Corporate Governance and Change

A Quick Review Of Basics

By: Saul Winsten,General Counsel
The Winsten Group.Trusted Counsel LLC.
A national Legal, Business, and Corporate Affairs firm
thewinstengroup.com

What is “Governance”?

Governance has been defined in different ways. For our purposes, corporate governance may be understood to mean the system, processes and relationships by which a corporation is controlled and directed. Boards of Directors are responsible ultimately for governance, the control and direction of the corporation they serve.
For brevity our discussion will focus on this topic as applied to closely-held and family-owned business corporations.

What has changed?

With ever increasing market competition, and pace and magnitude of technological change, the challenges encountered by closely-held and family-owned businesses and their Boards have grown. The traditional or legacy structures for governance, or legacy leadership may no longer be appropriate. New governance structure, processes, and leaders may be called for.

Questions concerning governance often include questions concerning the role and responsibilities of the Board, and how governance may be evolving in response to change. Below is a quick review of basic principles, and of some increasingly common business adaptations to change.

Basic Principles:

The Role and Responsibilities of Boards

Board responsibilities are separate from those of management. Boards are not to manage the business; executive management has that responsibility. The Board’s role and its responsibilities include:

1.To advise and consult with management on corporate strategy, operational performance & effectiveness, key performance metrics, executive performance and compensation, risk management, and growth and change matters
2.To provide oversight of and approve corporate strategy and strategic plans, major
acquisitions and divestitures, management and business performance, strategic matters,
company resource planning and needs, legal compliance, protection of assets, budget and
significant financing, mergers, and corporate reorganizations
3.To plan for executive and Board succession, select new executives, and
recommend new Board members

Board Requirements

Boards and Board members must act solely in and for the interest of the corporation. Board members should be qualified to carry out Board responsibilities, be informed and knowledgeable of matters that may come before the Board, exercise prudent business judgement, and act free from conflicts of interest that compromise such action and judgement.

Fiduciary Duties

Boards of Directors and individual Board Members have “Fiduciary Duties”, to act prudently, in and for the interest of the business and shareholders, with care, honesty, prudence, and in good faith.

The primary fiduciary duties have been referred to as “Duty of Care”, and “Duty of Loyalty”. Some courts and securities regulation also refer to a “Duty of Candor” or “Duty of Disclosure”. Various courts have identified and discussed specific aspects of these duties.

The “Duty of Care” requires Board members act with knowledge of the pertinent facts and circumstances, with care, after due consideration of all relevant information.

The “Duty of Loyalty” requires Board members act in the best interests of the corporation and shareholders, and to ensure that actions are taken in good faith.

“Good Faith” has been defined by Black’s Law Dictionary as requiring Board members act with “(1) honesty in belief or purpose, (2) faithfulness to one’s duty or obligation, (3) observance of reasonable commercial standards of fair dealing in a given trade or business, (4) absence of intent to defraud or to seek unconscionable advantage”.

Liability for Breach of Fiduciary Duties

Boards and individual Directors have been found liable for breach of their fiduciary duties.

Defense to Claim of Breach of Fiduciary Duties

A defense to an action against a Board for Board action is sometimes called “the business judgement rule”. Under that rule, a court generally will not “second guess” a Board decision if the Board: (i) followed a reasonable and informed process; (ii) took into account all relevant facts and circumstances; and (iii) made its decision” in good faith”.

Adaptations to Change
These include but are not limited to:

Enhanced Board “on-boarding” and education

To properly prepare new Board members for joining the Board and carrying out Board responsibilities, businesses and organizations are paying increasing attention to proper orientation, introduction and education of Board members. The need for such action increases with the size of the organization, complexity of the organization and its activities, demands of shareholders and stakeholders, and the nature and complexity of risks to which the organization is subject.

Use of Board Committees:

As the quantity and complexity of matters that Boards are to act upon have increased, the use of committees and the need for enhanced committee and Board expertise has increased.

Some matters, particularly complex matters requiring special expertise, are increasingly delegated to committees of the Board, which in turn make recommendations for Board deliberation and action. Committees such as Compensation, Audit, Governance, and Nominating, among others, are common.
Many Boards have an Executive Committee of corporate officers, who are tasked with developing recommendations on policy and other matters for Board action.

Matters requiring special expertise may be delegated to a committee which includes members with that special expertise.

An example of a committee tasked with matters requiring special expertise is the Audit Committee. This committee is charged with developing recommendations concerning matters concerning accounting policies, financial reporting, and other audit related matters. It is responsible for oversight of the independent auditor, internal financial control policies, financial risk management policies, and the performance of the internal audit function.

Another example is the Nominating and/or Governance Committee where identification of desired qualified candidates for Board service, selection of nominees for Board positions, governance standards and processes, Board and CEO evaluation may be discussed and recommendations made.

Other committees requiring specialized knowledge may be used by a business’ Board. These include Cybersecurity, Technology, Legal, Finance, Strategic Planning, M&A, HR, Ethics/Corporate Responsibility, and Environmental Committees, for example.

Addition of Independent and Specially Qualified Directors:

Another response increasingly used by Boards of closely held businesses, including family-owned or managed businesses, is the addition “Independent Directors” to their Boards. These Independent Directors assist the Board in carrying out its responsibilities by bringing independent thought, needed specialized expertise, and special perspective to those Boards. Examples of the knowledge and expertise sought and retained for Independent Directors include proven industry and outside business leadership, legal, finance, technology, cybersecurity, and other specialized expertise.
Some courts, notably Delaware, have addressed the issue of what makes a Board member “independent”.

Use of Board Counsel

Some larger businesses and organizations have retained special Board Counsel to provide independent advice and guidance on Board and governance matters of special concern. Board Counsel have been found especially useful where perspective, guidance, and advice independent of Board or executive leadership relationships, is desired.

Conclusion

Governance changes are driven by a number of factors. Growth, market competition, disruptive technology, regulatory requirements, and succession generated dynamics for example, may compel a company to change the way it does business, manages risk, and the way it is governed.
Businesses and organizations that will succeed are those prepared for change.