Corporate Liability Exposure and the Potential Risk of Individual Director Liability Resulting from Employment-Related Decisions: An Analysis of Recent Case Law and Recommendations on Corporate Governance

Article excerpt

During the past decade, there has been a virtual explosion of litigation against corporate directors for both public and privately held companies, focusing on directors breaching their duty of care. Allegations of corporate waste, squandering money, misappropriating property, or frivolous personal measures are at the heart of these suits. Derivative plaintiffs in duty of care cases seek to recover corporate losses on behalf of the corporation. As a shield, directors rely on the Business Judgment Rule, a doctrine created by courts that affords directors general deference to their decisions, so long as the decisions are rational and in the best interests of the corporation.

In these derivative cases, the corporate loyalty infractions at issue often involve a financial or other cognizable fiduciary conflict. However, objectionable corporate conduct is no longer confined to situations involving personal financial interest or fiscal waste. Rather, there has been a proliferation of lawsuits arising from adverse employment decisions.

This year, the Equal Employment Opportunity Commission (EEOC) announced a nine percent increase in charges of Discrimination and harassment against corporations.1 Allegations of retaliation, age discrimination, and pregnancy discrimination were the most frequently filed charges.2 In addition, a number of plaintiffs have begun to seek redress against directors for corporate decisions not normally associated witii a director, including investment plans, medical insurance programs, and adherence to the Family and Medical Leave Act.

This litigation influx is reshaping the traditional duty of care imposed on corporate executives. Consequently, courts have reaffirmed deference to corporations under a variant of the Business Judgment Rule in discrimination and harassment lawsuits. This article discusses the expanding reach of the Business Judgment Rule and suggests numerous practices to narrow the risk of corporate liability.

Business Judgment Rule-Generally

Directors owe three common law fiduciary duties to the corporation and its shareholders: (1) the duty of loyalty; (2) the duty of care; and (3) the duty of good faith.3 The board of directors must act in good faith and must exercise due diligence in its decision-making.4 A breach of any one diese duties may subject directors to personal liability.5 One of the most well-established corporate governance doctrines is the Business Judgment Rule. The Business Judgment Rule protects directors from liability for decisions made on an informed basis, in good faith, and in the honest belief that the decision is in the best interest of the corporation and its shareholders.6

In Caremark, the Delaware Court of Chancery recognized that:

Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation... only a sustained or systematic failure of the board to exercise oversightsuch 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.7

Thus, the existence of the Business Judgment Rule yields a highly deferential standard. The Rule is process-specific and articulates the manner in which directors approve transactions.

The Rule protects director decisions, even if the decision turns out to be unfavorable. Because derivative suits challenge the propriety of decisions made by directors under their authority,8 "Stockholder plaintiffs must overcome the powerful presumptions of the Business Judgment Rule before they will be permitted to pursue the derivative claim."9 The standard of care against which to measure the manner in which the director performed his duties, is that degree of care that a reasonably prudent person would have exercised under similar circumstances.

A Delaware Supreme Court recently affirmed the Caremark standard, stating that:

Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. …