Standards of Conduct
The potential for personal liability as a corporate director falls into essentially two categories: (i) action, or failure to act on the part of the director that could lead to individual personal liability, and (ii) acts or omissions of the corporation served by the director for which the director could be held vicariously liable.

The statutory standards are derived from the common law "business judgment" rule, described as "... a common law doctrine under which courts generally refuse to second guess a business decision, so long as management made a reasonable effort to make an informed decision." 3A Fletcher Cyclopedia Corporations, Section 1029, p. 14.

Conflicts of Interest
A significant potential but avoidable source of director liability is conflicts of interest. A conflict of interest can arise from a contract or transaction between the corporation of which the director is a board member and another business organization of which the director is also a director, officer, legal representative, or who has, or is related to individuals who have, a material financial interest.

Such contracts or transactions are not automatically prohibited if there is proper disclosure. Once the director’s interests are fully disclosed and the contract or transaction is approved by a two-thirds vote of the uninterested shareholders, by the affirmative vote of all shareholders, or by a majority of the board or appropriate board committee (the director can’t vote), the contract or transaction has been properly approved by the corporation.

New and emerging companies need the help and input of seasoned business people on their board of directors. Unfortunately, the specter of "director liability" has deprived young companies of this experience. There are ways a company can dispel that specter and recruit talented executives to the board.

A company may limit or eliminate the director’s personal liability to the corporation or to its shareholders in its articles of incorporation. In Minnesota, a corporation, unless prohibited by its articles, is required to indemnify persons acting in their official capacity.

Some actions, such as breach of duty or loyalty to the corporation or to its shareholders, bad-faith acts or omissions, intentional misconduct, or a knowing violation of the law, obviously cannot be excused or protected. In Minnesota, a director who acts in good faith, receives no improper personal benefit, observes the conflict of interest guidelines, and believes his or her actions were in the best interest of the corporation cannot be held liable for such actions.

An indemnity agreement is only as strong as the party undertaking the indemnity. An indemnity agreement by a corporation with few or no assets is virtually worthless. In such a case, the prospective director may want to consider personal indemnity by the principal or principals of the corporation for which his or her services are sought. Collateralization of the indemnity agreement, or provision of an escrow or letter of credit to fund the indemnity, might also be considered.

The corporation may purchase and maintain directors and officers liability insurance ("D & O Insurance"). Coverage can be provided beyond the scope of the statutorily mandated indemnity. Although this approach is the most protective, fledgling companies often cannot afford such coverage.

An agreement between the prospective director and the corporation is a supplemental and rarely used approach to minimize liability. In essence, a director can insist on corporate conduct that will minimize potential director liability.

The terms and conditions of a director agreement require a company to take certain actions before a director agrees to serve or to continue serving. Properly drafted, these conditions will be seen not as burdens imposed by the director, but as steps that will benefit both the company and the director.

Some key ingredients of a director agreement:

• The corporation’s agreement to remain in good standing, and to qualify to do business in all states in which it is required to do so, and to provide the director with confirmation of this fact. The director should be furnished with a Certificate of Good Standing of the corporation in the state in which it is incorporated, copies of the articles of incorporation, and a copy of the corporate bylaws. The director should receive an opinion of corporate counsel that the corporation is qualified to do business in all states in which qualification is mandated.
• The corporation’s agreement to conduct annual meetings of its shareholders as mandated by the bylaws.
• The corporation’s agreement to hold board of directors meetings as provided in its bylaws on no less than a quarterly basis. The corporation should also agree to deliver an agenda to the director no later than a week prior to the scheduled meeting, and to add such items to the agenda as the director may request. The corporation should provide annual (preferably audited) financial statements to the director; provide to the director copies of all periodic financial statements furnished to or prepared by any officer of the corporation to the director when they are generated, and agree that its books and records may be inspected at any time by the director, either personally or through his or her agents. 
• The corporation should agree to file all tax returns and pay all taxes in a timely fashion, and withhold and segregate moneys to pay all trust fund, unemployment tax, and other tax obligations, and confirm to the director that it has done so.
• The corporation should provide the new director with minutes of all previous director and shareholder meetings, going back at least six years.
• The corporation should agree not to make any distributions to shareholders without securing a prior written opinion of counsel that such distributions are in compliance with state and federal laws.
• The corporation should agree not to issue shares of stock to any party without engaging competent securities counsel and a reputable CPA firm to advise and assist in this process.
• The corporation should agree not to make loans to officers, directors, or employees (at least above a modest threshold) without approval from the directors.
• The corporation should agree to enter into an indemnity agreement with the director. An appropriate form of indemnity agreement can be attached to the director agreement.

Properly implemented director agreements, adherence to the fundamental rules of director conduct, and proactive awareness of and participation in the corporate affairs by the director will substantially lessen the director’s potential legal liability.

Once these become standard corporate operating procedure, the director should be in a position to make a substantial contribution to the corporation to further its entrepreneurial endeavors, with minimal fear of legal consequences.

This publication has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.