Liability Issues for Officers and Directors

Able, Baker and Christine own and operate ABC Access, a private high school that caters to the wealthy, offering assurance that graduates will have easy access to the best colleges and universities. When they founded their school they formed a corporation (ABC Access, Incorporated) so that their personal liability would be limited by law. All three owners are shareholders and are on the Board of Directors; Able serves as President, Baker as Chief Financial Officer, and Christine as Secretary.

ABC Access was successful for many years, but the untimely death of their top math teacher was a devastating loss. The school immediately sought a replacement and like a gift from beyond they received a call from David, a graduate from their school who had excelled in math while at the school and had gone on to a renowned east coast university with a major in math and physics.

David had been teaching at a small private college but was now unemployed and inquiring about a position.

Able, Baker and Christine were thrilled that David was available and quickly hired him without any background check, a check that would have revealed that David had been dismissed from his previous teaching job because of complaints that he had been sexually involved with several female students.

It did not take long. David convinced a female student that she needed extra math tutoring and the tutoring sessions became sex sessions. The student became scared, reported her encounters with David, and David was arrested.

The members of the Board of Directors of a corporation set the general policies of the corporation and appoint the Officers. The Officers run the day to day operations of the corporation business. In small corporations like ABC Access, Inc. the Officers and Directors are usually the same people.

The student’s parents will sue David as well as the school, but what about the personal liability of Able, Baker and Christine as the officers and directors of ABC Access, Inc.? The lawyer for the parents may well claim that Able, Baker and Christine are personally liable because, by failing to properly investigate David’s past before hiring him, they breached a duty to the corporation.

Officers and directors of a corporation may be subject to personal liability for acts performed as an officer or director. These liabilities can be divided into two types—(1) liabilities for which the corporation may indemnify the officer or director and (2) those liabilities for which indemnity is not available.

Indemnification of Officers and Directors:

Indemnification of officers and directors means that the corporation will provide for expenses incurred and amounts paid in defending claims brought against them for actions taken in good faith on behalf of the corporation. This indemnification is “first dollar” indemnification, which means that legal representation and defense is provided directly by the corporation as opposed to paid by the officer or director and later reimbursed by the corporation.

Actions subject to indemnity include all actions taken in good faith on behalf of the corporation as an officer or director. Theses liabilities may include allegations of defamation, improper or unlawful employment practices, breach of contract, and failure to pay wages and withheld taxes.

Examples of liabilities that are not subject to indemnity include:

  • Intentional breach of the duty of care to the corporation
  • Intentional breach of the duty of loyalty to the corporation
  • Misappropriation of a corporate asset for personal use
  • Commingling of personal and business assets
  • Failure to disclose a potential or actual conflict- of interest
  • Crimes against the Corporation
Directors and Officers Liability Insurance:

Directors and officers liability insurance (often called D&O insurance) is liability insurance payable to the directors and officers of a company, or to the organization(s) itself, to cover damages or defense costs in the event they suffer losses as a result of a lawsuit for alleged wrongful acts while acting in their capacity as directors and officers. Such coverage can extend to defense costs arising out of criminal and regulatory investigations/trials as well; in fact, often civil and criminal actions are brought against directors/officers simultaneously. D&O insurance covers liabilities of the corporation as well as the personal liabilities for the directors and officers of the corporation.

Frequently Asked Questions:
Can I be sued if I serve as a member of the parish Board of Directors?

Yes. Under our legal system a lawsuit can be filed against anyone. Many meritless lawsuits that name individual officers or directors are filed each day. This is the reason that corporations maintain D&O insurance. Whether the claims have merit or not, if the officer or director was acting in good faith on behalf of the corporation, the officer or director is entitled to be fully indemnified.

Can I be held liable for claims against that are solely against the corporation based on my status as a director or officer?

No. Consider, for example, a lawsuit is filed against the school by an individual attending the annual fundraiser gala who falls because of a poorly maintained dance floor.

If the court finds in favor of the gala guest, it could issue a judgment against the school for a large amount — perhaps greater than the school’s insurance coverage. The amount of the judgment that exceeds the available insurance becomes a debt of the school. But because of the school’s corporate status, the board of directors, officers, and shareholders are not personally responsible for paying that debt. The liability is limited to the assets of the school.

As an officer or director of the school, can I become personally liable for my actions?

Yes. If you fail to act in good faith, misappropriate assets or use the corporation for personal gain you may be held liable. Such liabilities, if found to be meritorious, would not be subject to indemnity by the corporation.

Are my personal assets at risk if I serve as a board member or officer?

Yes, but such risk is very unlikely. Before your personal assets would be at risk the following must occur: (1) a judicial determination that the claim asserted against the corporation has merit; (2) a judicial determination that the claim asserted against the corporation is not limited to the corporate assets; (3) a judicial determination that as a corporate director or officer you should be held personally liable for your conduct; and (4) the damages awarded against you exceed the combined assets of the corporation and the D&O insurance, if any.

What would happen if I were sued in my capacity as an officer or director of the school?

First a determination would be made as to whether the claim was one that would be subject to indemnification. The operative language from the corporate Bylaws typically provides:

“The indemnification shall only apply if he/she acted in good faith and in a manner he/she reasonably believed to be in, or not opposed to, the best interest of the Corporation.”

Provided the acts are subject to indemnity, the corporation, through its insurance program, would immediately tender a defense to the directors and/or officers and indemnify him/her against expenses (including attorney’s fees), judgment and fines, in connection with such action, suit or proceeding.

Is the potential exposure to directors and officer’s liability a sufficient reason to decide not to serve as a director or officer?

Clearly this is a personal choice you can make with your own counsel. You may want to inquire about the following:

  1. Does she school routinely train staff on legal issues, such as, negligence, report writing, crisis management, mandated reporting, deposition preparation, or testifying in court?
  2. Does the school use best practices to limit the liability of the school through its internal risk management program ?
  3. Does the school have D&O liability insurance? If so, what is the policy limit?

The benefits of serving your community, and children in particular, should far outweigh any potential for an adverse claim. Be sure to ask the right questions, fulfill your fiduciary duty as an officer or director and confirm that the school has adequate D&O insurance.

AND FINALLY, what about Able, Baker and Christine? It is hard to predict what a judge or jury might do, but it appears that the officers and directors would be entitled to indemnification if sued because their failure to investigate David would likely be deemed negligent as opposed to an act intended to cause harm.