Factors driving litigation
When you have volatility, you have litigation. There are lots of plaintiffs’ lawyers who are looking for things to do and the attitude these days seems to be “shoot first and ask questions later.”
Eliminating volatility significantly lessens the likelihood of litigation.
There are four main groups of volatility: earnings miss, guidance surprise, loss of a key customer, and failed product (includes drug trial). Other types of volatility include data breaches, “me too” allegations, and PR challenges.
Lately we are seeing changes in litigation:
more “event-driven” litigation: the plaintiffs’ lawyers are trying to reverse engineer litigation from an event.
securities cases are often followed by derivative cases, typically claiming the board members breached their fiduciary duty of oversight.
Stand-alone derivative claims are on the rise [typical with no stock price decline proof of claim] – meaning there’s an event that impacts the company but it’s not reflected in the stock price decline. In these situations derivative cases are being filed right out the gate, and the courts in Delaware are being receptive to these cases.
Market volatility caused by the pandemic will lead to additional securities class actions – and follow-on derivative suits naming directors.
Think of potential lawsuits arising from the pandemic as you would other regulatory risks. Have a process in place at the board level to understand how your employees will return to work, how people will be tested, and how you will ensure that if people come back to work employees will not be infected. Montor this process regularly.
Types of claims board members may face
Derivative cases that typically allege oversight claims
Oversight claims have survived motions to dismiss in at least three separate Delaware actions:
Relevant factors considered by the courts:
Lack of processes to apprise board of mission-critical risks
Insufficient time spent by directors on oversight duties; infrequent meetings
Lack of documentation of board oversight
As board members, more and more you are going to be held to understanding the specific risks to the company’s business, including making sure that there is a line of communication to the board so members understand what is happening at the business level as relates to those risks. To the extent you know you are getting information, you also need to make sure you are following up and asking a lot of questions.
Historically, settlements have typically involved “corporate therapeutics” – with no cash payments. Recent settlements have bucked that trend and plaintiffs’ lawyers are emboldened by this precedent.
Typically these suits are being settled with insurance money, but officers do pay from time to time.
Best practices for avoiding litigation
Have a robust system of reporting and control and then do something with that information – monitor it, check it, and document it in the minutes. If it did not show up in the minutes, then it did not happen.
A detailed set of minutes can help get a case dismissed under pleadings.
Be sure to review the minutes prior to approving them. Use your personal notes to ensure topics are included in the minutes, then destroy your personal notes.
Be proactive – think ahead of time about the company’s risks and make sure that you are a purposeful director.
It is important to partner with management on important financial issues including reserves and debt covenants. Particularly in the current environment, understanding issues that could come up in the next couple of quarters is important. Ask the CEO, “What’s keeping you up at night?”
Rely on internal and external professionals who have specific skill sets. If they attend a board meeting, reflect that in the meeting minutes. When there is good documentation, a plaintiff’s lawyer will have to think twice about proceeding.
Be mindful that while the requirement may be that statements are accurate at the time they are made, of course if they are ever scrutinized it will be with the benefit of hindsight.
Be mindful of trends and uncertainties. Revisit trends and uncertainties with the CEO and CFO.
Revisit insider trading policies and consider requiring 10b5-1 plans.
Work with underwriters as part of the D&O insurance process. Being able to differentiate your risk from your peers by talking about it in a sober way can be helpful.
It is important to understand the regulatory framework in which the company functions. Consider setting up specific board committees to deal with specific risks (e.g. cybersecurity).
Document, document, document – keep thorough meeting minutes. You do not get to supplement the record through deposition, it needs to be in the minutes already.
Strategies to limit personal liability
Adopt a Delaware forum selection clause. This is essentially a corporate document that requires that any disputes related to the internal affairs of the company be litigated in the Court of Chancery in Delaware. This is important because the judges in the Court of Chancery know corporate law extremely well, and by designating the jurisdiction you create predictability.
102(b)(7) provisions in the company’s bylaws – under Delaware law a company can have a by-law position that essentially holds a director free from harm – exculpates him/her from duty of care issues, meaning if you’re negligent, the company will hold you harmless. This means that the only claims that you can have personal liability for are claims for breach of duty of loyalty, bad faith or intentional misconduct, or a situation where you’ve got some personal benefit that wasn’t shared by the rest of the shareholders.
When a director is sued for negligence, or for not doing a good job, cases can be dismissed if the company has a 102(b)(7) bylaw provision. Then the only claim they’ll be left with is the oversight one.
When joining a board, the first two things you should ask are:
- do you have a forum selection clause and
- is it a 102(b)(7)?
Indemnification vs advancement
- Indemnification is reimbursement for fees, costs, and potentially judgments arising out of the director’s service in the company. Delaware law provides for indemnification for “expenses actually and reasonably incurred by such person.”
- Advancement is when the company pays the directors’ fees and costs prior to final disposition. If you have an indemnification agreement, consider reviewing it to make sure you have the best provisions from a director perspective in terms of indemnity advancement.
- A requirement under Delaware law if you do get advancement is that you have to sign an undertaking, which simply says:
I understand the company is advancing fees to me in advance of when it typically would have to as an identifier, and if it turns out that my conduct is determined later to be conduct that would not entitle me to be indemnified, I will pay the money back.
You cannot be indemnified for derivative settlements, because the money ends up going back to the company.
D&O Insurance = balance sheet protection for you and the company. The company has the obligation to pay your legal fees.
Obtain advice regarding coverage types (Side A, B and C), limits, and the size of layers.
Side A typically covers things that are not indemnifiable, e.g. company is bankrupt or it is a derivative settlement
Side B – reimburses the company for money they pay as part of their obligation to indemnify the directors and officers
Side C – is basically standalone insurance for the company if just the company gets sued
When buying Side A insurance, remember that you want to at least match the size of the self-insured retention. You want to match that deductible.
Your personal umbrella at home can cover you on a nonprofit board if you specifically ask your broker to do that. No personal umbrella policy can cover your services on the board of a for profit corporation.
Be proactive in renewing your D&O policy.
Make sure your D&O insurance policy does not include these two exclusions: