All other board functions are secondary.
Even venture capitalists who sit on boards where they have significant investments often forget this point. They write into their investment documents that they will occupy a seat on the board for as long as they are invested in the company, thinking of this as a protection for their investment and tool for them to influence growth.
Actually, there are two legal duties of board members. They are: the duty of care, and the duty of loyalty. Everything else is a self-imposed duty or responsibility. The duty of care is to care for the corporation asset itself, not the shareholders whom they represent. Each corporation when chartered becomes a live person in the eyes of the law, independent and subject to the care of its board of directors. Shareholders such as the investors are granted few rights by law. They can elect directors for their class of stock, approve mergers and acquisitions; approve increases or changes to the capital structure of the company and other more minor actions.
It is the board, made up of individual members, that is responsible for the care and maintenance of the corporate person. Sometimes, there will be a conflict of interest between the people representing the various shareholder classes on a board. This happens often when one class would be quite satisfied with the outcome of a sale of the corporation because it has lower expectations of exit value and a lower cost of shares, while another later investor class would see little relative gain in a sale and veto’s the proposed transaction. The duty of care is a legal responsibility of each board member and cannot be shed because the member was elected to protect a particular class of shareholder.
[Email readers continue here…] Second is the duty of loyalty – loyalty to the corporate person, not to the shareholders who elected the board member. Once again, there is a need to educate board members that in conflict of interest cases, the corporation comes first. Some investor board members are also member of boards for companies that may overlap in markets or even compete directly, although rare. Either way, I have seen many instances over the years of my board service with VC’s on the board, which the VC’s have had information about other firms that would be classified as confidential – that they offered at least piecemeal in a board meeting of another company where they serve. There are issues that stress the loyalty of board members such as placement of employees or recruiting of executives from firms where the VC or board member has inside knowledge. These are rare, but each stresses the duty of loyalty to the corporation on whose board they sit.
Should board members therefore withdraw and not participate in corporate planning, coaching the CEO and other issues not related to the duty of care or duty of loyalty? Of course they should not. A board, in exercising its duty of care, must do everything it can as an entity and each member as an individual to become acquainted with the issues, problems, opportunities and threats that overhang the corporation. In fact, there is a legal concept (not a duty) of “reasonable care” that board members must meet in order to be protected by the insurance carried by a company for directors and officers. Reasonable care means that members deliberate issues in depth, attract expert advice when appropriate, attend meetings regularly, stay current on corporate issues and hold regular sessions of the outside directors without management present. None of these requirements are by law, but the sum of these add to a powerful statement of commitment by board members and therefore a protection under the law when a group of shareholders sue boards or members for irresponsible actions. Most every court will side with the members of the board under the rule of reasonable care when these behaviors are in evidence.
Given the boards duties it will be interesting to see the lawsuits resulting from actions of reps of unions, hedge funds, etc. that might get elected as a result of the SEC’s new 3% proxy rule. Unions, investment bankers etc.,at best, often have interests which are different than those of the corporation over the long term.
How should members of management interface with issues that may benefit them?
How do outside board members behave in the face of pressure from managment on financial demands that some board members view as excessive?
John: Good questions. I’ve experienced both as have many long-time board members. If a member of management (CEO) is also a board member, after making the case for a benefit to self, s/he should be excused from the meeting while the others discuss and vote. The same would be true for any self-serving request for a vote made by any board member. These are straight forward. The problem comes when the remaining board members do not constitute a quorum of the board and therefore cannot complete a legal vote without the conflicted member(s). When this has happened in the past, either the vote was delayed until a missing member could be brought up to speed at a later time, or the board went about carefully documenting the case in the minutes and permitted the person to vote, since there would have been no way to obtain a quorum without the vote, now or later. This is rare, and a possible opening for a later shareholder action; so it is done very infrequently and only with the best advice and documentation.
Second question about excessive demands: A good board would point out the obvious and vote against such a proposal, knowingly at the risk of alienating members of the very management they look to for the successof the company. It is my experience that an uncompromising management member of a board that disagrees damages his or her relationship with the board in such cases, and upon reflection would probably not have been so intransigent.