Posted In: Litigation
on November 23, 2020
It is well understood that officers and directors of Ohio corporations owe a fiduciary duty to the corporation. This fiduciary duty is heightened when one serves on behalf of a close corporation. In these circumstances, a director owes a fiduciary duty to both the corporation and its shareholders, and the director’s actions may be more closely scrutinized. A powerful doctrine of corporate law, known as the business judgment rule, protects corporate officers and directors – even those of close corporations. This doctrine prevents courts from second-guessing the wisdom of actions taken by corporate directors in the absent evidence of fraud, bad faith, or abuse of discretion. Koos v. Cent. Ohio Cellular, Inc., 94 Ohio App.3d 579, 589 (8th Dist. 1994).
Additionally, the party asserting a breach of duty must first establish, through clear and convincing evidence, an initial showing of fraud, bad faith, or abuse of discretion. Only then does the burden fall on the accused director of showing good faith in his or her decision. Importantly, however, the business judgment rule can only be relied upon by “disinterested directors;” i.e., only those directors who do not appear on both sides of a transaction or who will not derive a unique personal financial benefit from the transaction that will not be received by the corporation or other shareholders.
The business judgment rule can be satisfied by tying the director’s decision to a rational business purpose. This is often demonstrated where the director has relied upon information provided by qualified consultants – including attorneys and accountants – or through committees or other groups of individuals tasked with evaluating the advisability of a particular course of action.
Application of the business judgment rule, documented by sound corporate governance practices, was recently demonstrated in the decision of Maas v. Maas, 2020-Ohio-5160 (Ohio App. 1st Dist. 2020), in which the actions of several officers and directors of a close corporation were challenged. The challenged actions involved facilities expansion, charitable giving, and self-dealing/mismanagement.
With regard to each challenged action, the court closely scrutinized the corporate governance activities leading to the decision. For example, regarding the facility expansion, the court noted that detailed meeting records demonstrated that the shareholders all agreed that expansion was needed but disagreed on how to address this need. Further, the court considered the directors’ careful analysis of the various options, and the reasoned decision-making leading to the selected option. Ultimately, the court found that it was not permitted to engage in a post hoc critique of the directors’ decisions reached after conducting proper due diligence.
The claims based upon charitable giving and self-dealing were equally disposed of with regard to established law concerning corporate governance. The court noted that the plaintiff presented no evidence that the charitable giving – which is expressly authorized in R.C. § 1701.13(D) – was excessive or resulted in a waste of corporate assets. The assertion of self-dealing – which was premised upon facts showing that a director had benefitted from consulting fees paid to an entity he owned and had otherwise used corporate funds for his own use – failed because those actions had already been investigated and resolved in conjunction with an investigation performed by corporate counsel and approved by the corporation’s audit committee and/or ratified by the board years earlier.
The directors were able to defend their actions because they had engaged in sound corporate governance practices. They engaged consultants where necessary to evaluate important decisions. They kept detailed records of their deliberation, analysis, and decision-making. And, where needed, they engaged outside counsel to assist with investigations in conjunction with authorized committees of the board. And, importantly, the board employed outside directors who were not family members or employees of the close corporation.
Perfect corporate governance remains a lofty goal. However, sound corporate governance is achievable when it is made a priority and resources are expended to protect the corporation and its officers and directors. The decision in Maas serves as an example of the importance of keeping sound corporate governance top-of-mind to ensure that the protections established by the business judgment rule are available to defend corporate actions that may be contentious or questioned by shareholders or dissenting directors.
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