Every corporate board can be comprised of both inside and outside directors. An inside director is a member of the company’s management team or a stakeholder in the business. An outside director is neither an employee nor a stakeholder.
An independent director is typically a lender requirement, while an indebtedness is outstanding, to have an appointed board member to protect against voluntary bankruptcy petition being filed by shareholders, members, partners, directors or managers (as applicable) of an otherwise solvent Special Purpose Entity. Independent directors are considered outside directors and are also known as independent members/managers, springing members/managers, or special members.
What does an independent director do?
Independent directors have a very limited role. Their duties & responsibilities are outlined in the entity’s corporate documents and are usually limited to voting on matters considered “material actions” such as voluntary bankruptcy petition, dissolution or selling of a property. Independent Directors have the duty to consider only the interests of the Company, including their respective creditors, in acting or otherwise voting on the matters. To ensure their independent decision-making, they are not affiliated with the entity, its management, shareholders, or other stakeholders.
In this article, we explore the role of independent directors, when they’re required, and how to choose an independent director for your company.
Key takeaways
- Role and importance: Independent directors are required to fulfill the lender requirement on a special purpose entity.
- Legal framework: Independence is not permanent; certain relationships or circumstances can disqualify an independent director from specific decisions.
- When required: Independent directors are beneficial or required in scenarios like bankruptcy remote entities, and LLC springing members.
The limits and legal framework of director independence
Independence is not a permanent or one-size-fits-all status. Certain relationships or circumstances can disqualify an otherwise independent director from being involved in specific decisions.
State laws can affect director independence. Delaware law, for example, aims to keep directors free from conflicts during specific board decisions. Much of Delaware’s law on director independence has been developed through court cases involving insiders or major shareholders where approval from outside independent directors is necessary.
These situations put directors under significant scrutiny. Regardless of their good intentions, if directors ignore the rules on independence, they may face challenges from lawsuits claiming they are compromised. They could also be held personally responsible if found to have violated their duties as board members.
When is an independent director required?
There are several scenarios where it’s beneficial or required for a company’s board of directors to include independent directors:
Bankruptcy remote entity
During major business deals like joint ventures, structure financing, commercial real estate transactions, securitizations, and complicated credit agreements, lenders often ask corporate borrowers to use “special purpose vehicles” or SPVs (also called “special purpose entities” or SPEs”). SPVs are designed to be “bankruptcy remote,” meaning they shield assets if the parent company goes bankrupt.
To provide extra protection in these high-value deals, lenders usually require that at least one board member of the SPV have no connections or interests in the parent company. These “independent directors” can use their veto power during votes and act as a safeguard against a healthy company's board filing for bankruptcy.
Note: An SPV cannot be rendered "bankruptcy proof," as it cannot be barred from exercising its right to file for bankruptcy. Lenders typically require the appointment of an independent director or manager to ensure that there is an individual involved who has no vested interest in the SPV, the borrower, or their affiliates. This person's role is to assess the circumstances and make decisions that are free from conflicts of interest when their vote or consent is needed.
LLC springing member
A springing member is designated solely to ensure that an LLC always has at least one member. This individual only becomes a member if and when the last existing member withdraws or ceases to be a member.
Any LLC can name a springing member in its operating agreement. While this is especially useful for single-member LLCs, multi-member LLCs may also want to consider this option to avoid dissolution if they lose members and end up with just one.
Springing members are often found in LLCs that exist just to hold assets for securing large loans. Lenders sometimes require borrowers to create an LLC and put the assets securing the loan into it.
In cases where lenders require the borrower to have independent directors, these directors often step in as the springing member.
How to choose an independent director
A professional corporate service provider specializing in independent director services can help your company identify and appoint a qualified independent director. When making your selection, consider the following key characteristics:
- Response time: Regardless of the number of entities your company holds, any service provider should be able to provide an independent director or manager on short notice and promptly replace an individual who can no longer serve in the role.
- Trustworthiness: Consider the provider’s tenure in delivering independent director services. Look for a provider with experience and a reputation for service excellence.
- Experienced personnel: Not all independent directors possess the same skills and capabilities. Partner with a provider who has personnel experienced in handling bankruptcies. Here are key points to evaluate:
- Access to legal support: Does the corporate service provider offer access to in-house or dedicated legal counsel who can advise independent directors and managers ahead of critical votes? Legal guidance ensures the director is fully informed of their duties and material facts. This is important in the event their vote is contested.
- Comprehensive service offering: Assess the provider’s full range of services. Can they also serve as a process agent? Given that most structured finance transactions involve many contracts and loan agreements, having a provider that can act as Agent for Process across these agreements adds efficiency and reduces complexity.
Conclusion
Independent directors and managers play an important role in large financial transactions. Selecting the right individuals for these roles is key to risk mitigation.
CT Corporation’s Independent Director Services help you advance your projects without delays. For more than 30 years, we’ve earned the trust of clients who rely on our team of Independent Directors and their breadth of knowledge to navigate through the often-complex requirements of even the most demanding lenders and rating agencies. CT Corporation’s Independent Directors are a team of highly qualified professionals and long-standing employees. They meet and exceed all lender and rating agency requirements.
To learn more, contact a CT Corporation specialist today.
