diversification, research and development, and sources of funding, availability of personnel, proposals of mergers or tie-ups with other firms.

Thus, disqualifying a competitor from directorship may be done to prevent the creation of an opportunity for an officer or director of a corporation, who is also the officer or owner of a competing corporation, from taking advantage of the information which he acquires as director to promote his individual interests to the prejudice of the corporation and its stockholders. Where two corporations compete against each other, it would seem improbable, if not impossible, for the common director to satisfy his loyalty to both corporations and place the performance of his corporate duties above his personal concerns.

Therefore, based on the Gokongwei ruling, it is clear that corporations are allowed, and in fact highly advisable, to establish in its by-laws a measure of self-defense to protect it from the danger that the election of a business competitor to the board of directors may bring upon the corporation and its stockholders. Sound principles of corporate management is against the sharing of sensitive information with a director whose duty of loyalty may well require that he disclose this information to a competitive rival. These dangers are even further enhanced considerably where the common director is a controlling stockholder of a competing corporation, as it would seem manifest in such situations that the director has an economic incentive to appropriate for the benefit of his own corporate enterprise the plans and policies of the corporation where he sits as a director.

Consequences of a director’s disloyalty

The law defines the liability of directors who engage in conflicting interests. To be sure, directors who willfully and knowingly vote for or assent to patently unlawful acts of the corporation, or acquire any personal or monetary interest in conflict with their duty as such directors shall be liable jointly and severally for all damages resulting therefrom suffered by the corporation, its stockholders and other persons. When a director or officer attempts to acquire or acquires, in violation of his duty, any interest adverse to the corporation in respect of any matter which has been reposed in him in confidence, he shall then be liable as a trustee, and must account for the profit which otherwise would have accrued to the corporation [Sec. 31, Corporation Code].

Given the foregoing, it is clear that where a fiduciary relationship exists, the duty of the director is to manage the property and affairs of the corporation with an eye single to the advantage of the corporation itself. In line with the general principles of equity, it is not proper for the fiduciary to take those opportunities unto himself. Thus, the fiduciary relationship between a director and the corporation he is serving imposes upon him a duty of loyalty, to act in accordance with the highest standards which a man of the finest sense of honor might impose upon himself [See: IBP Journal, Vol. XXVIII, p. 27; 21].

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Alburo Alburo and Associates Law Offices specializes in business law and labor law consulting. For inquiries regarding corporations and corporate governance, you may reach us at info@alburolaw.com, or dial us at (02)7745-4391/0917-5772207.

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