By: Jennifer Williams-Alvarez
A board director’s main responsibilities include attending and preparing for board meetings, setting exec compensation, keeping the CEO position filled with an adequate candidate and generally fulfilling fiduciary duties to shareholders. A more unwelcome aspect of the job, but one that is all but assured to come around for seasoned directors, is litigation, as perceived failures related to any or all of these requirements can be fodder for a court battle.
“One of the perils of being a public company director is the large number of class action lawsuits and derivative suits,” says Betsy Atkins, director on the boards of Wynn Resortsand Volvo. “Unfortunately, some percentage of these derivatives and class action suits or SEC suits end up in depositions, and an even smaller percent end up with a director having to testify.”
Lawsuits may be considered territory that comes with the job, but in some instances, the costs for companies and board directors alike can be high, both financially and reputationally, and can even result in directors’ resigning — or being forced from the board.
Potential headaches and exposure can, however, be limited by actions taken and questions asked by directors long before a lawsuit is a reality, attorneys and board directors say. Take, for instance, a director’s habits when it comes to taking notes and sending e-mails relevant to a particular company transaction, says Eric Feiler , partner at law firm Hunton Andrews Kurth. Exhaustive notes and documentation may provide a sense of comfort, he explains, but “directors who tend to take the most notes and send the most e-mails are the ones who get targeted by plaintiffs.”
Joseph Grundfest, professor of law and business at Stanford Law School and a board director at investment firm KKR & Co, similarly advises that directors be mindful of what and how they communicate. “It’s valuable for directors to recognize that all communications related to board matters, to relationships with other directors, and to the company’s operations, are potentially discoverable,” explains Grundfest, whose independence as a member of a special litigation committee of Oracle directors was scrutinized in a 2003 derivative suit in Delaware’s Chancery Court. “It doesn’t matter if it’s e-mail, text messages, or handwritten scrawls on board decks. It’s all potentially discoverable.”
His advice: “Think before you write or talk. That’s a reasonable rule for life in general. It’s also a good rule for board-related communications.”
In the ‘Hot Seat’
Generally speaking, attorney David Hennes recommends that the best move directors can make is to be actively involved in decision-making long before litigation is an actuality. Being educated about issues, attending meetings, actively participating — these are ways to ensure that directors’ duties are discharged, and also make it easier to explain in a deposition or in testimony why a decision was made, he explains.
Also important is that directors adequately prepare, says Hennes, a partner at law firm Ropes & Gray. Despite busy schedules, it’s imperative that when directors are heading for the “hot seat,” they put in the time, he adds.
Atkins suggests that directors remember to “follow the tried-and-true attorney guidance of ‘answer only what is being asked.’”
She contrasts preparing for testimony versus a deposition. In her experience, Atkins notes that in court, “you can be a little more forthcoming and give context,” because the judge or jury has “the opportunity to see you as a more three-dimensional, caring, human being.”
“Depositions unfortunately are not about being human; they are about not being taken out of context.”
Drawing on recent personal experience as a board director at Wynn Resorts, Atkins further draws a line between going before regulators and being involved in testimony or a deposition for a matter in court. Atkins was among the directors who were called to testify before the Massachusetts Gaming Commission related to the company’s suitability to maintain a gaming license following the allegations made against former CEO Steve Wynn, as Agendahas reported.
“Testifying before a gaming regulator is different than testifying in a deposition or a courtroom,” she explains. “Qualifying as a board member to a gaming licensee is about giving adequate information so the regulators can have comfort and confidence that you are ‘suitable’ for a gaming license.”
Even among regulators, there may be distinctions. In her time on more than 25 corporate boards, Atkins says, she has had to appear before the SEC once, an experience she describes as “both scary and humbling,” though it “turned out just fine” in the end. “I found them to be very straightforward, open and direct and I did not feel they were trying to entrap or play ‘got you.’” She adds, however, that she followed attorney advice to not volunteer extraneous information.
How Deposition Testimony Gets Used
A slew of cases currently on various court dockets allege that directors have failed to live up to their duties. One is currently sitting on the docket in the Delaware Chancery Court, where a $47 million settlement is pending approval. The three-way deal involves privately held Sierra Income Corporation, Medley Capital Corporation (MCC), a publicly traded business development company, and Medley Management, which advises both MCC and Sierra, according to an August 2018 announcement on the deal.
Medley Management, a publicly traded asset management firm, was founded and is majority owned by twin brothers Brook and Seth Taube. Shareholders filed suit in February 2019 claiming that the deal was nothing more than a way to reward the brothers and others in management positions “despite their miserable track record,” and further alleges that the Taube brothers, who hold various executive and board roles across the three entities, breached their fiduciary duties to shareholders.
In a March 11 opinion, vice chancellor Kathaleen McCormick pointed to director depositions concerning the process undertaken by the Medley Capital special committee of four directors in considering the deal. For instance, Medley Capital director John Mack’s deposition testimony — which exposed that he regularly spoke with Brook Taube about business matters but that, in his own words, he, Mack, “was not familiar with the specifics” of the transaction process and “may not want to know how sausage is made” — demonstrated to the court that he lacked independence.
The deposition testimony of Mark Lerdal was similarly used to show a lack of independence, as, for example, he shared special committee information with one of the Taube brothers.
Specific to the directors, the vice chancellor determined that Medley Capital board members violated their fiduciary duties in entering the proposed transactions and ordered the company to issue corrective disclosures to give shareholders adequate time to digest relevant information ahead of any related vote.
Seven days after the opinion was issued, Lerdal and Mack resigned from the Medley Capital board, according to a regulatory filing. Neither of the former directors commented for this article.
A proposed settlement revealed last month additionally stipulates that MCC would undertake a “go shop” process to solicit superior transactions and, if the original transactions are consummated, a $47 million settlement fund would be created, subject to court approval. The agreement also stipulates that David Lorber and Lowell Robinson will fill the vacant MCC board seats, according to a letter to vice chancellor McCormick.
A company representative and the Taube brothers did not comment.
Common Missteps and Critical Questions
Questions that Hennes recommends directors keep in mind when dealing with scrutiny in court or by regulators include whether one director or a subset of directors face separate accusations than others, which may require separate counsel if there’s a divergence of interests, as well as a consideration of what the company’s exposure is with respect to the given matter. Moreover, he says board members should ensure long before they are hauled into court that a company has appropriate insurance in place to protect directors in litigation.
Feiler additionally says directors should be conscientious about trying to uncover potential conflicts related to various advisors engaged by the board. This is because while directors are permitted to rely on advisors’ advice, failure to suss out possible conflicts could prove problematic in court, he explains.
Moreover, Hennes says the most common misstep when directors are called upon for explanation by litigants or regulators is that they are overconfident, leading to inadequate preparation.
“The risk is that [directors] won’t be able to adequately explain why it is that they did what they did in a deposition or in testimony, and that leads the finder of fact to conclude that they haven’t appropriately discharged their duties, or [to be] critical of their conduct,” he says.