Taking counsel

  • 2006-02-08
  • By Tuuve Tiivel [ Teder Glikman & Partners ]
Obligation of due diligence for board members

The issue of personal liability of members of commercial companies' board of directors has been a long-standing topic of interest in Estonia. Due to the latest major amendments to the Commercial Code, this subject has received even more public attention.

For applying liability to a director, it is foremost important to identify whether there has been a breach of duties. Upon finding what might be considered a breach, the essence and concrete substance of the duty has to by clarified. The law stipulates quite abstractly the criteria by undefined legal concepts of general duty of care and loyalty.

The most problematic to pin down is the standard of the general duty of care, which involves objective criteria. Directors have to perform their obligations with the due diligence and care normally expected from a member of the board of directors of a similar company, which means that one has to know, examine and do more and better than is required from an ordinary person.

The standard of due diligence may be even higher because of a director's specific knowledge 's e.g., in finance and law. So it is probably somewhat easier to determine the duty of loyalty and breaches of it in situations, for example, where the director uses the company's assets, confidential information or business opportunities for the benefit of the director's own personal interests.

Directors have to manage, organize, investigate, control and supervise as much as necessary. Upon evaluation of performance, the one to be assessed foremost is the quality of one's actions made at achieving goals. The results of the actions are not crucially important; however, there is potential for violation if the quality of the actions do not correspond to the requirements.

The director has to apply an appropriate decision-making procedure, which involves necessary investigation of the circumstances, gathering of information, internal control and counsel with specialists. A director's actions upon decision-making depend on very different aspects, such as the importance of a decision, time factors, the credibility of existing data and recommendations of assistants who prepared the project or transaction. The director's independent analysis does not have to be exhaustive but reasonably sufficient considering the situation.

Considering the often extraordinary character of business, directors also have to act immediately, relying on their intuition, previous experience and knowledge, as it is not always possible to use a bureaucratic decision-making procedure. Here one should be careful, as it may be difficult to prove the foundations of one's business-resolution and the fulfillment of the requirements of due diligence. When there is doubt about the reasonableness of the transaction, the abandonment of the execution of it should be considered.

Still, each business-decision contains some degree of risk regardless of the thoroughness of preparations. Business management means continually facing risks. This does not mean that the directors are per se liable for the obligations or successfulness of the business of the company. Upon assessment of the actions of the director it should be considered that in management one should not be passive or too conservative as losing a good business opportunity may basically mean the breach of the obligation of due diligence.

It would be best to take minutes of the board meetings as proof of correct discharge of duties. The minutes should contain information upon which decisions were based, providing a kind of checklist to show that the directors have acted with due diligence. It would be also prudent to retain all the important materials on which a decision was based.

Also, a standing order on the process of taking major decisions could be issued as a preventive measure. The order should define the notion of diligence and set minimum standards, the following of which would mean that the duties have been discharged correctly (e.g. reckoning with the departments, specialists, general business vision, plan, budget, etc).

For the application of personal liability of directors, it is not enough to only show that damages were the consequence of their decision. The circumstances of the decision-making have to be investigated, as later, when new facts are uncovered, it is difficult to correctly evaluate the business-decision only on the basis of its content and consequences. Hindsight, as the saying goes, is 20/20.

If the director acted during the decision-making process in good faith, was informed, consulted as much as was reasonably necessary, analyzed sufficiently possible risks and reasonably believed that the object of the decision was in that situation the best solution for the company, then the director cannot be liable if the consequences of the decision were not successful or were harmful to the company.