The Risks That Come with Serving on a Corporate Board

Underwriters in the legal malpractice insurance space often exercise caution when reviewing applications of firms that have one or more attorneys serving as an officer or director of a for-profit, non-profit, or closely held corporation. Of course, additional scrutiny will come into play if one of more of the entities also happens to be a firm client. And then, if you really want to get the attention of an underwriter, add into the mix an ownership interest by one or more firm attorneys in one or more for-profit client entities.

Why all the fuss?

It’s primarily due to conflict of interest concerns.  Juries have field days with conflict claims because the issues are so easily presented in the context of law firm or attorney making greedy self-serving decisions at the expense of their client. Even the appearance of impropriety can be disastrous.

Board memberships simply make matters worse because defense costs and loss payouts can be quite significant with claims that arise out of work done for a client at a time when a firm attorney also served on the board for all kinds of reasons. For example, significant decisions corporations make are often scrutinized and legal disputes abound; corporate legal issues continue to grow in complexity as even small businesses seek out global markets and/or work to develop a substantial online presence; and legal news headlines of law firms facing fallout due to a problem a corporate client is struggling with are commonplace.  Taken together, why someone charged with evaluating the level of risk that any given law firm represents might exhibit serious caution when there are attorney board memberships mixed into the equation starts to make sense.

Understand that when it comes to malpractice insurance underwriting, the challenge is in trying to set an accurate price for the coverage offered at the time that will fully cover the unknown losses that will arise years later. Insurance companies that do this well will remain in business and continue to grow. Those that do not will falter. A good underwriter knows that he or she is responsible for trying to forecast the future. The goal is to underwrite business that will lead to reasonable and predictable losses. In the insurance world, unpredicted large losses are a bad thing.  Insurance companies don’t like surprises and board memberships represent one potential source of large unpredicted losses.  This helps explain why some malpractice policies specifically exclude coverage for any work done on behalf of a corporation if a firm attorney was sitting on the board and/or held a financial interest in the corporation.

Board participation can be particularly concerning for an underwriter when the attorney is sitting on the board of a hospital or a financial institution.  Regulatory oversight and the potential for significant losses drive extra underwriting scrutiny. Worse yet is when the attorney/board member holds a meaningful ownership interest in these types of entities. Now the conflict concerns are such that an underwriter is going to be extremely cautious and, in some instances, will conclude that the risk is unacceptable.

Is this concern limited to for-profit boards only?

Absolutely not. Claims involving attorneys serving on client corporate boards exist in both the for-profit and non-profit arenas.  Claims have also arisen from attorneys acting as both legal adviser and board member for closely held corporations; and note that coverage disputes can and do occur in situations where an attorney is sitting on the board of a closely held corporation.  Most malpractice policies only provide coverage for claims that arise from work done on behalf of firm clients and sometimes the closely held corporation isn’t a client of the firm.  Instead, the attorney was acting independently, providing legal advice off the clock in furtherance of family financial interests. This can be a serious problem when it arises.

How can this concern be addressed?

Despite the conflict concerns associated with board memberships, there will be attorneys who will continue to serve on the boards of client organizations in one fashion or another.  Should you ever decide to do so, carefully think through the conflict of interest issues before making any commitment to serve.  Always disclose the conflict issues to the client organization and consider whether it would be prudent to obtain a written waiver.  If a waiver is called for, remember that this document must be more than a signed acknowledgement of the existence of a conflict of interest.  It must document informed consent if it is to be effective.  Informed consent is perhaps best described as obtaining client agreement to proceed after the client has been advised of all possible legal ramifications that any potential or actual conflicts represent to the client as well as advising the client to seek independent counsel about the advisability of agreeing to move forward given the existence of any actual or potential conflicts.

In certain situations, setting forth all possible ramifications will be a tall order. If it is too difficult to write this document in a way that any layperson could understand, then the better choice might be to keep it clean.  Either sit on the board and ensure that no one at the firm does any legal work for the corporation or keep the client and say no to an offer of board membership.  Truth be told, particularly with non-profit boards, the entity is often asking an attorney to sit on the board as one way to obtain legal advice at little to no cost.  As an attorney, you do not need to sit on the board in order to provide legal advice.  Again, keep it clean.  Agree that the entity will be a firm client so that malpractice coverage is in play and donate your time to the entity as outside counsel.

Are there any additional concerns to consider?

Yes, there are.  Here are a few other issues you should be aware of prior to agreeing to sit on a corporate board.

A) Increased Risk of a Malpractice Claim and Firm Disqualification. Attorney board members face a greater malpractice risk than attorneys who limit themselves to corporate counsel service, particularly if the attorney board member is sitting on a client board. The attorney board member often has more power and influence in corporate affairs than do other outside directors.  This makes the attorney board member an irresistible target for plaintiffs.  Typically, by suing the attorney board member, the plaintiff seeks in part to disqualify the attorney board member and their firm from representing the client company.  Yet even if they are not sued, the attorney board member may be disqualified from representing the company based upon the “lawyer as witness” rule.  In other words, they often become a witness because of their participation in corporate decision-making.

B) Loss of Attorney-Client Privilege. When an attorney attempts to wear the two hats of legal counsel and board member, it becomes difficult to determine which hat the attorney is wearing at any given time. Even in situations where the counsel/board member provides strictly legal advice, the counsel/board member will subsequently be viewed or portrayed as having acted concurrently as a board member.  The result is that when a counsel/board member participates in board conversations assume these conversations are not privileged communications.

C) Inability to Participate in Certain Decisions. Imagine a situation where the board considers taking alternative courses of action. One course will result in a significant fee for the attorney’s firm and the other course will not.  From a stockholder’s perspective, it is difficult to imagine how an attorney acting as both corporate counsel and board member could give disinterested advice or why the counsel/board member should even participate in voting on this matter.  In these types of situations, the counsel/board member should excuse themselves from the discussion and the subsequent vote and see that this recusal is properly documented.  The fallout of an attorney serving in a dual role does mean that there may be times when the entity is deprived of the counsel/board member’s advice—and perhaps on a critically important issue.

D) Malpractice Resulting from a Failure to Warn. If an attorney serves as both corporate counsel and director, they should warn the company’s management and the other directors of the above-mentioned hazards (A thru C) and, of course, document such warnings. If they don’t do so, the failure to warn may be sufficient basis for a malpractice claim if the company incurs significant expense, liability or other detriment that could have been avoided if the company was appropriately warned of the above.

E) Weakened Defense to a Malpractice Claim. When a corporation’s legal counsel is sued by stockholder plaintiffs, often they will try to defend their position by stating that the board declined to follow their firm’s advice or argue that the board was incompetent. However, if corporate counsel is also serving as a director, this defense is seriously weakened.

F) Insurance Coverage Disputes. Legal malpractice policies typically exclude coverage for director and officer liability and D&O policies typically respond only when the insured was acting as an officer or director. Thus, should a claim ever arise, an attorney acting as both corporate counsel and board member may suddenly find that coverage isn’t a given.

G) Inadequate Indemnification. The corporation’s bylaws may contain an indemnification provision, but the provision may not protect the board member for all claims. For example, under the corporate laws of many states, indemnification provisions cannot protect the director in successful shareholder derivative suits.  Also, the indemnification provisions obviously are meaningless if the company is insolvent.

In sum, before you agree to sit on the board of a client entity, don’t minimize the associated risks should you decide to try and simultaneously wear the two hats of counsel/board member.  Often the better decision really may be to either serve as a director and never give legal advice or agree to act as solely as corporate counsel and forgo serving as a board member.  If you ultimately decide to limit your involvement to sitting on the board, document that by providing the corporation with a letter stating you will be acting solely as a director and that you will be doing so in your individual capacity and not as a member or representative of your law firm.

If you will be acting as both corporate counsel and director, give the corporation’s management a written disclosure of hazards A thru C listed above.  Emphasize that the attorney-client privilege will not apply to any discussion or correspondence made in your capacity as a director.  Make certain that you have adequate D&O coverage and that the corporate bylaws have appropriate indemnification provisions.  Review the corporate finances to ensure that the corporation has sufficient resources to survive an adverse claim.

Finally, participation on a corporate board can be a meaningful and fulfilling experience.  Just remember that underwriters focus on the ramifications of board memberships for a reason.  Make certain you do as well because the decision to serve on a corporate board is one of those decisions that should never be taken lightly.