The Supreme Court of Delaware announced its much anticipated decision in Lyondell Chemical Company v. Ryan, C.A. 3176 (Del. Mar. 25, 2009) concerning whether the independent directors of a target company’s board were entitled to summary judgment on claims that they failed to act in good faith in conducting the sale of their company. 

The Court of Chancery had denied summary judgment in order to obtain a more complete record before determining whether the directors had acted in bad faith. The Supreme Court reversed that decision and remanded the matter for entry of judgment in favor of the Lyondell directors. In doing so, the Supreme Court held the trial court reviewed the existing record before it under a mistaken view of the applicable law. The Supreme Court indicated that three factors contributed to the trial court’s mistake.

“First, the trial court imposed Revlon duties on the Lyondell directors before they either had decided to sell, or before the sale had become inevitable. Second, the court read Revlon and its progeny as creating a set of requirements that must be satisfied during the sale process. Third, the trial court equated an arguably imperfect attempt to carry out Revlon duties with a knowing disregard of one’s duties that constitute bad faith.” 

It is important to recall from our posting on the trial court’s decision in Lyondell that the offer the board accepted, and forwarded on to shareholders for approval, included:

• A 45% premium over the company’s stock price; 
• 3% break-up fee; 
• A “no-shop” clause (with typical “fiduciary out” language and matching rights for the acquirer); and 
• A fairness opinion 

Yet the trial court was troubled by “the Board’s decision to grant considerable protection to a deal that may not have been adequately vetted under Revlon.”

However, the Supreme Court in its decision confirms that Revlon duties do not arise simply because a company was “in play” and could be potentially acquired. The duty to seek the best available price, under Revlon, applies only when a company “embarks on a transaction – on its own initiative or in response to an unsolicited off – that will result in a change of control.” Additionally, the Supreme Court held that there is only one Revlon duty- to “[get]the best price for the stockholders at a sale of the company.” And, that “[n]o court can tell directors exactly how to accomplish that goal, because they will be facing a unique combination of circumstances, many of which will be outside their control.” 

The foundation of the Supreme Court’s decision was its focus on the effect of the exculpatory provision in Lyondell’s charter precluding director liability for duty of care claims, which allows for only duty of loyalty claims for failure to act in good faith and requires a fiduciary to intentionally fail “to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.” The decision is clear that any question about whether directors should have done something differently or more is not sufficient to create post-transaction personal liability. “Directors’ decisions must be reasonable, not perfect. ‘In the transactional context, [an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties.’ . . . Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty.”

In overturning the trial court’s decision, the Supreme Court has shown that disinterested, independent directors will not be exposed to personal liability in responding to acquisition offers and affirming the board’s discretion in managing a sales process. 

The Delaware Supreme Court’s decision can be read here.

Whether warranted or not, commentators and the media continue to place the blame for the financial meltdown at the top of the organizations -- the board of directors. Given the outrage over the AIG bonuses last week, it is no surprise that commentators are again pointing at the board.

“People say that the definition of insanity is doing the same thing over again and expecting a different result. In this case, insanity is allowing the same people to continue to serve on the board after massive failure and expecting them to produce a different result.” 

-Nell Minow

Nell Minow, editor and chairwoman of the Corporate Library, continues to put the boards of directors in the cross-hairs for their actions, or, in her opinion, lack of action that were the failures of strategy and risk management in the troubled companies at the forefront of the financial meltdown. 

In her latest commentary, Nell Minnow addresses why she believes AIG’s board is to blame for the bonuses at AIG and discusses the risks of “overboarding.”

This commentary is available here.

While Washington and the media continue to criticize and analyze the make-up of the boards of those corporations at the heart of the financial crisis and the apparent lack of oversight, the Delaware Chancery Court has taken a step in the other direction. 

In Re Citigroup, Inc., Shareholder Derivative Litigation, No. 3338-CC (Feb. 24, 2009), the plaintiffs brought suit essentially alleging that the directors had breached their fiduciary duties by failing to properly monitor and manage the business risks that Citigroup faced from the sub-prime crisis and by ignoring “red flags” appearing in press reports and news events of the worsening conditions in the sub-prime markets and credit markets.

In its first detailed analysis of potential liability of directors under Delaware law for claims relating to a company’s losses resulting from a substantial exposure to sub-prime debt, the Court dismissed the claims on the grounds of failure to adequately plead demand futility. In doing so, the Court stated, “oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk.” And that “[t]o impose liability on directors for ‘making’ business decisions would cripple their ability to earn returns for investors by taking business risks. Indeed, this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a . . . [duty of oversight] theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.” 

The decision reaffirmed and clarified several key protections for directors established by the Caremark decision, with respect to oversight responsibilities. 

1. Plaintiff’s face “an extremely high burden” in bringing a claim for personal director liability for a failure to monitor business risk;
     
2. While directors could be liable for a failure of board oversight, “only a sustained systematic failure of the board to exercise oversight- such as an utter failure to attempt to assure a reasonable information and reporting system exists- will establish the lack of good faith that is a necessary condition to liability;” and
     
3. Bad business decisions, absent fraud or illegality, are not evidence of the bad faith necessary to establish oversight liability. But there is an important distinction between oversight liability with respect to business risk and oversight responsibility with respect to illegal conduct.

The Chancery Court has clarified that for directors to be personally liable for a failure in oversight the failure must be more than a failure to correctly predict the future failure or evaluate business risk. “To establish oversight liability a plaintiff must show that the directors knew they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act.” And Catastrophic business losses do not amount to bad faith—at least not according to the Chancery Court in this case.

Often, the most ignored governing documents for any organization with a governing board are the committee charters. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. 

A charter not only protects non-committee members from liability but also imposes that liability on the committee members. For directors, one of the most important protections from liability is the state-law right of reliance of directors upon committees of directors of which they are not members. 

However, a director may rely upon a committee only for matters within the committee's designated authority for which the director reasonably believes merits confidence. The committee to which such authority is delegated has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, and not opposed to, the best interest of the organization. 

Accordingly, committee charters should be in writing. More importantly, these charters should be periodically reviewed and discussed by directors. At a minimum, committee charters should be reviewed annually by the board. Therefore, care should be taken in reviewing, discussing and drafting any committee charter to balance both: 

1. the interest of non-committee members to be protected from liability for the matters delegated; and 
2. the competing interest of committee members not to be subjected to unreasonable risk of liability. 

Someone familiar with the legal rights and obligations of directors should lead the review and discussion of charters. This is often a regular function of a governance committee (which if not a standing committee is typically part of an organization's nominating committee). An organization and its individual directors should review the charters of committees with the following questions in mind: 

Is the legal nature (i.e., executive, oversight, recommendation or advisory) of the committee clear from the writing or charter? 

Each committee charter should establish the committee's legal nature or type, which is often in a purpose clause. Committees may be executive, oversight or recommendation. The most common of the three being oversight. 

• An executive committee has all authority to act on behalf of the board during intervals between meetings of the board. For the charter of an executive committee, typical language in a purpose or similar clause would read, "the executive committee will have and exercise the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board." Typically, any action or authorization by an executive committee is to be effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs. Executive committees are very common in nonprofit organizations but less common in publicly-held and privately-held for profit corporations. 

• An oversight committee, such as the audit, compensation or nominating/governance committee, generally "carries out" all authority of the board with respect to their matters of responsibility. The carry-out oversight committee is the result of the Sarbanes-Oxley Act and subsequently SEC, NYSE and Nasdaq rules requiring that oversight of the financial statement preparation and audit process and of executive compensation be by a committee composed of, or otherwise by, independent directors. For the charter of a carry-out oversight committee, typical language in a purpose or similar clause would read, "the audit committee will carry out the board's oversight responsibilities for the integrity of the organization's financial statements and reports." As a result, the actions of these two committees are effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs by not less than majority vote of those directors having no financial or personal interest in such matter. 

• A recommendation committee assists the board in reviewing certain matters but only makes recommendations to the board as to appropriate action. For the charter of a recommendation committee, typical language in a purpose or similar clause would read "the committee will assist the board by reviewing ... and recommending some action for the board's consideration." Accordingly, any act of the committee is not the act or authorization of the board unless the board affirmatively approves or authorizes such action. 

• An advisory committee is not a statutory committee of the board but only advisory to it. 

If the committee is properly composed, the right of reliance entitles non-committee directors to rely upon an executive, oversight or recommendation committee, but not an advisory committee because advisory committees are not statutory. 

Is it clear who the committee's voting members are, and, if so, are they directors? 

Under most states' laws, directors are entitled to rely upon committees only if the committee is composed of directors. This does not mean there cannot be non-voting members of committees, such as non-director officers, but only those members who are directors may have the right to vote. Voting members, accordingly, must have all rights to receive notice, attend, present and consider matters, vote and otherwise participate in any proceedings of the committee. Non-voting members can be entitled to be present in person, to present matters for consideration and to take part in consideration of any business by the committee at any meeting of the committee, but non-voting members cannot be counted for purposes of a quorum nor for purposes of voting or otherwise in any way for purposes of authorizing any act or other transaction of business by such committee. 

Is it clear who can call meetings, what notice is required, how meetings can be held, and what constitutes actions of the committee? 

Although not legally required, it is recommended that each committee's charter contain provisions as to how it conducts its proceedings, such as who can call meetings, the notice requirements for meeting and how meetings can be held (including written consents in lieu of meetings), etc. 

Are specific responsibilities of the committee stated, and, if so, do the stated responsibilities reflect the balance of both (I) the interest of noncommittee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability? 

The most important provisions of a committee's charter are the committee's responsibilities. These should be written in terms of what is expected of the committee keeping in mind the balance of both (I) the interest of non-committee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability. 

An example of responsibilities of an executive committee include: transacting all of the business of the organization and exercising the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board. 

An example of responsibilities of a "carry-out" oversight committee, such as an audit committee, include: carrying out the board's oversight responsibilities for the integrity of the organization's financial statements and reports, including (I) retaining and terminating the organization's public accounting firm responsible for auditing and providing an audit report on the organization's financial statements; and (2) approving the scope of all auditing services and the compensation and other terms of engagement of the external auditor. 

An example of responsibilities of a recommendation committee, such as a finance committee, include: periodically before each fiscal year or other appropriate period review making changes in proposed operating and capital budgets of the organization and recommending to the board adoption of those budgets for such period. 

Is it clear whether the committee has authority to have, at the organization's expense, independent advisors? 

One of the most important authorities of any oversight committee is the right to retain, at the organization's expense, such independent counsel or other advisors as it deems appropriate. This is particularly important for "carry-out" oversight committees. Typically, this may not be an express authority of an executive or recommendation committee and is infrequently an express authority of an advisory committee. 

Is the committee required to evaluate itself, its composition, the performance of its members and the provisions of its charter? 

Self-evaluations by the committee of its proceedings, as well as the skills and experience of its members, are important to the governance of not only the committee but also the board and the organization itself. Typically, a committee should conduct a periodic evaluation of the provisions of its charter, its performance under those provisions and each committee member's contribution to the committee's performance. 

How can the charter be amended? 

Finally, each committee charter is a governing document of the board as a whole, and it may not be amended except by the board. Accordingly, any considerations of the board in its self evaluation become recommendations to the board. The board may defer to such recommendations for consideration of a governance committee. 

Evaluating and answering these questions at the beginning of each year will ensure that all committee charters are current and properly structured. Further, such a review will ensure that all directors are aware of the authority that is delegated to each committee and to understand whether he or she may rely on that committee for an a particular issue that the board is facing.

With a new year upon us, it is incumbent on all boards to step back, take a critical look and assess their structure, composition, committee charters and past performance and determine whether the board is prepared for the current challenges and the challenges and risks associated with its organization's strategic plans. 

This year, we will address the topics below in a series of articles all with the goal of creating the best possible board for your organization. 

• Annual review of the Roles and Responsibilities of board committees and committee charters 
• Board best practices audit 
• Board evaluations and individual director evaluations
• Board succession planning; and 
• Board education/training. 

For any organization to be successful it must commit to improvement. To improve, an organization must look at its current practices and make changes where necessary. This includes changes to the board's composition and practices. While some boards may be instilling new members this year through election or to fill a vacancy, the majority of the directors on your board today are your organization's team that will lead it over the next year. To get the most out of this team your organization should consider the following: 

Annual Review of the Roles and Responsibilities of Board Committees and Committee Charters

All organizations need to review their committee charters, annually at minimum, to ensure that such committees have the requisite authority necessary to complete their delegated tasks and additionally to ensure that such committees do not have authority greater than what the full board desires to grant. Committee charters are often the most ignored governing document for any organization. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. 

A charter not only protects non-committee members from liability but also imposes that liability on the committee members. For directors, state law allows them to rely upon a committee of directors of which they are not members. However, a director may rely upon a committee only for matters within the committee's designated authority and the committee has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, and not opposed to, the best interest of the organization. Thus, it is imperative that the authority of a specific committee is properly and clearly designated in its charter. 

Best Practices Audit 

Most organizations, either by choice or regulation, have their financial statements audited on an annual basis. However, very few conduct an audit, either formal or informal, of their corporate governance practices. An annual audit of governance practices goes a long way in creating a productive board. 

Board Evaluations/Individual Director Evaluations

"If you want one year of prosperity, grow grain

If you want ten years of prosperity, grow trees

If you want one hundred years of prosperity, grow people" 

Boards must strive for commitment to excellence in their corporate governance and not just adhering to minimum standards prescribed by law. This requires a goal of continuous improvement. Similar to evaluating the organization's chief executive officer and management for the organization's performance, the board must evaluate itself to constantly improve. A yearly board evaluation will allow an organization to: 

• Check progress against mission and goals 
• Give directors a meaningful measure of accountability 
• Allow for a check of strengths and weaknesses 
• Emphasize the accomplishments of the board 
• Provide a yardstick with which the goals of the coming year can be measured
• Encourage team work approach to decision making; and 
• Give a feeling of accomplishment 

Board Composition/Succession Planning 

Succession is critical to the life of any organization, and as such, one of a board's most important responsibilities is succession of management and the board. A good succession plan helps to prevent staleness on the board. Preventing staleness or "institutionalization" of thought on the board is in the best interests of the company. However, adding directors with fresh or non-institutional thoughts comes with a price, whether accomplished through traditional approaches such as term limits or age restrictions or by involving the board in making itself an "expertise" board. Getting your board to buy into a succession plan helps create a multi-generational board that is future oriented and prepared of emergency absences.

Board Education/Training 

"A board's effectiveness depends on the competency and commitment of its individual members, their understanding of the role of a fiduciary and their ability to work together as a group [including] an understanding of the fiduciary role and the basic principles that position directors to fulfill their responsibilities of care, loyalty, and good faith." See "III. Director Competency & Commitment" of the "NACD Key Agreed Principles."  Boards will be measured by their least common denominator, so it is important that all members are knowledgeable not only with the policies and governance of the organization but also educated on how to be better directors. Such education sessions can be reserved for one or two day board retreats or part of a board's regularly scheduled meetings. Either way, it is important that all boards know what it means to be a board and how to fulfill their duties as board members. 

Commitment to continuous improvement requires work.  Committing to accomplishing any of the above five topics, if not all, will lead to improvement with your board. In turn such commitment adds to the growth and performance of the board's organization.

Today, nonprofit corporations are saddled with a changing governance environment that brings with it a need to examine current board practices and consider new ones. These changes in expectations for nonprofit boards have been prompted, in part, by the new Form 990 but also by the economic crisis fueled by the host of for-profit meltdowns of AIG, Lehman Brothers, Freddie Mac, Fannie Mae and others this past year. 

While the economic crisis was not driven by nonprofit companies, it will impact corporate governance of all organizations. This crisis has generated discussion and rumored regulation, and it requires nonprofit boards to adopt new practices. The evolving changes in today's governance best practices - and the way nonprofits should respond - are critical to the health and sustainability of the organization. 

Wall Street has shattered the public trust and confidence in the for-profit world, and retaining the public trust and confidence in charitable organizations and nonprofits is critical to accomplishing their missions. However, without shareholders, nonprofits are missing the built-in accountability of the for-profit world, which means that the boards and executive directors of nonprofits must play the role of watchdog to ensure that the public trust and confidence is maintained and to do their part to resurrect corporate America without increased regulation. 

To do so, it is incumbent on all boards to take a step back, take a critical look and assess their structure, composition, committee charters and past performance and determine whether they are prepared for the current challenges and risks to the organizations. 

As we embark on what will certainly be an uncertain year, nonprofit boards should consider taking the following steps to maintain the public's trust and confidence in their organizations and to act before the government can react: 

• Board Education. Boards should begin with educating their members to be better directors, to become more familiar with the risks to their organizations, to be more aware of the strengths and weaknesses of the members of management and to learn how to hold management accountable for information being provided.

• Assess Current Board Experience and Add Directors with Needed Experience, Skills and Expertise. Boards should assess and create a database inventorying the experience, skills and expertise of their current members. That database expertise should be reviewed periodically to evaluate whether the correct mix is represented by the current members of the board. The goal of the organization should be to create an "expertised board" composed of persons each having particular experience, skills or expertise needed for the board to have as a whole.

• Access to Independent Advisors Who Can Provide Necessary Counsel. Because it takes time to constitute a board composed of the appropriate mix of experience, skills and expertise, a board should require that it be given access to independent advisors having the experience, skills and expertise to counsel the board. This requires a board to first have access to a database of such advisors and then to have the resources to retain those advisors to counsel the board. This is important because it is likely that boards will be judged by state attorney generals, regulators, donors and eventually courts by the least experienced, least skilled or least knowledgeable of its members unless such members have access to such counsel. 

• Coaching on Asking Questions. Boards should periodically receive coaching or training on how to ask questions, including: the purposes for which they should be asking questions; the extent to which they should ask questions; when they should accept answers and stop asking questions; and when they need to explore more deeply. This should be considered on a matter-by-matter basis for issues a director identifies that may need the help of an independent advisor. It also should be considered periodically as part of the board's continuing education process. 

• Authorize a Standing Committee to Oversee Enterprise Risks. Boards should delegate to a standing committee, or constitute a new standing committee with authority on behalf of the board to investigate, assess and take appropriate action with respect to risks of the organization's enterprise. To facilitate the exercise of this authority, a board should require the organization's management, including each of its executive officers, to report such risks to this oversight committee and to meet at least annually with the committee in executive session.

• Annual Review of the Roles and Responsibilities of Board Committees and Committee Charters. All organizations need to review their committee charters to ensure that such committees have the requisite authority necessary to complete its delegated tasks and additionally to ensure that such committees do not have authority greater than what the full board desires to grant Committee charters are often the most ignored governing document for any organization. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. A charter not only protects non-committee members from liability, but also imposes that liability on the committee members. For directors, state law allows them to rely upon a committee of directors of which they are not members. However, a director may rely upon a committee only for matters within the committee's designated authority and the committee has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, or not opposed to, the best interest of the organization. Thus, it is imperative that the authority of a specific committee is properly and clearly designated in its charter. 

• Best Practices Audit. Most organizations have their financial statements audited on a yearly basis. However, very few conduct an audit, either formal or informal, of its corporate governance practices. A yearly audit of governance practices goes a long way in creating a productive board and ensuring your board is operating effectively. 

• Board Evaluations/Individual Director Evaluations. Boards must strive for commitment to excellence in corporate governance and not just adhering to minimum standards prescribed by law. This is especially true in today's environment and requires a goal of continuous improvement. Similar to evaluating the organization's chief executive officer, executive director and management for the organization's performance, the board must evaluate itself to constantly improve. A yearly board evaluation will allow an organization to: 

• Check progress against mission and goals Give directors a meaningful measure of accountability 
• Allow for a check of strengths and weaknesses 
• Emphasize the accomplishments of the board 
• Provide a yardstick with which the goals of the coming year can be measured; 
• Encourage teamwork approach to decision making; and 
• Give a feeling of accomplishment 

• Board Composition/Succession Planning. Succession is critical to the life of any organization. As such, one of a board's most important responsibilities is succession of management and the board. A good succession plan helps to prevent staleness on the board. Preventing staleness or "institutionalization" of thought on the board is in the best interests of the organization and its mission. However, adding directors with fresh or non-institutional thoughts comes with a price, whether accomplished through traditional approaches such as term limits or age restrictions or by involving the board in making itself an "expertise" board. Getting your board to buy into a succession plan helps create a multi-generational board that is future oriented and prepared for emergency absences. 

• Update your Organization's Conflict of Interest Policy and Disclosure Process. All nonprofit organizations need to have a well defined conflict of interest policy and disclosure process. A failure in an organization's conflict of interest policy will have an immediate impact on public confidence of any organization in addition to exposing the board to potential liability. 

• Review Executive Compensation. Review and, where appropriate, revise executive incentive compensation arrangements to ensure that they do not encourage executives and others in management to take unnecessary and excessive risks that threaten the value and mission of their organizations. 

What's Next?

Regardless of the cause, the melt down of the for-profit world will directly impact how directors of nonprofit organizations must think, evaluate and make decisions. Whether viewed as an overdue wake-up call or an unfair impugning of the nonprofit director's integrity as a result of the actions of the for-profits, it is important that all directors of nonprofit organizations understand the increased scrutiny on boards and the need for the boards to understand the risks of the organization. This includes understanding and recognizing the state of the environment the organization is operating. The economic crisis is going to have an effect on many organizations that are not interested in making a profit for private inurement. Nonprofits rely on corporate and private donations and interest income from their endowments for programs, operational support and long term sustainability, To maintain and to continue to receive this financial support in these challenging times, organizations need to strive to maintain the public trust and confidence in their operations, financial risk management and direction. 

Directors need to become risk smarter. They need to broaden their view of risk and not limit discussions or analysis only to specific areas of risk This will require directors to evaluate the role of the boards overseeing that there is adequate risk assessment and make changes where appropriate. As the watchdogs for the organization, directors must realize not only that they remain the first and best line of defense against mismanagement and fraud but also that they can be the best line of offense for good management and best practices.

As the new year begins the United States and the world remain saddled with an economic crisis that has not been witnessed in decades. 

A new administration in Washington takes over today, and there still exists uncertainty in how this administration, or Congress, will act to address this crisis in what commentators, and politicians, scream was a failure at the board level to understand and assess the risks of the organization and the boards failure to independently assess management of the organizations. Rumors abound speak of the Democratic Senate considering a bill to federalize fiduciary duties and impose a standard to act with the care that a prudent person acting in a like capacity and familiar with such matters would use -similar to the ERISA standard- as opposed to the state law ordinarily prudent person in a like position would use under similar circumstances. Yet to date we wait to see what the formal response will be.

As a result of the economic crisis, boards of directors will need to respond to unknown challenges and pressures. Boards need to review their past actions in monitoring performance, compliance and risk management—and understand the role they must play going forward. The risk oversight role of the board has never been more critical and challenging than it is today.

In reviewing their role in overseeing risk to the organization, boards need to understand the changes that are likely coming, either through the courts applying new standards or interpreting existing ones, that will directly impact how these boards perform their functions and fulfill their fiduciary duties and likely increase board responsibility for risk management. While the current standard for director liability, established in Delaware by the Caremark case, requires that directors act as reasonably prudent person in a like or similar situation and provides the protection of the business judgment rule, if rumors are true there is real possibility that, as a result of the current economic crisis, boards will need to change how they act. Boards’ decisions will be in the crosshairs and will provide courts with repeated occasions to second-guess board decisions. 

The only certainty going forward is uncertainty. Uncertainty as to the when the recession will end, when the liquidity markets will thaw, when things will return to “normal”—whatever that is. 

One thing that we can be certain of is that there will be some kind of regulatory response to the economic crisis: just as the federal government reacted to the market crash of 1929 with the 33’ and 34’ Acts, just as the federal government reacted to expansion of United States businesses into foreign countries with the Foreign Corrupt Practices Act, and just as the federal government reacted to the Enron and WorldCom scandals with the Sarbanes-Oxley Act. Yes- there will be a regulatory response. But again there is uncertainty as to what the end product will look like. Boards need to be proactive in addressing new risks and new challenges this year will bring. By doing so Boards will be well prepared to handle and adjust to whatever regulatory response comes out of Washington.

AIG, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Bros. et al. are the result of a fundamental flaw in governance of corporate America: Failure to provide independent oversight of management in the governance of these organizations. Management failed to assess, and boards failed to understand, the enterprise risks to these organizations in the debt and investment decisions made by management.

The likely reaction of the President and Congress after this November’s election will be to provide oversight through government regulation. To avert such regulation, corporate America needs to act quickly in correcting its governance.

The best defense against corporate mismanagement remains (1) independent oversight of management by independent directors (2) with counsel of independent advisers and (3) holding management accountable for the information provided:

(1) Independent directors know more about, and are closer to, the businesses of their organizations, and can take corrective action more quickly and knowledgeably, than any government official or agency.

(2) However, these directors need counsel of independent advisers who have not participated with or advised management. Part of the governance failure of AIG, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Bros. et al. is that their boards did not have an understandable assessment by independent advisers of the debt and investment risks being incurred by management and their advisers. The company counsel and other advisers to AIG, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Bros. et al. could not, because of their participation, provide independent counsel needed by the boards.

(3) A board is only entitled to rely upon management for matters that the board reasonably believes management is reliable and competent. Determining reliability and competence requires a board to ask questions. Not just once, but repeatedly and of different constituencies of management, sometime separately with each in executive session. Management must be held accountable for their answers because without reliable and complete information, governance will fail.

A likely reaction to the failure in governance will be a federal codification to increase the duty of each director from that of an ordinarily prudent person which is the standard under most states’ corporation laws to that of a prudent expert with knowledge of the enterprise which is the standard under ERISA. Doing so will likely have adverse impact on governance because it will discourage knowledgeable independent people from assuming the resulting increased risk of being independent directors.

The solution is for boards to act before the government can react. In so acting, boards should begin with educating their members to be better directors, to become more familiar with the risks to the enterprise of their organizations, to be more aware of the strengths and weaknesses of the members of management, and to learn how to hold management accountable for the information being provided. Boards should do so with counsel of independent advisers who have not participated in advising management. And boards should hold management accountable for the reliability and completeness of the information being provided.

Only then will investors regain faith in corporate America. Only then can corporate America avert oversight by government regulation.

The Delaware Courts have made another strong statement this year in regards to potential director liability. While earlier this year, Delaware took a stance regarding advancement of indemnification for former directors, the Chancery Court recently denied summary judgment to a group of independent directors due to a limited record of the board’s process in evaluating an acquisition offer. In doing so, the Court found that independent directors, acting without conflict, could potentially be personally liable for approving a premium cash offer, with standard deal protections, which was supported by stockholders.

In Ryan v. Lyondell Chemical Co., the Delaware Chancery Court denied summary judgment for the independent directors of Lyondell Chemical Company for breach of fiduciary duties under Revlon regarding the board’s actions during the sale process.

While there are some highlights to address, this blog post cannot provide an adequate summary of the 72 page opinion and the specific facts in the transaction at issue. We will provide a more in-depth summary in the next Acredula newsletter. 

Of particular importance, the offer that was accepted by the Board and Shareholders of Lyondell included:

• A 45% premium over the company’s stock price;
• 3% break-up fee;
• A “no-shop” clause ( with typical “fiduciary out” language and matching rights for the acquirer); and 
• A fairness opinion 

Yet, still the Court questioned the board’s knowledge and efforts to comply with its Revlon duties, even though it found that the board was “active, sophisticated and generally aware of the value of the Company.” Similarly, although the Court found the deal protections to be “typical,” it was not satisfied that the board’s acceptance of the protections was justified by the record.

While this was not a decision after a trial on the merits, there are some key lessons that directors should take away from this opinion to avoid personal liability, as this decision will serve as an invitation to plaintiff’s to seek post-merger litigation and higher settlements where the record is less than perfect:

1. When considering an acquisition, boards should avoid delegating the entire negotiation process to management and should instruct those, outside of the board involved in the process, to keep the board informed of all material contacts and discussion with potential acquirers.
    
2. Absent an auction process or post-signing market check, directors must be cautious to satisfy their duties to maximize shareholder value, even if the agreed upon deal is for a sizeable premium.
    
3. Boards need to create the documentary record of actions taken in response to or in anticipation of acquisition proposals, whether solicited or unsolicited.
    
4. Boards need to follow a deliberate process and establish a thorough record of deliberation, which involves outside financial and legal advisors, regarding its decision on deal protection terms. Specifically in regards to break up fees and matching rights.
    
5. Fairness opinions will not overcome a perception by the reviewing court of a deficient process.

An important part of both the duty of care and the duty of loyalty is that organizations and their governing boards should speak with one voice or not at all. Directors should presume that this applies to all matters coming before the board for its consideration. An individual director has no authority under applicable law. Instead, authority is vested in directors collectively as they determine by a majority vote at a meeting at which a quorum is present. This does not require unanimity in decisions, but instead requires a recognition that a board speaks only as a board as determined by a majority of its members at meeting in which a quorum is present. Occasionally on matters where it is important to have a single message, a board will speak only through its chairperson or the chairperson’s designee.

A director who dissents has the right to have his or her dissent reflected, with attribution, in the minutes of the meeting and may continue soliciting support for his or her position until the minutes are approved. Thereafter, the director may, subject to any rules of the board, request the board’s reconsideration of the matter. However, the confidentiality obligation that is part of each director’s duty of care requires that the matter remain within the board room, and the director’s ultimate right in any disagreement is to resign.