Directors & Boards: Column

Home |

Subscriptions |

Articles Archive |

Current Issue |

Back Issues |

Shopping

Advertising |

List Rental |

Editorial Calendar |

Background |

Column

Gary Sutton
‘Sutton’s Laws’ Columnist
Directors & Boards

A Textbook Case of Board Risk

The dangers are unreal … the liabilities are very real.

By Gary Sutton

My wife and I were personally sued in a class action suit for $458 million. This was roughly $459 million more than we were worth back then.

You see, I chaired this college. A student group filed, charging us with false recruitment advertising. If it were not for two things, I’d have been outraged. Those two things were newspaper ads that were, in fact, both false. Oops.

My friend was the chancellor and I had agreed to be his chairman for a single term without pay. We held four board meetings that year. Each lasted four hours.

It was a teeny-tiny little school, with about 100 students when we joined. There were just under a thousand enrolled the day this lawsuit struck. The school taught nursing, court reporting, basic computer, and other vocational skills. Our classes held no glamour and little philosophy but led to jobs. Ivy? Not.

A Tale of Two Campuses
We faced interesting challenges. The inner-city campus hosted many unwed minority mothers. They had a tendency to drop out and sue. Juries had a tendency to award them generous damages. That location, as a result, drained cash. I favored closing it. The chancellor, a kind-hearted and more liberal fellow than I, resisted that thought.

And he could. We could. Because there was also a suburban campus, filled with nonminority housewives looking to re-enter the workforce as their kids began school. The completion rate for the same courses ran way higher at that location and nobody sued us. So the one operation subsidized the other.

The ads that got us in trouble both said “97% Placement Rate Within Six Weeks of Graduation.” That was false: 97% of the graduates were employed within six weeks of graduation but we did not “place” them all. Some found jobs by themselves. While Harvard or Stanford would love to claim 97% employment for their grads in six weeks, that’s beside the point. And yes, we ran over a thousand ads each year, and these were only two. That’s also beside the point.

Our two ads were false. That’s the point.

This occurred several decades ago, by the way, and reflected the beginning of director liabilities, as loftier schools graduated more and more lawyers. And while a chairman reviewing every advertisement would be micro-management, even today, having only four brief meetings a year in a rapidly growing outfit was not even mentioned back then. That could be the centerpiece of a suit today — “obvious negligence.” And it’s also a lesson, then and now, about how the downsides of being on a board often dwarf the benefits.

A Job … and a Dangerous One
This is why anybody who’s real eager to join any board is inherently unqualified. They don’t understand that, done right, it’s another job … and despite D&O insurance, a liability when you don’t pay attention.

Well, the opposing lawyer turned out to have recruited the two-dozen students, promising each $10,000. He suggested to the judge that the total award be given to himself, since he knew better than anyone the amount of individual pain and suffering each student suffered and could pro rata the amounts passed on appropriately.

And yes, after claiming their policy didn’t cover fraud, our D&O insurer finally agreed to defend us. They settled for a total of $20,000 and raised our annual premium by $50,000. There’s a good business.

But, for six months, we simply didn’t know what would happen. The local media coverage was embarrassing. My kindly chancellor friend, a truly nice human being, went a little wobbly during the process and began to feel guilty. This scared me. The courtroom is not a place to carefully consider the other side. So, when you’re on a board, try to imagine how your CEO will react in a truly tough situation.

Di-gels Help
The college? It survived the bad PR and the insurance boost. So much so that the following administration acquired another vocational school in Los Angeles just six weeks before their big earthquake. That new school was housed in a brick building, three stories tall, and couldn’t continue classes. State law requires all tuition to be refunded if a course isn’t taught to completion. They’d already spent most of the tuition received on instructors. Under state law, the new chancellor was personally responsible for back tuition, and the directors’ liability remained hazy for several years. The insurance wouldn’t cover natural disasters. Di-gels probably helped.

Years later, the board started breathing easier, hearing nothing from the state and no lawsuits were filed.

The dangers are rarely predictable. The liabilities are real.

If you hear of any new board opportunities, please do not call.

Gary Sutton has been a CEO and director of a number of private and public companies in his career as a specialist in startups and turnarounds. He writes the “Sutton’s Laws” column for Directors & Boards.

He is the author of two books on business, “Corporate Canaries: Avoid Business Disasters with a Coalminer’s Secrets,” which has been translated into six languages, and “Six-Month Fix.”

He can be contacted at garysutton@san.rr.com.