Corporations, Module IV: Authorization, Lesson 2: Board Action
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The document discusses how corporate lawyers determine whether a corporate transaction is authorized. It explains that lawyers conduct "due diligence" by reviewing documents like board minutes, resolutions, bylaws and statutes. These provide evidence of proper authorization through things like board meetings with sufficient notice, quorums and voting. The "meeting rule" generally requires board action at official meetings, though there are exceptions. A hypothetical examines whether a guarantee from one company to another was properly authorized based on the bylaws, board consent and secretary's certification provided.
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Corporations, Module IV: Authorization, Lesson 2: Board Action
- 1. CORPORATIONS MODULE IV: AUTHORIZATION LESSON 2: BOARD ACTION Professor Seth C. Oranburg Duquesne University School of Law Spring 2020
- 2. Learning Outcomes ■ Understand why lawyers need to evaluate whether a corporate transaction is authorized ■ Explain how lawyers ascertain authorized through “due diligence” ■ Perform a basic analysis of authorization for a hypothetical transaction ■ Explain the “meeting rule” and apply it to “due diligence” of ascertaining authority
- 3. How Do Corporate Lawyers Ascertain Authority? ■“Due Diligence” –Review board minutes, resolutions, bylaws, contracts, filings, statutes, and the certificate of incorporation
- 4. Common Situations Requiring Ascertainment of Authority ■You represent Company whose Investor request a letter opining that the Company is authorized to sell stock ■You represent Buyer whose wants to enter into a large asset purchase agreement with Seller’s agent
- 5. Evidence of Authority ■What lengths must lawyers for outside party go to investigate corporate authority? ■What evidence is sufficient? ■Who is the outside party really protecting?
- 6. Evidence of Authority ■ Board Resolutions ■ Bylaws ■ Certificate of Incorporation ■ Statutory Law
- 7. Hypo 8.1a ■ You represent Home Supplies, Inc. ■ Home Supplies is negotiating a contract with Construx, Inc (a large construction company) to build a new warehouse for Home Supplies. ■ Home Supplies is worried about Construx’s finances and asks for a guarantee. ■ Construx says its equipment supplier - Big Machines, Inc. - will provide one
- 8. Hypo 8.1b GUARENTEE Big Machines, Inc., duly incorporated under the laws of the State of Delaware, guarantees the obligations of Construx Inc in the construction contract to be entered into with Home Supplies, Inc. - up to $10 million. Big Machines, Inc. George Kraft By: George Kraft Vice President / Treasurer
- 9. Hypo 8.1c BYLAWS of BIG MACHINES INC. Article 9: The Treasurer or Assistant Treasurer shall have the custody of all the funds and securities of the Company, and shall have power on behalf of the Company to sign checks, notes, drafts, bills of exchange and other evidences of indebtedness, to borrow money for the current needs of the business.
- 10. Hypo 8.1d BOARD CONSENT of BIG MACHINES, INC. After due notice of the matter, the undersigned directors of Big Machines, Inc., constituting a majority of the board, considered and approved in writing the following: RESOLVED, that the board of directors authorizes George Kraft, Vice President & Treasurer of the Company, to guarantee construction contract of Construx Corp. up to $10 million. Robert Able Ramona Best Richard Corn Royce Dupree Date: November 1, 2018
- 11. Hypo 8.1e BIG MACHINES, INC. I am secretary of Big Machines Inc, and the attached minutes are a true and complete copy of the minutes of the meeting of November 1, 2018 of the Corporation's board of directors. Sincerely yours, Humble Bumble By: Humble Bumble, Secretary MINUTES At a special meeting for which notice was waived and at which a quorum of directors was present (three by Skype connection), the board unanimously resolved: RESOLVED, that the board authorizes Charles Kraft, Vice President & Treasurer of the Company, to guarantee the construction contract between Construx Inc and Home Supplies, Inc. (dated November 1, 2018) up to $10 million.
- 12. Sources of Corporate Authority ■ Provisions of the statutory law ■ Articles of incorporation ■ Bylaws ■ Board of directors resolutions (including the minutes and a secretary’s certificate) ■ Evidence that the officer has done the same thing before and the corporation approved or ratified those actions
- 13. Formalities of Board Action ■The “Meeting Rule” ■One director = one vote ■No proxies –But telephonic meetings allowed
- 15. Notice ■ Regular meetings (ones on the corporate calendar) do not special require notice ■ Special meetings generally require 48-72 hours notice; the bylaws will specify – Action taken a meeting without due notice is invalid ■ Notice can be waived
- 16. Quorum ■Quorum is the minimum number or percent of directors required to take an action ■Unless bylaws specify otherwise a quorum is a majority of directors ■Action taken in absence of a quorum is invalid
- 17. Voting ■One director, one vote ■Unless bylaws specifically provide, a vote is decided by a majority of directors present
- 18. Exceptions to the Meeting Rule ■Close corporations ■Unanimous director approval ■Unanimous shareholder approval ■Emergency
- 19. Board Committees ■Boards can create committees that are authorized to handle specific tasks ■Some of these committees are requires of public companies by NYSE and NASDAQ listing requirements
- 20. Common Board Committees ■ Executive ■ Audit ■ Finance ■ Nomination ■ Compensation
- 21. Summary ■ The authority of officers to bind a corporation is based on agency principles ■ Lawyers determine whether an action is authorized through a process of “due diligence” ■ Generally, the board only has authority to act when at a meeting (the “meeting rule”), although there are specific exceptions
Editor's Notes
- Answer: Generally, counsel representing a party to an important transaction will demand persuasive evidence that the agents claiming to act with authority for the corporation have such authority.
- Where can corporate attorneys find evidence of authority? Board Resolutions Statutory Law Certificate of Incorporation Bylaws Evidence that the corporation has permitted the officer to represent it in similar situations and since recognized, approved or ratified those actions Question: How can third parties know the evidence they have obtained is authentic? Answer: Generally, third parties seeking to ascertain authority can have the secretary of the corporation (or other bookkeeper) certify the documentation. This saves third parties the hassle of conferring personally with directors to confirm that they have authorized the officer to act. Let’s try out some hypos to see how this works in practice — and how you would be assessed on your ability to do this on the exam.
- How can you, as counsel to Home Supplies, Inc., know that Big Machines has authorized a guarantee Construx’s financial obligations? What questions might you ask? Q: Why is an equipment supplier giving a large financial guarantee? A: There seems to be no reason. What documents might you want to see? You should get the guarantee in writing, and investigate authority.
- You receive the above document. Is that enough? If not, what questions should you now ask? Is Big Machines for real? How can you find out? If it is a public company, it is easy enough to look at its SEC filings. If it is not, you may be able to check its incorporation status, Dunn & Bradstreet, phone book, etc. Is the guarantee for real? Is it an extraordinary transaction? If it is extraordinary, you must investigate further to determine whether the agent for Big Machines, George Kraft, has authority. What is the business purpose of guarantee for Big Machines? It is hard to understand why an equipment supplier would guarantee a construction contract. Why is Big Machines guaranteeing the obligations of another company, one that might be financially risky? Why is this guarantee coming from the vice president/treasurer? Is Kraft actually the vice president or the treasurer? Perhaps the treasurer gives the company’s financial guarantees? What if the corporate bylaws do not specifically mention guarantees? In short, your job is not done yet!
- You ask for more information, so Construx sends you the Bylaws of Big Machines, Inc., which include the following information about the authority of the treasurer. Question: Does the above grant actual express authority, implied actual authority, apparent authority, or inherent authority? Question: Is this enough to show authority? Are guarantees a type of “evidence of indebtedness”? Is this something usual for a company’s finance department? Answer: This is not enough. You need the minutes in which the board gives specific approval, especially since this transaction is hard to explain. Why the Finance Department? What are the business grounds? Question: Is Kraft really the treasurer? Is he really the vice-president? Answer: If Big Machines is a public company, this would be easy enough to find in SEC filings. If it is not a public company, state filings (annual reports) often include this information. Or you might go back to Dunn & Bradstreet and making a phone call to the company. You tell Construx that you are still not satisfied. Let’s see what they send next.
- Question: Is this enough? Answer: Now we are looking at action by the board – the situs of corporate power. We are getting closes to comfort that the guarantee is authorized. The document mentions Kraft, but it still may not be enough. Question: Does this signing constitute valid board action? Answer: There is no indication that the board met on this matter. Remember that board action must happen at a meeting, after due notice and proper quorum and majority vote of directors present. According to the meeting rule the board of directors must have met. Question: What purpose is the meeting rule serving here? Answer: The power of the board is collective. It is important for group discussion and dynamics. Shareholders delegate power to the board, not to individual directors. Question: Would this have worked if it were all directors giving written consent? Answer: Yes, under most modern statutes. Sometimes convenience and urgency trump the rationale for meeting rule. In short, you are still not satisfied. Without knowing that this was approved either at a duly noticed meeting with a quorum, or by unanimous written consent, you still need further evidence of authority.
- Construx next forwards you this signed letter, with attachment. Is this enough? Q: Is it OK that notice of meeting was waived? A: Yes, probably. Notice of meetings can usually be waived. But you might want to check Big Machine’s bylaws to make sure this corporation’s directors are not expressly forbidden from waiving notice Q: Is it OK that the secretary simply said a quorum was present? A: Yes, probably. If you are really worried, or if this is a really major transaction, you would want to see addition evidence regarding the number of board members, and also to check the bylaws for the quorum requirements. Q: Is it OK that the meeting was held via Skype? A: Yes, probably. Skype (or any other means where all the members can hear and be heard by each other) is an acceptable means of attending the directors meeting — so long as the Certificate and the Bylaws do not provide otherwise. So, once again, you might check the bylaws for this. Q: Is it OK that this was done by a board vote and not by unanimous resolution? A: Yes, almost for sure. Almost all corporations are structured so that a majority of board members, at a meeting, can approve ordinary transactions. But, again, check the bylaws for any special voting rules! Q: Is it OK that the contract between Construx and Home Supplies is only mentioned, not attached? A: Yes, that is OK, although it would be better if the minutes said that the contract was provided to the board. Also, did you notice that that contract is dated the same date as the minutes? That is strange, because, we have not signed the contract with Construx yet. This raises a small concern. Q: Are there any other discrepancies or problems with this letter and minutes? A: There are at least two additional issues with the documents on their face: There is a discrepancy between first name of Kraft in the guarantee itself (George) and in the minutes (Charles). The resolution authorizes Kraft to guarantee the contract, not for Kraft to guarantee “on behalf of corporation.” For these reasons, it would have been better if you, counsel for Home Supplies, Inc., drafted the board resolutions that you needed to see to be comfortable and asked Big Machines to sign that! It could have saved a lot of back and forth… Q: Are you sure that Humble Bumble is indeed the Secretary of Big Machines, Inc.? Do you need someone to certify that the secretary’s certificate is indeed authentic? A: Now we are deep in the bee-watcher-watcher problem. The corporate authority rabbit hole goes almost infinitely deep. At some point — probably at this point, provided your lingering questions are answered — courts would probably find that Home Supplies, Inc. has done enough to be assured of authority. Now that you have seen how hard it is to ascertain corporate authority, does the doctrine of inherent authority start to make a little more sense?
- Question: How does the board of directors act? Answer: The directors have authority as a board, not individually. They act as a body. They have no authority to act except when assembled in a board meeting. This is called the “meeting rule.” Question: What does the “meeting rule” require? Answer: It requires that the board acts as a body and takes formal action by vote at a meeting. Each director gets one vote. No proxies.
- Regular meetings do not necessarily require notice. But special meetings do. Q: What happens is the company fails to notice a meeting? A: Actions taken at an improperly noticed meeting are invalid (unless a court later determines there was an emergency). However, notice can be waived. Q: How is notice waived? A: A director can sign a waiver before the meeting. In addition, if the director attends and participates in the meeting (beyond simply coming to complain about the lack of notice) it may constitute waiver. Q: What constitutes a quorum at a board of directors meeting? A: The statutory norm for a quorum is a majority of the directors, although a company’s bylaws or articles of incorporate may increase it above a majority, or decrease it to no fewer than a third of the directors. Q: What happens if a director leaves during a meeting? A: Quorum is broken if, at any time during a meeting, the number of directors required in the bylaws for a quorum is not present. This includes is someone goes to the bathroom, etc. Q: What happens if the board acts at a meeting without the required quorum? A: Action taken in the absence of a quorum is invalid. This cannot be waived. Q: Once a quorum is established, how many of the directors must vote for a measure for it to constitute board action? A: Generally, a majority of the directors present, although the bylaws can provide otherwise.
- Q: Can the board delegate its functions to committees? A: Yes. Corporate statutes allow boards to delegate responsibility for many functions to committees authorized to exercise the authority of the board. Q: What are some examples of common board committees? Executive Audit Finance Nomination Compensation The Dodd-Frank Act required financial companies to establish board risk committees.
- The authority to bind the corporation is based on agency authority “Actual authority” arises when the corporation (through its board) manifests to the agent express or implied consent to the agent binding the corporation “Apparent authority” arises when the corporation (through its board) acts so as to create a reasonable belief in the third party that the agent is authorized “Inherent authority” arises when social or commercial policies place on the principal (the corporation) the burden to be watchful of its agents The board acts only at meetings (the meeting rule) and all authority must come from action of the board Board meetings must be properly noticed; a quorum (typically board majority) must exist; the action must be approved by a majority of directors present Board resolutions, certified by the corporation’s secretary, constitute prima facie proof of board action – thus creating apparent authority Many board functions can be delegated to board committees, but some not (declare dividends, approve mergers) Legal opinions can be used to assure parties of corporate authority Outside counsel to corporation reviews documents and opines on authority of corporation and its agents Opinions can be “qualified” or “unqualified.” Legal analysis happens in “reasoned” opinions. Tthe meeting rule Board meetings must be properly noticed; a quorum (typically board majority) must exist; the action must be approved by a majority of directors present Board resolutions, certified by the corporation’s secretary, constitute prima facie proof of board action – thus creating apparent authority Many board functions can be delegated to board committees, but some not (declare dividends, approve mergers) Legal opinions can be used to assure parties of corporate authority o Outside counsel to corporation reviews documents and opines on authority of corporation and its agents o Opinions can be “qualified” or “unqualified.” Legal analysis happens in “reasoned” opinions.