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Page 1

AVOIDING PERSONAL LIABILITY:
A GUIDE FOR DIRECTORS
AND OFFICERS

Page 2

02 | AVOIDING PERSONAL LIABILITY: A GUIDE FOR DIRECTORS AND OFFICERS

According to the popular media, we are living in an era
of corporate crime. Scandals like Enron, HealthSouth and
WorldCom stretch so far back they seem like they are not
even of this millennium. Among the milestones since those
days are the stock option back-dating scandals, followed
by the convictions of Conrad Black and other high-profile
CEOs. More recent, high-profile corporate scandals are
making the news on a regular basis, contributing to the
modern environment of cynicism regarding corporate
decision-making. The next high-profile scandal could be
just around the corner – at least that is what stockholder
plaintiffs and their lawyers would have the courts believe.

This cynical phenomenon is reflected in the rising tide of lawsuits seeking to hold
directors and officers personally liable – not just for losses due to corporate scandals but
also for ordinary business transactions. The last two decades have seen a dramatic rise
in activist funds and law firms devoted to serving stockholder plaintiffs. The significance
of this problem becomes shockingly clear when one considers the statistics on M&A
litigation. Preliminary figures from a 2014 study prepared by Matthew D. Cain (US
Securities and Exchange Commission, Division of Economic and Risk Analysis) and Steven
Davidoff Solomon (University of California, Berkeley School of Law) on public company
M&A deals in 2014 showed:

■ 94.9 percent of all transactions resulted in litigation

■ Each transaction resulted in an average of 4.3 lawsuits

■ 33.8 percent of all transactions experienced multijurisdictional litigation and

■ Median attorneys’ fee awards per settlement were US$555,000.

The last two decades
have seen a dramatic
rise in activist
funds and law firms
devoted to serving
stockholder plaintiffs.

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08 | AVOIDING PERSONAL LIABILITY: A GUIDE FOR DIRECTORS AND OFFICERS

proceedings brought by or against third
parties as well as lawsuits or proceedings
brought by or on behalf of the company.
If a director is successful in the defense
of a proceeding, then indemnification is
mandatory; however, if a director is not
successful on the merits of a proceeding,
indemnification becomes permissive and,
in certain circumstances, may not be
available at all.

When a company’s charter or bylaws
so provide, a director may be entitled
not only to indemnification, but also to

advancement of expenses upon providing
the company with an undertaking to repay
the defense costs if it is later determined
that indemnification is not legally available.
The right to advancement of legal
expenses is significant because the defense
of actions alleging breach of fiduciary duty
can cost hundreds of thousands or even
millions of dollars, and it often makes a
critical difference if a director must pay
first only to be reimbursed at the end
of the case (most often, years after the
case was initiated). Advancement and
indemnification generally are available
to directors even after they cease to
be directors, so long as the lawsuit or
proceeding for which indemnification
is sought relates back to the director’s
service on the board.

Indemnification is limited to cases in
which directors acted in good faith
and in a manner they believed to be in
the best interests of the corporation.
Thus, where directors are found to
have acted in bad faith or to have
been motivated by an improper
personal interest, indemnification
will not be available. With respect to
lawsuits brought by or on behalf of
the corporation, directors typically are
not entitled to indemnification where
they are determined to be liable to the
corporation, unless a court specifically
orders otherwise. In lawsuits by or against
third parties, directors may be indemnified
both for expenses incurred in connection
with the lawsuit and for any amounts paid
in judgment or settlement of the suit;
however, in lawsuits by or on behalf of the
company, directors may be indemnified
only for expenses.

Because the scope of indemnification,
and the corresponding availability
to advancement, may differ in many

respects from company to company, a
person considering service on a board
of directors should obtain and, along
with his or her counsel, carefully review
the company’s charter and bylaws,
any indemnification agreements, and
other company policies governing
indemnification and the advancement of
attorneys’ fees and other defense costs.

INSURANCE

Under Delaware law, a company may,
but is not required to, provide insurance
for directors at the company’s expense
against any liability that may arise as
a result of directors’ conduct. The
company may provide such insurance to
directors whether or not the company
could indemnify the director, thus
making insurance a potentially broader
protection against personal liability
than indemnification.

The primary limitations on insurance are
found within the policies themselves.
So-called D&O policies differ from
corporation to corporation in scope,
coverage limits and deductibles, among
other things. Some companies do not
provide any D&O insurance. Just as with
indemnification provisions, a person
should obtain and, along with his or her
counsel, carefully review a corporation’s
insurance policy, if any, before agreeing
to serve on a board. A serving director
should also ask for at least an annual
update on D&O coverage and policy
inclusions and exclusions, par ticularly in
anticipation of a policy renewal.

PREVENTIVE MEASURES

In the current corporate environment,
directors must be especially zealous
about understanding the protections

… a person
considering service
on a board of
directors should
obtain and, along
with his or her
counsel, carefully
review the
company’s charter
and bylaws, any
indemnification
agreements, and
other company
policies governing
indemnification and
the advancement of
attorneys’ fees and
other defense costs.

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WWW.DLAPIPER.COM | 09

available to them in the execution of
their duties and the limitations on those
protections. Having a basic understanding
of these topics may help directors avoid
personal liability and may help prospective
directors make more informed choices
about whether to serve in such a capacity.
It may also help directors understand
when outside counsel or advice is needed
and, if so, what questions to ask.

Selecting the right attorneys is critical.
Directors who serve on boards of
companies engaged in battles for control,
companies with activist stockholders,
companies engaged in or about to
be engaged in major transactions or
companies with hostile or divided boards
of directors should especially consider
receiving advice from an experienced
attorney as to significant decisions and the
fulfillment of duties owed to the company
and its stockholders. In so doing, directors
must carefully consider whether to seek
advice from an attorney other than one
retained or employed by the corporation.
Taking appropriate steps and creating a
defensible record are things that cannot
be fixed after the fact. If a director cannot
avoid being sued, he or she should at
least make sure to be well positioned to
win. To that end, directors should bring
as much due diligence to the selection of
counsel as they do with any other critical
business decision.

There is no single, clearly defined
blueprint for taking preventive measures
to avoid being sued in the first instance
or to avoid personal liability if one is sued.
However, adherence to well established
“best practices” can help to significantly
reduce the likelihood of liability. Such
practices include, but are not limited
to, the following (some of which are
already mandated for public companies

by the Sarbanes-Oxley Act or stock
exchange rules):

■ Establishing well-defined and
conservative standards of director
independence

■ Setting a required number or
percentage of independent directors,
such as a majority

■ Establishing term limits for directors

■ Establishing a lead independent director

■ Considering the establishment of a chief
governance officer position

■ Maintaining separate CEO and chairman
positions

■ Developing and initiating active
compliance monitoring systems,
including the creation of a chief
compliance officer who reports directly
to the board

■ Encouraging, if not requiring, directors
and Section 16-level officers to
implement SEC Rule 10b5-1 trading
plans if they intend to purchase or
sell company stock, and ensuring
appropriate limits on when and how
frequently such plans may be altered

■ Ensuring that the minimum expectations
of director conduct standards, such as
Sarbanes-Oxley, NYSE or Nasdaq rules,
are met

■ Hiring and training directors with
diverse sets of skills and backgrounds

■ Evaluating the quality and effectiveness
of board meetings, including the
use of agendas, the preparation and
distribution of materials, and the timing
and length of meetings

■ Keeping apprised of corporate
governance trends and legislation

■ Developing and implementing
appropriately authorized committees
and subcommittees to oversee and
monitor areas of potential liability, such
as executive compensation, director
nomination, financial audits, and
regulatory compliance

■ Ensuring that key committees and
subcommittees are composed solely of
independent directors

■ Prohibiting related-party transactions
or requiring independent review of such
transactions

■ Creating and maintaining effective
internal reporting systems for
malfeasance or wrongdoing, including a
whistleblower policy

■ Developing and adhering to a code of
ethics

■ Taking an active role in corporate
disclosures

■ Maintaining open and active stockholder
relations

WHAT TO DO IF YOU ARE SUED

If you are sued in your capacity as a
director or officer, there are a number of
steps you can take to protect your rights
and help work toward the best possible
outcome. These include the following:

Immediately retain counsel to assist you:
The time to respond to a lawsuit varies
from jurisdiction to jurisdiction, but you
may have fewer than 20 days to act. It is
therefore critical that you quickly retain
counsel who can assist you in determining
when and how to respond to the lawsuit,

Selecting the right attorneys is critical. … Taking appropriate steps and creating a
defensible record are things that cannot be fixed after the fact. If a director cannot
avoid being sued, he or she should at least make sure to be well positioned to
win. To that end, directors should bring as much due diligence to the selection of
counsel as they do with any other critical business decision.

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WWW.DLAPIPER.COM | 15

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DLA Piper is a global law firm operating through DLA Piper LLP (US) and affiliated entities. For further information please refer to www.dlapiper.com. Note past results are not guarantees

of future results. Each matter is individual and will be decided on its own facts. Attorney Advertising. Copyright © 2015 DLA Piper LLP (US). All rights reserved. | APR15 | MRS000033897

www.dlapiper.com

ABOUT US

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FOR MORE INFORMATION

To find out more about the topics covered in this guide,
please contact:

Henry duPont Ridgely
Wilmington
T + 1 302 468 5653
[email protected]

John L. Reed
Wilmington
T +1 302 468 5635
[email protected]

Ed Batts
Silicon Valley
T + 1 650 833 2073
[email protected]

Ashley Altschuler
Wilmington
T + 1 302 468 5634
[email protected]

Stellman Keehnel
Seattle
T + 1 206 839 4888
[email protected]

James D. Mathias
Baltimore
T +1 410 580 4208
[email protected]

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