“Flight” may have worked for the Knights of the Round Table when confronted by the Killer Rabbit, but it’s unlikely to be an effective strategy for a board member faced with similarly challenging circumstances. That’s the message from two recent Delaware decisions, one of which features a “citation” by Chancellor Strine to Monty Python and the Holy Grail. These decisions strongly suggest that there may be particular risks associated with a director’s choice to resign during a period of corporate controversy or distress. As such, they may serve as a useful opportunity for corporate counsel to discuss with directors the broader topic of boardroom “exit strategies.”
The two cases are remarkably similar, involving shareholder derivative actions focused on the allegations of bad faith in the context of the board’s compliance oversight obligations. The fact patterns involved somewhat extreme circumstances. Yet the independent board members resigned in protest of legitimate, serious issues—in In re Puda Coal, Inc. Stockholders Litig. it was concern that management was appropriating corporate assets; in Rich v. Chong [PDF] it was concern that management was frustrating an audit committee investigation. In both decisions, the court interpreted the pleadings to state a claim for bad faith. In both decisions, the court observed that the act of resignation by the independent directors did not automatically exonerate them from any potential liability arising from their prior actions. And in both decisions, there was concern that the act of resignation would be tantamount to abandonment under the circumstances.
As Chancellor Strine remarked in Puda Coal:
“I’m not sure that the Monty Python response—and I refer to the scene involving the words ‘run away’ . . . there are some circumstances in which running away . . . in fact involves a breach of fiduciary duty. And I think the extreme consequences here might well constitute one. If these directors are going to eventually testify that at the time they quit they believed the [CEO] had stolen the assets out from under the company, and they did not cause the company to sue or do anything, but they simply quit, I’m not sure that that’s a decision that itself is not a breach of fiduciary duty.”
So dual breach of duty risks are presented: whether liability may arise from the prior alleged acts of the board, and (perhaps surprisingly) whether separate liability may arise from the act of resignation.
That’s not to suggest, of course, that the act of resignation itself carries with it some inherent breach of duty risk. That would be preposterous. Rather, the suggestion is that resignation is not, in and of itself, a “coat of armor” in every circumstance. A director may not be able to avoid liability exposure for actions arising from board service merely by resigning, no matter what prompted the resignation. Furthermore, there maybe certain types of circumstances—so inherently volatile in nature—from which directors may not be expected to retreat, by resignation or otherwise. These are circumstances—be they management, operational, compliance, financial, or personnel related—in which independent directors are expected to make meaningful efforts towards resolution. This is especially when, as in these two cases, the resignations left control of the company to those who were perceived as creating the underlying problem.
Resignations—no matter when they occur and no matter for what reason—can create significant boardroom turmoil. They can elevate internal discord to an extreme, create management unease, deprive the board of the contributions of an experienced director, and make it more difficult to recruit new directors. Courts may well take a “when the going gets tough, the tough get going” analysis when presented with similar fact patterns. So it is worthwhile to consider a boardroom conversation about the various factors that may affect a director’s decision to resign from the board. That conversation is likely to have several components, beginning with an understanding of applicable fiduciary duties. Would the discord or controversy prompting a resignation decision actually serve to heighten legal expectations of board conduct? Directors should also be made aware of any required regulatory or constituent notification of their resignation.
Other important concepts would include the role of the nominating committee in making sure the nominee is aware of what he or she “is getting into” before standing for election. “This is our business; this is our management team; this is our revenue model; here are our significant enterprise risks and opportunities. Questions?”
There is also value in identifying available means for reducing the tensions and concerns that might otherwise prompt a director to resign. These might include improved information flow; the use of executive session practice; access to key officers such as the general counsel, the compliance officer, and the internal auditor; the ability to contact the company’s external advisors; the extent of insurance and indemnification coverage; and the right to engage outside counsel to represent all or a subset of the board—and the circumstances when that can be done at the company’s expense. The goal would be to identify measures that would help directors be part of the solution to board controversy, as opposed to adding to the problem by their resignation.
Board membership is not intended as indentured servitude. A director must always have an “exit option,” whether by retirement, term limits, or resignation. But there may be consequences to an exit option, depending upon the circumstances. Corporate counsel can support informed board service by advising directors on the risks associated with these various options, and in doing so underscore the “special relationship” with the corporation that is at the core of fiduciary duty. Because after all, you never know when you’ll end up in front of a regulator or a judge who’s a Monty Python fan.
Michael W. Peregrine is a partner in the law firm McDermott Will & Emery LLP. He advises corporations, officers, and directors on issues related to corporate governance and fiduciary duties. Mr. Peregrine’s views do not necessarily reflect the views of McDermott Will & Emery or its clients.
