I’ve got three scenarios that I want you to think about. The first involves a purchaser who is about to lose his loan commitment, and the board, although it has interviewed the purchaser and reviewed the application and everything looks fine, is not able to get a meeting together to approve the purchaser. What do you do?
The second scenario finds a board that has decided that it’s going to embark on a large capital-improvement project, and there’s a lot of technical data that needs to be reviewed and analyzed. A decision needs to be made as to which contractor is best for the job, and which deal is best for the building.
In the third scenario, the board gets a letter from a shareholder claiming the president and the treasurer are stealing money and demanding that the board make efforts to get the money back on behalf of the corporation.
In each one of these situations, the right answer to the question is: a committee. In the first, where you need to take action and you can’t get the board together, you can have a committee that has the authority to act between meetings of the board in the same manner as the board.
There are a few important things to understand about committees. The first is that we’re talking about committees as authorized by the Business Corporation Law. That means committees must be made up of members of the board. You can have outsiders who participate in decision-making at your corporation, but they can’t have voting power. If you want to give the committee the authority to take action that the board can take, it has to be a committee comprised solely of directors.
That would be something that you want anyway, because you have directors and officers liability insurance to protect the decisions that are made by the board. If a mistake is made, the insurance protects the corporation against that mistake and any lawsuits that might follow. The authorization to create a committee must appear in either the certificate of incorporation or in the bylaws. The creation of the committee must be done by a majority vote of all the board members.
If you had an executive committee in the first scenario, and you had authorized the committee to take action in the name of the board, it could approve that purchaser. The only problem is that you need the formal action. So a previously created committee that has the authority to do that would solve the problem and save the purchaser’s interest rate from going up because the loan commitment is expiring.
In the second scenario, that’s a different kind of committee, to my way of thinking. That’s a situation where you have this enormous project, and it’s very technical. You have some people on the board who really have the capacity to evaluate that stuff, and they’re willing to do it, and they put in the time and effort. And they come back to the board and make a recommendation: “This is good. This is bad. This is not what the contractor is saying. We think this is problematic.” They make a report to the board that the board then relies on in making a decision.
This ties into an important part of corporate law, which is that members of the board of directors are responsible for acting in the way that a reasonably prudent person would act in similar circumstances. That’s the duty of the director, and if a director fails to do that, the director can be held liable. That’s why you carry the directors and officers liability insurance.
In defining the duty of a director to act as a reasonably prudent person, the Business Corporation Law specifically provides that the members of the board are entitled to rely on people who they think have enough information and enough knowledge to provide a report that they can rely on. Even if the information is wrong, they’re not held personally responsible for failing to investigate it personally.
If you have a committee that you think is reasonably capable of doing this, and you give to them the responsibility for parsing the numbers, talking to the contractors, and they come back to the board and say, ‘We can do it, we think we should do this’ – and then, relying on that, the director votes for it. Even if it turns out to be a bad decision, the directors can’t be held liable for that, because they relied on a committee that they reasonably believed to have the capacity to provide the information. So that’s an important kind of a committee that has a special expertise or is willing to put in the time and effort.
For the third scenario, you get a letter from a shareholder saying the president and the treasurer are stealing money. Everybody knows this shareholder is a pain in the neck. There’s nothing really going on, but you have to respond, because if you fail to respond, the next step will be that the shareholder may bring a derivative action in the name of the corporation against the president and the treasurer, and then you have the problem of having to defend that lawsuit.
How do you get around this situation? The president and the treasurer have a personal interest in what is happening in this decision, so they can’t participate in the decision. Maybe there are enough people involved so that, after recusals, you can’t even establish a quorum of directors to make a decision. You can appoint a special committee that’s given special directions and authority to address the situation. In this case, it’s usually referred to as a litigation committee, and you pick directors who are not being accused of having done something wrong. They are set up as a committee, and their job is to investigate whether there is a basis for the claim being made. Look at the evidence, talk to the shareholder, see what else there is to reach a conclusion.
If they determine that there’s no basis for the corporation to take action against the president and the treasurer, that determination can be protected by the Business Judgment Rule – as long as it was made in good faith and within the authority of the committee to make that decision. If that aforementioned derivative action is brought, it can be now be dismissed because a business judgment was made that there was no basis for going after those two individuals. That’s a lot faster and less expensive than having to defend that lawsuit and prove that there is no basis to the claim.
In the end, there are a lot of circumstances in which committees can be useful, and boards that are familiar with the use and the creation of committees and are creative about using them can make life a lot easier – and also more closely follow the requirements of the Business Corporation Law.
Howard Schechter is a partner at Armstrong Teasdale.