|SUING & DEFENDING CEOS|
By Michelle A. Blackwell
Enron. Tyco. Global Crossing. Adelphia Communications. WorldCom. And on and on. Each day brings new allegations of accounting irregularities and corporate abuses at successful mega-companies: the shifting of operating expenses into capital accounts, reporting profits when otherwise losses would have been shown, multimillion dollar loans made to CEOs then forgiven.
The intent of this article is to educate lawyers about the potential personal civil responsibility of corporate CEOs, and review theories of liability, trends and recent developments in the law. Defense counsel will learn how to decrease their clients’ exposure and of new developments in the law. Additionally, strategies for recovery are reviewed for creditors, corporate and shareholders’ counsel.
Recent illustrations of the point have included the acts of WorldCom CEO Bernie Ebbers, who resigned when questions arose about $366 million in his personal loans from the company. Another instance occurred where executives at Centennial Technologies, a Boston-area computer card manufacturer, allegedly sent fruit baskets to the CEOs’ friends, recording the shipments as $2 million in revenue.1
The scandal-ridden corporate world has shocked the economy and caused investors to lose trillions of dollars in the stock market. Headline news routinely reports the latest corporate abuses and photos of CEOs being carted off to jail in handcuffs. Prosecutors seek lengthy sentences. Congress and the president enact broad new regulations of corporations and their accountants, with stiffer penalties, to protect the nation’s retirement assets.
How are shareholders, corporations and third parties to be made whole? How can CEOs avoid personal liability?
The Sarbanes-Oxley Act of 2002
In July, President Bush signed into law H.R. 3763, the Sarbanes-Oxley Act of 2002. This act charges the Securities and Exchange Commission with enforcement of regulations designed to redress corporate and accounting fraud and corruption, ensuring justice for wrongdoers, and protecting the interest of workers and shareholders.2
In its initial stages, the bill contained language authorizing private civil actions against executives who knowingly misled investors.3 This language was removed from the final bill. As enacted, the Sarbanes-Oxley Act of 2002 does not authorize private civil actions against corporate CEOs. It is unclear whether the act will establish per se violation standards for private tort actions.
Corporate counsel, however, should note certain provisions of the act. Under the law, CEOs and CFOs must, among other things, certify the authenticity of financial statements, effective Aug. 14, 2002. H.R. 3763, Sec. 302. Further, in the periods when employees are prevented from buying and selling company stock in their pensions or 401(k)s, corporate officials are also banned from any buying or selling. H.R. 3763, Sec. 306. CEOs are highly encouraged to personally sign the corporation’s federal income tax returns. H.R. 3763, Sec. 1001.
Statutory Liability: the Reasonably
Prudent Officer and Payroll Taxes
An officer must discharge his duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances and in a manner the officer reasonably believes is in the best interests of the corporation. ORS 60.377(1). This duty is owed to the corporation and its shareholders.
Officers may be liable for unpaid payroll taxes. ORS 316.162(3), by definition, imposes the employer’s fiduciary duty on corporate officers who are responsible for seeing that the corporation performs its duty to pay withholding taxes. The statute makes the officers personally liable if that duty is not performed. Robblee v. Department of Revenue, 13 Or. Tax 1, 3 (1996).
The Business Judgment Rule
An officer is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, prepared and presented by an objectively reliable and competent employee, other officer, attorney or accountant for the corporation. ORS 60.377(2). This reliance, however, must be in good faith. Id.
The statutory duties imposed on officers appear nearly identical to the duties imposed on directors. Cf. ORS 60.357. The Oregon Code expressly provides for a director’s liability for unlawful distributions, but it is silent as to an officer’s corresponding duty. Cf. ORS 60.367 and ORS 60.371-60.384. This legislative void aside, the official comments to the Model Business Corporations Act imply that the standard of conduct for certain officers may in fact be more stringent than for directors in similar circumstances.4
An officer’s ability to rely on others may be more limited, depending upon the circumstances of the particular case, than the measure and scope of reliance permitted a director under section 8.30, in view of the greater obligation the officer may have to be familiar with the affairs of the corporation. [Official Comment, Model Business Corp Act Annot § 8.42, at 8-264 (3d Ed Supp 1998/1999)]
Historically, this stringent standard is imposed on officers under common law, rather than by statute.
Common Law Liability to the Corporation
An officer of a corporation is a fiduciary. Klinicki v. Lundgren, 298 Or. 662, 669 (1985) (Courts universally stress the high standard of fiduciary duty owed by directors and officers to their corporation.) Equity should subject corporate fiduciaries not only to the doctrine of unjust enrichment but to a standard of loyalty that will prevent conflicts of interest. Manufacturers Trust Co. v. Becker, 70 S.Ct. 127, 132 (U.S.N.Y.1949).
CEO misconduct and breach of duty to the corporation may lead to personal liability to the corporation. Knowledge and acquiescence by an officer of the corporation in his or another’s dishonest activities in any other capacity to the detriment of the corporation constitutes, as a matter of law, a breach of his fiduciary duty. Interstate Production Credit Ass’n v. Fireman’s Fund Ins. Co., 944 F.2d 536, 539 (Or. 1991).
Improper transactions may also be deemed void. Examples include misappropriation of corporate assets, excessive salary fixing, unapproved loans or loans not made in the best interest of the corporation, conflict-of-interest transactions, competing with the business of the company and improper benefit from corporate business.
Common Law Liability to Creditors
CEOs may be subject to common law liability for fraud, whether committed by an agent with the CEOs knowledge or whether committed personally, regardless of benefit. Fraud can take many forms, including securing pre-existing loans to an insolvent corporation to the detriment of outside creditors (i.e., 'debt financing').
CEOs may be personally liable to corporate creditors for fraud, even if the CEO incurred no personal benefit from the scheme. Creditors Protective Ass’n v. Balcom, 248 Or 38, 45 - 46 (1967) (Held, a director who actively participates in a fraudulent scheme to hinder the creditor’s enforcement of his judgment, and, pursuant to that scheme, withholds amounts due on garnishment is personally liable for the amount that garnishment would have realized.) In order to hold the officer of a corporation personally liable for fraud by an agent or employee, it is necessary to show that the officer had knowledge of the fraud, either actual or imputed, or personally participated in the fraud. Osborne v. Hay, 284 Or 133, 145-146 (1978).
A corporate officer, adviser or other agent who induces the corporation to breach a contract is liable to the other party to the contract for intentional interference with an economic relation only if benefit to the corporation played no role in the officer’s action. Thus, to enjoy immunity, a corporate officer or employee must be acting within the scope of his employment and acting with the intent to benefit the corporation. Beck v. Croft, 73 Or.App. 673 (1985); Welch v. Bancorp Management Advisors, Inc., 296 Or. 208, 216-217 (1983).
When a corporation is insolvent, or nearly so, CEOs may not take security interests in corporate property to secure preexisting debts to the prejudice of general creditors. Gantenbein v. Bowles, 103 Or 277, 289 - 290 (1922) ('By the great weight of authority, where a corporation is insolvent or has reached such condition that its directors or officers see that they must deal with its assets in the view of its probable suspension, they cannot use those assets to prefer themselves as creditors or sureties in respect to past advances to the prejudice of general creditors.')
A trend in the law is to recognize that officers of a bankrupt corporation owe a fiduciary duty to creditors to protect the company’s assets. See Jewel Recovery L.P. v. Gordon, 196 BR 348, 354 (Bankr ND Tex 1996). In Geyer v. Ingersoll Publications Co., 621 A2d 784 (1992), the court held that this fiduciary duty arises when the company is unable to pay debts when due or when its liabilities exceed the market value of its assets: 'Fiduciary duties to creditors arise when one is able to establish the fact of insolvency.' Id. at 790.
Creditors, shareholders and the corporation have a variety of remedies at law and in equity to recover against the personal assets of a wrongdoing CEO. The prudent CEO, on the other hand, is cautioned to comply with new federal regulations concerning financial practices and to carefully consider her exposure when accepting benefits or exercising preferences unfavorable to creditors, the corporation or shareholders.
ABOUT THE AUTHOR
Michelle A. Blackwell is a member of the board of directors of the Federal Bar Association (District of Oregon) and co-chair of the Lane County Bar Association, Federal Court Section. She practices federal civil litigation with Hutchinson, Cox, Coons, DuPriest, Orr & Sherlock, Eugene.
© 2002 Michelle A. Blackwell
1. 'Corporate accounting: Don’t try this at home,' July 22, 2002, by The Associated Press
2. 'Corporate Responsibility,' Aug. 5, 2002, whitehouse.gov.
3. 'Hill Leaders Agree on Corporate Curbs,' July 25, 2002, The Washington Post.
4. See OSB CLE, Advising Oregon Businesses, Vol. II, Ch. 27, 'Powers, Duties, and Liabilities of Corporate Directors and Officers,' by Mark A. von Bergen.