Being appointed a corporate director certainly is an honor. But it’s also a responsibility.
Like it or not, directors are responsible for the corporation’s property and finances, which means the directors must conduct and manage the corporation’s affairs in good faith. Acting negligently and beyond their powers could make directors financially responsible for the corporation’s losses. In the eyes of the law, ignorance on the director’s part is not an excuse.
So, before you accept your next corporate directorship, it’s important to know what the responsibilities will include, what level of care and diligence is expected, and how much you need to know about the company’s corporate affairs.
Directors also should have a general understanding of taxation, since many of their decisions on the corporation’s finances will have an impact on the company’s tax liability. If it’s proven that the corporation must pay penalty taxes because of a director’s decision or action, the director(s) could be held financially liable.
To protect against penalty tax liability, all of the directors should keep a current record showing that the company retained its earnings for the reasonable needs of the business and that it had instituted plans to use this surplus. For example, plans for the surplus could include a building reserve, architect’s plans, contractor’s bids, etc.
Knowing specifically what constitutes negligence is an important first step. For instance, are directors responsible for corporate losses if they are acting on the advice of other professionals, i.e. an accountant or attorney? If the misguided advice is the whole cause of the problem, and the director acted in good faith, the answer is no.
Directors also are not responsible for the negligent acts of others as long as they didn’t know about the action or had their dissenting vote recorded in the minutes.
Director liability can extend to creditors. If the directors approve a business action without the necessary capital to see it through, they are liable to the creditors. And if they pay themselves ridiculously large salaries or make it impossible for creditors to collect, they are liable.
To minimize your liability as a director, take the following steps:
1. Don’t skip directors’ meetings.
2. Take good notes and file them consistently.
3. Understand the financial reports and legal opinions prepared by the corporation’s accountants and lawyers.
4. Make sure any dissenting vote or disapproval of an officer’s or director’s action is recorded in the minutes.
5. Read the minutes of all meetings and make sure all disapprovals are noted.
6. Consider resigning if you emphatically disapprove of an action or cannot attend meetings regularly.
In general, you would not be liable for losses suffered by the corporation as a result of poor judgment if you have acted honestly and within your powers. However, the best defense is to obtain a significant amount of directors’ and officers’ liability coverage in the form of an insurance policy.
The corporation typically purchases this type of policy on behalf of the board of directors and its corporate officers. These policies, while expensive, are worth the cost, especially in light of the potential liability. Louis P. Stanasolovich, named one of the best financial advisers in America the last four years by Worth magazine, is founder and president of Legend Financial Advisors Inc., a fee-only financial advisory firm in the North Hills. Reach him at (412) 635-9210. The firm’s Web site is located at www.legend-financial.com.
