Director Liability: Myths, Realities, and Prevention

Fiduciary Duty Developments 

Nearly a decade has sped by since the National Association of Corporate Directors (NACD) convened its first Blue Ribbon Commission on Director Liability, and with each passing year directors have seen changes in the legal landscape. Fortunately, however, the fiduciary fundamentals underpinning corporate governance in the United States remain unchanged. For these two equally important reasons, we are pleased to offer an update to this classic guide. 

This 2013 edition gives directors the opportunity to revisit the original report, while alerting them to new developments that may have long-term implications. Our hope is that like the first report, this one will have perennial use. 

This new edition refreshes the text of the main report, and includes additional updates through a new foreword, updated endnotes, and a variety of new appendices. These timely elements highlight several new trends including shifting directors and officers (D&O) insurance claims patterns and more frequent and severe exposure to mergers and acquisitions (M&A) litigation; both are cited as issues in the original edition, but now they appear to have even more importance. 

D&O Insurance Claims Patterns 

Let’s consider claims patterns—the empirical proof of liability exposure. Traditionally, the hierarchy of prevalence in D&O insurance claims starts with stockholders, directly or (via a derivative suit) indirectly, and then moves to employees and finally regulators. This pattern hasn’t changed. But recently there have been some nuances, as reported recently by TowersWatson based on recent surveys of insurance brokers. To summarize some of the main findings: 

• More than 90 percent of mergers valued at over $500 million wind up in litigation. 
• Shareholder lawsuits overall, while still prevalent, have seen a decline. The 10-year trend for claims based on shareholder lawsuits (as a percentage of all claims) has been downward—from 46 percent as of 2011 to 36 percent as of 2012. 
• Derivative shareholder lawsuits are outpacing direct shareholder lawsuits, for both public and private companies. 
• Regulators are being much more aggressive in suing D&O, now comprising 23 percent of all claims, compared to only 16 percent two years earlier. 

Exposure to M&A Litigation  

M&A has always been a source of litigation exposure, as noted in the first edition of this report. Now, the stakes are higher than ever as litigation from M&A suitors or stockholders can stop a deal in its tracks and put directors on the defensive. Litigation centered on M&A activity often attempts to enjoin a transaction, or trigger personal liability for directors and officers, or both. These suits may come from disappointed M&A suitors, from stockholders using a derivative or class action, or from both sources. At recent gatherings of legal minds (e.g., the Tulane Corporate Law Conference in March 2013), the emphasis was clearly on M&A as a source of litigation often involving director liability. Recent developments include: 

• Some settlements or judgments in M&A cases have recently grown to tens and even hundreds of millions of dollars.  
• Even in a nonmonetary settlement, the defendants might become obligated to pay the plaintiffs’ attorneys fees, which can reach into the millions of dollars.  
• An expedited preliminary injunction proceeding before closing the transaction can be extremely expensive to defend because it can often be nearly akin to a full trial based on extensive factual discovery, yet takes place in a relatively short period of time.  
• Plaintiffs’ attorneys now frequently file similar suits in multiple jurisdictions, thereby increasing the directors’ defense costs and creating the risk of inconsistent court rulings, creating a significant problem for directors and the courts.  

On this last point of multijurisdictional litigation, there is a brand new development that has yet to play out—namely, the validation by the Delaware Court of Chancery of director-adopted bylaws requiring that internal corporate governance affairs of Delaware corporations must be brought in courts sitting in Delaware. 

Meanwhile, the Delaware courts have continued to focus on M&A and the role of directors in the sale of companies. Landmark cases include Lyondell Chemical Co. v. Ryan and Koehler v. NetSpend Holdings Inc. —two of several new cases featured in the case appendix (Appendix C) at the back of this report.  

The Global Fiduciary  

Courts are applying their judgments in an increasingly global marketplace. Chancellor Leo Strine of the Delaware Court of Chancery recently noted the emergence of new fiduciary questions for American-listed corporations with operations solely abroad, pondering the obligations of their directors: “What are the duties of those directors to stay apprised of material developments in a language they don’t speak and a political and business culture different from that of the United States?” His instructive answers appear later in this report.  

A Continued Focus on Strategy and Risk  

Clearly, given these trends and others highlighted in this new edition, corporate litigation remains an important issue for directors. At the same time, however, directors should not become overly concerned with their personal liability exposure. Their focus must be on corporate strategy and the assessment of risk. This is one of the reasons for the director protections under state law as discussed in Chapter One.  

We trust that this guide will provide useful guidance for effective directorial service now and in years to come.