In an interesting and provocative June 7, 2011 post on
the DealBook blog (here),
University of Connecticut Law Professor Steven Davidoff voiced his
frustration that public company directors are not held liable more often for
problems at their companies. Directors, he says, "have about the same chance of
being held liable for the poor management of a public firm as they have of
being struck by lightning."
Davidoff goes on to note that the Delaware courts set "an
extraordinarily high standard for finding directors liable for a company's
mismanagement" adding that "a Delaware court is not going to find them liable
no matter how stupid their decisions are," but will only find them liable "if
they intentionally acted wrongfully or were so oblivious that it was
essentially the same thing." The bottom line for Davidoff is that while the
"upside" for board member is "huge," their downside is "very limited."
I have some thoughts and comments about Davidoff's
column. My purpose is not to dispute his thesis or even necessarily to disagree
with him, but rather to try to sharpen the focus of the discussion. My
fundamental concern is that I think that there are already many more lawsuits
against boards than there are companies engaged in corporate misconduct.
My fear, given the civil litigation resources our society
already has deployed, is that more dramatic sanctions against corporate board
members could result only in unintended collateral damage rather than greater
traction in the fight against corporate misconduct. To me, a demand that all
directors must face greater financial consequences in civil litigation is akin
to a proposal that we must use more powerful rat poison in the kitchen - it is
just as likely that we will wind up killing off the family pets and Grandma as
it is that we will eliminate any greater number of rats. To be specific, if we
are going to employ more potent means of controlling corporate misconduct, let
us take great care to understand what our goals are and make certain the means
are well calculated to achieve the intended goal.
Let me just say at the outset that I have nothing but
respect for Professor Davidoff. His posts on the Dealbook blog are among
the best out there. By raising the questions as I do below, I am merely hoping
to consider his assumptions, not to disrespect his work in any way. I also
should probably declare my biases at the outset, as well. I have spent most of
my career worrying about the interests of corporate directors and officers.
There is no doubt that I come at these issues from the perspective of the
corporate officials, and with their interests in mind. However, I believe that
even if it may the product of a bias, this perspective still affords an
important take on these issues.
Davidoff seems very sure that directors are not being
held liable often enough. However, it is not clear why he thinks
directors should be held liable more often. Upon reflection, I can think of
three possible reasons why it might be argued that directors ought to face
civil liability more frequently: recompense; retribution; and deterrence. I
examine each of these three reasons below and consider whether or not they
substantiate the need for directors to face civil liability more frequently.
Davidoff addresses the issue of recompense, at least inferentially. After
identifying the two Delaware court cases in which directors have been held
liable, and reviewing the amounts paid in those two cases, he aggregates the
amounts paid and comments, with obvious derision, these payments amount to "no
more than $8.35 million in personal payments by directors over the 26 years."
While the cited figure may indeed represent the total
amount that directors have themselves paid during that period in Delaware
cases, it is hardly an accurate picture of the total amount of recompense paid
to investors or to companies during that period. There have of course been many
other cases settled during that period in which the settlement amounts were
funded by D&O insurance or other sources.
Davidoff briefly acknowledges the role that D&O
insurance plays, by stating that "even if there is a liability or a settlement,
it is almost always covered by insurance of directors and officers." But
if the goal is recompense, what difference should it make whether that the
funds were provided by insurance? The directors may not have paid these other
settlements out of their own assets, but the settlements have provided
extensive additional recompense to companies or to investors. Moreover, as I
have noted on this blog (most recently here),
the frequency of very large cash payments in Delaware cases and other derivative
suits has become increasingly common in recent years.
In addition, though Davidoff briefly refers in his column
to cases involving potential liability under the federal securities laws, he
omits to mention that there have been billions of dollars of recoveries
in these cases in recent years. Yes, as Davidoff notes, settlements in those
cases rarely include amounts paid personally by directors, but if the goal is
recompense (rather than retribution), the source of funds should be irrelevant.
The omission of any reference to these many other
settlements suggests that the real objection may not be that the cases do not
produce enough recompense, but that these case resolutions do not produce
enough pain for directors, because the funds did not come out of the directors'
pockets. But if the absence of pain is the problem, then the issue seems to be
retribution, not recompense.
Perhaps I am reading too much into Davidoff's words, but I do not think I am
being unfair in suggesting that behind Davidoff's words is a belief that
directors should face a greater threat of punishment, and specifically that
their personal assets ought to be on the line.
In considering whether or not directors should face a
greater threat of punishment, I think it is critical to note that in his column
Davidoff only refers to civil litigation (specifically, Delaware state court
litigation and federal securities litigation). His column does not address,
discuss or mention criminal or enforcement actions.
There unquestionably are occasions when retribution
against corporate officials may be appropriate. But the proper vehicles for
retributive justice are criminal actions and enforcement proceedings, which are
the appropriate means for enforcing societal values and imposing
There is and should be an entirely different discussion
whether or not the criminal and enforcement authorities have sufficiently
exercised their prosecutorial responsibilities in connection with corporate
misconduct. But Davidoff's column was restricted just to civil litigation.
Civil litigation may well serve the goals of recompense (as discussed above)
and deterrence (as discussed below), but I would contend that it is not the
purpose of civil litigation to serve the goal of retribution, which is the goal
of criminal and enforcement procedures.
Which brings us to the question of deterrence. I understand the argument that
if directors faced a greater likelihood of being personally liable financially,
there would be greater deterrence of corporate misconduct. But before examining
this question, I want to make a few points about deterrence as it currently
The problem with most analyses of the deterrent effect of
corporate and securities litigation is that it usually assumes that the only
effective deterrence is through financial consequences, and it overlooks other
possibilities. My own experience is that the threat of civil litigation (as well
as the possibility of criminal and enforcement proceedings) provides a powerful
deterrent effect, separate and apart from the threat of financial liability.
My experience is that most corporate directors have a
deep and abiding aversion to becoming associated with any type of corporate
scandal. The prospect of seeing their name in the media paired with the word
"fraud" or even "mismanagement" is a truly detestable possibility and one they
are deeply committed to trying to avoid. These individuals value their
reputations. They are keenly interested in avoiding the types of situations
that would draw them into scandal and tarnish their personal or professional
The individual directors are also highly motivated to
avoid the burden, disruption and expense of civil litigation. And with regard
to expense, I think it is critically important to note that Davidoff's analysis
of how often directors have been required to pay settlements or judgments
themselves omits to consider how often directors are compelled to fund their
defenses out of their own pockets.
Defending these kinds of suits can be hideously
expensive, and if indemnification is unavailable and insurance is inadequate,
directors can (and sometimes do) find themselves forced to draw on their own
assets to mount their defense. Directors are well aware of these possibilities
and they are highly motivated to avoid them.
In short, I believe that even conceding all of the points
in Davidoff's column about the infrequency of personal civil liability for
directors, the threat of civil litigation still provides a powerful deterrent
to corporate boards.
There are of course boards or individual directors to
whom these deterrents are not sufficient. However, there is nothing that says
that imposing greater financial liability in civil litigation would deter these
undeterrable boards and individuals. Very significant personal liability was
imposed on the boards of Enron, WorldCom and Tyco, but I would argue that
perhaps other than with respect to the specific individuals involved these
individuals' settlement contributions otherwise had absolutely no
measurable deterrent effect.
I can anticipate the argument that three cases alone is
not enough, that personal liability must be imposed more generally in more
civil cases in order to generate enough deterrent effect. But if personal
liability in three cases was not enough, how many will be enough? How do we
know? Doesn't this all seem rather speculative?
My fear is that in the highly charged current environment,
the generalized notion that individuals ought to be compelled to pay more out
of their personal assets could wind up imposing costs and burdens in ways that
far exceed the intended purposes - indeed, without any substantiation that it
would even potentially produce the intended benefit. And likely imposing
enormous costs on many of the wrong people.
Let me put it another way. The suggestion that
individuals ought to be held personally liable is a far more comfortable notion
if you are sure that the liability will never be imposed on you personally. It
is an easy assertion to make against a group from which you have not only
dissociated yourself, but that you have comprehensively demonized. However, you
would take a far different perspective if the question involved your own
personal assets. Particularly in our litigious society where sensational and
even outrageous allegations can be made with impunity and where the high costs
of litigation often can compel settlements simply as a way to avoid financial
ruin. In these circumstances, the insistence on personal director liability
looks to many directors like nothing more than a legally sanctioned predicate
for future hostage crises.
I know that in taking this position, I may well be flying
in the face of conventional wisdom. My purpose here is to provoke discussion
and to make sure that before we move on to what actions we should take, we make
sure that we identify our goals and ensure that the actions are well matched to
the intended goals. Stronger rat poison undoubtedly will produce many effects,
but there is nothing that ensures that it will result in fewer rats.
My own view is that there are already far too many civil
lawsuits against corporate boards, most of them involving circumstances where
nothing improper has occurred. The law has evolved in response to the excess of
litigation, and that is the reason for the barriers to liability that Davidoff
bemoans. A welcome and interesting discussion would be one that addresses the
question of how we can develop a more concentrated system of civil litigation,
in which meritorious cases are resolved and fewer of the other kind are filed.
More About Delaware:
This must have been the week to raise doubts about Delaware's courts. In her
June 9, 2011 "Summary Judgment" column on the Am Law Litigation Daily (here),
which included her remarks on the nomination of Delaware Vice Chancellor Leo
Strine to take the position of Chancellor of the Court, she commented,
among other things, that Delaware is "soft on Corporate America" adding that
corporate directors "have little to fear in terms of being held
accountable when they do a lousy job and harm a lot of people in the process."
She concluded by calling on Strine to reconsider the words of the courts
critics, adding that the Court "can and should send a much stronger message."
In Case You Missed It: I
hope readers had a chance to read the interesting guest post I published late
last Friday afternoon (here),
in which Bernstein Liebhardt attorney Brian Lehman presents his prediction of
the outcome the Janus Capital case now pending before the U.S. Supreme
Court. Lehman's interesting prognosis is worth a look, particularly given that
the Court is likely to release its decision in the Janus Capital case
any day now.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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