What's in it for me? Recent trends in litigation and settlement and their impact on outside directors
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Volume 2 Number 2
What’s in it for me? Recent trends in litigation and settlement and their impact on outside directors Anna Erickson White Received: 31st March, 2005 Morrison & Foerster, 755 Page Mill Road, Palo Alto, CA 94304, USA; Tel: +1 650 813 5680; Fax: +1 650 424 0792; E-mail: [email protected]
Anna Erickson White is a Securities Litigation partner in Morrison & Foerster’s Palo Alto office. She has represented public companies and their officers and directors in class actions and derivative suits. She has also conducted internal investigations on behalf of corporate boards. She received her BA in Economics from the University of California at Berkeley in 1985, with honours in her major and her JD degree from Stanford Law School in 1992, graduating with distinction.
ABSTRACT KEYWORDS: D&O insurance, Enron, good faith, indemnification, Securities and Exchange Commission (SEC), WorldCom
International Journal of Disclosure and Governance, Vol. 2, No. 2, 2005, pp. 142–150 Henry Stewart Publications, 1746–6539
Page 142
Traditionally, outside directors have been protected from liability through various legal mechanisms, such as the presumption afforded by the business judgment rule, exculpatory provisions that limited or eliminated their liability, indemnification agreements between the directors and the company, and directors’ and officers’ (D&O) liability insurance. As a practical matter, therefore, it was a rare event for a director to either be found liable or pay damages out of his or her own pocket. Recent court decisions, SEC enforcement actions and settlements involving institutional plaintiffs, however, have chiselled away at each one of these lines of defence. This paper explores those recent events, analyses their true impact on outside director liability and exposure, and suggests ways in which outside directors can protect themselves.
RECENT COURT DECISIONS AND THE DUTY OF GOOD FAITH Under state law, director liability may arise in two distinct situations. First, liability may arise from a board decision that plaintiffs allege was unreasonable or irrational and resulted in loss to the corporation or its shareholders. For example, plaintiffs may challenge a board’s decision to merge with another company, grant a certain compensation package to a chief executive officer (CEO), or make changes in the company’s capital structure. Secondly, and which is more often the case, director liability may arise from a board’s unconsidered failure to act or to monitor the corporation’s operations. Most day-to-day business decisions, after all, are not made by directors, but by officers and employees of the organisation. The first type of cases typically will be reviewed under one of the bedrock principles of corporate law — the presumption of the ‘business judgment rule’. Under this rule, recognising that judges and juries are illequipped to evaluate the content of a board decision, courts will refrain from secondguessing a board, as long as the court determines that ‘there was a good faith effort to be informed and exerc
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