Are You Sure You Want to be a Director?

By: Janice Wilken - Partner, Ice Miller LLP

The Indiana Supreme Court recently decided a case which could impose significant new responsibilities on directors of Indiana corporations. In Lean v. Reed, the court found a director of an Indiana corporation personally liable as a matter of law (i.e., without trial) for violations of the Indiana securities laws by the corporation. While this in itself is not groundbreaking, the facts underlying the case are rather startling.

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In non-legalspeak, directors and officers can be personally liable for a corporation's violations of the Indiana securities laws under some circumstances. A director will have a defense against personal liability if the director did not know, and in the exercise of "reasonable care" could not have known, of the facts giving rise to the violation. In Lean v. Reed, the director assumed without inquiry that management had taken the steps required to comply with the Indiana securities laws. And that was his mistake. The court found that the director had per se failed to use reasonable care because he did not ask. No trial of the facts required or permitted.

Further explanation of the facts only makes the case scarier from a director's perspective. Mr. Lean was a brand new director. The transaction in question was approved at his first board meeting. In addition, to the extent non-lawyers think about securities laws at all, it is generally in the context of fundraising transactions rather than business combination transactions. In the Lean v. Reed case, the transaction was a share exchange, fairly similar to a merger. It is not likely that a person untrained in legal matters would immediately recognize that the securities laws are implicated in a merger or share exchange.

So what does this mean? It essentially imposes a burden on directors to inquire into the company's securities law compliance whenever the corporation issues securities. Directors are now supposed to act like lawyers. Although it is not clear what will be sufficient to establish the use of reasonable care, we do know that you might be held not to have used reasonable care if you do not at least ask. The text of the opinion suggested that a memorandum from counsel or a counsel presentation to the board would be sufficient. More legal bills, anyone?

In addition, this ruling could put attorneys representing issuers in a difficult position. Generally, the attorney represents the entity issuing the securities, and not the individual directors or executive officers. This distinction could become significant in the case of a "close call" question of compliance with the securities laws. The attorney could find himself or herself in a conflict situation where he or she is forced to withdraw from the representation. At a minimum, attorneys will be forced to closely examine their relationships and clearly define the scope of their representation.

Overall, it seems to me that this decision could have a chilling effect on investment in Indiana. Institutional investors generally want some level of board representation, but, understandably, they are very concerned about protecting those directors from liability. A ruling like the one in Lean v. Reed could definitely be a strong factor in deciding not to invest in an Indiana corporation.

By the way, this ruling will not apply only to directors of Indiana entities. It will apply to directors of any entity issuing securities to Indiana purchasers, regardless of their jurisdiction of organization. This is not likely to encourage companies seeking investment to approach our angel investing community. Maybe that's the silver lining . . . more angel money that will stay in Indiana. But, I don't think so. More likely the angel money will just remain undeployed. And that's not really where we want to go.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.

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