Opting Only In: The Exegisis of Waiver of Liability (Part 3)

We are discussing a paper recently posted on SSRN titledOpting Only In: Contractarians, Waiver of Liability, and the Race to the Bottom and examining the development and use of waiver of liability provisions.    

Delaware became the first state to adopt an “opt-in” approach to waiver of liability in 1986. Section 102(b)(7) allowed companies to insert into their articles of incorporation provisions that waived monetary damages for breaches of the duty of care. As the provision provides:

• A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under § 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit. No such provision shall eliminate or limit the liability of a director for any act or omission occurring prior to the date when such provision becomes effective.

Companies may, therefore, waive liability against directors for breach of the duty of care.

Most attribute the adoption of Section 102(b)(7) to the Delaware Supreme Court's decision in Van Gorkom. Recall that the Court in Van Gorkom by a 3-2 vote found the business judgment rule inapplicable to a decision by the board to sell the company. The majority did so by finding evidence that the board was uninformed at the time it made the decision. The directors found themselves in the unusual position of having to show the fairness of the transaction in which they received no personal benefit. The case ultimately settled for more than $23 million, an amount apparently paid by the acquirer and the D&O policy.

In fact, at least if the legislative history is to be believed, the impetus was not Van Gorkom but the D&O crisis taking place in the 1980s. D&O insurance had, by the 1980s, become a fixture in the corporate board room. As the decade opened, however, a “crisis” occurred. In renewing their policies, companies often found that the costs had risen sharply, the exclusions increased, and the amount of coverage reduced. The reasons for the crisis were varied, including traditional cycles that affected all types of commercial insurance.

One development that did not explain the “crisis,” however, was the Supreme Court’s decision in Van Gorkom. Van Gorkom may have created consternation in the board room but did not significantly contribute to the D&O insurance crisis, something already well underway and, by the time of the decision, mostly over. Indeed, an argument could be made that if anything, the case encouraged greater diligence by directors in the board room, something that ought to have reduced liability and the cost of coverage.  Nonetheless, waiver of liability provisions followed quickly in the aftermath of the decision.

We will continue this theme tomorrow.