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Breach of Fiduciary Duty

3 Common Types of Lawsuits Brought Against Corporate Directors and Officers

Individuals serving as corporate officers or directors are highly susceptible to being sued for actions taken in the performance of those roles.  It is a common misconception that only large public companies face Director & Officer lawsuits (“D&O Lawsuits”).  In reality, any business or non-profit with a corporate board or advisory committee – small or large – can face a director and officer lawsuit.   In fact, these suits are so common that businesses often purchase D&O coverage to protect their directors and officers from personal liability if sued.  This post discusses common types of lawsuits filed against corporate officers and directors and some related considerations.

There are generally three main types of lawsuits brought against corporate directors and officers:

Derivative Lawsuits

If the shareholders of a corporation are concerned about the action of corporate officers or directors, they can bring what is known as a “derivative lawsuit.” A derivative lawsuit is an action brought on behalf of the corporation and generally alleges a breach of fiduciary duty, discussed in more detail below.  Shareholders must typically first seek to address the breach prior to suit unless such efforts would be futile. 

Direct Suit Lawsuits

The second type of lawsuit is a direct suit, often brought as a shareholder class action by an individual or group of similarly situated shareholders alleging personal harm.  These suits can be brought for many reasons, including, but not limited to 1) an alleged violation of a shareholder’s right to vote, 2) demand for payment of dividends that were promised, 3) failure to allow a shareholder to inspect records or 4) a violation of a shareholder’s ownership rights or harm incurred to a specific shareholder vs. the company.

Non-shareholder Lawsuits

Finally, though not as common, directors and officers may also be sued by non-shareholders.  For example, an employee or vendor may sue for breach of employment contracts, defamation or sexual harassment.

Allegations of Breach of Fiduciary Duties

Lawsuits brought against directors and officers of corporate entities often involve allegations of a breach of one or more of fiduciary duties.  Those who serve on the board of directors are required to act in the best interest of the shareholders and to maximize the company’s profits. Corporate officers and directors are charged with specific fiduciary duties in their service to the organization, including:

  • A Duty of Loyalty and Good Faith
  • A Duty of Care
  • A Duty of Obedience (for non-profits)

The duty of loyalty and good faith requires directors and officers to act in the best interest of the corporation and its shareholders.  Directors and officers must not exploit any of the organization’s business opportunities for their own personal gain or engage in self-dealing.  A breach of the duty of loyalty can put directors and officers at risk for personal liability and even punitive damages, depending on the specific facts and circumstances. 

The duty of care requires that directors and officers use the same degree of diligence, inquiry, and skill in performing their duties as a prudent person would use in similar circumstances. Directors and officers must make informed, good-faith decisions to further the organization’s purposes.  To satisfy this duty, directors and officers must be “reasonably” well informed before making a business decision.  As long as directors and officers exercise reasonable business judgment, they will generally fulfill their duty of care.  That said, the “reasonable business judgment rule” is both the relevant standard and main defense against these kinds of suits.

In the non-profit world, directors and officers must also fulfill a duty of obedience, which requires that directors and officers carry out an organization’s purpose as set out in its organizational documents. Because there are no shareholders in non-profit organizations, this duty ensures non-profit directors and officers act in a manner consistent with the organization’s mission.  The duty also serves to protect the public’s interest by ensuring donations and goodwill serve the represented purpose of the organization.

Overall, officers and directors must put the interests of the organization above their own personal interests. They must not seek to secretly profit at the company’s expense, nor compete against the interests of the company they serve.  All business between the directors or officers, on one hand, and the organization, on the other, must be conducted at “arm’s length.” Any breach of these fiduciary duties puts directors and officers at risk for civil or criminal liability. 

Organizations often hedge against personal civil liability of their directors and officers by purchasing D&O liability insurance.  However, even D&O coverage has its limits and is not likely to cover illegal acts, even those seemingly taken on behalf of the corporation.  Such illegal acts can include:

  • Lying to the government about corporate affairs
  • Being complicit in lying to the public
  • Stealing corporate resources
  • Embezzlement

If the alleged violation is an illegal act, no corporation or insurance may protect the director or officer from facing civil or criminal penalties and D&O coverage generally does not apply.

Right to Inspect

Another common lawsuit brought against directors and officers is based on shareholders’ inspection rights. Most states, including Florida, statutorily provide shareholders with the right to inspect certain accounting records and meeting minutes of the organization.  These types of suits often have some connection to an alleged breach of fiduciary duty, but can also involve criminal allegations. There are generally very specific procedural requirements set by statute, which dictate the manner and timing by which a shareholder must demand inspection and the organization’s response to that demand. 

The right to inspect can sometimes be viewed by the courts as a duty to inspect, particularly in cases where plaintiffs essentially race to file a thinly supported complaint after a corporate trauma is announced without substantive support.  In an attempt to avoid dismissal of a poorly plead complaint, plaintiffs will sometimes file a separate action to inspect the books. This course of action has been rejected by many courts because it essentially rewards the fast-filing plaintiff for filing without a proper pre-suit factual investigation.

Employment Law Violations

A third set of lawsuits commonly faced by directors and officers are lawsuits alleging violations of workplace or employment laws such as wage and hour statutes or alleged violations of federal and state discrimination statutes.  These cases are more and more often naming directors and officers individually for a variety of reasons.

In January 2021, we wrote about potential director and officer personal liability in lawsuits alleging violations of the Fair Labor Standards Act, click here for blog.  https://thecampbelllawgroup.com/can-officers-directors-or-managers-be-held-personally-liable-for-flsa-claims/.  Particularly since the start of the #MeToo movement, there has been an onslaught of both derivative and direct lawsuits filed against corporate directors or officers for their roles in either engaging in alleged sexual misconduct or covering it up.  The legal duties of corporate fiduciaries to prevent, respond to, and disclose the occurrence of workplace-based sexual misconduct are still developing as these suits become more and more common.

Conclusion

Directors and officers must satisfy their fiduciary duties or risk significant personal liability.  To avoid breaching their fiduciary duties, directors and officers need to understand what these duties require of them.  Fiduciary duties expand well beyond taking action to secure the organization’s financial health and must guide all actions taken by directors and officers.

Directors and officers should discuss indemnification packages when they are invited to join a corporate board or advisory committee.  There are additional risks to the officers and directors of a corporation as it approaches insolvency.  The business and litigation attorneys at the Campbell Law Group have extensive experience representing corporate officers, Boards of Directors, and individual directors to ensure they remain compliant, they are effectively represented should litigation arise and their personal interests are protected.

Our firm offers in-person and virtual consults, if you have any questions or concerns about the topic of this Article or any corporate, commercial, or employment law (Employer/Business Representation) issue, please feel free to call our office at 305-460-0145 or to schedule a consult here.

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