Pitfalls for Directors & Employees

Over the years, there have developed certain pitfalls for directors and employees of corporations, both business and nonprofit, of which those persons should be aware. There are, of course, many questions or issues to address with all operating entities which are supposed to limit the liability of principals and employees. The pitfalls or possible hidden traps considered in this article are considered only in the context of a corporation.

It is commonly believed that directors of corporations are shielded from liability if the entity which they govern is a Pennsylvania corporation. There are some limitations to that shield under Pennsylvania law. First, the overarching concept of the director as a fiduciary pervades all the actions or inactions of directors. This means that they must act at all times in the best interests of the corporation. Thus, if it is proved that a director is acting in his or her self -interest, or even not in the best interests of the corporation, he or she could be liable for a resulting monetary loss to the corporation.

If a director has a conflict of interest, that could cause a contract entered into by a corporation to be voidable. In order to avoid liability, the director must disclose the material facts of his relationship or interest to the other directors. Otherwise, fiduciary liability would not be limited.   For example, if a director is present at a directors meeting at which a proposed contract is to be approved in which he or she has an interest in or relationship with the other party to the contract, he or she can be part of the quorum. However, the interested director must advise the other directors of the conflict and abstain from voting. Otherwise, the contract could be voidable and the interested director would be in breach of his or her fiduciary duty. Even disclosure will not remove the contract from voidability if it is not fair to the corporation at the time it is approved.

If the bylaws of a corporation have the proper wording, a director may limit his or her liability by relying on the favorable opinion of knowledgeable directors, staff or consultants when a proposed contract or action is actually not in the best interests of the corporation. However, if the director knows there is a problem or the matter in question has to do with taxes or criminal activity, the director is not protected from liability for breach of his or her fiduciary duty.

There are pitfalls for both employees as well as directors with regard to reporting wrong doing. If a person goes public with something which he or she thinks a corporation has done wrong, he or she should be aware that the Pennsylvania whistleblower law only protects local, state and municipal employees. Thus, if the reporting of something wrong concerns a corporation in the private sector by one of its employees, there is no whistleblower protection under that law from retaliation such as discharge or lack of promotion.

The Sarbanes-Oxley Law is a federal law giving some protection to whistleblowers. It is usually applied to corporations with stock bought and sold on major exchanges The law does protect a whistleblower in other corporate situations in that there is the possibility for criminal prosecution of the person punishing the whistleblower. However, the protection is only afforded to whistleblowers who complain to federal (not state or local) officials.

The Pennsylvania corporation laws state the conflict of interest described in this article may be altered in the bylaws. This could be a further pitfall because many bylaws make the conflict of interest rules stricter than those in the applicable law. For instance, an interested director may not be allowed to count toward a quorum. Further, some corporations may not be able to contract with an entity in which a director has a sizable interest even though the conflict is declared. Such a bylaw provision could make an interested director’s liability for breach of fiduciary duty even more expensive because the contract would not be just voidable, but unenforceable.

The situation with regard to bylaws is more favorable for employees who wish to report wrongdoing. Best practices now dictate protection for whistleblowers in the bylaws or other declarations of policies such as human relations (“HR”) policies. Some organizations which have standards for their member corporations now even require protection for reporting persons who are neither employees nor directors.

When a corporation is sued, either criminally or civilly, directors or employees may also be sued in their individual capacity. Such actions can arise either because of service to the corporation or because of service to another entity at the request of the corporation at which he or she is a director or employee. When an employee is successful in such actions, Pennsylvania law requires the corporation to indemnify the employee or director for expenses including legal fees.   However, when judgments, fines or amounts in settlement are paid by the corporation, the corporation can only indemnify the employee or director in certain circumstances. There is express authority in the enabling legislation for both business and nonprofit corporations for a corporation to have liability insurance which can mitigate the situation for employees and directors.

Because of the possibility of pitfalls, a person should be aware of his or her situation in terms of the law, bylaws, HR policies and liability insurance of a corporation for which he is a director or employee. The bylaws, HR policies and liability insurance of a corporation are usually readily available to employees and directors. Because of the presence or absence of perceived protection in the law, a lawyer should be consulted before acting with regard to something in which a director has an interest or something in which he or she suspects is not right.   It is also suggested that if a person is preparing to report wrongdoing to the media or legal authorities, he or she consult a lawyer to see what protection he or she has under the applicable law, bylaws or HR policies.

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