Part 3: Staying Out of Trouble
A. Fiduciary Duties — What Founders and Directors Actually Owe
Once you're a director or officer of a corporation, you owe fiduciary duties — legal obligations to act in the company's best interest — that exist independently of anything written in your employment agreement. Understanding what these duties actually require, and when they're tested most severely, matters well before a crisis forces the question.
The Duty of Care
The duty of care requires directors to make informed decisions — gathering relevant information, considering alternatives, and deliberating reasonably before acting — rather than acting carelessly or without adequate process. Delaware courts generally protect good-faith decisions made through a reasonable process, even if the outcome turns out badly, under what's known as the business judgment rule.
The Duty of Loyalty
The duty of loyalty requires directors to act in the corporation's best interest rather than their own, avoiding self-dealing and conflicts of interest, or properly disclosing and managing them when they arise. This duty is scrutinized far more strictly than the duty of care, because courts are less willing to defer to a decision-maker's judgment when their own interests were on both sides of the table.
When These Duties Get Tested Most: Distressed Sales
Fiduciary duty questions come up constantly in ordinary operations, but they're litigated most intensely in distressed sale scenarios — when a company facing insolvency or a down-round sale must decide how to allocate limited proceeds between creditors, preferred stockholders, and common stockholders (often founders and employees).
Delaware case law in this area — including decisions addressing when duties shift toward creditors as a company approaches insolvency, and how courts evaluate board process in a distressed sale — has shaped a body of guidance directors rely on to navigate exactly these moments. The underlying theme across this case law is consistent: process protects directors far more than outcome does. A well-documented, informed, good-faith process — engaging a banker, getting a fairness opinion, documenting board deliberation — is the strongest defense against a claim that duties were breached, even in a sale that leaves common stockholders with little or nothing.
The Practical Takeaway for Founders
You don't need to memorize case names to run a board well. You need to internalize the underlying discipline: document your process, seek independent input on major or conflicted decisions, and be able to show — after the fact — that the board acted deliberately and in the company's interest, not reflexively or in anyone's personal interest.
The One-Sentence Version
Fiduciary duties are rarely about getting the outcome right — they're about being able to show, later, that you got the process right, especially in the moments when interests on your board or cap table start to diverge.
B. Self-Dealing and Related-Party Transactions
A related-party transaction is any deal between the company and someone with a conflict of interest — a founder, director, officer, or major stockholder, or an entity they control. These transactions aren't prohibited, but they're held to a higher standard than ordinary business deals, precisely because the person on both sides of the table has an incentive to favor themselves.
Common Examples Founders Overlook
Related-party transactions show up more often than founders realize: leasing office space from a building the founder owns, the company paying a founder's spouse for consulting work, a director's other company becoming a vendor or customer, or a founder's LLC licensing IP to the startup. None of these are automatically improper — but each one needs a process that a court or a future acquirer's diligence team would consider fair.
Why Process Matters More Than Outcome
Courts evaluating a self-dealing transaction generally look for full disclosure of the conflict to the disinterested directors or stockholders, approval by those disinterested parties (not the conflicted person), and terms that are fair to the company — comparable to what an arm's-length third party would have agreed to. A transaction that's substantively fair but was never disclosed or separately approved is still legally vulnerable, because the process, not just the outcome, is what's being evaluated.
California's Stricter Approach
Some states, including California, impose specific statutory requirements on related-party transactions for corporations and LLCs — self-dealing rules that go beyond the general Delaware fiduciary duty framework and can void a transaction that doesn't meet the statute's disclosure and approval requirements, regardless of how fair the terms actually were. Founders operating California entities, or with California-based leadership making these decisions, should treat the statutory checklist as a floor, not a formality to route around.
A Simple Process to Adopt Early
Any time a related-party transaction arises, disclose it to the full board in writing, have the disinterested directors specifically vote to approve it (documented in board minutes), and be able to articulate why the terms are comparable to what you'd get from an unrelated party. This is a small amount of process discipline that closes off a disproportionately large amount of downstream risk.
The One-Sentence Version
Related-party transactions aren't forbidden — they're just required to survive more scrutiny, and disclosure plus disinterested approval is the process that lets a fair deal actually hold up as one.
C. AI Tools and Legal Privilege
Founders and in-house teams increasingly use AI tools to draft contracts, summarize legal documents, and get quick answers to legal questions — often before looping in outside counsel. That convenience raises a question worth understanding clearly: does using an AI tool put attorney-client privilege at risk?
What Privilege Actually Protects
Attorney-client privilege protects confidential communications made for the purpose of seeking or receiving legal advice from an attorney. It's a narrower protection than people often assume — it doesn't cover business advice generally, and it can be waived, intentionally or not, by sharing privileged communications with third parties who fall outside the privilege.
Where AI Tools Introduce Risk
The core question courts and ethics bodies are working through is whether inputting privileged material into a third-party AI tool constitutes disclosure to an outside party in a way that could waive privilege — similar to historical questions about cloud storage and outside vendors, but less settled, because the legal and technical frameworks are still developing.
A related but distinct concern involves state bar ethics rules on confidentiality, which govern how attorneys themselves may use AI tools when handling client information — separate from, but connected to, the privilege question. Recent guidance and decisions, including a notable 2026 ruling addressing waiver in the context of AI tool use, are actively shaping how courts and bar associations expect these questions to be analyzed, and the answers are still evolving rather than settled.
Practical Steps That Reduce Risk
Whatever the eventual settled legal answer, a few practices meaningfully reduce risk in the meantime: understand the specific data handling and retention terms of any AI tool before inputting sensitive legal material into it, avoid inputting genuinely privileged attorney-client communications into general-purpose consumer tools without reviewing those terms, and involve counsel in decisions about which AI tools are appropriate for which categories of company information.
For non-privileged business use — drafting a first pass at a document, summarizing public information, general research — the calculus is simpler, since there's no privilege at stake to begin with. The higher-stakes question is specifically about material that would otherwise be protected.
The One-Sentence Version
AI tools are genuinely useful for legal work, but the question of what they do to privilege is still being worked out in real time — which means the safest approach is deliberate tool selection and involving counsel in that decision, not assuming the question has already been settled in your favor.
