In the Start-Up Entrepreneur Series, I will be taking a deeper look into some of the most common questions early stage founders face in putting together and operating their new businesses.
Last week, we talked about the various documents that make up the governing “law” of a corporation (or LLC). This week, we’ll talk about the individuals that govern the actions of a corporation: the Board of Directors and Officers.
(Note that because of the inherent flexibility in the LLC structure, a discussion of an LLC’s management at a generalized level is not possible. Know that an LLC can be organized as we discuss below (and that many do in order to emulate the more understood corporate form), but that it can also be organized in myriad other, distinct ways.)
What is a Board of Directors?
The board of directors of a corporation (henceforth, “the Board”) is a group of individuals with the highest authority to direct the affairs of the corporation. They are elected by the stockholders regularly (usually on an annual basis), and can be replaced by the stockholders at any time pursuant to the rules of the corporation’s governing documents (and applicable law).
Put more simply, the Board is the ultimate boss of the company. It usually consists of some of the company’s founders, representatives of the company’s major investors, perhaps an individual or two with strategic or technical knowledge of the company’s industry, and the Chief Executive Officer of the company (an officer role, discussed below). Except for officer and founder members, Board members are generally not expected to devote all their time and attention to the company. Most will serve on multiple boards and/or take a more “hands-on” role in other endeavors (i.e., their own companies).
The Board meets regularly, but not particularly often (sometimes bi-weekly, sometime bi-monthly or even quarterly, in each case as described in the company’s Bylaws and/or by Board resolution). One of the jobs of the officers of the company is to prepare reports to the Board so that the Board can be apprised of what has happened with company operations in the interim time between meetings.
Board approval is usually required for all major company actions: changing business lines, amending governing documents, appointing officers, selling stock, acquiring new companies, liquidations, bankruptcy, etc. Though the Board will often act on the recommendation of the company’s officers, the company cannot take such significant “game changing” actions without such approval.
What are Officers?
The officers of a corporation are the folks who get their hands dirty on a day-to-day basis. Unlike the Board, who meets only every so often, the officers of the company are the individuals that actually make decisions for the company “on the ground”. When employee contracts are being signed, when details on the latest advertising campaign are being ironed out, or even when the refrigerator in the lunchroom needs replacing, it is the officers of the company that work through the issues.
Officers are not directly elected by the stockholders of a corporation. Like in a representative democracy, the stockholders only get to elect the first set of representatives: the Board. It is the Board then who, on the stockholders’ behalf, appoints the corporation’s officers.
Under the most commonly used state laws, at least a President, a Secretary, and a Treasurer must be appointed as officers of a company, though one individual can hold all such positions. We refer to these as the “statutory offices”. The President (as one might expect) is the head executive, charged with overseeing the strategy and operations of the company itself. The Secretary is in charge of keeping the books and records of the company (i.e., complying with corporate formalities and making sure the law is followed). The Treasurer is in charge of the corporation’s finances.
After these “statutory offices”, the Board can appoint any other roles it sees fit (provided such roles are permitted in the corporation’s bylaws). Generally speaking, many companies bifurcate the President’s role into a Chief Executive Officer (CEO) in charge of the company’s “grand strategy” (“We are going to run bingo parlors!”) and a Chief Operating Officer (COO) in charge of implementing that strategy (“Our bingo parlors are going to operate north of 5th Ave!”). From there, as an organization becomes more complex, more officer roles are often needed: Chief Technical Officer (CTO), Chief Human Resource Officer, Vice Presidents, Executive Vice Presidents, etc.
Though many such roles have contours which are fairly easy to glean, it is important from a legal perspective to ensure that the authority of the individual being put in such a role is firmly established either directly in the bylaws of the company or in the board action appointing such officer. After all, if the company doesn’t establish what authority a “Chief People Person” has, then how are they (or anyone else) to know?
What are “Fiduciary Duties“?
Though framed differently (and more or less expressly) under the laws of the various states, it is a general rule that both the Board and officers of a corporation have “fiduciary duties” to the corporation’s stockholders. Said another way, the stockholders have placed their funds in trust with the Board and officers for the purpose of seeing those funds grow. Because of that, the Board and officers have a legal duty to protect those funds and make them grow to the best of their ability.
When folks talk about corporations only caring about “the bottom line”, a lot of that is built into the “fiduciary duty” DNA. No one running a corporation is legally permitted to think of anything other than maximizing stockholder value (unless the corporation or LLC is organized as a non-profit or as a “social” company, but more on that in another post).
While each state has its own interpretation of fiduciary duties and when they might be breached, most agree on the basics. Generally, both the Board and officers possess a “duty of care” and a “duty of loyalty” to the corporation and its stockholders. Entire books could be written on these subjects (and have been), but for purposes of brevity I will simply state that the duties are (broadly) as you would expect them based on their titling.
The “duty of care” requires both Board members and officers to use the attention, care, and process that would be expected of a reasonable person acting in a similar capacity. A Board member voting on a liquidation of the company is expected to have read through the Board materials describing such liquidation prior to the meeting, to make inquiries of the officers on the proposed plan, and generally to just know what is going on. An officer determining how to market the company’s latest widget is expected to conduct reasonable due diligence on the options before them. In other words, they are expected to do their jobs. While broad discretion is given to the Board and officers of a company to be “wrong” (the courts in general are very reluctant to substitute their own judgment for the “business judgment” of the Board and officers in hindsight), clear deviations from appropriate prudence can be penalized. In other words, the manner of decision-making more than the decision itself is the issue.
The “duty of loyalty” requires the Board and officers of a corporation to act in the corporation’s (and its stockholders’) best interests. Simple enough. Issues arise most commonly out of transactions that would directly benefit an individual Board member or officer at the apparent expense of the company. An officer may own and operate a vending service on the side, for instance, which he recommends for a corporate contract without informing his colleagues of his ownership interest. Or a Board member receives a tip on an investment in the company’s industry which such Board member would rather use for himself to start up a company competitor. Usually, but not always, violations of the concept of “loyalty” are fairly obvious after the fact. If the corporation has an interest in something that a Board member or officer is doing, such interest is to be disclosed to the Board and stockholders. Such interests can still be acceptable (after all that vending contract might be the best on offer), but it must be approved by parties that are “disinterested” (i.e., won’t make money directly off of) the transaction being discussed in order to avoid violations of the duty.
Breaches of these duties are offenses against the company itself. Claims can be brought by the company directly, or, as is often the case since the Board may not want to bring a claim against itself or its appointed officers, “derivatively” by the corporation’s stockholders on the corporation’s behalf. Either way, a court finding a breach of such duties can hold the individuals liable, roll back the action (or failure to act), or impose more draconian penalties. The existence of these duties is why I always advise my clients considering a board position to make sure that they are willing to put in the time and “do the homework” related to the role.
I hope this brief overview of the role of the board of directors and officers of a corporation has proven useful. As always, if you’d like to discuss please leave a comment down below or contact me at firstname.lastname@example.org. I’d love to hear your thoughts.