With the once unthinkable sight of shackled corporate executives being led away from their offices and into the glare of the criminal process playing out on our televisions with regularity, it should come to no one’s surprise that directors of New Jersey corporations face increasing scrutiny and potential personal liability as a result of such service.

Sources Of Liability

The personal liability of corporate directors arises from the fiduciary nature of the position.  While difficult to precisely define, a fiduciary duty implies a relationship of trust – the director is granted the trust of the corporation (as an entity) and of the corporation’s shareholders.  Violations of this trust fall into two general categories: breaches of the duty of care and the duty of loyalty.

A breach of the duty of care involves failure by a director to carry out a responsibility to manage or oversee the management of the business of the corporation.  For example, a director who fails to familiarize him or herself with the corporation’s accounting procedures and, as a result, fails to notice an employee’s embezzlement may be held personally liable for the losses to the corporation.

The duty of loyalty is more ephemeral, and generally requires that a director act, by vote or otherwise, to implement policies he or she honestly believes to be in the best interests of the corporation.  The quintessential violation of this duty occurs when a director receives an improper personal benefit in dealing with the corporation.  For example, the director could prevent the corporation from entering into a profitable contract in order to give the contract to another entity owned or controlled by him or herself.  The director could be personally liable for damages suffered by the corporation as a result of this diversion of corporate opportunity.

Sources of Protection

The situation for directors is not as bleak as it may seem, however.  To avoid making the position of director wholly unpalatable, New Jersey’s courts and legislature have recognized or enacted certain protections for those who serve.

The “business judgment rule” is the bedrock of director protection.  New Jersey courts invoke the business judgment rule to insulate a director from liability where the director acted in good faith, but made an honest mistake.  The courts will not second-guess the actions of a director simply because those actions may have been unwise.  To overcome the rule, plaintiffs must show that the director made the decision in bad faith or as the result of a conflict of interest.

Because plaintiffs occasionally succeed in overcoming the business judgment rule’s presumption that a director has acted in good faith (and because directors do occasionally act in bad faith), the legislature has enacted several statutes allowing corporations to further protect their directors from personal liability under most circumstances.  A corporation may indemnify its directors for expenses and losses incurred personally, and must indemnify a director for the expenses of successfully defending herself against suits brought by the corporation or third parties.  The right of indemnity need not be included in the corporation’s charter to be available to a director, but a charter provision could limit the company’s ability to indemnify a director.

A corporation may also limit or entirely exclude the personal liability of its directors for breach of all but a few key duties owed to the corporation or shareholders.  It is important to note, however, that the protection of exculpation must be proactively included in a corporation’s charter, either at the company’s formation or by amendment.

Given the current climate of increased accountability of directors, a prudent director should be familiar with the basic functional responsibilities of his or her fiduciary duties, and should be sure to review the corporation’s charter to determine whether he or she has the greatest protections from personal liability allowed by New Jersey law.