Duty of care: it’s more than legal
“Care” is a strong word. Care is ubiquitous and imparts responsibilities on people in many aspects of their lives.
In personal relationships, care stems from moral, cultural, and religious ideals that drive human interface. In business, care forms the standards by which we conduct ourselves and uphold professional responsibilities. Care extends beyond the individual and into organizations. A well-run organization is composed of people at all levels who carry out their duties with great care, engendering stakeholder loyalty and market confidence.
Ten years ago, the world was in the midst of the worst financial crisis since the 1930s. From 2008 to 2012, 465 banks in the United States failed, whereas only 10 banks failed in the 5 years prior to 2008. (See FDIC Failed Bank List.) But the crisis was not predicated on mere financial failures; it was a crisis of character and care. Many other iconic institutions have failed or struggled in recent years due to engaging in excessive risks, including financial, behavioral, and culture. What has changed? The notion of care has broadened.
Legal Perspectives on Care
Historically, the duty of care has been of such importance that it has been codified into corporate laws. It along with the duty of loyalty and duty of obedience are the three major fiduciary duties imposed on directors. The duty of care is deemed the most important responsibility owed by a director to an organization. The Model Business Corporation Actrequires that directors “shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.” Many states, including Delaware, have similarly modeled laws. The duty of care is frequently tested through legal proceedings that assess whether or not a board exercised due care in fulfilling its responsibilities.
Courts and legislatures have worked to define the breadth of requirements to uphold the board’s duty of care. In recent decades, in cases such as Smith v. Van Gorkam (Del. 1985), Unocal Corp. v. Mesa Petroleum Co. (Del. 1985), Revlon v. MacAndrews & Forbes Holding, Inc. (Del. 1986), and In re Caremark Int’l Inc. (Del. 1996), among others, the courts have sought to identify whether a board upheld its fiduciary duties in varied circumstances and decisions. Basic legal standards have evolved that allow a board to show it has upheld its fiduciary duties by applying their best business judgment, acting in good faith, and promoting the best interests of the corporation. These standards developed during the late 1900s limited the reach of the board’s duty of care.
Care Informed Governance
The latter half of the 20th century will be known in business circles as the era of management, with seemingly endless volumes of management books highlighting the vast study of how to manage a company well. The financial crisis of 2008 significantly impacted the business world’s view of risk and governance. The focus on management performance and especially short-term performance contributed to hundreds of bank failures and thousands of business failures. The distance between board and management precipitated these failures and broadened the concept of care and good governance. As a result, the first quarter of the 21st century will be known as the era of governance.
From a board governance perspective, meeting basic legal requirements is insufficient. As fiduciaries of an organization, directors are entrusted with ensuring the organization’s financial, operational, and cultural health and sustainability. Construing the duty of care narrowly to only major board decisions for the purpose of avoiding legal liability inherently limits the effectiveness of a board. Boards should aspire to exceed the minimum legal requirements for meeting the duty of care required by laws and courts and look to exercise care in all governance practices, striving for a higher standard of consistent governance excellence.
Cloudy Governance Signals a Lack of Diligence and Lack of Care
A caring and diligent board maintains:
- Clarity and Transparency
- Accountability and Independence
- Diversity and Inclusiveness
- Interactive Culture and Engagement
- Preparedness and Full Information
- Discipline and Keen Observation
- Inquisitiveness and Thoughtfulness
- Proactive Approach
Exercising Duty of Care in Governance Practices
These characteristics should guide the practices and dynamics of the board to ensure it exercises requisite care in its oversight and in major board decisions. A holistic approach to care ensures that a board’s governance practices promote a healthy corporate culture, which influences the overall health, functioning, and success of an organization. An effective board embeds care into its practices through key action points:
- Regular assessment of board composition
- Candid and open discussion
- Thoughtful selection, evaluation and oversight of the CEO
- A healthy, collaborative relationship with management
- Alignment of the board’s role in strategy
- Oversight of financial and operational performance
- Thorough review and approval of major transactions
- Understanding of talent development and culture
- Annual assessment of the organization’s governance policies
- Timely disclosure of conflicts of interest
- Cyber and physical protection of the organization’s assets
- Reviews to ensure integrity of financial statements and compliance with laws
- Engagement of outside experts, as necessary
- Regular assessment of the board’s practices and effectiveness
Care and governance are tightly linked concepts. Boards and board members who care are ones who understand the business. Care is more than showing up for four board meetings and reviewing financials. Highly effective leaders exercise care on an intellectual, emotional, and even spiritual level, as in what do you really believe about the business and its contribution to society. The Duty of Care is a legal board responsibility; caring is deeper human level of engagement.