As another year-end approaches, the demands placed on the members of a board of directors are often vastly increased by the seemingly annual sprint to close transactions by Dec. 31. When coupled with the personal commitments of this time of year, a director must resolve to juggle obligations.
The rulings in a number of cases and regulatory actions over this past year, however, serve as an important reminder that directors must remain vigilant in discharging their fiduciary duties or risk civil liability, criminal charges and regulatory sanctions.
Directors are subject to a number of fiduciary duties under law and case precedent. One such duty, the duty of care, is broadly adopted and requires a director to act with the same degree of diligence, care and skill that an ordinarily prudent person would exercise under similar circumstances.
In practice, a director can generally discharge this duty by acting on an informed basis, in good faith, and with the honest belief that his or her actions are in the company’s best interest. In fact, the “business judgment rule” used to assess the satisfaction of the duty of care, presumes a director has acted in such a manner. In furtherance of their duty, prudent directors regularly attend meetings, read submitted materials and ask questions.
To further carry out their duty of care, directors also often rely upon the opinions and recommendations of professional advisers, but recent cases illustrate that this duty cannot be fulfilled by blindly following professional guidance. Rather, ongoing supervision of advisers and review of their work product is imperative.
Review work product
In RBC Capital Markets v. Joanna Jervis, the Delaware Supreme Court closely reviewed several actions of Rural/Metro Corp.’s directors in the sale of the company. Of particular concern to the court was the cursory review of the investment banker’s valuation of Rural/Metro conducted by its directors, which was later deemed to be misleading.
The court noted that because the valuation was received only three hours prior to the meeting to approve such sale, there was only a short period of time in which the board could have conducted a review. While the board ultimately settled the resulting shareholder suit, the court, and just this past August, the SEC, cited the board’s careless review of the valuation materials and hasty approval of the transaction as misleading to shareholders and a violation of the board’s duty of care.
As such, we are reminded that a director cannot discharge a duty of care simply by passively relying on the thoughts of professional advisers. In order to avoid subsequent scrutiny, a director should always:
- carefully review the work product provided by an adviser;
- confirm an understanding of the adviser’s recommendations and the basis for such conclusions; and
- act only after thoughtful consideration of such recommendations.
Not all professional advisers are equal. Directors should be mindful to check the capabilities and historical experience of an adviser prior to engagement.
Don’t be afraid to ask for referrals from colleagues or for references from the adviser. Finally, be sure that a professional’s demonstrated experience correlates with the specifics of the then current need. Engaging advisers with the correct expertise may not only help the board satisfy its duty of care, but also help the company be efficient and stay on budget.
Avoid conflicts of interest
The past year also provided examples of litigation due to perceived breaches of the duty of care stemming from a trusted professional adviser’s conflict of interest. A conflict can arise when an adviser’s self-interest is, or is reasonably likely to be, at odds with the interests of the individual or company engaging the adviser.
For example, an attorney has a conflict of interest when asked to represent a potential client who has or may have an interest adverse to an existing client. Accountants engaged to audit financial statements of a company can have a conflict if asked to provide a valuation of the company for a sale, as they are being asked to essentially rely and review upon their own work product.
Finally, conflicts can commonly arise with professionals if payment of an adviser is contingent upon a successful outcome due to the inherent incentive to influence such outcome.
The recent case of Rural/Metro demonstrates the need for directors to discern and properly address conflicts as part of their duty of care. When Rural/Metro initially engaged its investment banker to value the company for sale there was not an apparent conflict of interest. A conflict of interest later arose, however, when the same investment bank was solicited to provide financing to a potential purchaser of Rural/Metro.
In its opinion, the court was disturbed by the failure of the directors to insist its investment banker disclose any conflicts throughout the engagement. Accordingly, when engaging an adviser it is prudent for directors to:
- enter into a separate engagement letter or require a written reaffirmation of the nonexistence of a conflict prior to the commencement of a new engagement; and
- expressly require in the engagement letter that the adviser perform a reasonable investigation to determine and disclose an existing conflict and establish processes and protocols designed to identify and disclose future conflicts.
Of course, determining the existence of a conflict is just the first step. Directors also need to take actions to acknowledge and address a conflict, such as establishing appropriate limitations on the advisers’ engagement or obtaining approval from disinterested parties.
Jeremy Wolk is a partner in Nixon Peabody LLP’s Business & Finance department. He developed this article with Isaac Figueras, an associate in the firm’s Business & Finance department.
11/11/2016 (c) 2016 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email email@example.com.