|
Part of the Bricker
& Eckler Board and Executive Series Your Responsibilities as a Officer1 October 6, 1999 Introduction 2The purpose of this discussion paper is to provide officers and employees of a corporation, including directors who are also officers or employees, with an overview of their general obligations to the corporation. A plethora of information exists on "directors and officers" liability. Publications have increased exponentially as have headline news about the FBI raiding the offices of Archer Daniels Midland and former directors and officers of Medical Mutual personally repaying $6.8 million to policyholders. Directors of a corporation are entitled to certain defenses and protections, such as the "business judgment rule," against potential liability. However, there is always a caveat to the effect that "these defenses and protections in no way limit potential liability for actions taken by officers and employees." So, what about officers? The Statutory Scheme The scheme of most corporate statutes is that directors are entitled to rely upon officers and, if they do so properly, may escape liability.3 Accordingly, if directors are entitled to rely upon officers, and if officers were entitled to the same defenses and protections as directors, no one would be responsible to shareholders. Most states’ corporate statutes do not entitle officers or employees (including directors who are also officers or employees) to the same defenses and protections that directors enjoy.4 The Common Law Duties Some states’ corporate statutes define the duties of a director, and do so to provide some protection.5 Most states’ statutes do not directly define the duties of officers or employees.6 These duties are left to judicially-made common law. They include the fiduciary duties of care and loyalty. The duty of care requires an officer to exercise the care that an ordinarily prudent person in a like position would exercise under similar circumstances. The duty of loyalty requires an officer not to misuse a corporate asset, including misappropriating a corporate opportunity, for a personal benefit. Furthermore, some states’ common law, like that of Delaware, requires officers to disclose all material information to the board of directors in order to enhance the directors’ ability to make informed decisions. Don’t Forget about Contractual Duties In addition, officers and often employees may have contractual duties that exceed these common law duties. These duties could include employment responsibilities and performance standards in employment agreements, restrictive covenants in noncompetition agreements, secrecy requirements in confidentiality agreements, and disclosure requirements in expense reimbursement agreements. These duties can also include those responsibilities set forth in employment policies that are incorporated as part of the employment agreements. The Negligence Standard Officers and employees are generally held to a negligence standard of culpability based upon a prudent person in like position under similar circumstances. Although a director’s duty of care is similarly based upon a prudent person in like position under similar circumstances, directors are afforded the protection of the so called "business judgment rule." Under this rule, courts do not question the wisdom of directors’ decisions unless there is proof of a breach of fiduciary duties, such as fraud, bad faith, or abuse of discretion. Therefore, directors are not liable for a business decision simply because it proves to be bad. This protection is not routinely afforded officers or employees. The Standard of Proof Most states require, as a standard of proof, a preponderance of the evidence to show negligence by an officer or employee (i.e., a showing that more likely than not a breach of duty or misconduct occurred). This is a lesser standard of proof than for actions against directors in some states which may require clear and convincing evidence that a breach of duty or misconduct occurred.7 Indemnification Under most states’ laws, corporations may indemnify, or agree to indemnify, directors and officers against liabilities, and directors and officers may in certain circumstances be entitled to indemnification.8However, in most states there are limits on indemnification. For example, in most states indemnification is precluded if a court finds a director did not act in good faith or in a manner reasonably believed to be in the best interests of the corporation.9 Some states preclude indemnification in a derivative action if the liability involves negligence or misconduct by the director in the performance of a duty to the corporation.10 D&O Insurance For officers, errors and omissions insurance is important. Most states’ laws do not prohibit insurance giving broader coverage of officer liability than permitted by indemnification. By reviewing and comparing coverages of the insurance products of different insurers, officers can usually find this broader coverage at reasonable rates. There are many reasons why senior management, as well as directors, should have the protection of D&O insurance including:
Contract, Insurance, and Indemnification Review Many boards, as well as members of senior management, are not aware that the business judgment rule under most state corporate statutes does not protect officers. Boards and senior management may not be aware that protection may not exist when needed if there is not a separate contractual or D&O insurance protection. Unless their employment agreements otherwise provide, officers are liable for negligence directly to their corporate employers as well as derivatively to their shareholders. Most boards should have an interest in offering senior management protective clauses in their employment agreements, adequate D&O coverage, and express corporate indemnification. We believe that boards would serve the best interests of the corporation as well as the shareholders by authorizing a review of employment agreements, D&O coverage, and corporate indemnification to see if senior management is adequately protected. footnotes: 1. This paper is intended for discussion purposes only and does not constitute legal opinion or advice. Directors, officers, employees, or other representatives of corporate entities should seek the advice of their personal or independent legal counsel on their actual circumstances under the laws of applicable jurisdictions before acting or relying upon any of the statements made herein. 2. Laurie A. Briggs, Esq. and Alexander M. Brown, Esq. of Bricker & Eckler LLP, made substantial contributions to this paper. 3. See 8 Delaware Laws Annotated §142(e) which provides that "A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member’s duties, be fully protected in relying in good faith upon… such information, opinions, reports or statements presented to the corporation by any of the corporation’s officers or employees…." See also, Ohio Revised Code §1701.59(B) provides that "a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, that are prepared or presented by... one or more directors, officers, or employees of the corporation who the director reasonably believes are reliable and competent in the matters prepared or presented." 4. For example, neither Delaware nor Ohio statutory law contains a provision entitling an officer to rely upon information, opinions reports or statements prepared or presented by other officers or employees, or professionals such as legal counsel or public accountants. See 8 Delaware Laws Annotated §142(e) and Ohio Revised Code §1701.59(B). 5. See, for example, Ohio Revised Code §1701.59(B) which provides that "A director shall perform his duties... in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation, with the care that an ordinarily prudent person in a like position would use under similar circumstances...." Then Ohio Revised Code §1701.59(C) protects a director from liability "unless it is proved by clear and convincing evidence that the director has not acted in good faith, in a manner he reasonably believes to be in or not opposed to the best interests of the corporation, or with the care that an ordinarily prudent person in a like position would use under similar circumstances…." Ohio Revised Code §1701.59(D) imposes the additional burden upon any plaintiff seeking monetary damages to prove by "clear and convincing evidence" that the director’s action or failure to act involved an act or omission undertaken with "deliberate intent to cause injury to the corporation" or with "reckless disregard for the best interests of the corporation." 6. See, for example, Delaware general corporation law under 8 Delaware Laws Annotated Chapter 5 and Ohio corporation law under Ohio Revised Code Chapter 1701. 7. See, for example, Ohio Revised Code §1701.59(C) and (D) which requires a showing by "clear and convincing evidence" 8. See 8 Delaware Laws Annotated §145 and Ohio Revised Code §1701.13(E) which each allows a corporation to indemnify directors, officers, employees, and agents, and under certain circumstances entitles directors, officers, employees, and agents as a matter of right to indemnification. 9. See 8 Delaware Laws Annotated §145(b) which provides that indemnification is only available "if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." See also Ohio Revised Code §1701.13(E) which provides that indemnification is only available "if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation." 10. See 8 Delaware Laws Annotated §145(b) which provides that "no indemnification shall be made in respect of any claim, issue, or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity…." See also, Ohio Revised Code §1701.13(E)(2) which provides that except that "no indemnification shall be made in respect of... [a]ny claim, issue, or matter as to which such person is adjudged to be liable for negligence or misconduct in the performance of his duty to the corporation unless, and only to the extent that, the court of common pleas or the court in which such action or suit was brought determines, upon application, that, despite the adjudication of liability, but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity…." 11. See, for example, 8 Delaware Law Annotated §145(f) and (g) and Ohio Revised Code §1701.13(E)(6) and (7) which each similarly provides that:
Delaware and Ohio courts construe those provision together as entitling directors, officers, employees, and agents of the corporation to receive full benefit of whatever protection is offered by whatever insurance is purchased and maintained by the corporation even if such protection is in addition to, or broader than that, of the indemnification statute. 12. See, for example, 8 Delaware Laws Annotated §145(b) and Ohio Revised Code §1701.13(E)(2)(a) which each generally denies indemnification if the director, officer, employee, or agent seeking indemnification is "adjudged to be liable" to the corporation unless a court finds the person is "fairly and reasonably entitled" to indemnification. That finding is a question of fact over which reasonable minds and different courts may differ. 13. See Rule 461(c) as contrasted with Rules 510 and 512 of Regulation C under the Securities Act of 1933 as amended. 14. See 8 Delaware Laws Annotated §145(d) and Ohio Revised Code §1701.13(E)(4) which each provides that indemnification after the fact can only be made by majority vote of disinterested directors of the board, upon written legal opinion of independent legal counsel, by majority vote of stockholders, or by a court of competent jurisdiction. 15. If resources of a corporation are limited, a board or its shareholders will have to choose between alternative uses for those resources in determining whether to allow indemnification. There are also solvency limitations that may prevent corporations from using its resources to provide indemnification. And there are limitations on corporations in regulated industries such as banking and insurance that may preclude indemnification based upon the financial condition and operations of the corporation at that time. |