Be Careful In Selecting Who Sits On Your Board

In one of the first California court cases involving disclosure of documents since the collapse of Enron, a decision of a California appellate court makes it virtually impossible for corporations to restrict a director’s access to confidential corporate information. This is true even when a corporation suspects, but cannot prove, inappropriate use of the corporation’s information by a director.

In the case of Saline v. The Superior Court of Orange County, a director sued a corporation to enforce his right to inspect corporate documents after the corporation denied him access in connection with a proxy fight. The trial court allowed the director to have access to corporate information not otherwise protected by attorney client privilege, but prohibited him from discussing the information with anyone other than his attorney and the other board members. On appeal, the court determined the trial court incorrectly restrained the director from disclosing corporate information and held that the director should have complete access.

The Corporations Code provides directors with “an absolute right at any reasonable time to inspect and copy books, records and documents of every kind...” According to Saline, protective measures are appropriate only when a corporation can establish by a “preponderance of the evidence” that a director intends to use corporate information to commit an “egregious tort” against the corporation. Under Saline, an “egregious tort” is one that causes harm that cannot be easily remedied by subsequent monetary damages against the tortious director (e.g. the disclosure of a secret formula). Absent such a showing, the law does not support corporations limiting directors’ access to corporate information except in a situation where a corporation is protected by its attorney-client privilege relating to litigation by a director against the corporation. Suspected self-dealing by a director or suspected disclosure of confidential corporate business or proprietary information to third parties is insufficient grounds to deny a director access to corporate documents.

Of course, a director can always be sued for breaching his fiduciary duties for misusing confidential corporate information or inappropriately disclosing that information, but that remedy is often considered too little and too late. As a result, companies must be careful in selecting board members, and in appropriate circumstances should consider adopting minimum board member qualifications and requiring board members to execute confidentiality agreements. In some instances, these additional common sense considerations may not be enforceable under California law.

Business Law Alert is a publication of the Business Department of Downey Brand LLP, a full-service law firm counseling California businesses since 1926.