March 25, 2020
In responding to the outbreak of COVID-19, caused by the novel coronavirus, Virginia corporations and their boards of directors may have to make significant decisions in “real time” based on imperfect information and rapidly changing circumstances. Virginia law is highly deferential to board decisions, and directors and officers are entitled to rely in good faith on the advice of other officers, employees, and outside advisors. Nevertheless, there are important lessons learned from the 2008 financial crisis that are pertinent now.
In the aftermath of the 2008 financial crisis, a federal bankruptcy court refused to dismiss a complaint brought by a bankruptcy trustee against the former directors and officers of a publicly traded Virginia corporation which, because of major liquidity issues at a subsidiary, had become insolvent during the financial crisis. In denying the defendants’ motion to dismiss, the bankruptcy court held that the complaint stated a claim that the directors and officers had engaged in “willful misconduct” by consciously refusing to take action in response to the corporation’s known liquidity problem. Among other things, the plaintiff alleged that the board failed to investigate the corporation’s problems, met infrequently, and failed to engage in any substantive discussions about the situation until the corporation’s bankruptcy was nearly certain. The plaintiff also alleged that the board of the corporation’s operating subsidiary did not have formal meetings as the crisis unfolded. While we believe there are significant issues and limitations regarding the case, we also believe it highlights some general principles that we encourage directors follow now more than ever.
Under the Virginia Stock Corporation Act (the VSCA), directors must discharge their duties “in accordance with their good faith business judgment of the best interests of the corporation.” The VSCA further provides that directors will not be personally liable for any action taken (or for any failure to act), so long as the directors have performed their duties in accordance with this standard. In addition, the VSCA does not hold directors to the standard of a hypothetical “reasonable person.” In discharging their duties, furthermore, both directors and officers are entitled to rely in good faith on the advice and reports of others, including employees and outside advisors.
It is well established under prior Virginia court decisions that “good faith is to be measured by the directors’ resort to an informed decisionmaking process, not by the rationality of the decision ultimately taken.” In reviewing a board’s decisionmaking process, a court may inquire into the number of meetings held, the types of written materials provided to the directors, and whether the directors received advice and reports from officers, employees, and outside advisors. It has long been clear that from a litigation standpoint creating an evidentiary record of a board’s process will best position that board to defend itself in future litigation. This is particularly important today, as the decisions made by a board of directors during a crisis may later be second-guessed by courts, shareholders, the media, and others.
Thus, a clear lesson from the 2008 financial crisis is that Virginia corporations can help protect directors and officers by focusing on the following aspects of board process in these challenging times:
In addition, corporations should do the following:
Each corporation’s situation is contextual, and we are available to our clients for assistance.
In addition, our firm’s COVID-19 resource center is available here.