Orange County Branch Newsletter

January 2015

Law and CE News

The Buck Stops at the Top: Personal Liability for Management Decisions

Since the depths of the Great Recession, virtually every building sector has seen a dramatic increase in construction starts—often by more than 20% each year. Our transactional department has seen a corresponding increase in the demand for contract review for new projects or restarts of stalled ones and drafting of design firm start-up documents, such as partnership agreements and incorporating documents. But whether you are starting a new firm or expanding your current firm, beware the old adage: the bigger they are, the harder they fall. Growth and expansion are great, but in taking those steps there are potential liabilities and risks owners and management need to consider.

If you are in the upper management of your design firm, chances are you owe fiduciary duties to the company or your partners. Breaching your fiduciary duties may result in you being held personally liable for any resulting damages—and the larger the firm, the greater the potential financial liability. Because guarding against such liability tends to be an afterthought in a rapidly expanding business, management personnel are often left completely unprotected until it’s too late. Having an early understanding of your personal duties and the tools that you can use to reduce your liability exposure is therefore essential.

If your firm is a corporation, its directors and officers, and sometimes even its majority shareholders, owe fiduciary duties to the company and shareholders. If your firm is a partnership, each partner owes fiduciary duties to every other partner and the partnership. Your major fiduciary duties include the duty of loyalty and the duty of care.

The duty of loyalty requires that you make business decisions that are in the best interest of your company. This means that you have to put the interests of the company ahead of your own personal interests. There are several ways that you can breach this duty, the most common being: acting on both sides of a transaction in which your company is involved (commonly known as self-dealing—such as taking a loan from the corporation with very favorable terms for you as the borrower); entering into competition against  your own company; taking advantage of a business opportunity for yourself that your company could otherwise have undertaken; and personally profiting from your work at the expense of the company.

The duty of care generally requires that you act and make decisions on an informed basis and with due care. While corporate directors and officers are generally shielded from liability for the wisdom  of their decisions (known as the Business Judgment Rule), you still must put reasonable procedures in place to prevent harm to your company and make reasonable inquiries into the facts and circumstances of the decisions that you make on a daily basis. Is that the best lease for your company? Would entering into that joint venture with another firm be in the best interest of your company? Being in management requires that you ask questions and ferret out the facts in order to balance the benefits against the risks.

Design professionals frequently—but often unknowingly—face decisions that implicate these duties. If your firm hires a subconsultant that is operated by the spouse of one of your firm’s directors, there is a potential breach of the duty of loyalty. If you give advice or create plans or drawings for a construction project and get paid for it (moonlighting) without offering that business to your firm first, there is a potential breach of the duty of loyalty—particularly if you used firm resources (software, employee time, etc.) to generate those plans or drawings. If you rely on another director’s recommendation that the firm submit a bid proposal without performing your own independent investigation of the adequacy of the proposal, there is a potential breach of the duty of care.

Once you understand the contours of your fiduciary duties, the next step is to put measures in place to reduce the potential liability which can never be completely eliminated. Director and Officer (D&O) liability insurance is widely available from almost all major insurance companies that provide professional liability and/or financial lines insurance. In addition, your partnership agreement or your company’s articles of incorporation may be used to alter management duties or even eliminate certain duties altogether, or to provide protection for the individual officers or directors.

In short, management liability is a real risk and the firm’s financial and your personal exposure increases when your firm starts to grow.  Therefore, you need to watch your step moving forward especially as you are expanding in this improving business environment so as to not create unintended financial liability.   If you have any specific matters that you would like to discuss with us, please do not hesitate to contact us at our Oakland, South Pasadena, Orange, or San Diego offices.

Please contact us at the Oakland, South Pasadena, Orange, or San Diego offices to discuss further.

David E. Barker, Esq. |

David J. Carroll, Esq. |

Collins Collins Muir + Stewart LLP
1100 El Centro Street | South Pasadena, CA  91030
Phone: (626) 243-1100    | Fax:  (626) 243-1111

Nothing contained in this article should be considered legal advice. Anyone who reads this article should consult with an attorney before acting on anything contained in this or any other article on legal matters, as facts and circumstances will vary from case to case.

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