Four Mechanisms to Reduce Director Liability in Texas
March 12, 2020 by
A board of directors has two primary roles: to advise and oversee a company. The board does not manage the company, but rather guides the strategic and operational direction of a company by consulting with management. The board also monitors company performance and cost-effectiveness to further the company’s vision and mission.
A board’s “independence” empowers its members to act with judgment unclouded by conflicts and solely in the interest of the company and its shareholders, which often requires challenging management when necessary. Thus, with this independence comes the board members’ legal duties, which include fiduciary duties, the duty of loyalty, duty of care, etc. While board members may be subject to duties under federal securities law, most of their duties arise from state corporate laws. The internal corporate governing documents direct what state law applies
In Texas, specifically, a company cannot limit and eliminate certain duties. It can, however, limit and eliminate liability for violating certain duties. The list below has four effective mechanisms to shield board members from liability in Texas:
- Business Judgment Rule. While the business judgment rule has historically insulated board members from liability if they act in good faith, the recent rise in “corporate activism” could erode this protection. For instance, if a company acts in the name of interests beyond profit, the shareholders could challenge that act or decision in a lawsuit. As a result, it is even more important than ever to ensure and document that the board:
- followed a reasonable process to make an informed decision;
- took key relevant facts into account when making their decision; and
- made the decision in good faith that the action taken is in the best interest of the company—especially if the “best interests” are not purely financial.
- Exculpatory Provision. Under the Texas Business Organizations Code (the “TBOC”), the company formation documents can limit or eliminate corporate director liability, particularly for monetary damages to the company or shareholders. The existence of an exculpatory provision and its specific terms—especially considering the corporate-entity type involved—is essential.
- Indemnification Provisions/Agreement. The TBOC outlines the statutory requirements permitting and prohibiting indemnification of directors. The requirements are lengthy, detailed, and unique to specific circumstances and entity types. To ensure and optimize protection, one must analyze the provisions in the internal corporate governing documents in light of the nuanced statutory requirements.
- Director & Officer Insurance. Lastly, the TBOC expressly permits insurance, self-insurance, or other arrangements providing indemnification for liabilities for which the Code does not otherwise permit indemnification. At bottom, this is always an option, should protection for you as a board member not exist otherwise. Anyone becoming an officer or board member should first ask if director and officer insurance is provided and then check the scope of coverage.
Joining a company’s board of directors is an exciting opportunity with inherent risks. Those risks, however, are best evaluated—and mitigated—in the very beginning before any issues arise. The four mechanisms listed above can and should be tailored to fit your unique situations.
Brown Fox is a business boutique law firm, primarily focused on serving businesses, executives, and entrepreneurs in the practice areas most common to their daily business needs: corporate, labor and employment, intellectual property, litigation and tax. The firm’s representative clientele includes start-ups; partnerships; small to mid-size, private Texas companies; publicly traded companies; international corporations; and C-level executives. Additionally, the firm represents numerous cities and governmental entities in governmental and municipal matters. Learn more about Brown Fox by clicking here.