Spencer Stuart / Directors & Boards Directors Roster
Legal Brief
Don’t run from the
‘Just for Feet’ finding
It’s not another Van Gorkom, but it is a strong reminder
of how careful and attentive directors need to be.
By Doug Raymond
I
n 1985, the Delaware Supreme whether individuals are putting too
Court decision in Smith v. Van much at risk when they consent to serve
Gorkom sent shockwaves through as outside directors.
boardrooms. In that case, the court
In a recent analysis, Outside Director
held that directors could be held person- Liability [58 Stanford Law Review 1055
ally liable for their boardroom activities (2006)], authors Michael Klausner with
if they were sufficiently inattentive to Bernard Black and Brian Cheffins surtheir fiduciary duties. Previously, out- veyed all settlements and judgments that
side directors had been, in effect, willing they could identify involving litigation
to accept the possibility of liability for against directors. The authors identified
their own personal dishononly 13 cases out of thouesty, self-dealing, or insider
sands filed since 1980 that intrading. However, before Van
cluded claims against outside
Gorkom they had not believed
directors. And these 13 cases
they risked personal exposure
included the settlements in
for failing properly to oversee
the WorldCom and Enron
management.
disasters. It is striking that
This decision provoked
out of the many thousands
a crisis in boardrooms and
of cases they identified that
among the corporate lawincluded claims against outyers. Many feared that this
side directors, only a handful
new risk of personal liability Doug Raymond is a
seem to have resulted in perwould make it more difficult partner in the law
sonal liability.
to attract qualified persons to firm Drinker Biddle &
Recently, the outside diserve as outside directors.
Reath LLP and heads
rectors of sneaker retailer
In response, state legisla- its Corporate and
Just for Feet Inc. made very
tures adopted protective leg- Securities Group
significant payments to settle
islation intended to counter (www.drinker­biddle.
a bankruptcy court claim for
the impact of the Van Gorkom com).
breach of fiduciary duty. The
decision. One such provision
company had been the victim
is Section 102(b)(7) of the Delaware of accounting fraud by executives who
General Corporation Law, which (gen- had overstated earnings. In the aftererally speaking) insulates directors from math, the company filed for bankruptcy
personal liability for their actions, so amidst guilty pleas by certain of the oflong as taken in good faith and without ficers, and eventually settled the resultviolating their fiduciary duties of loyalty. ing stockholder securities litigation for
Thus shielded, boardrooms were saved essentially the limits of the company’s
from the risk of wholesale defections of D&O insurance policy. This settlement
directors resigning rather than exposing did not resolve claims brought against
their own assets.
the outside directors, who eventually
This has, in general, worked out as the settled these claims for an aggregate of
legislatures had hoped. However, some $41.5 million.
recent cases have rekindled concerns
The Just for Feet settlement has re14 directors & boards
ignited some of the concerns that Van
Gorkom raised over 20 years ago. However, a few points are worth noting.
First, several of the outside directors had ties to private equity or other
investing firms or, in one instance, to a
commercial bank. Even if these directors
were not serving directly at the request
of these institutions — although it appears that at least one of the directors
had initially joined the board at the
request of an investor — it is possible
that the D&O policies of their employers contributed to these settlements.
Increasingly, private equity and hedge
funds and other investors are placing
their own representatives on the boards
of the companies in which they have
invested. These individuals themselves
generally have the benefit of D&O insurance policies obtained by the investment
funds for the benefit of their representatives serving on other boards, a practice
that is not lost on the plaintiffs. Indeed,
given the growing activism of such funds
as stockholders, we may expect plaintiffs
more frequently to seek payouts from
such policies. This may appear to outsiders to be an increase in personal liability, and may also encourage plaintiffs
to more frequently assert claims against
outside directors who increasingly have
access to such policies.
Second, these settlements underscore
the importance of adequate D&O insurance, especially insurance that is specifically designed for the outside directors
and which cannot be exhausted by the
company or the corporate insiders.
While the size of the Just for Feet
settlement attracted attention, it does
not seem to have significantly altered the risks that the outside directors face while serving on boards.
Nonetheless, it reminds us that directors need to be careful in fulfilling their
oversight responsibilities, and that they
should regularly check the adequacy
of the protections afforded in their
articles and bylaws, and by the available D&O insurance coverage.
■
The author can be contacted at doug.raymond@dbr.com.