The circumstances under which a director resigns his or her board membership, and the implications of that decision, merit a “new look” given the current intensified fiduciary environment.
Corporate directors are not required by law to serve the entirety of their term of office. The ability of a corporate board member to resign his or her position is a time-honored right under state business and nonprofit corporation law. There are any number of legitimate reasons that may prompt a director to resign. Professional and anecdotal evidence suggests that incidents of resignation (and threats thereof) are on the increase.
Indeed, a variety of emerging factors combine to shine new light on the rationale for the resignation decision, the process by which the decision is affected, the fiduciary impact on the resigning director and the response of the board to the resignation decision.
For those and other, similar reasons, there is value in having the board's nominations and governance committee (the committee), or a similar body, revisit the concept of resignation as it may apply to board membership and operations.
Basic Statutory Provisions
For example, the committee will want to be familiar with state law that speaks to the right to resign and the manner in which resignation is to be affected.
Each of the Revised Model Business Corporation Act, the Revised Model Not-for-Profit Corporation Act and the Delaware General Corporation Law (DGCL) expressly provide a resignation right for a corporate director. Under these provisions, the right is unequivocal and without exception or condition. The resignation may be effected by delivering a written notice of resignation to the company's board (or its chair) or secretary. If that is properly done, the resignation becomes effective when the notice is delivered.
Each of the Model Acts and the DGCL recognize the effectiveness of a resignation notice that specifies a later effective date or an effective date determined upon the happening of an event or events (e.g., a director failing to receive a specified vote for re-election as a director).
The committee should note that, absent some unique state law or judicial decision, the board cannot refuse to accept, or otherwise reject the effectiveness of, a director's resignation and acceptance of a director's resignation is not required for the resignation to be effective.
Reasons for Resignation
None of the Model Acts nor the DGCL prescribe an exclusive set of circumstances on which resignation must be based. Nevertheless, the committee will want to be familiar with the reasons frequently offered to justify the director's decision to resign. Generally speaking, these justifications fall in either “personal” or “operational” categories.
Personal reasons are those that relate to the director's personal circumstances, relationships, perspectives and qualifications. They might include concerns with the individual director's ability to commit the necessary time to board service, the potential for other relationships to create conflicts of interest in the future, whether the director believes he or she lacks the necessary expertise to function effectively as a director, disengagement between the director's personal values and what he or she perceives as that of the organization, personal conflicts or disagreements with other directors or executives and a misunderstanding of the role of the director for the organization.
Operational reasons relate primarily to those that arise in the context of corporate and board operations. They might include — but would not be limited to — such reasons as a critical conflict of interest that the director believe mandated his or her resignation; a director's concern with the effectiveness of the board's conduct of business; the unresolved presence of directors who, in the mind of the resigning director, were disruptive, unqualified to serve, conflicted, underperforming or violated the organization's code of conduct; fundamental disagreements with board decision-making on an individual or collective basis; unresolved concerns about the ethics and compliance of the organization; and, perhaps, concerns about liability matters and the financial stability of the organization.
The committee may be well-served to anticipate the potential for personal and operational conflicts to arise and seek a proactive resolution. This can be done in part during the director nomination process (e.g., the diligence, background check and interviews), the onboarding process, and the periodic individual and full board evaluation processes.
Implications of Director Resignation
The governance committee may choose to periodically remind board members of the implications of a resignation on their fiduciary obligations to the organization.
Of particular note is case law that serves to limit the ability of directors to resign in protest due to concerns for their own liability exposure.
In particular, directors should be aware of several Delaware decisions (grounded in Caremark claims) that identify the fiduciary risks associated with a director's decision to resign during a period of corporate controversy or distress.
Both decisions involved extreme fact patterns, in which independent board members resigned to protest what appeared to be serious issues. In In re Puda Coal Inc. Stockholders Litigation, it was the suspicion that management was misappropriating corporate assets. Rich v. Chong involved the suspicion that management was creating barriers to an internal investigation.
In both decisions, the court interpreted the pleadings to state a Caremark-style claim for bad faith. Also in both decisions, the court expressed concern that the act of resignation would be tantamount to abandonment under the circumstances. It's important to note that both court decisions arose in response to defendants' motions to dismiss the plaintiffs' claims, and therefore were analyzed by the court in the most plaintiff-friendly light (i.e., that the plaintiffs' claims of wrongdoing were merely “reasonably conceivable”).
The Puda Coal decision is also noteworthy for Chancellor Leo Strine's famous “Monty Python” and the Arthurian Knights analogy:
I'm not sure that the Monty Python response — and I refer to the scene involving the words “run away” . . . there are some circumstances in which running away does not immunize you. It, in fact, involves a breach of fiduciary duty. And I think the extreme consequences here might well constitute one.
Chancellor Strine was concerned that the defendant directors, when confronted by evidence of possible CEO malfeasance, failed to take responsive action and simply resigned (which left the company under the control of the sole remaining director, the implicated CEO). The Rich v. Chong court mirrored this concern: that independent directors could, by their resignation, abandon a troubled company to the sole control of those who had harmed the company, and that such resignation would not have the effect of automatically exonerating such directors from breach of fiduciary duty claims.
The potential for director liability exposure in the “run away” scenario is somewhat similar to that of a conflicted director abstaining from voting on a transaction. Delaware courts have repeatedly expressed that complete recusal by a conflicted director from any participation in a board's consideration, negotiation and approval of a transaction will permit that director to avoid liability, but that a conflicted director's decision to simply abstain from voting on a transaction alone will not insulate the director from liability.
From a proactive perspective, the committee may wish to inquire in the nomination diligence process whether the candidate has ever resigned from a board in the past and, if so, for what reasons (if they can be shared within the limits of confidentiality).
Possible Policy Considerations
Governance counsel will want to monitor the potential for further refinement of director resignation principles by case law or statute, particularly as it may relate to the exercise of good faith in connection with the resignation decision.
In “The Sound of Silence in Corporate Director Resignations,” Asaf Eckstein and Ziv Granov proposed the establishment of a “concrete legislative framework that governs the relationship between director resignations and fiduciary duties.” This served to mitigate the uncertainty that the authors perceive arose from Delaware decisions Puda Coal and Rich v. Chong. The authors thus recommend that the law draw a distinction between resignations tendered in good faith (i.e., with the purpose of alerting shareholders and regulators) and resignations motivated by personal interests (i.e., with the purpose of providing specific protections for directors who resign in protest). The benefits of this framework are suggested to be twofold: assuring that material information can be effectively relayed to shareholders through resignation and protecting directors who do not wish to align with the firm's misconduct. The authors also propose that corporations be authorized to pursue defamation complaints against departing directors who leverage their resignation right to resign in protest in bad faith.
Overarching Considerations
As third-party expectations for director conduct increase, nominations and governance committees should anticipate a corresponding increase in director consideration of resignation as a solution to their boardroom concerns. Resignation remains, however, an imperfect solution to those concerns for several reasons.
First, it serves as a disincentive to engaging in the kind of “heavy lifting” in difficult organizational circumstances that boards are otherwise expected to exercise. Second, it does not provide any certainty as to protection from individual director liability. Third, it may prompt some directors to use the threat of resignation as leverage in board discourse, with negative implications on boardroom culture.
With this in mind, the nominations and governance committee, working in concert with board and executive leadership, should be proactive in the following areas, among others:
- Greater transparency during the nomination process as to expectations for director commitment
- Identification of prior resignations in the nomination diligence process
- Increased onboarding support to new directors as they adjust to their responsibilities
- Concentrated leadership response to circumstances that could prompt resignation options
- Thoughtful board response to individual director/full board evaluation results
- Effective communication forums within and external to board meetings for opposing director views to be shared
- Commitment to improving intra-board culture, in a manner consistent with the recommendations of the National Association of Corporate Directors in its Blue Ribbon Commission Report, Culture as the Foundation: Building a High-Performance Board.
A Closer Look
Resignation certainly has an important and legitimate role in connection with the corporate governance dynamic. It serves as an accessible mechanism by which a director may separate from board service under circumstances that he or she may feel appropriate or necessary. Similarly, it is the ultimate execution element of effective off-boarding protocols. On the other hand, it can be used in a manner to disrupt effective board functions for selfish or otherwise inappropriate reasons.
These and other reasons recommend closer board review of the circumstances under which director resignation is properly exercised and the process by which the resignation is affected.
Peregrine thanks his colleagues Brigit Dunne, Alan LeBlang and Nathan Barnett for their contributions to this article.