07/11/2013 12:59 pm ET Updated Sep 10, 2013

Directors Serving as Officers May Not Have Business Judgment Rule Protection

In many situations a corporate board member may also serve as a corporate officer. The business judgment rule insulates directors from personal liability for corporate financial losses when the directors make informed decisions in good faith. However, a number of judicial decisions, particularly involving California corporations, indicate that the business judgment rule may not protect directors for decisions made in the role of a corporate officer.

A July 8, 2013, decision by the U.S. District Court for the Central District of California, FDIC v. Faigin, applied California state law in determining that the business judgment rule did not insulate directors when making decisions as corporate officers. This case involved the FDIC as a bank receiver attempting to recover from the directors the losses incurred from bad loans. The directors asserted a number of defenses including the business judgment rule but the court allowed the case to proceed. In this situation the directors were personally reviewing and approving the loans in question, an officer function.

Consequently, the precise decisions in question, made as directors or officers, influence the application of the business judgment rule. Thus, a general decision by the directors to engage in real estate lending may be protected by the business judgment rule but the approval by the directors of a specific loan may not fall under the business judgment rule. Another complication surrounds individuals acting in an agency or trustee capacity. Typically, the law of the state of incorporation applies overall.

The Delaware Supreme Court has determined that the same fiduciary duties of care and loyalty apply to both directors and officers (Gantler v. Stevens). A shareholder vote ratifying a decision does not automatically foreclose all violation of fiduciary duty claims. A broadly written exculpatory clause in the corporate charter is not unlimited either. Hence, there is no easy formula that one may apply to all situations. Directors need to be informed concerning not only the law of the state in which they act but also the law of the state of incorporation. Directors should realize that acting in multiple capacities compounds potential personal liability.