Courts Turn Up Corporate Heat

This heightened level of scrutiny is highlighted in several recent court decisions: In Re The Walt Disney Company Derivative Litigation, C.A. No. 15452 (Del. Ch. May 28, 2003), In Re Abbott Laboratories Derivative Shareholders Litigation, 325 F.3d 795 (7th Cir. March 28, 2003) and John S. Pereira, as Trustee of Trace International Holdings, Inc. and Trace Foam Sub, Inc. vs. Marshall S. Cogan et al., 294 B.R. 449 (S.D.N.Y. May 7, 2003). Significantly, each of these decisions potentially limits the scope of the protections provided to directors by the business judgment rule, as well as the protections afforded by “exculpatory” provisions that are expressly provided for by state corporate statutes in order to shield directors from liability for breaches of their duty of care. Under these exculpatory provisions, director liability can generally be limited only to those actions constituting 1) a breach of the duty of loyalty (eg, a theft of corporate opportunity or an improper self-dealing transaction), or 2) acts or omissions that are not in good faith or which involve intentional misconduct or a knowing violation of the law.

As discussed below, these cases suggest that directors must take their responsibilities seriously in the post-Enron era. The business judgment rule and exculpatory provisions in a company's charter will continue to protect directors against liability for a decision taken in good faith that turns out to be a mistake. However, these protections will not be available to directors who fail to inform themselves adequately when authorizing corporate action turns out to be ill-advised, or who fail to take action when presented with evidence of corporate impropriety.