By: Harvey L. Pitt
For at least a century, the role of non-management corporate
directors was often treated as one of passivity, not activism.
Power to manage a corporation’s affairs was believed to reside
exclusively in the hands of its senior officers, with the proper
role of outside directors being generically and non-intrusively to
oversee, and approve (when asked to do so), significant managerial
decisions.
Corporate scandals bred in the ‘90s exposed this weak
leadership, which at times had permitted practices that were
clearly illegal to occur and thrive nonetheless. The passage
of the Sarbanes-Oxley Act (“S-Ox”) in July, 2002 reemphasized the
role of directors as elected representatives of the shareholders
and the stewards of company assets.
The liability landscape for corporate directors has been
changing dramatically. Most recently, three events are
causing greater focus by directors on the thorny issue of personal
liability: (1) The Emerging Communications case,
decided by the Delaware Chancery Court last June; (2) the Disney
shareholders’ suit over former President Michael Ovitz’s $140
million severance package; and (3) the recent proposed settlements,
by outside directors, of WorldCom and Enron class action litigation
last month. The outcomes of these three phenomena suggest the
need for outside directors to adopt a proactive stance in
performing their oversight functions.
Traditionally, corporations shield individuals from personal
liability except in egregious circumstances. This is why
corporations are separate legal entities. As a separate
“person,” the corporation is generally responsible for the firm’s
actions. This is so because corporations are expected to take
appropriate business risks. If personal liability extended to
managers and directors, they would take far fewer risks. That
would mean fewer corporations, fewer investments, and fewer
jobs. Managers and directors would not be inclined to pursue
transactions where the costs exceeded the benefits to themselves,
the wrong measure for any corporate decision. Therefore, from
a policy perspective, corporate law traditionally has embraced the
view that it is better to encourage directors and managers to take
risks, so corporations can create wealth and jobs. In the
end, the threat of personal liability might make directors and
managers excessively risk averse in their decision-making, thereby
injuring shareholders, chilling investment, and diminishing
efficiency.