Business & Insurance Litigation Newsletter for Indiana

Directors and Officers of a Corporation May Be Personally Liable to Shareholders

Recently, in part because of the public demise of once successful corporations such as Enron and WorldCom, the liability of directors and officers has become a hot topic. However, such liability is not limited to directors and officers of large corporations. Directors and officers of any business, even not-for-profit corporations, need to be aware of their potential liability.

Generally, a director or officer owes three main duties to the corporation and its shareholders: the duty of care, the duty of loyalty, and the duty of good faith. The duty of care is set forth in Indiana Code §23-1-35-1(a), which states that a director shall discharge his or her 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 director reasonably believes to be in the best interests of the corporation. Liability arises if the director breaches this standard or fails to act accordingly and such breach or failure constitutes willful misconduct or recklessness. IC §23-1-35-1(e). This so-called business judgment rule provides wide leeway for directors and officers to make decisions concerning the operation of the business since negligence alone is not a sufficient basis for liability. See G & N Aircraft, Inc. v. Boehm, 743 N.E.2d 227, 240 (Ind. 2001) (finding that director did not act recklessly or intentionally and was therefore not liable for choice of bad accounting or tax policies).

The duty of loyalty arises from the fiduciary relationship between the corporation and its directors and officers. As a fiduciary, a director or officer must deal fairly, honestly and openly with the corporation and its shareholders. G & N Aircraft, 743 N.E.2d at 240; Hartung v. Architects Hartung/Odle/Burke, Inc., 301 N.E.2d 240 (Ind. Ct. App. 1973). A director or officer "must not be distracted from the performance of his official duties by personal interests." G & N Aircraft, 743 N.E.2d at 240; Hartung, 301 N.E.2d 243 (finding that director breached his fiduciary duty by appropriating a business opportunity for his own use).

Claims against corporate directors and officers range from claims of self-dealing, corporate waste or mismanagement, to outright fraud. In light of this potential liability, corporations are permitted, and sometimes required, to indemnify their directors and officers. See IC §23-1-37-8. Since corporations cannot always indemnify their directors and officers, because of insolvency or otherwise, directors' and officers' liability insurance is important.