Corporate Governance Legal Checklist by Phillips Kaiser

The Corporate Governance Legal Checklist

BY HOUSTON BUSINESS ATTORNEYS

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The Complete Guide to Corporate Governance

 

Corporate governance is more often than not defined in the public imagination when it doesn’t work.

News stories are rife with corporate governance examples gone awry where a company’s stakeholders, including shareholders, management, customers, financiers, suppliers, government agencies, and the general public, are at each other’s throats.

Notable examples of corporate governance failures include the astonishing bribery and corruption scandal endured by Siemens in the mid-2000s and Enron’s catastrophic implosion.

Siemens, for example, underwent the biggest corruption scandal in the history of the German Federal Republic. As a result of poor corporate governance, where corruption became institutionalized, the company was forced to pay a fine of $1.6 billion US dollars, the largest fine for bribery ever imposed at the time. The total costs, including attorney fees, were $2.8 billion US dollars.

The outlook was so dim for the company that many experts didn’t expect the company to survive. But it did. So today, Siemens has become a two-fold story of failure and redemption.

The company’s recent history has been one of the poor corporate governance examples that nearly drove it into the ground and the right corporate governance model that has rehabilitated and redeemed the company in the eyes of consumers, shareholders, government regulators, and those within the company itself.

Bad corporate governance nearly killed Siemens.

Good corporate governance saved Siemens from the fate of an Enron or a WorldCom.

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Section 1

What Is Corporate Governance?

Like our government, corporations are directed and controlled by a system of internal rules and regulations, and practices.

Corporate governance also balances the sometimes conflicting interests of various relevant stakeholders, including consumers, shareholders, management, suppliers, partners, financiers, governments, and the communities in which they operate. When one or more of these stakeholders are ignored or overruled, scandals or bitter conflicts can emerge.

What Is Corporate Governance by Phillips | Kaiser

When there is balance and corporate governance is working as intended, a company can benefit and prosper from the long term stability.

Because corporate governance touches on nearly all aspects of a company’s existence, from its day-to-day activities to its long-term vision and strategy, it can be difficult to ascertain what corporate governance is.

In essence, corporate governance can be seen as the set of rules, controls, policies, and resolutions put in place as an edict to a company’s expected behavior and direction.

Poor corporate governance, exemplified in the case of Siemens in the mid-2000s by the criminally lax attitude towards corruption, led the company as a whole to behave corruptly.

Likewise, the strict supervision and corporate ethical controls, rules, and regulations established by both angry shareholders and government regulators helped the company to correct its harmful behavior and begin a journey towards a financial (and public relations) recovery.

Examples of Corporate Governance

  • Leadership or executive team directives or committee charters
  • Board of Directors Committee Charters
  • Inside and independent board member requirements
  • Articles of Incorporation
  • Governance documents (e.g., code of conduct or compliance policies)
  • Bylaws
  • Stock ownership guidelines
  • Internal corporate controls procedures
  • Auditors
  • Corporate balance of power rules
  • Remuneration guidelines

4 Key Components of Corporate Governance

1. Vision

The leaders and executives of a corporation are responsible for determining a corporation’s comprehensive vision, mission, and business direction. Making strategic decisions and addressing current and future concerns are essential ways for a company to execute on their vision. A strong vision and mission not only gives the corporate body motivation and a strong sense of purpose to move in a unified direction, but it also displays the company’s intention to the general public and the world at large.

Illustration of Industrial Property Rights

2. Stakeholders

Corporate governance must satisfy and hold in balance the many stakeholders involved in a corporation. These stakeholders include consumers, regulators, executives, management, shareholders, financiers, suppliers, and the public at large.

The most prominent stakeholder to which corporations are beholden are often the shareholders who own the company. Shareholder relations form an essential aspect of corporate governance with many companies providing their shareholders with important documents and information about decisions and company considerations.

3. Corporate Citizenship

Although often neglected in favor of shareholder relations, corporate citizenship in the wider community cannot be discounted. Consumers, communities, and the general public engage with corporations on a daily basis, and thus it falls on the corporation to be governed, or behave, in a way that reflects the corporation’s broader message to the world and in a way that respects the public and the environment.

When this aspect of corporate governance is neglected, public relations usually suffer, and regulatory actions often follow.

4. Oversight & Accountability

Strong corporate oversight and accountability, built on a foundation of balancing powers, are crucial for the long-term survival and success. This has everything to do with a company’s corporate governance.

For example, Siemens had weak internal ethical oversight and a culture of corruption that was institutionalized and never questioned. Ultimately, this unacceptable behavior and poor corporate governance were driven by executive greed to enrich themselves at the expense of the other stakeholders, and as a result, the company itself.

The goal of corporate governance when it comes to oversight and accountability is to ensure that leaders and employees work in the company’s interest and of the company’s shareholders and other stakeholders.

Corporate Governance - Code of Conduct

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Section 2

What Every Board Member Needs To Know

To accept membership on a Board of Directors is to take on enormous responsibility and potential liability. The board is the guiding force of any for-profit or non-profit organization. They are ultimately accountable for decisions that can impact hundreds of staff, thousands of shareholders, or millions of customers.

To meet these responsibilities and protect the company, board members must know the most vital functions of their prestigious roles.

How To Respect Fiduciary Duties

Board members are considered fiduciaries, and they are legally obligated to act on behalf of their organization.

Board of Directors - Fiduciary Duties

The nature of these obligations may differ slightly from state to state, but the following duties are recognized in part or whole throughout the country.

Duty of Care

The duty of care (also known as the duty of good faith) is an obligation to give each decision its due consideration. Every decision that is made and handed down should be explored, refined, and submitted to criticism in proportion to its impact on the organization and shareholders.

Duty of Loyalty

The duty of loyalty is an obligation to hold the organization’s best interest and shareholders as the highest priority. Board members are obligated to avoid conflicts of interest, self-dealing and other situations where their self-interest is placed in direct conflict with their duty.

Duty of Obedience

The duty of obedience is an obligation to respect all laws and governing documents of the organization. The violation of external laws is itself a risk to the organization. The violation of internal laws defrauds the shareholders who have ratified those laws to ensure excellent governance.

How to Advance the Mission of the Organization

 

Board of Directors - Houston Business Attorneys

The Board of Directors are the leaders most responsible for an organization’s direction and the ones most accountable to the shareholders. For that reason, it is imperative that every member of the Board fully understand the core idea of the organization and the broad strokes of the mission that will make that idea possible.

Board members should understand the mission and articulate it to the officers who will be expected to carry it out and the employees who will action it at every level. Each Board member is responsible for fostering the unity that creates clarity of purpose throughout an entire organization.

How to Assess, Appoint and Compensate Officers

 

Board of Directors Compensation - Houston Business Lawyers

Board members are expected to provide top-level leadership in an organization, steering it toward the most ambitious and profitable goals. However, the decisions that steer the organization must be executed on the ground level by the Chief Executive Officer and other high-level officers.

One way that Board members exercise their duties is by choosing officers who are well-qualified for their duties and compensated well to avoid instability. They must define what is expected of the role, carefully assess the candidates, and make an appointment based on the best available information.

How to Identify and Resolve the Deficiencies of the Organization

 

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Board members must be active in solving the problems that keep the organization from reach its full potential. Understanding problems result from active attendance and participation in each meeting throughout the year, along with the review of any materials produced by the officers and the practice of privately engaging the shareholders.

One of the most effective ways that Board members can resolve problems is participating in Board committees and task forces. Most Boards form regular committees to allow special attention to particular ad-hoc issues or ensure close collaboration between the Board and key subject matter experts in the organization.

How to Protect the Unity of the Board

 

How to Protect the Unity of the Board

Every Board member shares the responsibility of ensuring that the Board remains free of the dysfunction that results from apathy, factionalism, and disrespect. The Board must remain a unified force to set an example for the rest of the organization.

Board members should know how to resolve a conflict on the Board by encouraging mediation, finding common ground, and setting firm boundaries. When necessary, they should know when to give up on an idea whose time has not yet come instead of creating a rift.

The Board member who understands these duties will be a credit to their organization. They will build an organization and a legacy that will inspire pride for years to come.

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Section 3

What Is The Role of the Board of Directors?

Let’s consider the compelling reasons, beyond simple legal compliance, to consider establishing a board of directors, what a board of directors can do for you, and how to set up and manage a board of directors.

Effective Board Leadership - Corporate Governance

 

What is a Board of Directors?

 

A board of directors (B of D) consists of a select group of individuals jointly appointed to oversee an organization’s management and affairs, and to set its strategic direction.

But wait, you may be asking yourself, isn’t that the CEO or management’s job?

This is a common misconception.

The position of the CEO and management is to manage and to carry out the day-to-day business operations.

It is the job of a board to govern a company.

Think of the Board as the highest-ranking body within a company’s hierarchy. It’s the board’s job to set the strategy for the organization, oversee the CEO and the performance of management itself and, if need be, take corrective measures if performance is lacking.

Two mandates neatly sum up a board’s functions within a larger organization:

Advisory

A board consults and advises the CEO and management regarding the strategic and operational direction of the company.

Oversight

A board makes sure management’s actions are in the best interest of various stakeholders, including shareholders, and monitors its performance. This is also known as corporate governance.

The board can consist of insiders or outsiders.

Insiders have some role or stake in the business, such as shareholders, founders, or employees.

Outsiders are people with no ownership interest in the business, such as retired CEOs of other companies, industry experts, or other seasoned business managers.

Typically, both insiders and outsiders are selected for a board based on their organizational or industry knowledge, experience, and business relationships.

Determining the right composition or mix of insiders and outsiders is crucial. Usually, a company’s board should represent the interests of management and shareholders. Although relatively rare in the United States, some corporate boards even include labor representatives who promote and protect employees’ interests.

Ultimately, the ideal board of directors should make decisions that further a company’s goals and interests, thereby benefiting shareholders, management, and workers themselves.

A small business or a private company can determine the mix of their board, but publicly-traded companies are required to have a certain number of outside directors.

Other details, such as the number of members on the board or how they are selected, are determined by the state’s rules. The business is incorporated or by a company’s internal processes and corporate governance documents such as bylaw an operating agreement for LLCs.

Role of the Board of Directors

Ultimately, the board of directors is the final authority and the highest governing body of a company.

It is the board of directors’ role to hire the CEO and general management of a business. They also assess the overall strategic direction of a company. While management may hire individual employees and workers and oversee day-to-day operations, the board of directors is responsible for overseeing the company’s management.

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Section 4

Why Do Companies Need A Board of Directors?

Some companies have no choice but to elect a board of directors. Businesses structured as C corporations and S corporations, whether for-profit or nonprofit, are required by state law to elect a board of directors. The exact rules and regulations can vary by state.

However, there are also important reasons why any business, whether small or large or nom C corporations (e.g., LLCs), may want to elect a board of directors despite no legal requirement to do so.

Why Do Companies Need A Board of Directors

Establishing a board of directors is not just a formality. Electing a board of directors can alter the course of your business. On the one hand, companies that effectively utilize their board to drive value and maintain a pristine reputation can drive success and growth. A competent board can be a valuable tool for a business.

How A Board of Directors Can Provide Value

  • Ethical oversight
  • Steering the company towards long-term success
  • Reinforcement and embodiment of the company culture
  • Strong corporate governance
  • Streamlined decision-making
  • Credibility and legitimacy

On the other hand, businesses that ignore the need for a board of directors or treat their board as a check-the-box legal maneuver may be leaving immense value on the table or even making a costly mistake.

 

Benefits of Having a Board Go Beyond Mere Legal Requirements

 

Electing a board serves an organization in more useful ways than just legal protection. If you are legally required to have one, why not fully utilized this understated tool? You may also want to start weighing the benefits of having a board of directors if you are looking for long-term growth.

As you try to justify the price tag of having a board, consider the following benefits a board of directors can provide to a company.

6 Benefits A Board of Directors Can Provide To A Company

1. New Opportunities

Establishing a board means not only gaining more advocates for the company, but it also means expanding your company’s network. Directors can bring along their networks and business contacts (e.g., partners, investors, and suppliers), which may be relevant for growing companies.

2. Skills and Knowledge

It’s impossible for a founder/CEO to have all the skills, knowledge, and experience to operate effectively in an unpredictable environment. Upper management and the CEO need an objective and fresh perspective from directors that bring expertise from complementary but diverse backgrounds.

3. Strategic Direction

This is perhaps the best way a board adds value. A founder and CEO may be too stubborn or too interested in personal gain to think about long-term success. Instead of being burdened with day-to-day operations, directors can spend more time on key issues and formulate vital strategies such as raising capital, expansions, acquisitions, dispositions or even doing an initial public offering (IPO), etc.

4. Independence and Accountability

Directors are supposed to act independently – free from conflicting interests and work only in your company and shareholders’ best interest. As such, a board can objectively measure the management’s performance and make sure the company stays on track with the business plan. Because the CEO answers the board, the directors can speak frankly and hold a CEO’s actions accountable even if other employees are afraid to do so.

5. Continuity for the Organization

A board can be the perfect way to ensure a smoother transition from one generation of leadership to another. No CEO or founder lives forever, so an orderly succession is critical for the business. Having a board in these types of situations separates the company’s needs from any potential conflicts of interest that could damage or weaken the company in the future.

6. Credibility and Trustworthiness

A board of directors keeps the bigger picture in perspective. The board ensures a balance between being innovative and taking risks while still maintaining compliance and behaving ethically. A business’s credibility and reputation are essential. For example, many financial institutions and investors place great importance on reputation and trustworthiness. Companies with a positive board of directors reputation can often obtain a lower cost of financing, which is crucial for business growth.

The Importance of a Board of Directors for Good Corporate Governance

 

WorldCom’s board of directors’ dramatic failure to detect and address financial fraud and address general bad behavior by management is one of the key reasons why the company imploded. Even before the revelation of massive accounting fraud, the board already showed a lack of ethical oversight and rigorous decision-making. The company loaned the late CEO, Bernard Ebbers, over $400 million that he used for personal expenses.

Not only was this money never accounted for appropriately, but some members of the board also didn’t even know that the loans had been made. A dysfunctional board and total lack of board oversight of management ultimately created the conditions that resulted in WorldCom’s spectacular failure.

Effective Board Leadership

A properly-governed company always knows what it “is”

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Section 5

How To Fire A Toxic Board Member

A corporation’s board of directors has the important responsibility of steering the company through rough waters, developing strategy, and guiding the company into the future in the interest of the shareholders.

Unfortunately, sometimes a dysfunctional, negligent, or toxic board member can do enormous harm to a company. In some cases, a toxic board may even drive an otherwise healthy organization into the ground.

7 Signs of A Toxic Board of Directors

1. Personal conflicts of interest.

Healthy corporate boards have strict conflict of interest policies designed to ensure that every director’s personal goals are aligned with those of the business.

Organizations that do not have an explicit policy addressing conflicts of interest or ignore obvious signs of conflicts of interest may have a potentially toxic board of directors.

At a minimum, every board’s conflict of interest should address the board’s fiduciary duty, a duty of loyalty, and a duty of confidentiality. A healthy board will take conflicts of interest seriously and spell out disciplinary actions or outright removal procedures for directors who do not comply with agreed-upon policies.

2. Negligence or lack of attendance.

Falling asleep at the wheel of a car can lead to disastrous and even deadly consequences. Likewise, a negligent board that is asleep at the wheel can also result in disastrous results.

Any director who isn’t paying careful attention to the company or participating in board meetings may not only be negligent, and they could also be breaching their fiduciary duty towards shareholders.

The duty of care is generally evaluated according to the “business judgment rule,” under which directors and officers are presumed to make decisions on an informed basis and in good faith.

Needless to say, a board member who skips meetings may very well be a toxic board member.

3. Lack of personal investment in the organization.

While all board members should avoid real or perceived conflicts of interest, they should be actively invested in the company or organization they purport to lead. It just makes sense to select board members who have “skin in the game” and are financially invested in your organization’s performance and longevity. After all, if they aren’t invested in outcomes, you have to ask yourself if they might have higher priorities or other interests that may put the organization at risk.

4. No internal audit committees.

In government, politics, or business, every decision-making body should have an internal process for accountability. Internal accountability is typically maintained for a board of directors through internal committees, particularly an audit committee. This indispensable internal body is in charge of overseeing financial reporting and disclosures, especially for larger companies. A lack of such a committee for a larger company would be a red flag that the board may need to be reformed; for publicly-traded companies, it’s the law.

5. No internal compensation committee.

Another crucial internal accountability body, every board of directors, should have is a compensation committee that includes outsiders and organization insiders.

This committee has the responsibility of determining executive compensation packages, incentives, and bonuses. As a result, it is important to ensure that the internal compensation committee has a healthy balance of skilled outsiders and company insiders.

6. Unbalanced or unrepresentative.

The key to a functional and successful board of directors is one that is well balanced and represents the interests of all shareholders, management, and in some cases, even employees themselves.

A balanced board should have the right balance of executive (insider) and non-executive (outsider) directors. More importantly, a board should also have a healthy mixture of abilities, knowledge, and industry or institutional experience.

7. Too big or too small.

However, depending on the organization’s size, needs, and complexity in question, company board sizes can range from just three (3) directors to as many as 30. As a general rule of thumb, many business analysts consider seven (7) people to be the ideal group size that balances agility and experience.

How To Remove Toxic Board Members

 

More often than not, a toxic board isn’t the result of poor business practices or a lack of internal accountability, but rather the result of particular, toxic personalities. Unfortunately, the presence of a toxic director or two can completely derail your board of directors and your organization.

The following are signs of a toxic board member:

  • Has conflicts of interest.
  • Rude, manipulative, abrasive, or threatening.
  • Gives or takes bribes.
  • Micromanages executive management.
  • Refuses to raise funds.
  • Skips meetings.
  • Cannot be trusted to handle confidential information.
  • Expects special treatment or favors.
  • Gives favors to family members or professional allies.
  • Shows contempt for others.

The best solution to toxic board members begins with prevention through proper recruitment and training.

But what can a business do if an unconstructive board member manages to get a seat on the board?

The first step is always to make the wayward party aware that his or her behavior or lack of responsibility is detrimental to the board’s mission and will not be tolerated.

Many common signs of toxic behavior, such as combativeness, rudeness, or lack of respect for other board members, can be nipped in the bud with quick, coordinated action by the board president or other board members. Depending on the person in question, sometimes gentle persuasion is needed to make them aware of their wayward behavior.

Other times, a particularly abusive board member may need to be sharply confronted or, if their toxic behavior has become an ongoing problem that distracts the board from carrying out its obligations, removed outright. For example, fraudulent behavior, irreconcilable conflicts of interest, or fiduciary duty breaches should not be tolerated.

The following is 4 ways to remove a board member that has become too toxic:

  • Resignation through personal intervention
  • Leave of absence
  • Use organizational bylaws or impeachment
  • Term limitations

4 Ways To Remove A Toxic Board Member

1. Leave of absence

Sometimes, a board member’s health or well-being or other priorities such as family or other pursuits may be the underlying cause for their poor performance.

A board member may have an understandable reason for being unable to commit to regular meetings or execute their duties as a board member. Nonetheless, an under-performing board member is a risk to the board and the company and should be removed and replaced if possible.

Suggesting some time off, or perhaps a more extended leave of absence, can help them not only address their underlying issues but also give them a professional, respectful, and tactful way out.

Oftentimes, board members in this predicament may actually be ready to leave or step down and are just waiting for the right opportunity. With a leave of absence, the board member is given an opportunity to reflect and refocus and, should it be in the organization’s interest, be allowed to return at a later time.

2. Resignation

The most direct way to remove a board member is simply asking them to step down or resign.

Depending on the person’s relationship with the board, this can be a challenging proposition. Oftentimes a director who is at odds with the company, will not simply resign or step down when asked. However, sometimes personal intervention between a wayward board member can yield the best results. When handled tactfully and judiciously, simply talking to the person in question discreetly can allow all parties to move forward without undue drama or bad blood.

Being tactful is key. Unfortunately, someone who has adopted an adversarial stance will be unlikely to resign without a fight. If this is the case, stronger measures may be necessary.

3. Impeachment via bylaws

Most board of directors operate according to agreed-upon bylaws. These bylaws often include policies on behavior and performance and methods for formally removing members who cause trouble or run afoul of company policies.

Bylaws will vary from one organization to another. However, most bylaws accord the board the ability to impeach a director through a simple two-thirds majority vote. In other words, if a member’s behavior or actions are so egregious as to warrant impeachment, he or she can be voted out of their seat.

4. Term limits

Finally, one of the best ways to build in protections against poor or corrupt board members is to implement term limits.

Once a board member’s term is up, they can be either reappointed to their positions or removed and replaced. This type of limited tenureship not only builds in accountability, but it can also reward high performing board directors while limiting the damage wrought by bad ones.

Always Work With A Business Attorney

When seeking to remove a board member, always work with a business attorney. Depending on the size of your business, state regulations, and specifics of the case, there may be legal implications or stipulations that must be met. It is always prudent to turn to an expert on corporate governance and business law, such as Phillips Kaiser, Houston business attorneys.

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