What is the Liability to You When You Serve as a Director of a Corporation?
Will
a Lawsuit Affect You Personally When you Serve as a Director and Cause
you to Lose Everything?
Which
State Provides the BEST Protection?
Discover
why Nevada has Powerful Protection from
Both "Inside" and "Outside" Liability!
"An
individual director's greatest legal exposure is internal. In contrast
with officers, directors seldom deal with the public. Directors do not
act as agents for the corporation . . . ; [rather], they act as fiduciaries
of the stockholders." Clarence E. Hagglund, Britton D. Weimer &
Joseph P. Monteleone, D & 0: Directors & Officers Liability:
Guide to Risk Exposures and Coverage (The National Underwriter Co.,
1999), at 1. "Directors and officers owe fiduciary duties only to the
corporation and its shareholders, and generally not to creditors or
other third parties. Courts generally have concluded that creditors
and other third parties are entitled only to the protection afforded
by the terms of their contracts with the corporation and, because those
third parties have no direct privity with the directors and officers,
no fiduciary duties are owed to creditors." William E. Knepper &
Dan A. Bailey, Liability of Corporate Officers and Directors,
6th ed. (Lexis Law Publishing, 1998), Vol. 1, § 6-2 at 201-02 (footnote
omitted). Because of this, a director's greatest threat comes
from "inside" liability; that is, from the corporation itself
or the shareholders.
In
Louisiana, a Series of Bad Business Decisions led to Personal Liability
for Five Directors in the amount of $5,798,441!
That
was over $5 MILLION in PERSONAL Liability!
The one
great exception to this is when a "corporation is in the vicinity of
insolvency or approaches bankruptcy. With increasing frequency, courts
have recognized that directors of an insolvent company owe creditors
a fiduciary duty to protect the assets of the company." Id. at
203. See also at 203-05.
Directors
"are not frequently sued, but when they are, the lawsuit often
presents potentially enormous exposure." Hagglund, et
al., supra, at xii. For directors, "the level of interest
in this topic could not be greater since their homes and other personal
assets are literally at risk if perceived wrongdoing occurs[.]"
Id. at xi.
What,
then, protects directors from personal liability? Two things:
Directors
"are not Frequently Sued, but when they are, the Lawsuit often Presents
Potentially Enormous Exposure."
Are
You Willing to Risk Your Personal Assets?
Director
protection statutes "allow corporate articles of incorporation to
include provisions eliminating director liability for . . . breaches
of fiduciary duty." Id. at 7. Delaware was the first state to
create such a statute, in 1986. Dennis J. Block, Nancy E. Barton &
Stephen A. Radin, The Business Judgment Rule: Fiduciary Duties of
Corporate Directors, 5th ed. (Aspen Law & Business, 1998), Vol.
I at 226. Currently, 35 states have such laws. These are
Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware,
Georgia, Hawaii, Idaho, Iowa, Kansas, Louisiana, Maryland, Massachusetts,
Michigan, Minnesota, Mississippi, Montana, Nebraska, New Hampshire,
New Jersey, New Mexico, New York, North Carolina, Oklahoma, Oregon,
Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Vermont,
Washington, and Wyoming. Hagglund, et al., supra, at 7.
Seven
states have adopted statutes which heighten "the standard
of culpability for directors of all corporations chartered in those
states." Block, et al., supra, at 238. The seven
states are Florida, Indiana, Kentucky, Maine, Nevada, Utah, and Virginia.
Id. at 238-40. Under these states' laws, directors are protected
even in the absence of an article provision eliminating such liability,
and the corporation cannot override the protection. Ohio, Pennsylvania,
and Wisconsin have similar statutes, but allow the corporation to "opt-out"
of the statutory standard. Id. at 240. Be careful that you
don’t "opt-out" to a state with less protection!
All director
protection statutes have different approaches. See id.
at 226-42. Delaware's, for example, protects directors
from breaches of the duty of care, but not for a breach of the duty
of loyalty, or for acts not in good faith. See Emerald
Partners v. Berlin, 787 A.2d 85 (Del. 2001). In those states which
have heightened standards of culpability, the protection for directors
is superior. In Nevada, for example, no director is liable
to the corporation or its stockholders unless his breach of fiduciary
duties involves "intentional misconduct, fraud or a knowing violation
of law." Nevada Revised Statutes (NRS) 78.138(7). This is a very
high standard.
In the
10 states which have heightened the standards of director culpability
by law, the absence of a provision in the corporate articles is not
a concern. In the rest of the states, it is a great concern,
since the only protection left is the business judgment rule.
"The
business judgment rule is a standard of judicial review for director
conduct, not a standard of conduct. The rule presumes that business
decisions are made by disinterested and independent directors on an
informed basis and with a good faith belief that the decision will serve
the best interests of the corporation." Block, et al.,
supra, at 4-5. The rule is currently recognized in 23 states
and in Washington, D.C. The states are Alabama, Arizona, California,
Connecticut, Delaware, Florida, Illinois, Iowa, Maine, Maryland, Michigan,
Minnesota, Missouri, Nevada, New Jersey, New York, Ohio, Oklahoma, Pennsylvania,
Rhode Island, Tennessee, Texas, and Wisconsin. Hagglund, et al.,
supra, at 4-5.
These states,
for the most part, recognize an exception to the rule for acts of "gross
negligence" or recklessness. Id. at 5. (Some only require
simple negligence. See, e. g., FDIC v. Raffa, 882
F. Supp. 1236 (D. Conn. 1995); Resolution Trust Corp. v. Rahn,
854 F. Supp. 480 (W. D. Mich. 1994)). While "gross negligence" is
a fairly high standard, if it is met a director is liable personally
for his act or omission. See, e.q., FDIC v. Bierman,
2 F.3d 1424 (7th Cir. 1993); Francis v. United Jersey Bank, 87 N. J.
15, 432 A.2d 814 (1981); Hoye v. Meek, 795 F.2d 893 (10th Cir.
1986).
In the
other 27 states which do not recognize the business judgment rule, the
standard of liability is simple negligence. This is a very
low standard to meet, and when it is, personal liability
will follow. See Theriot v. Bourg, 691 So.2d 213 (La.
App.), writ denied, 696 So.2d 1008 (La. 1997)(a series
of bad business decisions led to personal liability
for five directors in the amount of $5,798,441).
In
the other 27 States which do not Recognize the Business Judgment Rule,
the Standard of Liability is Simple Negligence.
Of course,
the "business judgment rule protects [only] good faith mistakes, not
intentional harm to the corporation. Thus, directors are subject to
personal liability when they engage in fraud or other bad faith conduct."
Hagglund, et al., supra, at 6.
In
Nevada, no Director "is Individually Liable for a Debt or Liability
of the Corporation, unless the . . . Director . . . Acts as the
Alter Ego of the Corporation."
As can
be seen, a state with automatic director protection, such as Nevada,
has much greater protection for directors than does a state which requires
an affirmative act in the articles of incorporation in order to provide
some director protection or, in the absence of such a provision, relies
on the "gross" or simple negligence standard. And, in those rare cases
in which a director faces "outside" liability (such as when the corporation
is approaching bankruptcy), the standards in these states remain the
same. However, in Nevada, no director "is individually liable for
a debt or liability of the corporation, unless the . . . director .
. . acts as the alter ego of the corporation." NRS 78.747(1) (effective
June 15, 2001). In other words, whereas other states find that a director
has fiduciary duties to creditors when a corporation approaches insolvency,
Nevada protects directors unless the standards for piercing the
corporate veil are met. NRS 78.747(2). And, in Nevada, it is quite difficult
to meet this standard.
Nevada
Protects Directors Unless the Standards for Piercing the Corporate Veil
are Met-the Highest Level of Protection!
"Undercapitalization
coupled with mere instrumentality is not enough to pierce the corporate
veil in Nevada-- it must be coupled with a sham to perpetrate a
fraud." David Mace Roberts & Rob Pivnick, "Tale of the Corporate
Tape: Delaware, Nevada and Texas," 52 Baylor L. Rev. 45, 62 (2000)(citing
Paul Steelman, Ltd. v. Omni Realty Partners, 885 P.2d 549 (Nev.
1994); Rowland v. Lepire, 662 P.2d 1332 (Nev. 1983)).
To this
end, only two veil piercings in Nevada have been
upheld since 1980. See Polaris Indus. Corp. v. Kaplan,
747 P.2d 884 (Nev. 1987); Lorenz v Beltio, Ltd., 963 P.2d 488
(Nev. 1998).
Nevada
Provides Tremendous Protection for Directors from "Inside" Liability,
and even GREATER Protection
from
"Outside" Liability!
The best
protection outside of the statutes and rules discussed above is
insurance for corporate directors and officers. Such insurance
policies have "evolved over the last 20 years from a virtually unknown
and rare insurance product to an essential and highly visible policy
within a corporation's insurance portfolio." Hagglund, et al.,
supra, at xi. Such policies are highly technical and cover
"potentially catastrophic exposures for important decision makers[.]"
Id. As such, corporations should turn only to very knowledgeable persons
when seeking such protection. Id. (For the best presentation
in print of all of the potential issues involved in this endeavor, see
id. chapters 614, at 69-176.)
While such
insurance can provide some protection for corporate directors, the benefit
in any particular case will depend upon the unique situation of a particular
corporation. There also exists cost and coverage issues, as well
as a myriad of other factors. See id.
Incorporation
in a State with Statutorily-Created High Standards for Corporate Director
Liability, such as Nevada
To lessen
the worries, incorporation in a state with statutorily-created high
standards for corporate director liability, such as Nevada, can
be quite advantageous. Nevada provides tremendous protection for directors
from "inside" liability, and even greater protection from "outside"
liability. And, since all Nevada corporations enjoy these protections
as a matter of law, there is no added cost for director protection.
Nevada,
for most people, offers more benefits for incorporating!
You
are welcome to call our office directly for a FREE consultation at (888)
466-7566.
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