Case Alert - Corporate Officer Liability
Court Rules that Corporate Officers Are Not Protected From Personal Liability Under Business Judgment Rule
A recent decision by a U.S. District Court has definitively limited the application of the business judgment rule in holding that it does not apply to corporate officers. Rather, the California common law business judgment rule (the "BJR"), codified in California Corporations Code § 309, applies only to directors acting in their corporate capacity. The immediate effects of this decision are twofold: (1) it may be advisable for corporate officers to have broader exculpatory provisions in their employment agreements, to guard against potential personal liability for their conduct; and (2) small corporations may wish to consider provisions in their governing documents that expressly apply the BJR protections to their corporate officers.
FDIC v. Perry is a case brought by the Federal Deposit Incorporation ("FDIC"), acting as receiver for Indymac Bank, F.S.B. ("Indymac"), against Indymac's former CEO, Matthew Perry. The FDIC argues that Perry breached his fiduciary duties towards Indymac and acted negligently by permitting Indymac to purchase over $10 billion in risky residential loans in mid-2007. After the housing collapse, Indymac sustained losses in excess of $600 million on the loans. In 2008, Indymac ultimately closed and the FDIC was appointed as its receiver.
In response to the FDIC's complaint, Perry filed a motion to dismiss, arguing that the FDIC failed to plead facts sufficient to overcome the BJR. Perry argued that when he made the subject decisions, he was acting in his capacity as a director and officer, and that both are covered by the BJR. The Court disagreed, held that Perry was being sued for decisions made in his capacity as an officer, and that the BJR does not apply to corporate officers.
The Perry Court explained that the common law BJR has two components—one which immunizes directors from personal liability if they act in accordance with its requirements, and another which insulates from court intervention management decisions which are made by directors in good faith and in what the director believes is the corporation's best interest. The Court explained that based on its own research, no California court had ever published a decision applying the common law BJR to corporate officers.
The Court explained further that the legislative history of Corporations Code § 309 made it abundantly clear that the BJR was intended to apply only to corporate directors, and not officers. The Court cited the legislative record, which explained: "Although a non-director officer may have a duty of care similar to that of a director, his ability to rely on factual information, reports or statements may, depending upon the circumstances of the particular case, be more limited than in the case of a director in view of the greater obligation he may have to be familiar with the affairs of the corporation." In short, the distinction between officers and directors for purposes of the BJR is that directors are generally considered to be disinterested and acting with limited information, while officers are viewed as corporate employees intimately familiar with the affairs of the corporation.
The holding in Perry creates immediate implications for corporate officers, especially in small-businesses where corporate officers often serve as directors. Pursuant to Perry, the BJR does not shield an officer from personal liability for decisions that cause injury to a corporation and/or its shareholders. Unfortunately, while the Perry holding may discourage unnecessary risk by officers, it may also likely result in curbing innovation. Moreover, management decisions made by corporate officers are not insulated from Court intervention, and second-guessing. This may have a significant impact on the ability of corporate officers to defend themselves against derivative actions brought by disenchanted shareholders.
While the ruling in Perry was made at an early stage of the litigation, and is likely to be appealed, the Court's holding should nevertheless be taken seriously. Perry makes it clear that corporate officers do not enjoy the benefit of the BJR presumptions to protect them. Given the lack of California authority to the contrary, corporate officers and small businesses would be wise to take heed of Perry and take all necessary precautions to ensure that corporate officers have the broadest protections available to guard against personal liability.
Corporate officers should insist on including broader exculpatory and indemnity clauses in their employment agreements. Such clauses must be structured so that they comply with existing California law (which precludes exculpation for fraud, willful injury or other violations of law), but at the same time provide equivalent BJR protections to officers. Such clauses will ensure that the corporation, and not the officer, will be responsible for defending the officer's conduct in the event a lawsuit is filed.
In addition, small businesses should strongly consider including new (and broader) exculpatory and indemnity clauses in their bylaws. Because small businesses are less likely to have employment agreements for their corporate officers (who often double as corporate directors), it is important that the bylaws contain adequate protections to guard the officers from personal liability arising out of their decisions.
 Cal. Corp. Code § 309(a) provides: "A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation and its shareholders and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances."
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Authored by: Roger J. Brothers, Esq. and Dominic V. Signorotti, Esq.
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