Governance Issues: Fiduciary Duties, Manager v. Member Management & Other Power Sharing Considerations

BUSINESS LAW DUMBED DOWN Premiere Date: February 22, 2017

This webinar is sponsored by: EisnerAmper 1  

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MODERATOR Peter Feinberg Hoge Fenton

PANELISTS Alex Davie Riggs Davie PLC Jonathan Friedland Sugar Felsenthal Grais & Hammer Russell Silberglied Richards Layton & Finger

MEET THE FACULTY

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SERIES SPONSOR

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ABOUT THIS WEBINAR

Any business with more than one owner will face the issue of how it is to be governed.

If it is a corporation, how many directors should it have on its Board?  Should outsiders (that is, non-shareholders) be included?  Should certain actions require supermajority votes?

More generally, what are the majority’s fiduciary obligations to the minority?

This webinar discusses how companies can minimize the likelihood of disagreement in their articles, bylaws and shareholder agreements.  It also explores similarities and differences between corporations and LLCs, and delves into member management versus manager management.  This should be a fascinating and feisty hour which will help you understand how businesses are run.

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ABOUT THIS SERIES This webinar series holistically considers the dizzying array of choices and issues which individuals (and later, the entities which they have incorporated or organized) face in corporate and commercial law from the outset of the business until the termination of their interest in it.

This is done primarily by considering issues of entity choice and locale, capitalization and governance, common and important issues companies encounter when working with customers, suppliers and other commercial parties, and sales and other exits from business ownership.

This series will be helpful for those considering starting or purchasing a business for the first time as well as those who already own existing businesses or are looking to begin another business, in addition to those who advise them on legal, accounting, risk management and financial issues. Each episode is delivered in Plain English understandable to business owners and executives without much background in these areas. Yet, each episode is proven to be valuable to seasoned professionals.

As with all Financial Poise Webinars, each episode in the series brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. And, as with all Financial Poise Webinars, each episode in the series is designed to be viewed independently of the other episodes, so that participants will enhance their knowledge of this area whether they attend one, some, or all of the episodes.

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EPISODES IN THIS SERIES EPISODE #1 Formation Issues: Entity Choice; Entity Venue; 1/18/2017

Capitalization; Other Out-of-the-Gate Issues

EPISODE #2 Governance Issues: Fiduciary Duties, manager v. member management & 2/22/2017 Other Power Sharing Considerations

EPISODE #3 Common Deal Points: Commercially Reasonable v. Best Efforts, 4/5/2017 Liability Limiting Provisions & Other Commonly Recurring Negotiation Spots

EPISODE #4 Transition & Exit Planning and Executing a Sale & Other Exit Strategies 5/10/2017

Dates shown are premiere dates; all webinars will be available on demand after premiere date

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EXECUTIVE SUMMARY

•  Corporations are governed by their boards of directors, although as a practical matter, day-to-day management is exercised by their officers.

•  Shareholders* are the owners of the corporations, but other than certain major actions, typically have minimal say in how the corporation is run.

•  Much of the specifics of corporate governance is statutory, but laws can vary significantly from state to state.

•  The key documents for corporate governance are a corporation’s articles of incorporation, bylaws and shareholders agreement, if any.

* Different states use “stock” (both for the instrument and for its owner) rather than “share” and “certificate” relating to the document required for incorporation or organization rather than “articles”. Use of one term here should be deemed to include the other.

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EXECUTIVE SUMMARY (CON’T) •  Officers, directors, and in some cases, majority shareholders, owe a fiduciary duty, comprised of up to

five separate duties, to the corporation and its shareholders. While the principals are clear, how they are applied is often far from it.

•  While the scope of these duties is hazier in regard to LLCs, managers generally should be assumed to owe similar duties to non-managing members, absent express provisions so disclaiming (the enforceability of which may vary from state to state).

•  While some of these responsibilities are statutory, it generally behooves shareholders to consider how these responsibilities may be applied in regard to governance, employment, and the purchase and sale of their shares at the outset of the founding of the business of their involvement with it.

•  Aggrieved shareholders may have remedies such as inspection of corporation records, suing for involuntary dissolution of the enterprise, breach of fiduciary duty, recoupment wrongful payments or oppression of a minority shareholder in certain circumstances.

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CORPORATE GOVERNANCE, GENERALLY

•  Corporate governance is the system of rules under which the entity is directed and operated.

•  Corporate governance is generally the same for S corporations, which we discussed at length in the first episode of this series, as C corporations, except that S corporations can only have one class of shares and directors.

•  It’s also important to keep in mind that people may wear more than one hat (director, officer, shareholder and/or employee) and to be clear under which capacity the person in question is acting in each situation.

•  A company’s board of directors is the primary decision maker for the broad, general issues which the entity faces.

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CORPORATE GOVERNANCE, BOARD OF DIRECTORS

•  Corporations with one shareholder may generally have a board of directors with only one director, but once a company has more than one shareholder, there is significant variance from state to state how many directors it will be required to have.

•  Subject to the above, the number of directors a company has may be set out in its bylaws (and sometimes articles) or provided for by resolution as well as the term of the directors, whether voting for directors is to be staggered, the circumstances under which a director may be removed during his or her term, etc., all as may be subject to state statutory rules.

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CORPORATE GOVERNANCE, BOARD OF DIRECTORS (CON’T)

•  The directors of for profit corporations are voted in by a corporation’s shareholders. A corporation may require that its directors also be shareholders, and for privately held corporations this is typically the case even without a formal requirement, but this is generally not statutorily required.

•  The general rule is that each share of stock is counted equally in voting for directors, but companies may specify more than one class of shares in their certificate or articles of incorporation and may specify more than class of directors.

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CORPORATE GOVERNANCE, BOARD OF DIRECTORS (CON’T)

•  Directors act either through meetings, regularly scheduled or special, or through written consents.

•  Companies’ articles of incorporation may also specify that certain matters require a supermajority (that is, > than 50.1%) vote of its directors or require a majority vote of more than one class of directors for the action in question to be approved.

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CORPORATE GOVERNANCE, BOARD OF DIRECTORS (CON’T)

•  Boards may set up committees to assist with certain tasks, such as hiring or compensation. Boards may have non-voting members, and companies can have advisory boards, although it is relatively unusual for privately-held companies.

•  Among the most typical and important tasks for boards of directors are setting up executive compensation, approving material agreements, issuing authorized securities, setting strategic direction for the entity, approving budgets, audit committee, the appointment of officers and general oversight (Caremark function).

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CORPORATE GOVERNANCE, OFFICERS

•  A company’s officers serve at the pleasure of its board of directors. A term of service may be specified in an officer’s employment agreement but is rarely set forth statutorily or in a company’s governing documents.

•  The laws of the state in which a company is incorporated (and, perhaps, headquartered) will specify what officers all companies incorporated in that state must have, but a company’s organization documents will specify what officers it will have, if any, in addition to what is required.

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CORPORATE GOVERNANCE, OFFICERS (CON’T)

•  Typically, at a minimum, a company is required to have a president or chief executive officer and a secretary, which may or may not be required to be two different people. A chief financial officer or treasurer is often required as well.

•  Officers may also be shareholders of the company and/or directors of the company. A company’s organizational documents may require an officer to be a shareholder, or limit the director role of an officer.

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CORPORATE GOVERNANCE, OFFICERS (CON’T)

•  The officers are typically in charge of the day-to-day management of the company. These responsibilities include, without limitation, hiring and firing of non-executive employees, working with customers and suppliers, regulatory compliance.

•  A corporation may provide for other officers and their responsibilities in its organizational documents.

•  Corporate officers typically act individually, although companies may provide that certain acts or types of agreements require approval by more than one officer.

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CORPORATE GOVERNANCE, SHAREHOLDERS

•  Shareholders primarily have governance power, and only indirectly, in the companies in which they own equity by voting for directors (similar to representative democracy).

•  Ownership of a certain percentage of stock may entitle a shareholder to elect one or more directors. There is significant variance in this from state to state, and how this is calculated is beyond the scope of our program today. But for companies organizing initially or taking in new shareholders who will receive a material amount of shares, this should be a critical consideration for the company and majority shareholder(s).

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CORPORATE GOVERNANCE, SHAREHOLDERS (CON’T)

•  Key governance actions which might require shareholders’ votes include, without limitation, setting up stock option plans, authorizing additional shares, the merger of the company into another or acquisition of the company or its assets by another company, and amendment of a company’s certificate of incorporation.

•  Like directors, shareholders act through either meetings, either regularly scheduled or special, or written consents.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/ARTICLES OF INCORPORATION

•  The one corporate document which is always mandatory is its articles of incorporation, which generally begins the corporation’s life.

•  This document can be, and should be, quite short, unless the corporation has more than one class of stock, in which case the document can be quite long, since it will set out the rights, preferences and privileges of each class of shares.

•  Information which is required will include the company’s name, address, agent for service of process, number of shares and par value.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/ARTICLES OF INCORPORATION (CONT’D)

•  Companies should generally think carefully about including other matters (other than indemnification of directors) because a) this is a public document, and b) if the company decides to amend this document, it will require shareholder approval, which may be time-consuming, expensive and difficult for larger companies to obtain.

•  Certain provisions, such as exculpation, must be in the certificate to have any legal effect.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/BYLAWS

•  Bylaws are an internal company document.

•  Adoption and amendment may or may not require shareholder approval, depending both on the law of the state of the company’s incorporation and what’s in the company’s articles regarding this.

•  Unlike articles of incorporation, a company can technically operate in at least some states without bylaws, but the consequence will be that it is subject to default statutory provisions and may not be able to avail itself of advantages such as being able to use e-mail for corporate communications.

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CORPORATE GOVERNANCE, KEY DOCUMENTS, BYLAWS (CON’T)

•  Bylaws typically include provisions on shareholder voting, meetings and consents, election and number of directors, types and responsibilities of officers, recordkeeping, stock certificates, and indemnification (which may also be in the articles).

•  Less typically, bylaws may include a provision requiring disputes relating to the company’s governance to be litigated in its state of incorporation and/or provisions relating to the purchase and sale of its shares.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/SHAREHOLDERS AGREEMENT

•  Shareholders agreements are private, discretionary documents.

•  But unlike bylaws, which may also be discretionary but which almost all companies do adopt, many companies do not have shareholders agreements.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/SHAREHOLDERS AGREEMENT (CON’T)

•  Shareholders agreements restrict the ability of a shareholder to transfer his/her/its shares and set forth the requirements of what must be done in the event of a proposed transfer.

•  Typically, the shareholder considering the transfer must give notice of the proposed transfer to the company and/or the other shareholders, who then have the opportunity to purchase those shares, either at a price specified by some type of formula or that offered by a third party; if this option isn’t exercised within a certain period of time, the transferring shareholder will be free to transfer his shares, subject to any securities restrictions, discussed below.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/SHAREHOLDERS AGREEMENTS (CON’T)

•  The circumstances under which this ordinarily arises include a proposed sale to a third party, a transfer in the event of death, bankruptcy or divorce, and the right to purchase in the event of disability or a termination of employment.

•  It may also include the right of a shareholder to participate in the event another shareholder proposes selling his shares to a third party and the above repurchase right is not exercised (known as a tag along right), to compel a shareholder to sell his/her/its shares in the event of a proposed sale of the entire sale of the company (known as a drag along) or the right to participate in a future offering of the company’s shares (pre-emptive rights).

•  Separately but of critical importance, shareholders agreements can also restrict sales of shares to third parties which might jeopardize a company’s S election or violate securities laws, via legends on share certificates and/or requiring an opinion of counsel.

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CORPORATE GOVERNANCE, KEY DOCUMENTS/SHAREHOLDERS AGREEMENTS (CON’T)

•  Shareholders agreements are also a highly effective but under-utilized tool of resolution of corporate disputes.

•  In the event of deadlock between shareholders, a shareholders agreement may set up a mechanism for resolving the disagreement, such as appointing a third party to act as a tiebreaker in the event of deadlock, or even more dramatically, giving one shareholder the right to call the other’s shares or put his shares to him/her/it.

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CORPORATE GOVERNANCE/DISPUTES, CAUSES OF ACTIONS AND REMEDIES

•  General rule: shareholders holding the same class of stock have to be treated the same on a per share basis, such as distribution of dividends.

•  But there are some narrow exceptions, such as a company generally being able to choose to repurchase (redeem) one shareholder’s shares and not another’s.

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CORPORATE GOVERNANCE/DISPUTES, CAUSES OF ACTIONS AND REMEDIES (CON’T)

•  More broadly, a company may choose to employ one shareholder in lieu of another, pay them different rates of compensation, do business with one shareholder’s company, rent property from him/her/it, etc.

•  This implicates the fiduciary duties (which may include obedience, good faith and fair dealing, loyalty, disclosure and care) owed by officers and directors to shareholders and majority shareholders to minority shareholders.

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CORPORATE GOVERNANCE/DISPUTES, CAUSES OF ACTIONS AND REMEDIES (CON’T)

•  Individuals may wear more than one hat (shareholder, employee, officer and/or director) within the company, and it’s important to determine which is involved in the pertinent situation.

•  Facts of interested party transactions need to be considered carefully by companies and the affected persons. Statutory law may prevent some proposed transactions, but others may be permissible with some combination of disclosure, recusal from discussion/voting and disinterested party approval. Aggrieved shareholders may have a cause of action for breach of fiduciary duty or oppression of a minority shareholder.

•  Parties may be able to minimize these disputes arising by putting provisions in shareholders or other agreements relating to employment, pre-emptive rights, distributions, redemption of shares, etc.

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LLC GOVERNANCE, GENERALLY

•  Limited liability companies (LLCs) may be governed by either their member(s)--the equity owners--or a manager or managers.

•  Similar to officers and directors in a corporation, managers are not statutorily required to be members, although the individual LLC may require it in its organizational documents.

•  LLCs may also have officers and boards of directors similar to corporations.

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LLC GOVERNANCE, GENERALLY (CON’T)

•  The key documents for LLC governance are a LLC’s articles of organization (or certificate of formation) and its operating agreement (or LLC agreement).

•  LLCs articles are very similar to a corporation’s, that is, generally, very brief and limited.

•  The operating agreement is often broader, though. In addition to the types of matters discussed above in bylaws, it may include buy-sell provisions, clauses relating to the dissolution and winding up of the entity, securities representations, confidentiality and non-competition restrictions.

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LLC GOVERNANCE, GENERALLY (CON’T)

•  LLC operating agreements are fundamentally contracts between their members, and more leeway is given to the members and/or manager to determine how the entity will be governed than a corporation and its shareholders.

•  Similar to shareholders in a corporation, members in a manager-managed LLC only have a right to vote on a limited number of specified matters.

•  LLCs are not statutorily required to have annual meetings of members nor to maintain records of any meetings which occur (although the operating agreement of a LLC may require it).

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LLC GOVERNANCE, GENERALLY (CON’T)

•  There are many more open issues relating to governance of LLCs than corporations, which may be a reason founders contemplating forming a business may, at the outset, choose to form a corporation rather than a LLC.

•  Although there is a uniform LLC Act (unlike with corporations) which should minimize differences between states, laws pertaining to LLCs are more flexible generally than those relating to corporations.

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LLC GOVERNANCE, GENERALLY (CON’T)

•  Unlike shareholders of corporations, for example, members of LLCs may distribute profits and allocate losses in ways which do not directly correspond to equity ownership.

•  There is also relatively little case law to guide LLC members and their attorneys, since this form of entity has only been in wide use for 20-25 years.

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LLC GOVERNANCE, GENERALLY (CON’T)

•  The combination of statutory silence, flexibility and paucity of case law has left open the question of the status of fiduciary duties of managers to members or majority members to minority members in LLC and whether there may be a cause of action for oppression for minority members of a LLC.

•  The Delaware Court of Chancery has held that, in the absence of a provision in an operating agreement expressly waiving such fiduciary duties, they apply as if in a corporation (Feeley v. NHAOGC, LLC Ca. No. 7304-VCL (Del. Ch. Nov. 28, 2012)).

•  However, the Delaware Court of Chancery has held that members may limit or eliminate fiduciary duties in an operating agreement, analogizing it to a partnership agreement for a limited partnership (Related Westpac LLC v. JER Snowmass, LLC, et al. C.A. No. 5001-VCS (Del. Ch. July 23, 2010)).

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ABOUT THE FACULTY

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PETER  FEINBERG  peter.feinberg@hogefenton.com  

Peter  Feinberg  has  almost  25  years’  experience    represenCng  primarily  middle  market  companies  in  all  aspects  and  many  sectors  of  merger  and  acquisiCon  transacCons.    Mr.  Feinberg  has  successfully  closed  well  over  100  merger  and  acquisiCon  transacCons,  represenCng  buyers  and  sellers,  public  and  privately  held  companies,  mulCnaConal  firms,  family  owned  businesses  and  private  equity  firms.    He  pracCces  in  Silicon  Valley  at  Hoge  Fenton  Jones  &  Appel,  a  more  than  60  year  old,  40+  aTorney  firm.    He  has  previously  been  a  partner  at  Thelen  Reid  &  Priest  and  Ferrari  OToboni  and  has  worked  in  house  at  NetApp  and  Clorox.  

ABOUT THE FACULTY

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Alexander  Davie  is  a  partner  in  the  Nashville,  TN  law  firm  Riggs  Davie  PLC.  He  works  extensively  with  technology  companies,  including  startups  and  emerging  growth  companies,  as  well  as  businesses  in  other  industries,  providing  legal  counsel  on  company  formaCon,  business  planning,  mergers  and  acquisiCons,  technology  transacCons,  corporate  governance,  debt  and  equity  financings,  and  securiCes  offerings.  In  addiCon,  Mr.  Davie  represents  investment  advisors,  securiCes  brokers,  hedge  funds,  private  equity  funds,  and  real  estate  partnership  syndicators  in  numerous  private  offerings  of  securiCes  and  in  ongoing  compliance.    Alex  began  his  career  in  2003  at  Ballard  Spahr  LLP  and  later  at  Hangley  Aronchick  Segal  Pudlin  &  Schiller,  both  of  which  are  based  in  Philadelphia,  PA.  Beginning  in  2008,  Alex  served  as  vice  president  and  general  counsel  to  a  private  investment  fund  manager.  In  2011,  he  returned  to  private  pracCce  and  founded  Riggs  Davie  PLC.      

ALEX  DAVIE  adavie@riggsdavie.com  

ABOUT THE FACULTY

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JONATHAN  FRIEDLAND  jfriedland@sfgh.com  

Jonathan  Friedland  is  a  partner  with  Sugar  Felsenthal  Grais  &  Hammer,  LLP,  with  offices  in  Chicago  and  New  York.  Jonathan  regularly  advises  private  funds  in  their  M&A  acCvity  and  private  companies  in  their  day-­‐to-­‐day  affairs.    Jonathan  has  extensive  experience  in  guiding  companies  and  their  boards  through  a  variety  of  challenging  situaCons,  including  in  Chapter  11  and  other  insolvency  regimes.          

Jonathan  graduated  from  the  SUNY  Albany,  magna  cum  laude,  in  1991  (afer  three  years  of  study)  and  from  the  University  of  Pennsylvania  Law  School  in  1994.    He  clerked  for  a  federal  judge  before  entering  private  pracCce.    He  was  an  Adjunct  Professor  of  Strategic  Management  at  the  University  of  Chicago’s  Graduate  School  of  Business  for  several  years  and  was  the  2006  Clayton  Center  for  Entrepreneurial  Law  VisiCng  Professor  of  Business  Law  at  the  University  of  Tennessee  College  of  Law.    

Jonathan  has  been  profiled,  interviewed,  and/or  quoted  in  numerous  publicaCons,  including  Buyouts  Magazine;  Smart  Business  Magazine;  The  M&A  Journal;  Inside  Counsel;  LAW360;  BusinessWeek.com;  The  Bankruptcy  Strategist;  Dow  Jones  Daily  Bankruptcy  Review;  Bankruptcy  Court  Decisions;  Dow  Jones  LBO  Wire;  and  The  Daily  Deal.  Jonathan  is  also  lead  author  and  editor  of  several  significant  treaCses,  several  chapters  in  other  treaCses,  and  hundreds  of  arCcles  on  law  and  business.    Jonathan  holds  the  highest  possible  raCng  from  MarCndale-­‐Hubbell  (AV®  Preeminent™)  and  AVVO  (10/10),  has  been  repeatedly  recognized  as  an  Illinois  “superlawyer”  in  mulCple  areas  of  pracCce,  including  Business/Corporate  Law  and  Bankruptcy  &  Creditor/Debtor  Rights,  has  been  named  several  Cmes    

ABOUT THE FACULTY

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RUSSELL  SILBERGLIED  Silberglied@rlf.com    

Russell  Silberglied  is  a  Director  at  Richards  Layton  &  Finger  in  Wilmington,  DE    pracCcing  both  bankruptcy  liCgaCon  and  core  chapter  11  work.  Examples  of  Russ'  bankruptcy  liCgaCon  maTers  include  breach  of  fiduciary  duty  suits,  equitable  subordinaCon  and  recharacterizaCon  liCgaCon,  first  and  second  lien  liCgaCon,  valuaCon  fights,  and  contested  plan  confirmaCon  and  DIP  financing  hearings.  

In  core  bankruptcy  maTers,  Russ  represents  debtors  and  creditors  in  chapter  11  and  chapter  15  cases.  He  also  advises  troubled  companies  on  non-­‐bankruptcy  soluCons.  

In  addiCon,  Russ  regularly  advises  boards  of  directors  of  troubled  companies  concerning  their  fiduciary  duCes  and  corporate  governance  issues.  He  frequently  lectures  and  publishes  arCcles  on  this  topic.  

Visit www.eisneramper.com EisnerAmper. Let's Get Down to Business®

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space  in  the  financial  services  marketplace.  As  companies  grow  we  help  them  reach  their  goals  every  step  of  the  way.      With  offices  in  New  York  (NY),  New  Jersey  (NJ),  Pennsylvania  (PA),  California  (CA),  and  the  Cayman  Islands,  and  as  an  independent  member  of  Allinial  

Global,  EisnerAmper  serves  clients  worldwide.  

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