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| Home - Industry Article - Dec 03 Issue |
Directors of Financially Troubled Companies Beware
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For Non-Payment of Wages
The failure of a corporation to pay employee wages (including commissions, overtime and accrued vacation) can result in civil and criminal liability of the officers and management of the corporation. A director acting in a managerial capacity may be held individually responsible for unpaid wages.
For Non-Payment of Certain Taxes
The failure to pay "trust fund" taxes (that is, sales or withholding taxes collected from others and held in trust for the government) may become the personal liability of the officer who was responsible for paying the trust funds to the government. Although the responsible officer is usually a member of management, it is not uncommon for the IRS or a state taxing authority to sue all directors and officers in these situations.
Indemnification and D&O Insurance
Many corporate charters include provisions requiring the corporation to indemnify its directors and officers. In general, these provisions provide reimbursement for liabilities and expenses arising out of legal proceedings brought against directors or officers in their capacity as such if they acted in good faith and in a manner reasonably believed to be in the best interests of the corporation.
Most states also authorize corporations to purchase and maintain "D&O" insurance on behalf of officers and directors against liabilities incurred for actions taken in their official capacity. However, most D&O policies contain exclusions from coverage under certain circumstances, such as self-dealing. In addition, most policies do not protect against wage or tax claims.
Once a corporation is insolvent or in bankruptcy, the issues associated with its insurance coverage become more complex. For example, if the corporation is in bankruptcy, it is possible that the proceeds of the D&O policy will be considered an asset of the debtor corporation with policy proceeds unavailable to officers and directors for their legal expenses.
In light of the numerous issues that can arise with respect to insurance coverage, it is important that the company's D&O policy be set up from the beginning to try to provide the desired result in the event of later financial difficulties.
Should a Director Resign?
Directors of financially troubled companies often consider resigning in hopes of mitigating their personal liability. Whether resigning is advisable is a highly fact-specific issue that must be analyzed on a case-by-case basis. For a number of reasons, however, resigning may do little or nothing to decrease a director's liability and may even increase it. If there is already liability for past actions, resignation will not wipe the slate clean.
With appropriate attention and professional advice, remaining on the board may help the director avoid incurring new liabilities. When a corporation faces financial problems, many decisions requiring extensive discussion and analysis will need to be made, including whether to sell some or all of the corporation's assets, responding to lawsuits and creditor claims, and satisfying employee and tax claims. If something goes awry, it will be easier to blame directors who have resigned and are not there to defend themselves.
Similarly, if decisions must be made with respect to D&O insurance, it may be better to participate in the decision-making process. In one case, the judge permitted indemnification reimbursement for litigation expenses for those directors and officers who were still in office, but not for those who had resigned.
The question of whether to continue to serve on the board of a financially troubled company can be even more challenging for a director with multiple roles which create real or perceived conflicts of interest. For example, the director may be affiliated with an entity that is both a creditor and a stockholder of the financially troubled company. In such a situation, the director must be careful to fulfill all applicable duties in each capacity.
William Gehrke is a Senior Partner in the Corporate Department of Hale and Dorr LLP. He is a member of the Hale and Dorr Venture Group (HDVG) and the firm's Software and Telecom Group. He concentrates his practice on corporate and securities law and the representation of start-up, venture-backed and technology companies. To send feedback, email: william.gehrke@haledorr.com or visit www.haledorr.com for more information.
 
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