Think only multi-national conglomerates are confronted with million-dollar lawsuits filed on behalf of disgruntled investors? While it may be tempting to assume such pricey legal entanglements only apply to corporate giants like the Enrons and WorldComs of the world, a recent milestone for a cash settlement belongs to a much more modest business. What began as a single store stocked with athletic footwear that opened in Birmingham, Ala. in 1977 has become famous for much more than its shoe selection.
Just For Feet, Inc., which specialized in brand name athletic shoes, eventually grew to rank as the second-largest retailer of its kind in the U.S. When faced with a recent shareholder lawsuit, the beleaguered company’s outside directors opted to settle for what is believed to be the largest out-of-pocket payment in U.S. history.
$41.5 Million Settlement
In April, Just For Feet’s outside directors agreed to personally pay $41.5 million to settle a lawsuit brought by the bankruptcy trustee. Given that the directors in question were not among those accused of fraud in the company’s failure, it signifies a potential progression in the scope of liability and its implied impact on outside directors. Here, the directors were accused of, among other things, breaching their fiduciary duties and acting in bad faith by delaying the bankruptcy filing against the advice of outside experts.
According to many observers, the case validates the business judgment rule (BJR) that states the law will protect directors who act in good faith by making informed decisions. Conversely, the law will not provide protection for directors who fail to educate themselves enough to make informed decisions on behalf of the company’s shareholders. This begs the question of what it means to act in good faith. And what protections does the BJR provide?
Business Judgment Rule Protection
In different contexts, protection under the BJR can be achieved by different means. The key is that directors must make a good faith attempt to educate themselves in regards to whatever subject over which they exercise authority, while acting on behalf of shareholders. In lieu of educating themselves, directors can seek expert advice. When entering transactions, for instance, history has shown that directors can place themselves squarely under the protection of the BJR by hiring experts to provide a Fairness Opinion. The caveat to seeking outside counsel is that these advisors must act independently and be recognized as legitimate experts in areas to which they opine.
Again, using a transaction scenario as an example, a board of directors would only be protected if the expert providing the fairness opinion was qualified. It is important to help find a financial advisor who will meet the highest standards in their preparation of the fairness opinion. At a minimum, the issuer of a fairness opinion should:
Collect historical company data, asset information, and legal documents
Conduct management interviews and site visits
Analyze historical financial statements and trends
Analyze economic and industry data and trends
Compare the company’s performance to industry standards
Identify and select appropriate valuation methodologies
Once a board of directors has educated itself on the subject and identified an advisor who meets the criteria of “qualified expert,” the directors should rest well knowing that they have done all they can to act in good faith on behalf of the shareholders and that they have appropriately protected themselves as well.
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