Directors of Privately-Held Companies Face New Risk

Think it's relatively "safe" to be a director of a privately held company?

Think again. In the past, few of us were concerned about potential liability in becoming a director of a non-public, privately held company. As a result, we were pleased to be a director of a friend's company or of a family business. Sometimes, we were even given the protection of a director's liability policy. But, realistically, we felt there was little or no risk since the principal of the company was the major or sole stockholder. This situation may have been dramatically changed!

Recently the federal court in Manhattan ruled against the CEO and the directors of a privately held non-public company that had filed for bankruptcy. The bankruptcy trustee brought the suit on behalf of the corporation and its creditors. The court found that the CEO overpaid himself, declared improper dividends and improper loans, and otherwise treated the company's treasury as though it was his own. Moreover, the directors were found jointly and severally liable along with the CEO. In short, the court imposed the same standards on the directors of a privately held company as is done with public companies. The case is on appeal, but it is an eye-opener as to what is happening in the world of litigation of corporate activities.

What does this mean for the director of a privately held firm?

The court case has potential ramifications that every director should be aware of. If the ruling stands on appeal, the risk to directors of private companies will be the same as those of public companies. They will be held accountable not only to the stockholders, but to the corporation and its creditors, even if the directors received no potential benefit. This opens the door to creditors who may now look to the directors in a private company and go after their assets in addition to those of the company. An Advisory Board is a viable option, providing great value with less risk.

As opposed to a corporate board, an Advisory Board is a meaningful alternative. Advisory board members have virtually no legal responsibility, no approval obligations, no authority, no governance, no overview, no voting. They provide only an advisory role. This is something that owners should seriously consider if they wish to continue to avail themselves of the valuable benefits of having objective outside perspective and knowledge in the running of their business. It allows them access to invaluable business advice while lessening the risk for participants.

Board participants must be ever so diligent in accepting positions on corporate boards. Even the unknowing director, well motivated and attentive to his directorate duties, may find him or herself as a responsible party. All of us should consider taking alternative paths to both assisting companies and protecting ourselves.

Jay L. Fialkow

© 2003 RossFialkow Capital Partners, LLC

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