The Curious Case of Directors' and Officers' Liability for Supervision and Management: Exploring the Intersection of Corporate and Tort Law

Martin Petrin

doi:10.2139/ssrn.1407589

Abstract

Directors’ and officers’ liability under corporate and securities laws continues to be a hotly debated subject. Yet, their liability toward non-shareholder third parties under common tort law and statutory provisions has generated relatively modest scholarly interest. Thus, it has gone mostly unnoticed that corporate directors and officers can be held personally liable in tort to non-shareholder third parties based on failures in exercising their core corporate duties - supervision and management.However, as this article explains, the current liability regime in this area is in need of repair. It fails to distinguish between the corporation’s duties and the duties of directors and officers, neglects the separate corporate personality of the corporation, unduly shifts the risk of doing business to directors and officers, and undermines the heightened liability protections provided to directors and officers by corporate laws. Consequently, a new approach is required. This article proposes a novel model for corporate liability that is centered around the nature of directors’ and officers’ duties and focuses on the individual’s state of mind. At its core, the proposed model is based on the belief that in order to preserve the corporate shield, liability standards in tort law should not conflate the standards imposed on individuals with those imposed on directors and officers.

Highlights

Should directors and officers[1] be personally liable in tort for gunshot wounds sustained by a mall patron after management reduced mall security in order to maximize profits? Should directors be personally responsible for failing to install exterior lighting when the failure to do so led to a resident being robbed and attacked in her condominium unit? Should directors and officers be liable for negligently managing underwriting risks or for failing to detect misconduct by employees?
Unlike claims that are brought by shareholders, the law governing tort claims by non-shareholder third parties against directors and officers remains an area that is largely neglected by legal scholars
Separate corporate identity may be disregarded and liability imposed upon an individual if a court finds that the corporation is controlled and operated in a manner that makes it a “mere instrumentality of another” and that the “observance of the fiction of separate existence would, under the circumstances, sanction fraud or promote injustice.”[51]. Interestingly, under a veil-piercing approach, courts can find directors and officers personally liable in cases where they did not participate in the tortious acts and where there would be no liability under participation or duty-based theories.[52]

Summary

INTRODUCTION

Should directors and officers[1] be personally liable in tort for gunshot wounds sustained by a mall patron after management reduced mall security in order to maximize profits? Should directors be personally responsible for failing to install exterior lighting when the failure to do so led to a resident being robbed and attacked in her condominium unit? Should directors and officers be liable for negligently managing underwriting risks or for failing to detect misconduct by employees?. Part IV argues that the current approaches for adjudicating tort-based supervision and management claims in the corporate context are, for the most part, inadequate and lack the necessary protections for directors and officers. Part V explores the revised approach by offering an alternative model of corporate tort liability that is duty-based Throughout this Article, the focus will be solely on directors’ and officers’ tort liability toward non-shareholder third parties in the context of supervision and management.[15] some of the arguments put forward in this Article in support of the revised liability model may apply to other legal entities—such as Limited Liability Companies or Limited Liability Partnerships—and their agents, the present discussion will be limited to the liability of directors and officers of corporations.[16]. Without limited liability, the problem is less pronounced, as it is likely that individuals who were held personally liable are in a better position to recover indemnification payments under agreements with their entity, since these indemnification claims will not be wiped out in bankruptcy

AN OVERVIEW OF TORT LIABILITY FOR DIRECTORS AND OFFICERS

Focus on Participation

Focus on Duty

Veil Piercing

Statutory Liability

DIRECTORS’ AND OFFICERS’ TORT LIABILITY FOR SUPERVISION AND MANAGEMENT

Common Law egligence Claims

Statutory Claims

PROBLEMS ASSOCIATED WITH TORT-BASED LIABILITY FOR SUPERVISION AND MANAGEMENT

Internal versus external duties

The corporation as exclusive bearer of duties

Failure to Align Corporate Law and Tort Law Liability Standards