The following excerpt is from The Corporation Handbook: An Introduction to Corporations for the Legal Professional.
A corporation is managed by directors and officers. Directors act as a group known as a board of directors. The board of directors is the corporation’s governing body. It manages the corporation’s business and affairs and has the authority to exercise all of the corporation’s powers. Corporations also have officers who are appointed by and receive their powers from the board. Generally, the board of directors is responsible for making major business and policy decisions and the officers are responsible for carrying out the board’s policies and for making the day-to-day decisions.
Election and term of office of directors
The statutes generally provide that a board of directors may consist of one or more individuals. The number of directors the corporation will have, or a minimum and maximum number of directors that the corporation may have, are set forth in the articles of incorporation or bylaws.
Generally, any individual may act as a director. However, the corporation can provide in its articles or bylaws that an individual must meet certain reasonable qualifications in order to serve as a director.
A corporation’s first directors are either named in its articles of incorporation or elected at the organizational meeting. They serve until the shareholders hold their first meeting and elect their successors. Thereafter, directors serve until the next annual shareholders’ meeting.
Corporations may also classify or stagger their directors’ terms. Typically, the corporation must have at least 9 directors in order to classify the board. In a classified board of directors, the shareholders elect either 1/2 or 1/3 of the directors at each annual shareholders’ meeting. Each director then serves a 2 or 3-year term. If a vacancy occurs on the board, it can usually be filled by either the shareholders or the remaining directors. The bylaws may provide for the exact method of filling vacancies. Directors may resign at any time. They may also be removed by the shareholders for cause or for no cause unless the corporation provides in its articles that shareholders can remove directors for cause only.
A corporation’s business and affairs are managed by or under the direction of its board of directors. Although the board has the power to make all decisions on behalf of its corporation, many business decisions are actually made by the corporation’s officers. The board of directors is, however, responsible for making certain major decisions. For example, the board is responsible for determining corporate policy with respect to products, services, prices, wages and labor relations. The board fixes executive compensation, pension, retirement, and other plans. The board decides if dividends should be declared, if new shares should be issued, or if other financing and capital changes should be made. The board of directors appoints officers. The board also proposes certain extraordinary corporate matters such as amendments to the articles of incorporation, mergers, asset sales, and dissolutions.
Directors are subject to limitations on their powers. They may not act outside the corporation’s articles of incorporation or purposes. They may not take any action that is in violation of the law. There are also actions that directors cannot take—such as amending the articles or merging into another corporation—without first obtaining the shareholders’ approval. In addition, bylaw provisions may further limit the powers of directors.
As persons in control of the property of others, directors are fiduciaries. As such, they must act in the best interests of those they serve. Chapter 6 —Directors and Officers 39 Directors owe a duty of care to their corporation. This duty requires directors to stay informed about corporate developments and to make informed decisions. In addition, directors owe the corporation a duty of loyalty. This duty mandates that the best interests of the corporation take precedence over any personal interests a director may have. For example, directors cannot compete with the corporation or usurp a corporate opportunity for personal gain.
Most states have adopted a statutory standard of conduct that directors must abide by. These statutes generally provide that a director must discharge his or her duties as a director in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner he or she reasonably believes to be in the best interests of the corporation.
In discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements prepared or presented by: (1) officers or employees whom the director reasonably believes to be reliable and competent, (2) lawyers, accountants, or other persons as to matters the director reasonably believes are within the person’s professional or expert competence, and (3) a committee of directors if the director reasonably believes that the committee merits confidence.
A director is not liable for any action taken as a director, or any failure to take any action, if the director performed the duties of his or her office in compliance with the statutory standard of conduct or in compliance with his or her fiduciary duties. However, a director who does not act within the statutory standard or who breaches his or her fiduciary duties can be held liable, to the corporation, for the damages those actions caused.
In addition, a director who votes for a dividend, distribution, or stock purchase made in violation of law or the articles of incorporation, is liable, with all other directors, to the corporation for the amount of the payment that exceeds what could have been paid without violating the law or the articles.
Corporations may eliminate or limit their directors’ liability for a breach of fiduciary duty by so providing in their articles of incorporation. However, in general, they cannot eliminate or limit liability for a breach of the duty of loyalty, for acts made in bad faith or which involve intentional misconduct or a knowing violation of law, for approving unlawful dividends, distributions or stock purchases, or for any transaction in which the director derived an improper personal benefit.
Director conflict of interests
On occasion, a corporation will enter into a transaction in which a director has a direct or indirect interest. This is known as a conflict of interest transaction. For example, if a director sells property that he owns to the corporation, this is a conflict of interest transaction. A corporation may wish to void such a transaction because the director’s financial interest may have affected his judgment in a manner adverse to the corporation.
Several states have special provisions dealing with conflict of interest transactions. Under these statutory provisions, a conflict of interest transaction will not be voidable by the corporation solely because a director had an interest if certain conditions were met such as the transaction being fair to the corporation, the material facts of the transaction, and the director's interest, being disclosed to the board of directors or the shareholders, and the board or the shareholders approving or ratifying the transaction.
A board of directors may create one or more committees and appoint members of the board to serve on them. These committees may exercise the powers of the board. However, by law, there are certain matters that the board must act upon itself and cannot delegate to committees. For example, in some states, directors’ committees cannot authorize dividends and other distributions, propose to shareholders’ actions that require their approval, fill vacancies on the board, or adopt, amend, or repeal bylaws. The corporation may further restrict the powers of directors’ committees in its articles or bylaws.
Common committees include audit committees (which select the corporation’s auditor and discuss the corporation’s financial performance with management), compensation committees (which review compensation and benefit levels), and nominating committees (which make recommendations with respect to senior management and board positions).
The officers of a corporation are the agents through which the board of directors acts. The board makes the decisions and designates the officers to execute them.
As a rule, the duties of each officer are set forth in the bylaws or, to the extent consistent with the bylaws, are prescribed by the board of directors. Usually, the bylaws will provide for several corporate officers. The most common are the president, vice president, secretary and treasurer. The president usually makes decisions of corporate policy and operations. The vice president assumes the president’s functions in his or her absence. A vice president will also often be responsible for running part of the corporation’s business or operations.
The secretary makes and keeps the corporate books and records. This includes keeping the records of directors’ and shareholders’ meetings and the corporation’s stock record book. The secretary also has the authority to send out notices of corporate meetings and to keep a register of the names and addresses of the shareholders. The secretary also keeps the corporate seal if there is one. Some states provide that the offices of president and secretary cannot be occupied by the same person. The treasurer receives and keeps the corporation’s money and is responsible for taxes, financial reports, etc.
Corporate officers—like directors—must discharge their duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner they reasonably believe to be in the best interests of the corporation. Officers also owe duties of fidelity, honesty, good faith, and fair dealing to the corporation. An officer will not be liable for any action taken as an officer, or any failure to take any action, if the officer performed his or her duties in compliance with these standards.
Liability under federal securities laws
Corporate officers and directors may also be subject to liability for violations of the extensive anti-fraud and disclosure requirements of the federal securities laws—particularly the Securities Act of 1933 and the Securities Exchange Act of 1934.
Corporate directors and officers may be sued for actions they took during the course of their employment. Indemnification provides financial protection by the corporation for those directors and officers against the expenses and liabilities they incurred because of those lawsuits.
Every state has a statutory provision providing for indemnification. In addition, a corporation may have a provision in its articles of incorporation or bylaws establishing the scope of the indemnification it will provide to its personnel.
The statutory provisions typically require a corporation to indemnify directors or officers who were wholly successful in defending themselves. Voluntary indemnification may be made if the corporation determines that the directors or officers acted in good faith and reasonably believed that their conduct was in the best interests of the corporation. However, indemnification may not be made to directors or officers who were found to be liable in a suit brought by or on behalf of the corporation, or who were found to have received an improper personal benefit as a result of their conduct.
The statutes also generally provide that a corporation may make advances for expenses incurred by a director or officer before the proceeding is completed and may purchase insurance on a director or officer's behalf against any liability regardless of whether the corporation would have the power to indemnify him or her.