Monday, January 12, 2009

Corporate Board Members' Personal Liability

Corporate suits against current or former corporate board members are not only reserved for the likes of Enron, failed hedge funds, and the Sun-Times, but are also available to aggrieved shareholders of smaller, local businesses and non-profits.

A lot of regular, working people volunteer for Board positions at smaller corporations, including homeowners’ associations. It may be frightening for some of them to learn that they face personal liability for injuries to the corporation if those injuries are caused by the board’s neglect or mismanagement.

That is why I found the case Davis v. Dyson, decided by the 2nd Dist. on December 19, 2008, particularly interesting. The case involved the embezzlement of more than $550,000.00 from a Condo Association by a former property management company.

Several homeowners filed suit against the individuals who sat on the Association’s Board of Directors during the time that the fraud was occurring. The homeowners brought suit on individual and derivative bases. A derivative action is one that a corporate shareholder brings on behalf of a corporation, when the corporate management declines to act due to fraud or incompetence. The defendants were former members of the Association’s Board of Directors.

Plaintiffs alleged breaches of fiduciary duty. Corporate board members owe fiduciary duties to shareholders. In the case of a condo association, this includes complying with Illinois Condominium Property Act and the Association’s bylaws. Plaintiffs specifically allege that the board members violated the Condo Act by failing to purchase insurance to protect the Association against the fraud that occurred.

The defendants asserted the business judgment rule. They argued that the fraud was not foreseeable and that it did not make sound business sense to carry that much insurance. Under the business judgment rule, absent evidence of bad faith, fraud, illegality, courts are not at liberty to interfere with the exercise of business judgment by corporate directors. In other words, it isn’t a breach of fiduciary duty to simply make a bad business decision.

The Court affirmed the trial court’s dismissal of the homeowners’ individual counts. The Court held that the plaintiff homeowners did not allege any separate and distinct injury from that suffered by all of the other homeowners.

The injury was to the Association, so the Court reversed the trial court’s dismissal of the homeowners’ derivative count. In doing so, the Court found that plaintiffs’ allegations, when viewed in the light most favorable to plaintiffs, could potentially support a finding that the director defendants breached their fiduciary duty of due care.

Therefore, the case was remanded to the trial court for further proceedings, where the defendants will face personal liability for the decisions they made while on the board.


Michael W. Huseman said...

Thank you very much. Check back often. We are glad to have you.

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