Author: Priya Cherian Huskins
Being appointed to a board is an honor and a privilege. It's also a lot of work and carries with it tremendous responsibility.
Even in normal times, deciding to resign from your role as an independent director can be a tough decision, but it can usually be done. In some rare cases, however, the act of resigning may be a breach of your fiduciary duty or at least open you up to such an accusation.
Let's look closer at five resignation scenarios.
Situation 1: Personal or professional reasons
Board members may decide to resign from a board for a variety of reasons. Some of these reasons may be perfectly benign.
It might be a matter of professional preference. Maybe the board in question isn't a good fit anymore. Or perhaps there are personal reasons like family issues, illness or simply being overcommitted.
These situations are specific to the board member and have nothing to do with the company itself. In these cases, it is normally acceptable to step down, assuming you've made a tidy exit. A proper transition includes giving the rest of the board plenty of notice and a chance to find and even empanel your replacement.
Of course, if you've been leading a special project or something similar, you will also want to bring that project to a natural end (or pause, as the case may be).
With any resignation, you will want to offer your resignation in a letter in which you identify the exact date of your separation. The last thing you want is to be held responsible for an action taken by the board after you thought you had resigned. Without a letter, the date of your separation may be ambiguous.
Finally, remember that the resignation of a public company director triggers a required 8-K filing.1 Rather than leaving your company to scramble, it's a good idea to discuss the possibility of your separation proactively with your chairman and general counsel before you resign. This advance notice gives all parties time to prepare the appropriate filing.
Situation 2: Not rowing in the same direction
Another reason a board member might decide to resign is if the member disagrees with the strategic direction the company is taking.
Of course, we expect that board members might vigorously debate the important business issues that face a company, and seasoned businesspeople won't always agree with one another. However, after the debate is done and a decision has been made, everyone must pull in the same direction.
In some cases, it could be that a particular board member will find themselves unable to support an extremely consequential decision the rest of the board has made. That board member might then be out of sync with the rest of the board in a way that is no longer productive.
As this Columbia Law School blog points out,2 when contemplating an exit, a director should consider "whether he or she can be an effective voice on the board or if he or she no longer is serving the interests of shareholders by being a dissenting board member."
Situation 3: Financial woes
Sometimes a board member wants to resign because the company is no longer willing or able to provide D&O liability insurance for its directors. This sometimes happens when a company is in especially dire financial straits, possibly even facing corporate bankruptcy.
A company's unwillingness or inability to provide D&O liability insurance is a common reason for directors getting off a board. Most directors don't want to continue serving if the company is no longer able to provide the protection board members expect.
On the other hand, some board members may feel that they should stay on a company's board even through corporate bankruptcy.
They may feel that they have a responsibility to stay when the going gets tough. Their view may be that doing so is consistent with the reason they were chosen to serve on the board in the first place: to help guide the company and protect shareholders.
Situation 4: Corporate scandal
Sometimes board members resign to help a company put a scandal behind it. This was arguably the case when two Wells Fargo board members resigned in March 2020.3
The two board members who resigned in March 2020 had been called to give testimony to the House Financial Services Committee, something that would have no doubt kept Wells Fargo in the spotlight for less-than-favorable reasons.
(Note that the two board members still testified, but they did so as former board members rather than as board members with ongoing responsibilities to the shareholders of Wells Fargo.)
The reasons the two directors gave4 for their resignations were typical in this type of situation:
It can certainly be the case that board members of a company with too many scandals will no longer be seen by shareholders and regulators as having the credibility to reform a company. In such a situation, resignation may indeed be the best path forward, particularly if fresh directors untainted by scandal are already empaneled on the board.
It's worth noting here that resigning from the board doesn't mean a board member loses the protection of the D&O insurance policy since these are typically written to cover former directors in addition to current directors. A well-written indemnification agreement will also continue to respond on behalf of a director even if that director resigns from the board.
Situation 5: Intentional wrongdoings
Intentional wrongdoing is the trickiest situation of all.
What happens when a board member becomes aware that a company may secretly be engaging in intentional wrongdoing, even to the extent of criminal activity? And what if that board member attempted to right the wrongs but simply couldn't? Is it OK to resign?
Two cases come to mind, re Puda Coal Stockholders' Litigation and Rich v. Chong (Fuqi),5 where suits were filed against company directors due to corporate wrongdoings. Ahead of these suits, some of the company directors had resigned because of discovering the wrongdoings.
The independent directors in both cases filed for a motion to dismiss but were denied by the Delaware court. In both instances, the court denied the directors' motions to dismiss because the court couldn't conclude that, as a matter of law, the directors' resignation wasn't a violation of their fiduciary duties.
In Puda Coal, the CEO allegedly stole assets from the company. It's reported that the independent directors attempted to pursue a lawsuit but were stonewalled, and so they resigned.
According to then-Chancellor Leo E. Strine, who denied the motion to dismiss, the independent directors had left the scene at a critical time.
Chancellor Strine pointed out that their resignation left the company "under the sole dominion of a person [the CEO] they believe has pervasively breached his fiduciary duty of loyalty," and that may be a breach of fiduciary duty.
In his words from the bench:
In Fuqi, the company transferred more than $100,000,000 to third parties in China at the direction of the chairman of the board. The company was subsequently unable to produce financial statements that proved the funds had been repaid in full. An audit investigation commenced.
During the investigation, the company failed to pay the parties involved in the audit. Four independent directors resigned over the course of about two years; two of them resigned in protest.
Vice Chancellor Sam Glasscock pointed out6 that the independent directors "who could have conducted a meaningful investigation on behalf of the company, resigned from their posts," and that made matters worse.
To be sure, losing a motion to dismiss isn't the same as being found to have breached one's fiduciary duties.
Still, these cases and their lengthy discussions about fiduciary duties send a clear message: The Delaware Chancery Court sees board resignations in the wrong circumstance as possibly being a breach of the directors' fiduciary duties owed to a company's shareholders.
The resignation litmus test
If you're an independent director considering a resignation, the critical question to ponder is this:
When has the situation of the company reached a place where the act of resigning from the board is itself a breach of one's fiduciary duty to shareholders?
For public company board members, the stakes are even higher. Case in point: "noisy withdrawal." As pointed out in the Columbia Law School article linked to earlier:
If you are resigning because of a disagreement, you are obligated under the law to make that disclosure. And sometimes board members don't want to do that.
Why liability coverage is key as you're making decisions about resignation
These sticky situations are exactly why you want to have excellent D&O liability insurance and indemnification agreements in place.
Even as you are doing the right thing, for example, staying on a board to correct newly discovered wrongdoings, you may face litigation filed against you personally. You'll want to have strong protections in place to help you defend yourself.
Of course, if the company's troubles are financial, the indemnification agreement won't be that helpful. In this situation, you want to have already secured an excellent D&O insurance program that was placed by a broker familiar with and skilled when it comes to helping a company get through bankruptcy.
Unfortunately, though, this situation is something that you want to think about before the trouble hits. As I have advised recently:
When a company is financially troubled, it can be difficult to secure a good renewal. Carriers may even attempt to put bankruptcy exclusions on the D&O insurance policy of a company that has to renew its insurance when the company is on the verge of filing bankruptcy.
It could even be the case that the company is so far gone that it doesn't have the cash to pay for the renewal. You can choose to go on the board of a company that has poor prospects for its D&O insurance, but when you do so, you are exposing your personal assets if you are sued.
So, can board members resign when they want to? The answer is yes, except when they can't.
In the worst-case situation where you know something is happening that hurts your shareholders, you are duty-bound to protect your shareholders and not abandon them... at least that's what the Delaware court opinions suggest.
Published: June 3, 2020
