The disengaged director: is there a breach of duty?
We have all sat in board meetings at which a director is paying more attention to their BlackBerry than management's presentation or the discussion at hand. Being disengaged at a meeting, while unfortunate, is not the focus of this article. Rather, this article addresses how to think about a director's chronic underperformance: when he is so derelict that he no longer engages with other directors or management.
An effectively functioning board requires directors to honor their fiduciary duties to the corporation: the duty of care and the duty of loyalty. While self-dealing and other conflicts of interest clearly violate the duty of loyalty, when does a director's disengagement reach that level? When does such conduct become a breach under the legal standards for the duty of care and the duty of good faith? More importantly, what can companies do to resuscitate such a director and prevent the problem in the future?
It is unlikely that a director's underperformance would be considered a breach of the duty of care. The duty of care requires that directors inform themselves of all material facts and give due deliberation to them before making a business decision. However, courts will rarely find that directors have breached their duty of care; indeed, Delaware courts have required that a plaintiff show a "sustained or systemic failure of a director to exercise reasonable oversight" in order to sustain a claim that director inaction is a breach [In re Caremark International Inc. Derivative Litigation, 698 A.2d 959 at 971 (Del. Ch. 1996)]. Thus, in the vast majority of cases, an underperforming director likely will not violate his or her duty of care absent additional egregious factors.
Similarly, a finding of the breach of the duty of loyalty is reserved for rare egregious cases and not mere director disengagement. The duty of good faith, a subpart of the duty of loyalty, requires that directors act with a conscious regard for their responsibilities as fiduciaries. Thus, Delaware courts have found that "[d]eliberate indifference and inaction in the face of a duty to act can breach the duty of loyalty [In re The Walt Disney Company Derivative Litigation, 907 A.2d 693 at 755 (Del. 2005)]. Recent cases have emphasized that to find a breach of the duty of good faith, directors must have "knowingly and completely failed to undertake their responsibilities" [Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009)]. Thus, unless the director intentionally disregards their duties, it is unlikely that their inattentiveness would be considered a breach of the duty of loyalty.
It is therefore unlikely that a court would find that a director breached his or her fiduciary duties due to a lack of attention or interest. However, a director's disengagement nevertheless can be harmful to the board and company without rising to the level of a breach of fiduciary duties. Asking the governance committee to recommend to the shareholders that a director be removed should be a last resort. The chair, lead independent director or another board member should frankly speak with the director about her lack of engagement and underperformance. In the majority of cases, the director will not have realized the extent of his perceived disengagement and will be willing to remedy the issue once confronted. If not, more severe steps will be necessary.
Resuscitating a director may be uncomfortable and difficult. To avoid the problem from occurring in the first instance, companies should consider the following steps:
* Ensure that board members understand what is expected of them by establishing written board member expectations or job descriptions that articulate specific responsibilities and standards.
* Implement a board member evaluation process by which board members receive periodic assessments of and feedback on their performance.
* Provide ongoing director training and mentoring to enhance motivation and understanding of roles.
* Conduct evaluations of the effectiveness of board committees and consider whether they should be changed to promote productivity.
Since a director's conduct rarely will rise to the level of a breach of fiduciary duty but can nevertheless be detrimental to the board, preventing director disengagement before it occurs is the best way to ensure that boards continue to operate effectively.
Matthew L. Biben is a litigation partner at Debevoise & Plimpton and member of the firm's White Collar & Regulatory Defense Group and the Banking and Consumer Finance practices (www.debevoise.com). He has extensive experience advising boards and senior management on a wide-ranging set of matters. He can be contacted at firstname.lastname@example.org. Liz Alspector, a corporate associate with the firm, assisted in the preparation of this article.
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|Title Annotation:||BOARD DYNAMICS: COVER STORY|
|Author:||Biben, Matthew L.|
|Publication:||Directors & Boards|
|Date:||Mar 22, 2016|
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