Virginia Directors’ Duties: Key Considerations and Lessons from the 2008 Financial Crisis

In responding to the outbreak of COVID-19, caused by the novel coronavirus, Virginia corporations and their boards of directors may have to make significant decisions in “real time” based on imperfect information and rapidly changing circumstances. Virginia law is highly deferential to board decisions, and directors and officers are entitled to rely in good faith on the advice of other officers, employees, and outside advisors. Nevertheless, there are important lessons learned from the 2008 financial crisis that are pertinent now.

In the aftermath of the 2008 financial crisis, a federal bankruptcy court refused to dismiss a complaint brought by a bankruptcy trustee against the former directors and officers of a publicly traded Virginia corporation which, because of major liquidity issues at a subsidiary, had become insolvent during the financial crisis. In denying the defendants’ motion to dismiss, the bankruptcy court held that the complaint stated a claim that the directors and officers had engaged in “willful misconduct” by consciously refusing to take action in response to the corporation’s known liquidity problem. Among other things, the plaintiff alleged that the board failed to investigate the corporation’s problems, met infrequently, and failed to engage in any substantive discussions about the situation until the corporation’s bankruptcy was nearly certain. The plaintiff also alleged that the board of the corporation’s operating subsidiary did not have formal meetings as the crisis unfolded. While we believe there are significant issues and limitations regarding the case, we also believe it highlights some general principles that we encourage directors follow now more than ever.

Under the Virginia Stock Corporation Act (the VSCA), directors must discharge their duties “in accordance with their good faith business judgment of the best interests of the corporation.” The VSCA further provides that directors will not be personally liable for any action taken (or for any failure to act), so long as the directors have performed their duties in accordance with this standard. In addition, the VSCA does not hold directors to the standard of a hypothetical “reasonable person.” In discharging their duties, furthermore, both directors and officers are entitled to rely in good faith on the advice and reports of others, including employees and outside advisors.

It is well established under prior Virginia court decisions that “good faith is to be measured by the directors’ resort to an informed decisionmaking process, not by the rationality of the decision ultimately taken.” In reviewing a board’s decisionmaking process, a court may inquire into the number of meetings held, the types of written materials provided to the directors, and whether the directors received advice and reports from officers, employees, and outside advisors. It has long been clear that from a litigation standpoint creating an evidentiary record of a board’s process will best position that board to defend itself in future litigation. This is particularly important today, as the decisions made by a board of directors during a crisis may later be second-guessed by courts, shareholders, the media, and others.

Thus, a clear lesson from the 2008 financial crisis is that Virginia corporations can help protect directors and officers by focusing on the following aspects of board process in these challenging times:

• The board of directors should continue actively to oversee and monitor the corporation, including the corporation’s response to COVID-19. To do so, many boards will need to convene more frequently through telephonic special meetings to receive updates from management. It may also be appropriate for management to send periodic written briefings to directors between board meetings, but such briefings should not substitute for meetings.
• Directors should understand the key risks facing the corporation from COVID-19 and management’s strategy for avoiding or minimizing those risks. Management’s strategy should deal with short-term and long-term crisis scenarios. While each corporation’s situation is unique, potential topics include:
  • evaluating the crisis’s effects on the corporation’s operations and financial condition, liquidity, ability to service debt, and compliance with debt instruments;
  • minimizing health risks for officers, employees, and other stakeholders;
  • reviewing management’s strategies under a variety of COVID-19-related scenarios, including extended government closures;
  • reviewing emergency succession plans in case key executives become ill;
  • evaluating supply chain and distribution channel risks;
  • evaluating the corporation’s rights to recover business losses under insurance policies; and
  • considering whether potential business opportunities have been created.
• In monitoring the corporation, some boards may delegate certain functions to existing committees. Some boards may also decide to form new committees to oversee the corporation’s handling of the COVID-19 crisis between board meetings.
• In conducting meetings, boards and committees should try, to the extent practicable under the circumstances, to adhere to regular formalities regarding notices, waivers of notice, agendas, pre-meeting board packets, and executive sessions.
• It remains important for management to do its best under the circumstances to provide directors with timely and accurate information, even though that may be impossible in some situations.
• Board and committee meetings should be documented through appropriate minutes that help build an evidentiary record that the directors were discharging their duties.
• Utilize outside experts and advisors to advise the board where appropriate, including bringing in outside counsel to review briefly the directors’ fiduciary duties under Virginia law to create a record that the board understood its role and obligations in an unprecedented situation.
• Exercise caution in declaring dividends or other distributions or authorizing stock repurchases, all of which are subject to a statutory insolvency test.

In addition, corporations should do the following:

• Consider whether to adopt a forum selection bylaw, which is permitted by the VSCA, if the corporation has not previously done so.
• Be mindful that, while directors may be protected under Virginia’s statutory standard of conduct in approving executive compensation matters, dividends, or stock repurchases, such actions may have consequences in seeking government assistance.
• Exercise a high degree of caution before dealing in the corporation’s securities, given the risk that an insider may possess material nonpublic information; indeed, the Securities and Exchange Commission has advised recently of its concern about the risk of unlawful trading in this turbulent market.
• Evaluate carefully whether it is prudent to hold formal board meetings for operating subsidiaries, which meetings should be documented with minutes.
• Prepare a shelf-ready shareholder rights plan to prevent opportunistic takeover tactics or to safeguard net operating loss carryforwards.

Each corporation’s situation is contextual, and we are available to our clients for assistance.

In addition, our firm’s COVID-19 resource center is available here.