An early stage company, once incorporated, is required to have a board of directors. The role of the board is to protect the shareholders of the corporation. In the case of a newly formed company, the investors are often the same people as the founders and are also the members of the board. However, once a company starts to grow and take on outside investors, the composition of the board will start to change, as the investors will ask for a seat on the board and will require that certain decisions not be made without approval of the board (board management rights/veto at rights will be the topic of a future article).
The rules and formalities of organizing a board of directors are set out: (1) in the by-laws of the company; (2) in the company shareholders’ agreement, and, (3) in the corporate statute (the Ontario Business Corporations Act or Canada Business Corporations Act for Ontario and Federally incorporated companies, respectively). Each of these sets of rules should be complementary, however, it is useful if one of the sets of rules specifies which rules to adhere to in the event of a conflict.
Board formalities include the following matters:
Part One: Electing Directors1. Nomination: Often if a company is growing and investors decide to invest in a company, both investors and company founders will want the right to nominate certain board members. For example, an investor might require they have the right to nominate a single board member, the founders have the right to nominate a single board member, and both have the right to jointly nominate an independent board member who may or may not hold shares in the company. This is useful for making sure that decisions are well thought out and the interests of the founders, investors and the company (through the independent board member) are all attended to.
The right of nomination often requires a minimum threshold of share ownership, so for example, if the ownership of the founders falls below a certain threshold, or the ownership of the major investor falls below a certain threshold then their rules of nomination may fall away.
- Election of directors: Shareholders have the ultimate right to elect or remove members of the board, who are then entrusted to run the company. Although the investors may have nomination rights, the nomination is a two-step process, i.e. first, board members are nominated and second, they are elected. The shareholders will have the final say regarding election of such board members. Rights of nomination should therefore correspond with a requirement that the shareholders elect board members in accordance with the nomination requirements.
- Timing of election (and time limits): The rules for election of board members may also set out a time limit for board member tenure (for example, a board member has a one year tenure and needs to be re-elected at the end of that year). This may be a useful feature to avoid the awkwardness of calling a meeting to remove a director, instead, an annual election would force consideration of board contribution and fitness to serve on the board on a periodic basis.
Part Two: Organizing meetings
Once board members are appointed, it is important to understand the rules for organizing meetings and recording decisions. This article provide a very high level explanation of these points.
- Proper Notice of meetings: The corporate by-laws will generally set out the number of days (both minimum and maximum) before a meeting. For example, by-laws may specify a meeting cannot be called without the provision of 14 days notice. This ensures a board member will not be surprised by a board meeting. This advance notice is important because if things get tense at a company, a board meeting may need to be called to terminate an employee, or terminate or remove a director. It is also a requirement that an agenda be provided in advance to prevent “blindsides.” A board member will want to know and receive plenty of notice of meetings so there is no surprise meeting which they are unable to attend.
- Quorum (minimum number of directors required to attend): rules regarding quorum can be very simple (e.g. attendance of a majority of the directors – so if there are five directors, three are required to attend), or, they can be much more detailed. For example a major investor may require that quorum be never achieved unless the investor him/herself is in attendance at the meetings (e.g. so if 3 are required to attend, at least 1 must be a nominee of the major investor). If quorum is not achieved, by-laws or rules for calling a meetings may allow that a second meeting be called in a certain number of days and that the quorum threshold is reduced.
- Recording approval of board decisions. (a) By recording minutes: “Minutes” (usually written notes) of a board meeting record who is in attendance, the agenda of matters before the board, the decisions proposed to the board, and the vote of the board with respect to those decisions. Minutes of a meeting are circulated post-meeting and are usually approved at the following meeting as the first item on the agenda.
(b) By written resolution: Often board members are not able to meet in person, however decisions will still need to be made. Director by-laws will often specify that approval may be made by written resolution (so a document signed by the board members). This document often needs to be signed by all board members, rather than just a simple majority. The rationale is that if there is no opportunity for discussion and debate, then all directors should unanimously agree in writing. In some cases, to ensure that decisions are expedited, the by-laws will require that only approval from nominees of certain investors be required for a board decision to be approved in writing.