When Can a Board Resignation be a Breach of Fiduciary Duties?
The board of directors has an important role in a company, acting as representatives for stockholders while making decisions for the company and putting in place corporate management policies. The number of individuals on the board can vary, as the structure and powers of the board are determined by the corporation’s bylaws. But it’s not uncommon for a venture fund investing in a startup to want to designate one of its members to the board. This can be a way for the fund to remain informed and maintain influence in the corporate decision making.
But what happens when a director wants to resign? Under Delaware law, a director can generally resign at any time, unless the certificate of incorporation or bylaws require otherwise. Before a director decides to step down, however, she needs to carefully consider what her duties require.
Reasons for Resignation
Sometimes the motivation to resign can have nothing to do with the company itself. For example, there might be family issues or a situation where the individual has simply overcommitted herself. In these circumstances, stepping down is typically acceptable and doesn’t raise significant problems.
There might also be disagreements with other board members about the direction of the company. While healthy debate is essential to the functioning of an effective board, consistent disagreement can be disruptive. Provided there is no reason to believe anything illegal or unethical is going on, it might be in the best interest of the company for the dissenting board member to consider resign.
Another reason a director might consider resigning is if the company is in financial trouble and unable or unwilling to provide sufficient director and officer (D&O) insurance. Without such insurance, a director may face liability for certain claims against the corporation. It’s not uncommon for directors to want to leave the board under these circumstances.
Duty of Loyalty
One of the trickiest situations is when a director wants to resign over concerns about company wrongdoings. Directors have an obligation to act in the best interest of the shareholders. There are a pair of Delaware cases which illustrate that resigning from the board of directors of a troubled company isn’t necessarily a simple matter.
In re Puda Coal Stockholders’ Litigation: The case involved allegations that the CEO stole assets from the company through a series of unauthorized transfers. The independent directors attempted to pursue a lawsuit but were “stonewalled,” so they resigned.
In a 2013 ruling, then-Chancellor Leo E. Strine refused to dismiss a claim for breach of fiduciary duty against the independent directors. The chancellor was critical of the independent directors for resigning when they did, noting their resignation left the company “under the sole dominion of a person [the CEO] they believe has pervasively breached his fiduciary duty of loyalty.” “[T]here are some criticisms in which running away does not immunize you,” Chancellor Strine wrote. “It in fact involves a breach of duty.”
Rich v. Chong: Fuqi, the company at issue in the case, transferred over $100 million of from the company to third parties in China, authorized by the chairman of the board. It later reported that the company had been repaid in full, but was unable to produce audited financial statements to confirm. An audit investigation was launched, but the company failed to pay the parties involved. The independent directors later resigned, two of them in protest of the defunding.
Vice Chancellor Sam Glasscock III wrote in a 2013 ruling considered the board’s "abandonment of the investigation as an abdication of its duty to investigate the demand." The chancellor emphasized that “the conscious failure to act, in the face of a known duty, is a breach of the duty of loyalty.”
Together, these cases make clear that the Chancery Court views director resignations under the wrong circumstances as having the potential to be a breach of their fiduciary duties to a company’s shareholders. They can be a useful guidepost to consider directors’ legal and ethical duties.
In many situations, it is perfectly acceptable for a director to resign, provided they’ve made a neat exit. But once a director suspects or becomes aware of corporate wrongdoing, their responsibilities change. Simply resigning without seeking to rectify the issue can be a breach of duty. To avoid liability, a director’s first action should be to take reasonable steps to stop the violations. If met with stonewalling, they should seek out independent legal counsel. A resigning director should submit a written statement to the board chair for circulation to the board, and possibly to shareholders as well.