Corporate investors face special risks: As an employee of a corporate investor serving as a board member, you face risks different from those of board members from traditional venture capital firms. These risks arise because the corporate investor may have interests in the business and opportunities which you learn about through your participation as a board member or board observer.
As a reminder, under corporate law, as a director you have a personal fiduciary duty of loyalty to the portfolio company – you do not have such a duty under law as a board observer, but you may agree to such obligations by contract, which we advise against. This duty of loyalty requires you to act in the best interests of the portfolio company and all of its shareholders collectively, including putting the portfolio company’s interests above those of your corporate investor employer.
How do these risks arise? Two common scenarios can increase your risk of liability as a director of a portfolio company – receipt of confidential information from the portfolio company that is useful to your employer, and business opportunities that may be valuable to both the portfolio company and your employer.
As a board observer, only the first issue is a risk because the “corporate opportunity” doctrine is based on corporate laws which apply solely to directors, unless you agree otherwise by contract.
Confidential information of use to both companies:
As a board member or board observer, you will often learn of confidential or competitively sensitive information in board meetings and by receiving materials circulated by management. Some of this portfolio company information may be relevant to your work on behalf of your corporate investor employer.
If the corporate investor pursues a similar or competitive direction, you could be accused of misusing the portfolio company’s information to benefit your employer, which could result in a claim that you have breached your duty of loyalty to the portfolio company as a director or violated your contractual obligations as a board observer. The violation of this obligation can be very expensive.
A court awarded $120m in damages against a director accused of disclosing Lexar Media’s confidential information to a competitor when he was serving on its board – this award was part of a $465m judgment, although the case was later settled.
Craigslist and eBay are currently in court over the alleged competitive use by eBay of Craigslist confidential information said to have been received from an eBay board member who served on the board of Craigslist.
How to protect yourself from claims of misusing confidential information: You need to ensure you and your corporate investor employer understand these obligations and the associated risks.
Corporate investors should put in place policies limiting the use and sharing of a portfolio company’s confidential information.
The existence of, and adherence to, such policies can be important in proving that confidential information was not shared or used inappropriately. You may be asked by the portfolio company not to disclose information it provides you to business units of the corporate investor and you should abide by such requests. You may also want to document an understanding with the portfolio company that certain types of information will not be shared with you, so as to avoid the potential taint of such information within your organisation.
Note, however, that limiting the information you receive may affect your ability to serve as a fully-informed board member.
You should consider recusing yourself from voting on issues for which you have not been able to review adequate information. You may also want to recuse yourself from discussions in which you could learn problematic confidential information.
Corporate opportunities of potential interest to both companies: You may learn of business opportunities that could benefit both your employer, the corporate investor, and the portfolio company. As a director, your duty of loyalty to the portfolio company requires that “in some circumstances… a director may make a business opportunity available to the corporation before the director may pursue the opportunity for the director’s own or another’s account”.
For example, you may learn of the need of a large company for a product which can be satisfied by both the portfolio company and the corporate investor.
How to protect yourself from claims of misappropriation of a corporate opportunity? As you evaluate whether you need to offer a potential business opportunity to the portfolio company first, consider the following.
l How similar to the portfolio company’s existing or contemplated business is the opportunity?
l Did you come to know of the opportunity in a manner related to the portfolio company?
l Is it likely to be a significant growth opportunity to the portfolio company?
l Would the portfolio company reasonably expect you to make the opportunity available to it?
l Does the portfolio company have the resources to take advantage of the opportunity?
Some corporate investors limit this risk by designating a director from a business unit that is not competitive with the portfolio company to help avoid the possibility of such a conflict.
However, the best approach is to have an explicit agreement in the investment documents – frequently in the certificate of incorporation – that makes clear that the corporate investor may undertake competitive activities and competitive investments.
Such agreements are clearly enforceable under US Delaware law because of an explicit provision for it, but their enforceability in other jurisdictions is less certain.