If you are a director, an officer or business owner of a troubled company, you need to be especially careful. You now have two groups to whom you must answer: investors and creditors. As you know, these two groups have conflicting interests. Therefore, if you wrong one group over the other, you increase your chances of the offended party suing you. To keep you out of trouble, you need to know your responsibilities to each group.
Your responsibilities to investors
You have the responsibility of exercising care in your governance of the company and loyalty to the investors of the company – even if the only investor is your spouse. This is your fiduciary responsibility Here is what that means:
· act in the best interests of the company and its investors.
· act in good faith. You must not have any intent of fraud, deceit or misconduct.
· decide the firm’s strategy.
· replace top management if they have mismanaged the firm.
· educate yourself fully about the issues facing the company so you can soundly lead the firm.
Your responsibilities to creditors
Under normal circumstance, your loan agreements and seller contracts lay out your only duties to your creditors. This changes when your firm enters the zone of insolvency. When you are in the zone of insolvency, you have the following fiduciary responsibilities to creditors:
· act in the best interests of the creditors.
· act in good faith and not have any intent of fraud, deceit or misconduct.
· decide the firm’s strategy.
· replace top management if they have mismanaged the firm.
· educate yourself fully about the issues facing the company so you can soundly lead the firm.
As you can see by looking at the two sets of fiduciary duties, your responsibilities are the same except you must act in the best interest of both investors and creditors. This is a difficult task. It is the reason your personal liability increases significantly when your firm gets into trouble.
Business Judgment Rule
Before receiving my recommendations on how to deal with your increased liability, you must get some information about the Business Judgment Rule. Fiduciary duties do not require the business owners, CEOs, directors or officers to be perfect or mistake free when running the company. Otherwise, there would be D&O lawsuits every time a company had a slight upset or did not grow as much as some “expert” expected.
This protection from ordinary mistakes is the Business Judgment Rule. Under it, the business leaders are not liable for poor decisions if they have acted in the following ways:
· without any intent to defraud or deceive
· with enough information
· in the best interests of the investors.
· in the best interests of the creditors if the firm is insolvent or close to insolvent
Therefore, if you acted as above, your investors and creditors cannot hold you liable for the firm getting into trouble. Your main concern is to run the firm in the best interests of both the investors and the creditors so neither party sues you.
Increase your Director & Officer Liability coverage if your firm is a corporation or LLC. Get as much as you can afford. If the premiums are too expensive for your firm right now, you and your directors and officers should consider paying for the policy out of your own pockets. The peace of mind is worth the money. In addition, ask your insurance agent or broker about exercising the “tail” of the D&O policy. Most D&O policies have extended coverage called the “tail.” This coverage remains in force to cover D&O suits after the firm has shut its doors. Usually, you pay this tail in a lump sum before shutting down the firm or declaring bankruptcy and the coverage lasts three to five years.
Be aware that resigning from the board and running away from the firm’s troubles can hurt you. If you are not present, the other directors and officers could blame you for the firm’s troubles. They can name you as the main culprit of the firm’s mismanagement in any lawsuit. By resigning, you also will have no say in any settlements to which the board agrees. Such settlements may affect both your investment in the firm and your personal liability.
Tags: AskTheCFO, Business Debt Reduction, Business Debts, CFO, Financing