Oftentimes when running a business much of the focus is centered on ensuring the success of the product, especially in the early stages of growth. Companies, understandably so, sometimes let certain corporate governance matters fall by the wayside or simply do not recognize the importance of maintaining and complying with corporate governance standards and, the potential implications for failing to do so. This article discusses the essentials of good corporate governance and why corporate governance is important to ensure continued success in the future.
What is Corporate Governance?
Corporate governance is a “system of rules, practices, and processes by which a [company] is directed and controlled.”[1] A business should establish and follow its procedures, both those required by law and specific to its own business, when making decisions regarding its business dealings and affairs. Many of these rules and procedures will be set out in the company’s by-laws or incorporating document, such as the articles of organization or the certificate of incorporation. These processes typically describe the method of conducting annual meetings of both shareholders and directors, as well as mechanisms for conducting these meetings, such as notice, the requirement of a quorum, and the option to utilize a written consent in lieu of a meeting. As described here in a Forbes article discussing the development of corporate governance to support growth, “[t]he purpose of corporate governance is to make sure your organization is held accountable in fulfilling its fiduciary duties – i.e., investors know they can trust you with their funds; customers know they can rely on you to provide worthwhile services, and your internal stakeholders can be confident that funds will be managed fairly and honestly.”[2] Maintaining a corporate minute book or file with accurate records and minutes, an up-to-date capitalization table, and any other important documents such as government licenses, permits, or transaction documents will make it easier for a company to take the next steps toward growth. As previously discussed, here, business owners should ensure they have asked themselves several important questions regarding their corporate governance procedures and necessary documents.
Below is an overview of several important facets of corporation governance and formalities, including what they are and why they matter.
Annual Meetings- Notice/Quorum
A corporation is required to have annual meetings of its shareholders, unless utilizing a written consent as discussed below. Under the laws of New York State, “meetings of shareholders may be held at such place, within or without this state, as may be fixed by or under the by-laws, or if not so fixed, at the office of the corporation.”[3] The shareholders are required to be notified of this meeting, unless they have previously waived the notice requirement. The notice must state the date, time, and place of the meeting.[4] This annual meeting must include the election of directors and “the transaction of other business on a date fixed by or under the by-laws.” [5] A quorum is required at the meeting of the shareholders. For the purposes of determining a quorum, the laws of New York require “the holders of a majority of the votes of shares entitled to vote thereat shall constitute a quorum at a meeting of shareholders for the transaction of any business. . .” [6] These requirements may differ depending on the state or on the specific bylaws or certificate of incorporation of the corporation. Please be sure to consult the appropriate documents of your corporation and the specific requirements for your state.
Typically, an annual meeting of the board of directors will follow the annual meeting of the shareholders. Regular meetings of the board do not require notice to the members; however, special meetings of the board do require notice and the specific bylaws of the corporation should describe what constitutes notice for these purposes.[7] At the annual meeting, the board of directors will be required to approve any actions to be taken by the corporation that are outside of the ordinary course of business. The board will also be required to appoint officers for the corporation. Some examples of these actions include, amending the incorporating document or the bylaws, entering certain corporate transactions, issuing additional shares of stock, and entering into important agreements that may have a significant impact on your business. A quorum is also required for the meeting of the directors before making any decisions. For the purposes of New York law, a majority of the entire board generally constitutes a quorum, but this can be changed in the bylaws.[8] Developing appropriate procedures for these annual or special meetings at the outset will help to ensure compliance with these requirements.
Unanimous Written Consent
Most states, including New York, provide that actions by both shareholders and the board of directors may be taken without a meeting through written consent. For shareholder actions, unless specified otherwise, this written consent must be signed by all the holders of outstanding shares entitled to vote and must describe the actions taken.[9] For the board of directors, unless specified otherwise in the certificate of incorporation or bylaws, action may also be taken without a meeting if all board members consent to adopting the resolution authorizing the action.[10] If a corporation decides not to conduct annual meetings, obtaining unanimous written consents in lieu of these meetings is an important aspect of corporate governance procedures.
Minutes
Whether it is an annual or special meeting of the shareholders or the board of directors, keeping accurate and current minutes of these meetings is crucial to provide a record of the decisions made during a specific meeting. These minutes should provide a written record of the individuals in attendance at the meeting, when the meeting occurred, and any items discussed or actions taken during the course of the meeting. Any unanimous written consent in lieu of a meeting should also be kept with the minutes of the corporation to reflect that no meeting occurred. If kept accurately, these minutes provide a meeting-by-meeting story of how the corporation came to its current situation. These minutes can be crucial in the course of due diligence by investors or if potential litigation arises for the corporation as they paint a picture of the corporation’s decisions and when they were made.
Piercing the Corporate Veil
Good corporate governance is a critical component of avoiding “piercing the corporate veil.” While courts generally have a strong presumption against piercing the corporate veil, this doctrine is important for business owners and founders to understand, especially those of closely-held corporations.[11] When starting a business, most founders form a separate legal entity, such as a corporation or a limited liability company to shield themselves from any potential liability stemming from actions taken or debts incurred on behalf of the entity. Thus, this entity is distinct and separate from its founders, managers, directors, or shareholders. However, courts will sometimes determine there is not a sufficient degree of separation between the individuals responsible for running the company and the corporate entity itself and, in turn, will impose liability on the shareholders and directors. A corporation’s failure to follow corporate formalities is one of the most common reasons a court will “pierce” the veil and impose liability on shareholders and directors.
Some relevant factors courts will consider when determining whether there is a lack of corporate formalities include: the failure to issue corporate stock; the failure to elect directors; the nonfunctioning of other officers or directors; the absence of meetings of directors and shareholders; the absence of corporate minutes and records and of corporate resolutions authorizing loans and other significant transactions; and the commingling of corporate and personal funds.[12] If a corporation is keeping up-to-date, accurate records many of these factors will likely not be applicable.
Why Corporate Governance Matters
The existence of corporate governance standards within a company will certainly be an important consideration for investors when deciding whether to make an investment in a company. Most investors will want to review the minutes and formation documents of the corporation in the course of due diligence and maintaining current and easily accessible records will help to avoid future hassle and potential loss of an investment opportunities. Good corporate governance policies and procedures also signify ethical business practices to your customers and interested third parties. It demonstrates a genuine concern for following procedures. Finally, certain information in minutes or records of a corporation may also be required when applying for a license or permit with a governmental agency or for a commercial loan, and maintaining corporate formalities will make this process much more efficient. Ensuring your business follows the corporate formalities discussed in this article will help to ensure you are prepared at any time for potential growth opportunities as they become available.
[1] “Corporate Governance,” Investopedia, https://www.investopedia.com/terms/c/corporategovernance.asp.
[2] Jonathan Herpy, “Six Ways to Develop a Governance Strategy that Supports Growth,” Forbes, (Nov. 6, 2020). https://www.forbes.com/sites/forbesbusinesscouncil/2020/11/06/six-ways-to-develop-a-governance-strategy-that-supports-growth/?sh=437bbad33054.
[3] New York State, Business Corporation Law § 602.
[11] See “Piercing the Corporate Veil”, Legal Information Institute, https://www.law.cornell.edu/wex/piercing_the_corporate_veil.
[12] Ronald J. Colombo, “Law of Corp. Offs. & Dirs.: Rights, Duties & Liabilities. § 21:9 (Oct. 2021).
"Ultimately, it comes down to stability and accountability. The purpose of corporate governance is to make sure your organization is held accountable in fulfilling its fiduciary duties"
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