By: Tempestt Watts

So, you’ve decided to form a Delaware corporation. Under Delaware law, a corporation must have a board of directors (consisting of at least one person). The board of directors is responsible for that corporation’s management and oversight. Given its importance and function, founders should 1) inform themselves of the board’s role and laws that govern the board’s behavior, and 2) carefully consider who will serve on the board.

 

The Board’s Role

 

Decisions about the operations of a business are made by officers and the board of directors. Officers, like the CEO, typically make decisions about the day-to-day operations of the business. In contrast, the board is responsible for making decisions about major corporate actions and the direction of the corporation. While there isn’t a comprehensive list, the following decisions will typically require the board’s approval:

  • amendments to the certificate of incorporation or bylaws;
  • equity grants or transfers;
  • distributions/dividends to stockholders;
  • borrowing or lending money;
  • adopting an annual budget;
  • hiring or terminating members of senior management (i.e., officers) or amending the terms of their employment;
  • a sale or other distribution of all or substantially all of the assets of the company;
  • mergers and acquisitions;
  • conversion to a different entity type (e.g., limited liability company, partnership);
  • a dissolution or winding up of the company; and
  • entering into any agreements that could be of material importance to the company (intellectual property licenses, vendor contracts, customer contracts, etc.).[1]

 

The board can act by adopting resolutions at meetings, which can be held in person or via video or telephone conferencing, or by written consent signed by all of the members of the board. However, a quorum must be present at a board meeting in order to conduct business. In Delaware, the default rule requires that at least a majority of the board be present in order to have a quorum.

 

After the certificate of incorporation is filed, the directors should meet to draft the corporation’s bylaws, which are the operating rules for a corporation.[2] Delaware law requires that a board have at least one director.[3] The number of directors must be included in the corporation’s certificate of incorporation or the bylaws. The bylaws should also include the following provisions relating to the board of directors:

  • the procedure for calling board meetings;
  • directors’ voting rights’;
  • the minimum number of directors who must be present at a board meeting to legally transact business (quorum);
  • the term for which the directors are elected; and
  • the process for filling board vacancies and removing directors.[4]

 

While Delaware law does address these issues, directors still have flexibility in determining the structure of the board. This means that the board can change as the startup’s needs change. For example, as a part of an agreement for venture capital funding, a board might modify the certificate of incorporation to allow the venture capital firm to appoint some of the board members. In many cases, Delaware’s laws are just the default rules that will apply if the governance documents do not contain alternative provisions. Directors should consult an attorney for assistance with drafting the company’s governance documents to ensure that they understand which rules are mandatory.

 

Fiduciary Duties

 

Directors occupy a position of great power within a corporation, and as a result, directors owe corporations and their shareholders certain duties as fiduciaries. A fiduciary is someone who has a legal obligation to act in a way that benefits the beneficiary.[5] Specifically, Delaware law requires that directors fulfill fiduciary duties of care and loyalty. A director who breaches his or her fiduciary duties can be sued by the corporation/its shareholders, resulting in a range of consequences such as dismissal and monetary liability.

 

The duty of care requires that directors act with reasonable competence. This means that board members must be reasonably informed about the business and the issues being discussed before making decisions. While this duty is demanding and should be taken seriously, Delaware law also recognizes that making decisions for a business involves risk. Alleged violations of the duty of care are typically reviewed using the business judgment rule. If a director is informed before making a decision and didn’t have a conflict of interest, he or she will likely not be found to have breached the duty of care, even if, in hindsight, the director made a bad decision. For example, shareholders sued Citigroup’s directors after the corporation lost billions of dollars when the subprime mortgage market crashed. However, a Delaware court, applying the business judgment rule, found that the directors had not breached their duty of care and would not be liable for the decision to transact in a risky market.[6] Additionally, Delaware allows corporations to put provisions in their charters that waive liability for monetary damages for directors that violate the duty of care.[7] Similarly, through indemnification or Directors’ & Officers’ insurance, a corporation may be able to reimburse directors for the legal fees and damages that result from a shareholder lawsuit.

 

The duty of loyalty requires directors to exercise their authority in a good faith attempt to advance the interests or purpose of the corporation. A director must put the corporation’s interests ahead of his or her own interests and may not use the company’s confidential information for personal gain. For example, if a director learns of a business opportunity through his position on the board of directors, he may not take the opportunity away from the corporation and pursue it himself. It’s much harder for a director to overcome an allegation that he or she breached the duty of loyalty. Delaware law does have some avenues for directors to overcome liability for the breach, which mainly focus on disclosure of the conflict of interest and majority approval from disinterested directors or shareholders, but the standard of review is much less director-friendly.

 

Composition of the Board

 

A board’s composition is just as important as its function. While owning a majority of the shares will give a founder some control over the business, particularly when there is a shareholder vote, it will not give the founder control over the board’s decisions. For example, the board would not need to consult the founder before issuing a dividend. In order to be involved in the board’s decisions, many founders also serve as a director on the board of their corporation. Additionally, founders may consider adding someone to the board who has experience in the industry or a skillset that the founders lack.[8] For example, if none of the founders have business experience, it is probably a good idea to appoint a director who can advise the board on the business aspects of its decisions.  Finally, founders should be careful not to create a board that is too large to be effective. A board should be small enough that it can still be accountable and act as a deliberative body. Many venture-backed companies have five directors, and an early stage company will require even fewer directors.[9] If it becomes necessary to add more directors to the board as the corporation, and the board’s responsibilities, grow, the board can do so by amending the certificate of incorporation or the bylaws.

 

Conclusion

 

Ultimately, the board of directors will play a significant role in shaping the future of a corporation. For startups, having an effective board is essential. Startups should consult an attorney to ensure they understand the board’s responsibilities and the legal requirements that govern its activity.

 

[1] https://www.cooleygo.com/decisions-need-approval-board-directors/

[2] 8 Del. C. 1953, § 108, http://delcode.delaware.gov/title8/c001/sc04/index.shtml

[3] 8 Del. C. 1953, § 141

[4] Constance E. Bagley & Craig E. Dauchy, The Entrepreneur’s Guide to Law and Strategy 439 (5th ed. 2017).

[5] https://www.law.cornell.edu/wex/fiduciary_duty

[6] In re Citigroup Inc. S’holder Derivative Litig., 964 A.2d 106 (Del. Ch. 2009).

[7] 8 Del. C. 1953, § 102(b)(7)

[8] https://techcrunch.com/2016/11/05/what-you-need-to-know-about-startup-boards/

[9] https://gust.com/launch/blog/startup-board-of-directors