Congratulations! You are a director and minority shareholder of a corporation that has a shiny new license to sell marijuana. You have hired the talent. Your company’s CEO and CFO are on the job. You, your other shareholders, and your lenders have paid for your retail Taj Mahal, and now you can go to the beach and laugh while watching your bank account explode. So this is what they meant by passive income.
Corporate director liability was a hot topic in the mid 2000s with Enron and Worldcom directors ponying up tens of millions of dollars in personal assets to pay huge settlements to shareholders. Most observers paid attention to the risks for outside (non-officer) directors in mega-companies, but many of those same lessons apply with nearly equal force to mom and pop corporations with only a handful of shareholders.
Directors of companies, no matter the size of the company, still owe fiduciary duties to their corporations. As a fiduciary, a director’s primary duty is to the corporation, and personal interests are subordinate to that duty. Fiduciary duties are generally split up into two categories: duty of loyalty and duty of care, though they can be further dissected into a lot of different categories (duty of fair dealing, duty of good faith, etc.).
The duty of loyalty is something that is generally understood by even corporate novices. If you are a director of the company, you cannot enter into transactions that present a conflict of interest without disclosure and acceptance by the other directors. Say that your company has developed a new, more efficient method of processing a marijuana concentrate. If a director turns around and sells that technology to a competitor for personal gain, there is an issue, and the shareholders can sue that director and win. Not too controversial. What if a director buys a small ownership stake in another marijuana company with its own top grade marijuana concentrate? What if a director buys a large ownership stake in another marijuana company with its own top grade marijuana concentrate? These are tricky questions, the answers to which typically require analyzing all of the facts and applicable law.
The duty of good care is trickier to wrap one’s head around. As a director, it would be nice to do nothing but show up to the annual meeting, cast a vote in favor of the officers, and go back to your margarita-induced perpetual state of relaxation. However, you expose yourself to shareholder liability if you do not do more. You need to do something like the following types of diligence before taking any votes:
- Obtain and consider all relevant information
- Take time to evaluate corporate actions
- Consider the advice of experts
- Understand the terms of the transaction
- Understand the corporation’s financial statements and monitor related financial controls
- Review and monitor the performance of the CEO and other senior officers
- Implement and monitor systems to check for failures to comply with laws and regulations
Though the above sounds like a lot of work it really just comes down to the director staying informed about the health and compliance of the company while also being knowledgeable about the company’s finances.
If these duties are owed to the company, who sues if there is a breach? Individual shareholders do. In the closely held corporation, the other shareholders are often friends, family, and long-time business associates. When a company begins to falter, shareholder litigation is often a next step. You may think that your friends and close business associates will never sue you, but if that were true, there would not be lawyers out there who do nothing but take on this sort of lawsuit.
Bottom Line: If you are going to be a director of a cannabis company, you should first make sure that the company has insurance in place to cover your director liability and you should take your duties seriously.