As the cannabis industry matures, the shuffling of corporate directors has received widespread attention, shedding light upon the manner by which directors are required to serve their companies and shareholders.
These days, directorship with any cannabis company is a coveted role that requires navigating ethical predicaments unique to the cannabis industry. Cannabis companies are often still considered criminal enterprises by the federal government and even ancillary businesses may be regarded as co-conspirators.
Corporate directors and officers who intentionally cause a business to openly violate federal law may be necessarily operating in open breach of their fiduciary duties, risking personal liability even when acting in the best interests of their shareholders. It is further questionable whether traditional indemnification and exculpation provisions, which ordinarily may absolve directors from personal liability for breach of fiduciary duty, are sustainable in the cannabis space.
The scope of a corporate director’s fiduciary duties varies from state to state. Typically, when courts review decisions by a company’s board, they presume that such decisions are made: (a) on an informed basis; (b) in good faith; and (c) in the best interests of the shareholders. This doctrine, known as the presumption of regularity, is often applied in tandem with the “business judgment rule.” Under the business judgment rule, if there is any “rational business purpose” supporting a board’s decision, a court will not substitute its judgment over the board’s. This presumption may be overcome, however, if a plaintiff demonstrates that the board acted disloyally to shareholders, in bad faith or in clear derogation of due care (such as in breach of fiduciary duty).
Generally, corporate directors owe two primary fiduciary duties both to the company and its shareholders: duty of care and duty of loyalty.
Under the duty of care, each director is charged with the responsibility to make thoughtful, calculated, informed decisions throughout the decision-making process. Proper recordkeeping of the decision-making process — including deliberations, objections and abstentions, and memorializing consents and resolutions — is critical.
Directors may seek the advice of experts and are entitled, as a matter of law, to rely upon information and opinions presented by any other person as to matters reasonably believed to be within such person’s professional competence, when that person has been selected with “reasonable care” on behalf of the company.
When analyzing whether or not a director properly exercised the duty of care, courts will analyze the extent to which the director actually performed due diligence with respect to the proposed action and engaged in the decision-making process. Directors who fail to evaluate and assess information, seek expert advice or request backup evidence with respect to the issues they are considering may run afoul of this duty.
The duty of loyalty requires directors to act in the company’s and its shareholders’ best interests, by subordinating any personal interests to the company. Directors who stand on both sides of a prospective transaction, engage in self-dealing or who may receive a benefit distinct from any shareholders’ benefit risk violating this duty, as do directors who are beholden to a party similarly “interested” in the transaction.
Some conflicts of interests, depending on applicable law, may be resolved provided that the conflict is fully disclosed to the board and shareholders; the decisions made are beneficial to the company and shareholders, independent of any special benefit that may also be conferred upon the director; and procedural safeguards to protect the integrity of deliberations are utilized.
If the business judgment rule is satisfied, directors will not be personally liable for corporate actions, nor will courts invalidate such actions. But if even one of the business judgment rule factors is not satisfied, directors lose the presumption of validity, and courts will review the corporate action under a stricter “entire fairness” standard, to assure that the transaction was conducted at a “fair price” and through “fair dealings.”
Cannabis transactions primarily implicate a subset of the duty of loyalty: the duty of good faith. “Bad faith” conduct might not be disloyal to the company, but nonetheless rises above mere inattention or failure to be informed. Such conduct is undertaken for purposes other than the company’s best interests, in knowing violation of applicable law, or with conscious disregard for one’s duties. That said, as cannabis law evolves, consistent with legalization and shifts in federal enforcement priorities, a “knowing violation” is not always easily ascertainable.
The cannabis industry has witnessed numerous high-profile changes in corporate boards.
Late last year, MassRoots announced significant board reshuffling with the resignations and replacement of three directors. Early this year, Denver mayoral candidate, cannabis consultant and former dispensary owner Kayvan Khalatbari announced his resignation from the board of the National Cannabis Industry Association, citing alleged dysfunction (among other things). Rob Kampia “separated” from Marijuana Policy Project amid allegations of a hostile work environment after serving as its executive director for 15 years. Around the same time, Washington, D.C. dispensary owner Chanda Macias, Ph.D., was appointed as chairwoman of Women Grow’s Board of Managers. And in mid-April, retired Ohio Senator and former Speaker of the House John Boehner, a former cannabis prohibitionist, announced that he would be joining the Board of Directors of Acreage Holdings (formerly High Street Capital Partners), an investment company and cannabis operator with holdings in 11 states.
To avoid liability for directors, cannabis companies should assure that shareholders are fully apprised of the nature of the business and have the opportunity to acknowledge and appreciate the various risks associated with their investment — particularly regarding gray areas of illegality and the tension between federal and state law — and paper transactions accordingly.
In such cases, courts are more likely to view allegedly aggrieved parties to have “assumed the risk” of the transaction at issue and deny relief.
Lauren Rudick represents investors and startup organizations in all aspects of business and intellectual property law, specializing in cannabis, media and technology. Her law firm, Hiller, PC (www.hillerpc.com), is a white-shoe boutique firm with a track record for success and handling sophisticated legal matters that include business and corporate law.