Corporate Governance: The Legal Obligation of the Board of Directors

Introduction

The board of directors serves as the governing entity of the association, entrusted with the ultimate oversight of the organization's management. The board is accountable for formulating policies, while employees (and, to some extent, officers) are tasked with carrying out the day-to-day operations to execute the policies established by the board. Nevertheless, the board bears the ultimate legal liability for the actions (and lack thereof) of the association.

The board can act in accordance with the law only through consensus (majority vote of a quorum in most cases) and solely during a duly convened and conducted meeting or by unanimous written consent (in most states, boards are not permitted to act via mail, fax, or electronic ballot).

Delegation

The board may delegate authority to act on its behalf to others, such as committees, but in such cases, the board is still legally responsible for any actions taken by the committees or persons to whom it delegates authority. An individual board member has no individual management authority simply by virtue of being a member of the board.

However, the board may delegate additional authority to a board member, such as when it appoints board members to committees. Similarly, an officer holds only the management authority explicitly assigned in the bylaws or by the board, although the delegated authority can be general and broad.

Members

Members have no management authority, as such authority is held by the board of directors. However, state nonprofit corporation laws generally reserve to members the right to remove officers and directors and to amend the association's articles of incorporation, among other rights.

Under some associations' bylaws, certain matters, such as the amendment of the bylaws or the election of officers and directors, must be submitted to the membership for a vote. However, most other matters generally are not submitted to the full membership, but rather are handled by the board, one or more of its committees, or the officers or employees of the association.

Legal Obligations

• Duty of Oversight

To be proactive in ensuring you have the full and necessary information, including adequate internal control systems of the organization

• Fiduciary Duty

Individuals holding positions of responsibility and authority within the governing framework of an association, including both unpaid volunteers and paid staff, bear a fiduciary obligation to the organization. Succinctly put, this implies they are obligated to act reasonably, cautiously, and in the utmost interests of the organization, to refrain from negligence and fraudulent activities, and to avoid conflicts of interest.

• Duty of Care

This duty is broad, requiring officers and directors to exercise ordinary and reasonable care in the performance of their duties, exhibiting honesty and good faith. Officers and directors must act in a manner that they believe to be in the best interests of the association, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.

The "business judgment rule" protects officers and directors from personal liability for actions made in poor judgment as long as there is a reasonable basis to indicate that the action was undertaken with due care and in good faith.

• Duty of Loyalty

This is a duty of faithfulness to the association. This means that officers and directors must give undivided allegiance to the association when making decisions affecting the association. In other words, officers and directors cannot put personal interests above the interests of the association. Personal interests may include outside business, professional, or financial interests; interests arising from involvement in other organizations; and interests of family members, among others.

Officers and directors should be careful to disclose even potential conflicts of interest to the board of directors and should recuse themselves from deliberation and voting on matters in which they have personal interests.

• Duty of Obedience

This duty requires officers and directors to act in accordance with the organization's articles of incorporation, bylaws, and other governing documents, as well as all applicable laws and regulations.

• Reliance on Experts

Unless an officer or director has knowledge that makes reliance unwarranted, an officer or director, in performing his or her duties to the organization, may rely on written or oral information, opinions, reports, or statements prepared or presented by:

Officers or employees of the association whom the officer or director believes in good faith to be reliable and competent in the matters presented.

• Willful Ignorance and Intentional Wrongdoing

Directors cannot remain willfully ignorant of the affairs of the association. A director appointed as treasurer, for example, with limited knowledge of finance, cannot simply rely on the representations and reports of staff or auditors that "all is well" with the association's finances

Reducing Personal Liability Risk

Association officers and directors can help minimize their risk of personal liability by doing the following:

• Being thoroughly and completely prepared before making decisions.

• Becoming actively involved in deliberations during board meetings, commenting as appropriate, and making inquiries and asking questions where prudent and when such a need is indicated by the circumstances.

• Making decisions deliberately and without undue haste or pressure.

• Insisting that meeting minutes accurately reflect the vote counts (including dissenting votes and abstentions) on actions taken at meetings.

• Requesting that legal consultation be sought on any matter that has unclear legal ramifications.

Apparent Authority

In the landmark 1982 case American Society of Mechanical Engineers v. Hydrolevel, the U.S. Supreme Court determined that an association can be held liable for the actions of its officers, directors, and other volunteers (including actions that bind the association financially), even when the association does not know about, approve of, or benefit from those actions, as long as the volunteer reasonably appears to outsiders to be acting with the association's approval (i.e., with its "apparent authority").

Directors’ Business Judgments

The director must maintain the confidentiality of board deliberations and decisions. Many matters that come before the board are confidential and must remain so

Enhanced Legal Framework in Corporate Governance

In the context of the legal duties imposed on board members by U.S. law, the duty of loyalty requires faithfulness; a board member must give undivided allegiance when making decisions affecting the organization. This principle is central to corporate governance legal frameworks and is enforced through various statutes and case laws.

The Sarbanes-Oxley Act exemplifies legal corporate governance by mandating strict compliance and transparency in financial reporting, thereby reinforcing the legal obligations of the board of directors in corporate governance. Non-compliance can lead to significant penalties, highlighting the importance of adhering to corporate governance law.

Additionally, the Delaware General Corporation Law (DGCL) provides a comprehensive structure for corporate governance legal issues, particularly emphasizing the role of the board of directors in corporate governance. The DGCL outlines the legal requirements for the board of directors, ensuring that their actions align with the best interests of the corporation and its stakeholders.

Understanding these legal obligations is crucial for directors to navigate the complexities of corporate governance obligations and to mitigate risks associated with corporate board litigation. By adhering to these legal standards, directors uphold the integrity and accountability essential to effective corporate governance.

Conclusion

What are examples of ways directors can meet their fiduciary standards for the duty of oversight? Directors should monitor the General Manager or the Chief Executive Officer through recruitment, evaluation, retention, and compensation decisions. Where applicable, directors should make use of third parties for employees to report possible dishonest or illegal activities that might be occurring, and have a formal whistleblowing policy in place.

Risk committees within the board are sometimes used to monitor the overall risk faced by the company because of transactions undertaken by management. Directors should ensure that the company has a certified audit and interview auditors to make a choice suitable for their company. Understanding the nature of the company’s internal control process is a necessary duty for the directors.