Contingency Planning As Asset Management—Legal Issues

By John B. Copenhaver, CDRP

 

For the moment, imagine yourself as a hardworking American citizen nearing retirement age. You have worked most of your adult life and managed to build up a nice "nest egg" for your retirement in the form of shares of your employer’s stock; these shares have been accumulated through your company’s 401(k) plan and assorted stock options. Despite advice from your friends, you have almost all of your money invested in this one stock. One morning you wake up and hear on the morning news that an overnight fire has almost completely destroyed the company’s manufacturing and distribution facilities, as well as its adjoining data center.

The following hours and days are a nightmare - your employer was almost totally unprepared for such a disaster, and the company’s stock plunges. Contractual obligations go unfulfilled, bills go unpaid, and within months, what had once been a robust business slips quietly into bankruptcy. Your money - and your retirement plans - are gone. Your next step is a common one in the United States - you contact a lawyer. What are your chances of recovering anything at all? Let’s take a (brief!) look at the legal issues involved.

 

Duty

Before you can demonstrate that you are entitled to an award of any kind, you must prove that your investment carried with it a duty, express or implied, of protection. Simply stated, you must prove that someone had a duty towards you to protect your investment. In this scenario, your attorney would likely forget the officers and directors of the company as having had this duty; under the laws governing the legal obligations of corporate officers and directors towards their corporations, these officers and directors are considered "fiduciaries" with respect to the assets of their companies. This "fiduciary" relationship imposes a very strong responsibility upon officers and directors to exercise the utmost in care in their management and protection of corporate assets. Your partial ownership of the company - in the form of your company’s stock - would be the likely vehicle for your attorney to establish the existence of a fiduciary duty owed to you by the company’s officers and directors (at least one of them).

 

Breach of Duty

Once the duty owed to you by someone (in this case the officers and directors as corporate fiduciaries) has been established, the next step is to demonstrate that this duty was broken (or "breached") by actions or inaction on the part of the obliged parties. This is the crux of a legal action of this sort, and is ordinarily the most difficult aspect of prosecuting a lawsuit. Given our scenario of a huge fire destroying your company’s manufacturing, distribution and data processing facilities, you will likely be required to prove that at least one of the corporate officers or directors was negligent - or even grossly negligent - in failing to be adequately prepared for the fire or its ensuing consequences.

This "breach of duty" will be anything but easy to prove. Courts traditionally hesitate (and rightfully so) to substitute their after-the-fact judgment for that of corporate executives, using a standard of review called the "business judgment rule" - if an action or inaction of a corporate executive can be construed as falling within the exercise of the duty authorized "business judgment" of that executive, then a court will not step in to attach legal sanctions to such an exercise. Stated in English, courts recognize that corporate executives are constantly being called upon to make "judgment calls," and that it is virtually impossible for all of these calls to be 100% correct. If a company’s officers and directors could be held liable - even personally liable - for the consequences of an honest mistake in judgment, then few, if any qualified candidates would ever accept these positions! Putting this concept in the specific terms of your "nest egg" loss, you would have to prove that virtually any reasonable and prudent corporate executive would have mandated a level of preparedness sufficiently higher than was present at the time the fire occurred to reduce the losses to the corporation. Again, this "reasonable executive" standard may not be easy to prove.

 

Damage

Finally, you will have to prove that the breach of the duty owed to you by the defendants in the suit resulted in measurable damage to you and/or your property. Before you jump quickly to the conclusion that this will be the easy part - that the damage done is clearly the loss in value of your stock investment - let me throw in another factor to consider. In most disasters, there will be some part of the ensuing losses that will be deemed "unavoidable." In the case of a disaster caused by an unlawful act, this component may be small (and you would hope that the person having committed this act had enough money to cover its consequences!) However, in an accidental fire or, worse yet, a natural disaster such as an earthquake or a hurricane, there may be a significant portion of the loss deemed as "unavoidable," meaning that even the best planning efforts would not have eliminated these loss components. In our overnight fire scenario, you will have to prove that the component of loss you have suffered would have been avoided had the defendant(s) not breached the duty of care owed to you. Once again, this particular burden of proof may be difficult to carry.

 

Conclusions

In the contingency planning industry, it is common practice to second-guess our employers for their lack of attention to the critically important emergency preparedness and disaster recovery needs of the enterprise. While it is not my intention in this article to resolutely defend corporate executives for bad judgment in failing to adequately address these needs, neither will I take the burden off our own shoulders as practitioners to help "shore up" these perceived lapses in judgment by: a) continuously working to educate all levels of society on risks and risk mitigation tactics; b) creating standards or best practices within our industry to help answer the question "How much planning is enough?", and c) constantly striving to improve the cost-of-risk versus cost-of-protection equation to equip our executives with the best and most effective means of exercising their asset management responsibilities.

 

John Copenhaver, CDRP is the Worldwide Crisis Response Team Advisor for IBM.


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