Both the Delaware General Corporation Law and the Model Business Corporations Act protect corporate directors from liability in situations where the directors take action in good faith reliance on advice provided to them by company officers or competent outside experts. Some bank board directors wonder just how far courts are willing to extend these statutory protections to real world situations.
Delaware GCL § 141(e) provides that a corporate director “shall . . . be fully protected in relying in good faith upon . . . information, opinions, reports or statements presented to the corporation by any of the corporation’s officers or employees . . . or by any other person as to matters the member reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation.” Similarly, Section 8.42(c) of the MCBA — which has been adopted with varying modifications by approximately 24 states — provides that a director is entitled to rely upon, “(1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided; [or] (2) legal counsel, public accountants, or other persons retained by the corporation as to matters involving skills or expertise the director reasonably believes are matters (i) within the particular person’s professional or expert competence or (ii) as to which the particular person merits confidence.”
The protections afforded by these statutes are not without limits; to secure the protections, a director generally must (1) be relying in good faith on the advice given, (2) have a reasonable belief in the professional or expert competence of the person presenting the advice, and (3) in the case of outsiders, have selected such person with reasonable care.
An illustration of a court’s application of the statutory protections to a real-world situation is provided by the authors’ successful defense of a $54 million shareholder derivative lawsuit brought in California against the directors of Nara Bancorp, a Delaware corporation. In that case, to ensure that the bank’s financial results would meet expectations, the bank’s CEO crafted a letter agreement with the bank chairman pursuant to which the CEO agreed to forfeit a profit share due to him in exchange for a promise of future compensation. This earnings-smoothing arrangement was not disclosed to the bank’s board or auditors at the time it was entered, nor was the arrangement reflected in the bank’s SEC filings.
When the arrangement later came to light, the bank’s audit committee commenced an investigation into the circumstances surrounding the letter, and whether the company’s financial statements required revision. The audit committee hired national caliber legal and forensic accounting firms to conduct a thorough investigation. Those advisers ultimately recommended that the company restate its financial statements. Relying on that advice, the board directed the company to issue a restatement, and requested the resignations of the culpable parties.
The dismissed chairman sued his former board colleagues, alleging (among other things) that the board breached their fiduciary duties by hiring the outside advisers to “reach the predetermined conclusion” that a restatement was necessary.
The board defendants successfully won summary judgment at the trial court level, and the Court of Appeal recently affirmed, principally on the ground that the bank board members were protected under Delaware GCL § 141(e). The appellate court held that it was unreasonable to infer that the directors consciously disregarded duties or risks when they made their decision to issue the restatement after hundreds of hours of investigation, after receiving advice from competent professionals and after they followed those professionals’ advice. In one noteworthy passage of the ruling, the Court of Appeal even noted that the Delaware statute provides an even higher level of protection to directors than the business judgment rule.
Be sure to (1) take an active role in carefully selecting outside advisers, and not leave the hiring process to management, and (2) when provided with advice from such advisers, intelligently consider and act on the advice provided in a prudent and good faith manner.
Robert D. Weber is of counsel and Perrie M. Weiner is a partner at the law firm DLA Piper LLP in Los Angeles. Contact Weber at robert.weber(at)dlapiper.com. Contact Weiner at perrie.weiner(at)dlapiper.com.
Copyright (c) March 2012 by BankNews Media