Legal Perspective

Director Liability: Be Aware of the Risks
By Mark Hanson & Todd Guerrero | April 01, 2005
The boardroom has changed more in the last four years than in the previous 50. The swift pace of change has a direct effect on directors and their relationship with the board. We've all heard of the Enrons, WorldComs and Disneys, but it is becoming increasingly important that directors at small and mid-cap companies understand the expanding liability issues.

As discussed in the February Legal Perspective, directors need to discharge their duties in good faith and in the best interests of the company. They have the duty of care and loyalty to the company, and are entitled to rely on the business judgment rule in making decisions. A director must also devote the time necessary to govern the business and affairs of the company. Given a director's importance, and his or her responsibility to the company and its shareholders, we wanted to further expand on these issues.

Board authority, director responsibility and liability
The authority to govern the company and make decisions relating to that governance lies solely with the board. The concept is important but frequently misunderstood.
-A director represents the company, not individual shareholders.
-Only the board is authorized to act, not individual directors.
-A director has the responsibility to carry out the duties associated with the position, regardless of how the board proceeds collectively.
-A director has personal liability for not discharging his or her duties in good faith, regardless of how the board acts.

Conflict: director duties, board actions
On certain issues, directors will find themselves at odds with a majority of the board. If there is fraud or illegal activity on the part of management of the board, directors have an obligation to object and have their objections noted. If the action or decision is one of business judgment-where there is no one right answer, which is frequently the case-directors should discuss and analyze the issue until the majority of the board is in agreement. A director must support the governing authority of the board to make business decisions, even though the director may not personally support it. Finally, directors must not undermine the authority of the board by repeating confidential board discussions or business information outside the boardroom.

There may be actions and decisions by the board that the director believes threaten the company. A dissenting director has a duty to present his or her view to the board, have the dissenting views and vote noted in the minutes, and, if the director believes other directors are derelict of their duties, the dissenting director should consider resigning from the board.

The position of director continues to change, with more responsibility and greater potential liability for mistakes. The first issue for a new director is to evaluate the company and the job of being a director. This means the person must:
-Understand the strategic business plans of the company and fundamental structural changes in the company's industry
-Understand the nature and type of the company's competition
-Understand and monitor the company's business plan, management's implementation of the business plan and the operations of the company.
-Review and understand the financial information of the company.
-Act in good faith on each transaction and comply with the law.
-Use good faith reliance on consultants, advisors and management.
-Understand the limits and limitations of liability and indemnification under the company agreement and under applicable director and officer (D&O) insurance policies.

Three primary challenge areas for producer-owned businesses likely will be areas of potential liability: capital, liquidity and enterprise value. Producer-owned businesses are less accustomed to assessing enterprise value, and thinly traded equity interests reflect disparate unit holder and shareholder assessment of value compared to how the market would assess enterprise value. These different views of value are a prime driver in unit holder or shareholder suits and present vexing problems for directors and management.

In summary, directors should carefully evaluate the demands, responsibilities and liabilities that the position requires, understand the limits of D&O insurance, insist on good corporate governance practices and use good faith reliance on consultants, management and advisors.

Mark Hanson and Todd Guerrero are members of the agribusiness and alternative energy practice group of Lindquist & Vennum PLLP, a leading provider of legal assistance on bioenergy projects throughout the country. They can be reached at (612) 371-3211.
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