On April 26, 2016, Governor Hogan signed House Bill 354 (chapter 171), which amends the Maryland General Corporation Law (the “MGCL”) to clarify that a director of a Maryland corporation only has an obligation to comply with the statutory standard of conduct – and not unspecified common law duties – when acting as a director. The bill also makes corresponding amendments with respect to the duties owed by trustees of Maryland real estate investment trusts (formed pursuant to the Maryland REIT Law). These important amendments will be effective October 1, 2016 and will provide much needed clarity as to the legal duties that directors and trustees owe their entities and constituents.
Since 1976, when the General Assembly enacted Section 2-405.1(a) of the MGCL, a director of a Maryland corporation has been required to act: (1) in good faith; (2) in a manner [the director] reasonably believes to be in the best interests of the corporation; and (3) with the care that an ordinarily prudent person in a like position would use under similar circumstances. By adopting the standard of conduct articulated by the American Bar Association in the Model Business Corporation Act, the General Assembly elected into codified director duties and out of the common law fiduciary duties that historically governed director conduct. As now revised, Section 2-405.1(c) (formerly subsection (a)) is relatively unchanged, but its reach has been clarified. Most prominently, new subsection (i) provides that Section 2-405.1 is the sole source of duties of a director to the corporation or the stockholders of the corporation. This clarification resolves the ambiguity created by Shenker v. Laureate Education, Inc., 411 Md. 317, 983 A.2d 408 (2009) and its progeny.
In Shenker, the Court of Appeals of Maryland held that, among other things, Maryland law recognizes certain undefined common law duties that govern the actions of a director in addition to the standard of conduct articulated in Section 2-405.1. The court held that the statute applies to “managerial” decisions, but that there are other, unspecified common law duties that would apply to non-managerial decisions. While the legal duties articulated by the court in Shenker, the duties of candor and maximization of value, were widely viewed as subsumed within the statutory standard of conduct, questions arose as to what other common law duties might exist under the court’s formulation. The amendments to the statute eliminate the distinction and clarify that new subsection (c) is the sole source of a director’s duties.
To preserve the ultimate holding in Shenker, that a stockholder would have a direct remedy for a breach of the director’s duties under certain circumstances, the newly-enacted statute eliminates former subsection (g) of Section 2-405.1, which was the product of a 1999 amendment to the statute. Former subsection (g) limited enforcement of the standard of conduct to those acting by or in the right of the corporation. As revised, a stockholder’s right to sue directly or derivatively for a breach of the standard of conduct will be developed from the judicial case law (as was the case from 1976 until the addition of former subsection (g) in 1999). Consequently, a direct action against a director would retain the benefit of the statutory business judgment rule articulated in new subsection (g) (formerly Section 2-405.1(f)).
It is also worth noting that new subsection (a) clarifies that an “act” includes not only an overt act, but also an omission, a failure to act or a determination made not to act. Acts are also distinguished from “duties” owed by directors. Further, the bill makes contemporaneous grammatical and technical changes to the statute to clarify its content and application, and conforming changes to Section 5-417 of the Courts and Judicial Proceedings Article and Section 8-601.1 of the Maryland REIT Law.
Finally, for those interested in further background on the House Bill 354, written testimony submitted by the Business Law Section of the Maryland State Bar Association (the only written testimony submitted with regard to the bill) can be found here and my oral testimony in support of the bill along with that of Del. Benjamin Kramer can be found on the general assembly website (my oral testimony on the identical cross-filed bill, Senate Bill 148, along with that of senate sponsor Sen. Brian J. Feldman can be found here).
Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.
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