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EXCERPT

Lessons from a Board that Lost Its Way

  

 

By WILLIAM DEVINE, 1 February 2014   |   See Corporate Law:  Corporate Governance eJournal version here.

 

 

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et’s say that you are a director of a California corporation and you do not own a crystal ball.  Let’s say that you are thus concerned about being sued someday if, despite your best efforts, you and your fellow board members make a decision that ends up hurting the company.1 

The good news is that the California Legislature will not let anyone hold you liable for an honest mistake of business judgment.  

The bad news?  There will not be bad news, as long as you comply with California’s business judgment rule.2  Compliance with the rule takes more, however, than making honest, careful decisions based on the information in front of you.  In some circumstances, you have a duty to inquire beyond the information in front of you. 

How will you recognize those circumstances?  This case study of the Board at Pennsylvania State University offers insights into the answer to that question. 

 

During the months after learning of key employees’ cover-up of a scandal, the Board makes its performance public in an unusual and revealing series of disclosures.  This case study explores the first 26 days of that performance, during which time the Board grapples with the business judgment rule. 

 

The Stakes Are Raised

 

As November 2011 begins, the Penn State Board of Trustees includes seven company presidents, six CEOs, four attorneys, three State cabinet members, two PhDs, and a venture capitalist.3  University enrollment stands at approximately 96,000 students.4  The annual operating budget is approximately $4.3 billion.5

The University’s mission statement declares that Penn State is—

“…a multicampus public research university that educates students from Pennsylvania, the nation and the world, and improves the well being and health of individuals and communities through integrated programs of teaching, research, and service.…”6 

 

The University’s Charter, Bylaws and Standing Orders charge the Board with “complete responsibility for the government and welfare of the University and all the interests pertaining thereto including students, faculty, staff and alumni.”7 

On 5 November 2011, following a grand jury investigation...

 

 

 

 

 

 

 

 

 

 

 

 

 

Note:  unless otherwise indicated, all web-based sources cited below were accessed on 15 August 2012 and 15 November 2013.

 

1.  Let’s also say you realize that, while indemnification agreements, liability insurance, and provisions in the Articles of Incorporation can reduce risk of liability, they will not eliminate it.  Indemnification agreements, after all, are only as good as a company’s balance sheet.  Liability insurance can be prohibitively expensive, comes with coverage limits, and inevitably contains exclusions.  The Articles cannot eliminate liability when a director should have been aware of risk of serious injury to company or shareholders.  See California Corporations Code §317 and §204(a)(10)(A)(4).

2.  California Corporations Code §309. 

3.  Board of Trustees, Current Membership,” Pennsylvania State University, accessed 15 August 2012.

4.  Fall to Fall Enrollment Comparison, 2012 and 2011,” University Budget Office, Pennsylvania State University. 

5.  Penn State Budget Primer,” Pennsylvania State University.

6.  This Is Penn State, Mission and Character,” Pennsylvania State University.

7. Board of Trustees,” Pennsylvania State University.

 

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