Board Game Settled

CORPORATE BOARD MEMBERS, already under pressure to be more vigilant, now face greater scrutiny because of two recent court decisions. Significantly, the rulings make no distinction between directors of public and private companies when defining levels of loyalty and care.

A federal district judge in New York ruled that the former CEO and chairman and several directors of a bankrupt, privately held company were liable for more than $40 million in damages. [Pereira v. Cogan, No. 00-Civ. 619, S.D.N.Y.] U.S. District Judge Robert W. Sweet found that board members had breached their fiduciary duties by ignoring the CEO's actions when he granted himself a salary increase and favorable loans. The judge also faulted the directors for allowing the CEO to liquidate the company.

In another case, a Delaware state court judge refused to dismiss a suit brought by shareholders of The Walt Disney Co., its board of directors and a former company president. [The Walt Disney Co. Derivative Litigation, Consol. Civ. Action No. 15452.] The suit challenges, among other matters, a board decision to grant former president Michael Ovitz a severance package worth $140 million.

“The facts alleged … suggest that the defendant directors consciously and intentionally disregarded their responsibilities, adopting a ‘we don't care about the risks’ attitude concerning a material corporate decision,” said Delaware Chancery Judge William B. Chandler III. The case now proceeds to the stage in which the parties will seek documents, conduct depositions and prepare for trial.

The lesson for directors within the waste industry and elsewhere is to keep abreast of key activities and developments, particularly concerning officer compensation and the content of financial statements. The time has passed when directors can gather at an upscale resort, skim reports, listen to “rah-rah” speeches by officers and blithely assume that everything is on track. The federal court ruling underscores the risks that directors face by failing to act and overlooking shareholders interests.

In most states, directors are shielded from liability under variations of the so-called “business judgment” rule, which courts have refined and developed over the years. Under the rule, if a company suffers an economic setback stemming from a board decision, the directors may not be liable if they acted in good faith. Until recently, most judges were reluctant to hold officers and directors liable for mismanagement unless they personally benefited from a transaction. Indeed, state laws tended to address gains that resulted from conflicts of interest.

“The decision to impose a very large financial liability on directors and officers who didn't benefit will impair a corporation's ability to find qualified directors and officers and [corporate legal counsel],” says Robert A. Meister, who represented three defendants in the Cogan case. His clients intend to appeal the ruling, he adds.

Joe Goodwin, who heads an Atlanta-based executive search firm, agrees. “People are turning down board positions that they would have taken three to five years ago,” he told The National Law Journal.