Budge Law Offices LLC

Are you a closely held corporation? A closely held corporation is defined to be a corporation that has a relatively small number of shareholders and no active market for trading its securities. Closely held corporations take many sizes and shapes – from a one-shareholder corporation to family-owned businesses to wholly owned subsidiaries; they can be small businesses as well as large corporations (think Cargill, Chrysler, Ikea, to name a few).However, size doesn’t matter when it comes to protecting yourself against personal liability when you are a board member of a closely held corporation. As we discussed previously (see “Protecting yourself against personal liability”, November 2009), failure to observe corporate formalities or an absence of corporate records may leave you exposed to being personally liable for the acts of the corporation.Have Written Bylaws – these are the written rules for conduct. Bylaws generally provide for how meetings will be called, procedures for electing board of directors and officers, they will describe the types and duties of officers, types of committees and other routine conduct. Bylaws must be formally adopted by the Board.Board Meetings – Yes, you should have them! The Board sets the direction of the corporation on behalf of its shareholders/members. Even if you are a small company, with a small board, I recommend that you meet at least one or two times a year. That said, meetings should be held as often as is needed to adequately care out the directors’ oversight responsibility. Remember, the Board is generally responsible for setting salary of its executives, as well as setting the strategic direction of the corporation.

Details – Schedule the meeting in advance (following the procedures for calling meetings as established in the bylaws). Prepare an agenda and circulate it in advance of the meeting. Generally, the CEO sets the agenda, but all board members should have an opportunity to add items on the agenda. The meetings may be in person or by conference telephone, or by any other means of communication by which all members can hear and be heard.

Quorum – in order for the board to take action at a meeting a quorum must be present. Unless the articles of incorporation or bylaws state otherwise, a quorum consists of the majority of the total number of directors.

Formalities – There are no required formal rules of procedures for board meetings. While it is important to budget your time during the meeting, it is equally important to have open and honest communications, without a lot of form rules, such as Robert’s Rules of Order. That said, I highly recommend that you designate one of the directors as the chair to preside at the meeting in order to stay on schedule and on topic.

Board Minutes – All meetings of the board of directors (including any board committees) should be memorialized in minutes kept by the corporation. Minutes are actually important legal documents – reviewable by auditors, shareholders (in certain situations) and by the courts. Minutes should not be a verbatim record of the meeting, but should be summarize important discussions and actions. Remember: minutes provide evidence of the level of care, obedience and loyalty that the board exercised in carrying out their duties.

This is part 3 of our three part series in addressing standards of conduct for board members.

In family-owned or other closely held businesses an individual can wear many different hats: the shareholders are board members and board members are officers. As such, it is important to know what hat you are wearing at any given time.

For example under Minnesota law, a director’s standard of conduct is to discharge his or her duties in good faith, in a manner the director reasonably believes to be in the best interests of the corporation, and with the care of an ordinarily prudent person in a like position would exercise under similar circumstances. This same standard of conduct applies to an officer of the corporation. However, as a board member, a director is entitled to rely on information opinions, reports, etc., presented by an officer or employee of the corporation, whereas, an officer has no right to rely on information provided by another person if the matter relied upon is within that officer’s area of direct responsibility.

Let’s apply this standard to setting of compensation. Subject to any limitations in the Articles or Bylaws, the board may fix the compensation of directors. Traditionally, the board has set the salary for the officers as well as the directors. There are fiduciary considerations in setting levels of compensation. The board should consider the financial health of the corporation in setting such compensation and conform to the business judgment rule. A salary should not be unreasonable, excessive, or arbitrary. So if the board sets the officer’s compensation and the board member is the officer as well, it is imperative that the board member act in good faith and not set excessive salaries (whether for the board or for the officers).

Fiduciaries must be particularly careful when they assume multiple roles, such as when serving as stockholders, directors, and officers of a close corporation involved in transactions in which they sit on both sides and in which they have a self-interest. As one Court observed, “wearing more than one hat…requires a fiduciary to be very nimble as well as most prudent. While the fiduciaries may purport to wear one hat at a particular moment, in truth all hats are worn together at all times.” Johnson v. Witkowski, 30 Mass. App. Ct. 697, 704 (1991)

We talked about the duty of care and the duty of loyalty, to continue with this topic (which is turning out to be a three-part series, with the 3rd part coming soon) we turn to the concept of the Business Judgment Rule.

Generally, even where a corporate action has proven to be unwise or unsuccessful, a director will not be liable if he or she acted in good faith, in a manner reasonably believed to be in the corporation’s best interest, and with independent and informed judgment.

Investopedia says:

The reason for this rule is to acknowledge that the daily operation of a business can be innately risky and controversial. Therefore, the board of directors should be allowed to make decisions without fear of being prosecuted. The business judgment rule further assumes that it is unfair to expect those managing a company to make perfect decisions all the time. As long as the courts believe that the board of directors acted rationally in a particular situation, no further action will taken against them.

For an interesting article on this subject, especially surrounding setting of executive salaries I recommend the following article from Compliance Week: Business Judgment Rule: Feeling New Pressures?
By Stephen Davis and Jon Lukomnik, Compliance Week Columnists — January 13, 2009.