Corporate Law

by Stephen F. Aton

A board of directors is responsible for the overall policy and objectives of a corporation, while the officers manage the company on a day-to-day basis and implement the board's directives. But directors may become liable for breaching their duty of care in oversight and supervision of the officers.

Although the courts have not established uniform standards for directors to follow, recent case law is providing more certain guidelines.

A director's duty of oversight must be carried out with the care and skill which ordinarily prudent and diligent persons would exercise under similar circumstances. A director who is compensated may have an even higher standard of care to meet.

If that standard of care is breached, such as in the instance of directors utterly failing to supervise the activities of the officers, personal liability may follow. Most cases in Missouri that have ascribed liability to directors involve self-dealing, clear negligence or misjudgment.

There are several defenses that a director may use to avoid liability for an alleged breach of the duty of care. Perhaps the most common defense is that of the business judgment rule.

The rule provides an evidentiary presumption, which may, of course, be overcome by facts showing otherwise, that directors have acted on an informed basis and in good faith, with the belief that the decision made was in the best interest of the company.

Courts are slow to second-guess business decisions of directors when reviewing past acts. Courts generally require directors not to be grossly negligent in delegation of management to officers, and to search out the facts when their suspicions are aroused or should be aroused by corporate activities.

Directors clearly cannot ignore problems that a prudent person would recognize.

Missouri law also provides a statutory defense for directors who have relied in good faith upon the books of account of the corporation or statements prepared by any of its officials as to the value and amount of assets, liabilities and earnings of the corporation. Directors may also rely on the advice of attorneys with respect to the propriety of an action.

An early case in the nationally influential Delaware courts, Graham vs. Allis-Chalmers Manufacturing Co., which involved corporate criminal activities, held that directors can rely on the honesty of the management until something occurs that alerts them to a problem. At that point, there is a duty to act.

But until a suspicious problem presents itself, there is no affirmative duty to install a system to seek out wrongdoing. This standard reflects the general rule that a director must act prudently, or the law will place the liability upon the director.

A recent case in the Delaware Chancery Court may be representative of national trends on the issue of director liability. The case, In re: Caremark International Inc. Derivative Litigation, again looked at directors' oversight responsibilities in a criminal context, but many of its precepts apply generally.

The court stated that "only a systematic failure of the board to exercise oversight such as an utter failure to attempt to assure a reasonable information and reporting system exists will establish the lack of good faith that is a necessary condition to liability." Many commentators think directors should have liability only for a total abdication of responsibilities.

Directors may seek insurance against the liability, but it is usually sought, if at all, not by closely held companies but by large publicly traded companies with a higher risk of lawsuits from minority shareholders.

Utilization of common sense and attention to the activities of the officers will relieve directors of most liability concerns. The burden of establishing director liability in Missouri is still significant.

(Stephen F. Aton is a Springfield attorney practicing in the areas of corporate law and taxation, and estate planning.)

INSET CAPTION:

Courts are slow

to second-guess business decisions

of directors when reviewing

past acts.[[In-content Ad]]