Recent Developments in Director Liability

By Klimko, Justin G. | Business Credit, January 2006 | Go to article overview

Recent Developments in Director Liability


Klimko, Justin G., Business Credit


The last two years have seen significant developments regarding director liability in shareholder lawsuits. Two notable developments have been the erosion of the protection provided by so-called "exculpation" clauses that many corporations include in their charters, and recent settlements requiring directors to pay amounts from their personal funds without indemnification by the company or proceeds from directors and officers liability insurance.

Exculpation Clauses

Beginning in the mid-1980s, many states added provisions to their corporate taws permitting corporations to include in their charters a provision that directors will not be liable to the company or shareholders for monetary damages for breach of certain duties. The most well known of these statutory provisions is Section 102(b)(7) of the Delaware General Corporation law. It provides as follows:

(b) In addition to the matters required to be set forth in the certificate of incorporation by subsection (a) of this section, the certificate of incorporation may also contain any or all of the following matters:

(7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under [section] 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective. All references in this paragraph to a director shall also be deemed to refer (x) to a member of the governing body of a corporation which is not authorized to issue capital stock, and (y) to such other person or persons, if any, who, pursuant to a provision of the certificate of incorporation in accordance with [section] 141(a) of this title, exercise or perform any of the powers or duties otherwise conferred or imposed upon the board of directors by this title.

The Michigan Business Corporation Act also includes a provision of this type, which differs in some significant respects from the Delaware statute. All states require that these provisions can only be included in the corporate charter (articles of incorporation or certificate of incorporation, depending on the state), meaning that shareholders must first approve the provision.

The statutory provisions were added in response to turmoil in the market for directors and officers' liability insurance following decisions, particularly in Delaware, on director liability issues in the light of the feverish takeover activity of the 1980s. One of the most notable of these was the decision of the Delaware Supreme Court in Smith v. Van Gorkom. Prior to that time, directors had generally been found to have breached their duties in corporate control contests only when they sought to resist offers to acquire their companies. In Van Gorkom, directors were found liable for having accepted an offer, one which was at a premium to market.

The following cases have been relevant in this area:

In re Oracle Corp. Derivative Litigation

This shareholder derivative suit claimed that certain officers and directors of the corporation violated their fiduciary duties by participating in insider trading. A special litigation committee was formed to investigate the claims, The committee included two directors who were tenured professors at Stanford University. All special committee members were independent based on the factors by which independence has customarily been measured. The two Stanford faculty members who were directors received no compensation from the corporation other than as directors, neither was an Oracle director at the time of the alleged insider trading; and both offered to return their compensation as committee members if necessary.

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