Stockholders own corporate entities, but elect a board of directors to govern the corporation. The board is responsible for overseeing the general management of the company’s business (for the benefit of the stockholders) and — except for certain matters reserved for stockholders — has decision-making authority over the company’s affairs. Directors in turn delegate much of the day-to-day operational matters of running the business to officers of the company, who in turn hire employees and engage other third-party consultants and advisors. Boards must approve most major corporate actions that involve significant financial, legal, or tax consequences, including, for example: distributions, hiring and firing of senior officers, operating budgets, amending the corporation’s organizational documents, borrowing or lending money, changes to employee benefit plants, and any major sale or merger transaction.
Companies require directors to attend board meetings on a regular basis (often monthly or quarterly). In advance of a board meeting, directors typically receive a package of information regarding the matters to be discussed at the upcoming meeting. Companies should expect directors to spend time reviewing and analyzing the meeting materials. Directors also need to be generally available to the company’s management should issues come up that require impromptu board calls or special board meetings.
Legally, directors have certain duties and responsibilities owed to the corporate entity and, therefore, to the corporate stockholders:
- Duty of Loyalty. The duty of loyalty requires a director to act in the best interests of the corporation, which means putting stockholder interests above their own personal interests when making decisions on behalf of the company. This duty includes not engaging in self-dealing, not usurping corporate opportunities or making use of company confidential information for personal interest or gain. The duty of loyalty requires that when the board takes action, it must do so with independence and absent any conflict of interest. The duty of loyalty also encompasses a duty of good faith, which requires directors to act with the intent to further stockholder interests and to act in what directors honestly believe to be the best interest of the corporation.
- Duty of Care. The duty of care requires that directors exercise the same degree of care that an ordinarily reasonable person would use when faced with similar circumstances. This proactive duty requires that directors obtain all material information available to them before making a decision. While directors must keep informed about the corporation and its decisions, they are permitted to reasonably rely on the corporation’s records, management and advisors.
Directors should understand the importance of their responsibility to uphold their duties to the corporation, as stockholders can bring direct lawsuits, or derivative lawsuits on the corporation’s behalf, against directors for violating these fiduciary duties. Board decisions are usually protected by the deferential business judgment rule. The business judgment rule provides that as long as the board of directors decisions were informed and the board can point to a reasonable business purpose, a court will not question such decisions even if those decisions turn out to be wrong in hindsight. The business judgment rule rests on a presumption that board decisions were made by directors who were disinterested and independent, acted in good faith and used a reasonable decision-making process. Courts generally recognize that judges and stockholders are often not in the best position to second guess business decisions that a company’s board of directors made, so courts will focus on the board’s process rather than the substance of the decision.
Directors should proactively take certain steps to fulfil their role and satisfy their duties:
- Stay Informed – Directors should be educated about the business — including results of operations — and should understand the company’s strategies and corporate plans. Directors should ask questions and inquire into any areas of concern.
- Conduct Diligence – Directors should perform diligence as necessary when making board decisions, including engaging experts and advisors, and insisting upon adequate information from management. Directors should make sure to fully understand the terms and consequences of any proposed action.
- Be Involved – The board should hold regular meetings and be involved in and approve all major corporate decisions, such as deciding whether to enter into a significant transaction. Directors should spend time considering and deliberating on all important issues involved in any major decision. See How to Run an Effective Board Meeting for more information on board meetings.
- Document Clearly – Directors should ensure the board maintains full and complete minutes. Minutes are necessary to record and demonstrate the scope of the board’s analysis in making important decisions, which a court may rely on to evaluate whether directors have satisfied their fiduciary duties in making business decisions. See 8 Things to Know About Board Meeting Minutes for more information on board minutes. Notably however, in certain circumstances, such as a merger or sale of the company, courts may apply a stricter standard of review.
For a company to be successful, it needs a board that is comprised of engaged directors who have a clear understanding of both their legal and business responsibilities. The expectations set forth above, along with the proactive steps directors can take to better serve the company, will go a long way towards this goal.