Don't run from the 'Just for Feet' finding: it's not another Van Gorkom, but it is a strong reminder of how careful and attentive directors need to be.

• Author: Raymond, Doug
• Position: LEGAL BRIEF

IN 1985, THE Delaware Supreme Court decision in Smith v. Van Gorkom sent shockwaves through boardrooms. In that case, the court held that directors could be held personally liable for their boardroom activities if they were sufficiently inattentive to their fiduciary duties. Previously, outside directors had been, in effect, willing to accept the possibility of liability for their own personal dishonesty, self-dealing, or insider trading. However, before Van Gorkom they had not believed they risked personal exposure for failing properly to oversee management.

This decision provoked a crisis in boardrooms and among the corporate lawyers. Many feared that this new risk of personal liability would make it more difficult to attract qualified persons to serve as outside directors.

In response, state legislatures adopted protective legislation intended to counter the impact of the Van Gorkom decision. One such provision is Section 102(b)(7) of the Delaware General Corporation Law, which (generally speaking) insulates directors from personal liability for their actions, so long as taken in good faith and without violating their fiduciary duties of loyalty. Thus shielded, boardrooms were saved from the risk of wholesale defections of directors resigning rather than exposing their own assets.

This has, in general, worked out as the legislatures had hoped. However, some recent cases have rekindled concerns whether individuals are putting too much at risk when they consent to serve as outside directors.

In a recent analysis, Outside Director Liability [58 Stanford Law Review 1055 (2006)], authors Michael Klausner with Bernard Black and Brian Cheffins surveyed all settlements and judgments that they could identify involving litigation against directors. The authors identified only 13 cases out of thousands filed since 1980 that included claims against outside directors. And these 13 cases included the settlements in the WorldCom and Enron disasters. It is striking that out of the many thousands of cases they identified that included claims against outside directors, only a handful seem to have resulted in personal liability.

Recently, the outside directors of sneaker retailer Just for Feet Inc. made very significant payments to settle a bankruptcy court claim for breach of fiduciary duty. The company had been the victim of accounting fraud by executives who had overstated earnings. In the aftermath, the company filed for bankruptcy amidst guilty pleas...