While courts wish to protect minority shareholders from high-handed and self-serving board decisions, they're not interested in second-guessing every decision the board makes. If company decision makers had to worry constantly about personal liability, they might avoid risk, which is central to entrepreneurship. That's why courts observe the "business judgment rule," a legal principle designed to protect officers and directors who are just trying to do their jobs. Courts normally assume directors or officers have fulfilled their duty to the corporation if they are reasonably well-informed about the subject of the decision, rationally believe their decision is in the corporation's best interest, and reveal any conflicts of interest.
Consider a case recently decided by the Supreme Court of Connecticut after 10 years of legal wrangling. Two brothers had been in business together since 1938, each owning half of a metal processing company and a business that made aluminum masts and sailboats. As the older brother moved into retirement, their relationship deteriorated. The younger brother refused to separate their business interests and made numerous decisions his brother disliked, including a $1 million outlay to expand a facility when the company's annual income was half that much.
The older brother sued to have the corporations dissolved, alleging gross mismanagement. However, the courts refused to interfere in these decisions because the younger brother had supervised the companies "in a manner consistent with due care." He had consulted experts, made sure the project was completed within budget, and avoided illegal and oppressive conduct.
In addition to the protection offered by the business judgment rule, most states now allow corporations to amend their charters to say that directors violate their duty of care only if they act recklessly or intentionally inflict harm on the corporation. You should check to see whether your corporation has this in its charter.
Also check for the third level of protection: a directors' and officers' (D&O) liability policy. Although expensive, such an insurance policy pays for your legal defense in case of a shareholder lawsuit, plus the judgment if you lose. Don't expect it to cover you, though, if you violated the duty of loyalty. "D&O insurance almost never covers self-dealing," Thompson says. If your company can't afford a D&O policy, try for a written commitment to reimburse directors and officers for litigation over decisions made in good faith. It's usually best to include the commitment in the corporation's bylaws.
Of course, the best defense is staying out of trouble. Some tips:
- Be sure board members have all relevant documents regarding a proposal before the board meeting so they have ample time to review them. At the board meeting, officers should state their views of the impact of the proposed action on the business.
- Make sure each meeting has an agenda and complete minutes to show you gave decisions due consideration.
- If you believe an action is not in the best interest of the corporation, make sure your dissent is noted in the minutes. Those who can prove they dissented are usually off the hook.
Steven C. Bahls, dean of Capital University Law School in Columbus, Ohio, teaches entrepreneurship law. Freelance writer Jane Easter Bahls specializes in business and legal topics.