Kodak: Board Members Beware
By Jane Genova - January 1, 2012 | Tickers: EK, GGP, KKR | 0 Comments
Jane is a member of The Motley Fool Blog Network -- entries represent the personal opinions of our bloggers and are not formally edited.
If a public company is approaching or is in the "zone of insolvency," the game changes - big time - for board members. Recently, three members of the board have left Kodak (NYSE: EK) without explanation from them or the company. Given that development, we have to wonder if Kodak will be entering a zone of insolvency. That's the phrase used to indicate that either a company's liabilities outweigh assets (balance sheet insolvency) or its cash position is inadequate to pay the bills (cash flow insolvency). The three who exited were Laura Tyson, professor at the University of California, Berkeley's School of Business, and Adam Clammer and Herald Chen of private equity fund Kohlberg Kravis Roberts (NYSE: KKR).
When the corporation is in or near insolvency, board members become a whole lot more vulnerable to lawsuits and actions by regulatory bodies such as the SEC. That's because their job is expanded from watching out for shareholder interests to responsibility to creditors, secured and unsecured. Examples range from shareholder lawsuit against all General Growth Properties (NYSE: GGP) board members for not accepting a buyout offer to the SEC action against several Syntax-Brillian Corp (NASDAQ: BRLC.DL) board members for alleged fraud. The suits happened years after troubles began and Chapter 11 was filed. So, parachuting out provides no overall legal protection. What X board member decided three months before departing could be an item in the complaint. Exiting might only prevent additional items from being listed in the lawsuit. Also in insolvency board members can be sued not only collectively but as individuals. Obviously, negative publicity is inevitable and that can deliver a hit to a board member's professional brandname and credibility.
As many know, even among companies not distressed, the number of lawsuits keeps increasing for breach of fiduciary duty. In "Walt Disney Co. Derivative Litigation," the Delaware court found board members inattentive, including terms of employment, termination, and severance for Hollywood agent Michael Ovitz. That's exactly why it's difficult to recruit board members.
Sure, companies try to make it financially worth their while to serve and do provide Directors and Officers (D&O) liability insurance. However, both in the worst and best of times being a director entails - or should entail - continually doing a kind of due diligence on proposals, how systems such as accounting and executive compensation operate, performance, and emerging threats. Accepting management statements at face value can be construed as violating the so-called "business judgment rule," which presumes directors perform their duties in good faith. In a lawsuit, plaintiffs have the burden of proof to show that wasn't so.
Way before Kodak might become insolvent, board members should have consulted with their private lawyers about what they shoud be doing or discontinue doing.