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When your boardroom harbors trouble

How to handle the breeds of “disloyal directors”

Do you have a bad egg in your boardroom? Jeff Gerrish tackles this challenge as he tackles many community bank conundrums from long experience. Do you have a bad egg in your boardroom? Jeff Gerrish tackles this challenge as he tackles many community bank conundrums from long experience.

Over the past 30-plus years, I have had the joy of working with community banks and their decision makers—generally their CEOs and the directors. One of the most enjoyable aspects of my job is that most of the directors I work with are salt of the earth types. They are local business men and women who are interested in their community, their bank, their livelihood, and their shareholders’ value.

Occasionally, however, I run into what can best be described as a board that puts the “fun” in dysfunctional. The cause varies …

• Sometimes it is a board that conducts most of its business in the “parking lot meeting,” after the regular board meeting or over coffee in the local coffeehouse every morning.

• Sometimes it is a board that has a seriously obnoxious board member that the chairman either refuses to control or has given up trying to rein in.

• And sometimes it simply is a board with a director who has an interest at heart that is other than all the shareholders’ and the community bank’s best interest.

I call this latter situation the “disloyal director.”

Characteristics of disloyal directors

The disloyal director would typically be one of two types:

1. He or she may be someone who has a difference of opinion with the board with respect to the ultimate strategic direction of the community bank holding company. Typically, this is a director who thinks it is time to sell, and the rest of the board does not.

2. Alternatively, the disloyal director represents what I call a different “constituency.”  Some banks, whether they are public or private, have large investors that place a director on the board to represent their constituency’s interest.

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Both a “constituency director and a disloyal director who wants to sell the bank, is difficult to have in the boardroom. In my experience, having that individual there somewhat chills the discussion.

I’m not saying that such directors don’t have a right to be there. They do. They were elected by the shareholders or appointed by the board. However, in these cases it becomes clear that he or she is not working toward the majority of the board’s interest in moving the institution forward.

At least, not in the direction the rest of the board favors.

Can these directors be shut out?

One issue that always comes up with constituency directors is whether you have to give them all the information that you give all the rest of the directors.

In other words, does this constituency director who represents a hedge fund or other large investor, or the director who really wants to sell the bank, get unfettered access to all the information in the books and records of the bank, like any other board member?

And if they do, can they then share that information with anybody they want? 

Can the pro-sale director take the information and share it outside the bank with other shareholders in order to promote the position that the bank should be sold? 

Can the hedge fund’s representative director or the director representing the activist investor share that information with the constituent, the activist investor? 

Can the board restrict or limit the information provided to these types of constituency directors?

Answer: It depends

As you can imagine, this issue has come up multiple times over the last several years in community bank holding companies that have received investments or had disloyal directors. Many bank holding companies were chartered a long time ago in the state of Delaware and are subject to Delaware law.

The Supreme Court of Delaware has dealt with this issue a number of times. Under Delaware statute: “Any director shall have the right to examine the corporation's stock ledger, a list of its stockholders and its other books and records for a purpose reasonably related to the director's position as a director.” 

The courts have interpreted this statute to mean that “a director who has a proper purpose has virtually unfettered rights to inspect books and records, which implies a right of access at least equal to that of the remainder of the board.” (Emphasis added.)

These broad inspection rights correlate to directors’ duty to protect and preserve the corporation as fiduciaries. In order to satisfy their fiduciary responsibilities, directors must have access to books and records.

A practical perspective

However, Delaware does put some limitations on what the constituency director can do or share. As a matter of law, directors are subject to the duty of loyalty, which requires the director to act in the best interest of the company and its shareholders, rather than his or her own best interest, which would include, by association, the best interest of the constituent.

A true disloyal director who wants to sell the bank certainly should not be sharing information outside the boardroom with other shareholders or others. Indeed, some boards enter into confidentiality agreements with these constituency directors, so that they cannot share information outside. With a true constituency director who represents the activist investor or hedge fund or whoever it is, there is a little more understanding that that director will likely share some of the information that is available.

If you have a situation like that, in general the best practice is for the chairman (assuming you have a strong one) is to deal with the issues of the constituency director or the disloyal director head-on and make sure that bank information is not being compromised.

Jeff Gerrish

Jeff Gerrish is chairman of the board of Gerrish Smith Tuck Consultants, LLC, and a member of the Memphis-based law firm of Gerrish Smith Tuck, PC, Attorneys. He frequently contributes to Banking Exchange and frequently speaks at industry events.

In mid-2016 Gerrish's blog received a national bronze excellence award from the American Society of Business Publication Editors. This followed his receipt of the regional silver excellence award for the Northeastern Region from the same group.

Gerrish formerly served as regional counsel for the FDIC’s Memphis regional office and with the FDIC in Washington, D.C., where he had nationwide responsibility for litigation against directors of failed banks. Since the firm’s formation in 1988, Gerrish Smith Tuck has assisted over 2,000 community banks in all 50 states across the nation with matters such as strategic planning, mergers and acquisitions, common stock private placements, holding company formation and reorganization, and a wide variety of regulatory matters. Jeff Gerrish can be contacted at jgerrish@gerrish.com.

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