Why would an organization want to make sure it exercises due care in its usual course of operations?

What Is Duty of Care?

Duty of care refers to a fiduciary responsibility held by company directors which requires them to live up to a certain standard of care. This duty—which is both ethical and legal—requires them to make decisions in good faith and in a reasonably prudent manner. These people are required to exercise the utmost care in making business decisions to fulfill their fiduciary duty.

Key Takeaways

• Duty of care is a fiduciary responsibility held by company directors which requires them to live up to a certain standard of care.
• The duty requires them to make decisions in good faith and in a reasonably prudent manner.
• The duty of care also applies to other roles within the financial industry, including accountants, auditors, and manufacturers.
• Failure to uphold the duty of care may result in legal action by shareholders or clients.
• Along with the duty of care, the other main fiduciary duty is the duty of loyalty; the duty of loyalty seeks to prevent directors from acting against the best interests of the corporation.

Bad Faith Insurance Definition

Understanding Duty of Care

Duty of care is often an implicit responsibility that comes with being a company director, but it may also be part of a written contract. This duty requires them to make decisions that are financially, ethically, and legally sound. These decisions should be made after taking all available information into account. Directors must act in a judicious manner that promotes the company's best interests.

Duty of care can, therefore, be summed up as the requirement that directors be present, informed, and engaged. They should use good and independent judgment, consult experts for their advice and trusted information, and refer to meeting minutes. They must also stay abreast of legal developments, good governance, and best practices that affect their companies. Directors should also schedule and be prepared to discuss and review things such as budget issues, executive compensation, legal compliance, and strategic direction.

Duty of Care vs. Duty of Loyalty

Along with the duty of care, the other main fiduciary duty is the duty of loyalty. The duty of loyalty is different from the duty of care because it seeks to prevent directors from acting against the best interests of the corporation or acting in such as way as to reap a personal benefit unavailable to other shareholders.

This duty requires company directors to put the fiduciary interests of the company before their own. It also imposes the responsibility to avoid possible conflicts of interest, thereby precluding a director from self-dealing or taking advantage of a corporate opportunity for personal gain. If a company director violates their duty of loyalty or their duty of care obligations, they may be ordered to pay restitution and stiff fines.

The duty of care also applies to other roles within the financial industry. Accountants and auditors are bound to and responsible for the best interests of their clients. Manufacturers are held accountable for the safety of consumers with the products they make and market.

In reality, the duty of care is not a high standard. In many daily activities, such as driving a car, doing lawn work, manufacturing products, keeping stores safe for customers, delivering medical care, many people owe various other people a duty to avoid hurting them by their negligent behavior.

Special Considerations

Failure to uphold the duty of care may result in legal action being brought by shareholders or clients for negligence. Courts generally do not rule on whether a business decision was a sound one or not in the case of company directors. This is known as the business judgment rule, meaning courts normally defer to the judgment of corporate executives. Instead, their main focus is on assessing whether the directors:

1. Fulfilled their duty of care by acting in a reasonably prudent manner when making the decision in the best interest of the corporation.
2. Conducted an adequate degree of due diligence, otherwise known as ordinary care.
3. Acted in good faith.
4. Have not wasted corporate assets or resources on overpaying for goods, property, or labor.

Given that courts tend to defer to the judgment of executives, it can be exceptionally hard to prove a duty of care breach. In fact, in Brehm vs. Eisner, the Delaware Supreme Court found that the business judgment rule protected Walt Disney's board after it awarded $150 million in payments to Michael S. Ovitz for just 14 months of work as part of a no-fault termination of his employment agreement.

The court found that the company's board exercised bad business judgment but was covered under procedural requirements by the fact that they consulted an expert before allowing Ovitz's severance. The decision reinforced the belief that there is little shareholders can do to hold directors accountable.

Example of Duty of Care

Assume a public company, PubCo, makes a large acquisition of rival firm ABC Holdings that effectively doubles its size. The market reaction, judging by the decline in PubCo's share price after the acquisition is announced, is that PubCo paid too much for ABC Holdings.

PubCo's management is initially very confident that the acquisition will be accretive to earnings. But a few months after the deal closes, PubCo announces that ABC's management was engaged in accounting fraud that grossly inflated its revenue and profitability. Despite PubCo's management asserting that they had no inkling of anything amiss at ABC, PubCo's shares plunge 30% and shareholders launch a class-action lawsuit against PubCo's directors.

Most cases are settled out of court. But in such a situation, if the case does go to trial, the court would not rule whether PubCo paid too much for ABC. Rather, it would assess whether PubCo's board of directors conducted their due diligence on ABC and acted in good faith. The fact that the directors failed to detect the accounting fraud at ABC does not necessarily constitute a breach of the duty of care. But if PubCo's directors were aware of it and chose to go ahead with the acquisition anyway, this could be construed as a breach of duty.

Duty of Care FAQs

What Is an Example of a CPA’s Duty of Care to a Client?

Those working in the accounting profession have the opportunity to make substantial financial gains from their relationships with clients. Because of this, the obligations of duty of care and duty of loyalty are very important for Certified Public Accountants (CPAs) to uphold.

Accounting firms ensure that their CPAs are acting objectively and independently by requiring employees to review client lists for potential conflicts of interest, requiring them to sign independence agreements, establishing quality control policies and procedures to deal with potential conflicts of interest and independence issues, and by assessing client relationships and public responsibility.

In turn, CPAs are expected to provide professional services to the best of their abilities. This is accomplished through continuing education, seeking consultation when needed, ensuring adequate planning and supervision, and performing annual performance evaluations.

When preparing a customer's tax returns, a CPA owes a duty of care in order to minimize the chance of an Internal Revenue Service (IRS) audit.

What Is Duty of Care in Healthcare?

All healthcare providers, whether they are physicians, nurses, or therapists, are obligated to maintain a duty of care when working with their patients. Failure to meet the appropriate level of care for the patient can lead to allegations of negligence on the part of the healthcare provider. In the medical profession,negligence is defined as a failure to take reasonable care or steps to prevent loss or injury to another person.

What Is Duty of Care in the Workplace?

In the workplace, the duty of care means recognizing that your company has a legal and moral obligation to keep its employees safe while at the workplace. Examples of this include ensuring the safety of employees that are traveling internationally for business, creating a work environment that safeguards employee health during a pandemic, or preparing your business for the hurricane season with minimal disruption.

How Do You Establish Duty of Care in Tort Law?

In tort law, a duty of care is a legal obligation that is imposed on an individual. Duty of care requires adherence to a standard of reasonable care while performing any acts that could foreseeably harm others. If it has been established that a duty of care has been imposed by law, breaching this duty may subject an individual to liability.

What Is Duty of Care in a Personal Injury Case?

In a personal injury legal case, the law must establish that the person or company that injured you was in a position in which they were obligated (by law) to act—or refrain from acting—in a way that would cause foreseeable injury to you.

There are four levels of duty in tort law and, therefore, in personal injury law.

• Duty to Refrain from Intentional Injury: In the event that one person injures another person intentionally, the injury is caused wrongfully in the eyes of the law, and the injured person has a right to recover damages.
• Negligence: People should refrain from negligent behavior; this means if an action doesn’t have an intent to injure others, but creates a foreseeable risk of injury to others, you have a duty to refrain from acting in that way.
• Recklessness: Individuals have a duty to refrain from reckless behavior; this means not acting with utter disregard for the safety of others.
• Strict Liability: In those cases involving manufacturing defects in products, there exists a strict liability; this means that if a product defect causes injury—or if using a product in the manner it was intended to be used causes injury—the manufacturer is liable even if there is no proof of negligence or recklessness.

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