When a board of directors fails in its mission, impacts to shareholder value can be catastrophic. The financial press has a field day when a public company practically evaporates, but private company boards experience many of the same struggles – strategic missteps, regulatory problems, miscalculated mergers, and so on.
Less frequently discussed, though, are the challenges that boards of all stripes sometimes face from within – challenges caused by “dysfunctional directors.”
Providing strategic direction to a company is difficult work under the best of circumstances. And given the power and responsibilities entrusted to each director, a single under-performing or misbehaving individual can sometimes disproportionately impact a board’s ability to function.
Unfortunately for board chairs and CEOs, it’s the shareholders, and not the board, who elect and remove directors under the laws of most states, even if a director has been convicted of a crime. And since shareholders don’t usually attend board meetings, they are often unaware of problems in the boardroom, absent any press coverage.
What’s a board to do? And how can counsel help?
In the spirit of leading with good news – potential problems in the board room usually can be prevented or kept to a dull roar through good governance practices. And although shareholders are in the driver’s seat, the board isn’t always powerless to deal with problems.
And now the bad news – not every board room dysfunction can be fixed.
Controlling founders often keep underperforming friends and family members on boards well past the point where it is still amusing.
An investor or other party with a contractual board seat right can usually appoint whomever they wish. Anecdotes and commentary suggest that investor-designee board members pose greater risks for incompetence and conflicted loyalties than directors identified through well-managed searches.
Many companies have ownership, cultural or process drivers that keep highly ineffective boards in place. The president of a large but failing online social media company recently lamented that nobody on his board uses social media.
Lastly, even in situations where a board room problem can be solved by the board itself, the process usually involves some level of difficulty and stress for those involved.
Dysfunctional or Merely Disagreeable?
If a good board member is one who is engaged, prepared, knowledgeable and professional, what makes someone a bad board member? Certainly not just challenging management and pushing on issues with his or her colleagues. By law, board members are required to exercise independent judgment and to take their fiduciary responsibilities seriously.
While reasonable minds may differ, these are the most commonly cited concerns:
Significant absenteeism or neglect of duties.
An unusually difficult or divisive personality.
An ill-fitting background relative to the company’s business.
Intellectual limitations that prevent meaningful participation.
A propensity for getting stuck on or distracted by the wrong issues.
Integrity or character concerns involving civil, criminal, regulatory or ethical allegations.
If you search online for “bad,” “terrible,” or “worst” and “board members,” you’ll find colorful stories involving dominators, sleepers, and all types of characters in between. But behind each of these amusing anecdotes is a board that may not be fully meeting its legal obligation to oversee the management of the business in the best interests of the corporation and its shareholders.
Since Sarbanes-Oxley was enacted, expectations for boards and their directors have only increased. When one or more directors is distracting the board or otherwise holding it back, the board might be more at risk for not meeting those expectations.
“Can We Fix This?”
While board dysfunctions are generally problems for the board chair, independent lead director or CEO to recognize and fix, for better and for worse, serious dysfunctions are rare enough that not every board chair, independent lead director and CEO has much experience dealing with them.
General counsel and senior outside counsel can help their clients’ boards understand their options for preventing and correcting board dysfunctions. In fact, as an officer, a company’s general counsel arguably has both an ethical and a fiduciary obligation to help ensure his or her board is functioning well and in the best interests of shareholders.
And while not always as close to such problems, outside counsel are also on safe ethical ground pointing out board dysfunctions to the board chair or CEO and suggesting possible solutions.
Options for Improving or Removing Directors
With the caveat in mind that not every problem is fixable, how should counsel advise a board or CEO on how to reign in or remove a dysfunctional director?
As a general rule, it’s best to counsel moderation. The initial solution should be crafted to achieve the desired result without undue severity. This can help to minimize unnecessary distraction or stress for other board members. If a gentle approach fails, firmer measures can be considered.
The Quiet Conversation.
In the spirit of moderation, absent any formally prescribed process, a first step generally should be for the chair or another board member to pull the problem board member aside privately for a diplomatic talk about the offending behavior and the need to correct it.
A board member who frequently dominates meetings with ideas not shared by the other members might be confronted with specific examples of the behavior and evidence that the ideas have little or no support among the group as a whole.
A member who berates, interrupts or insults individual managers or board peers should be told promptly that such behavior is troublesome and detrimental to the functioning of the board.
Many times, a private talk, or two, or three, is all it takes to fix a problem. A banking CEO recently described requiring several coaching conversations with a board member who would never cast a vote in the board room without first asking the CEO – in front of the rest of the board and management - how he should vote.
Wait out the Problem. Assuming the difficult director isn’t a majority shareholder or entitled to a board seat under a stock purchase agreement, merger agreement or other such document, and assuming the director’s dysfunctions are not completely derailing the board, it may be best to wait for the director’s term to expire and simply not re-nominate him or her.
Board terms generally range between one and three years. Depending on the board member’s remaining term, this may be the path of least resistance if efforts to improve performance are unsuccessful.
The Less Quiet Conversation. What if a director is truly disrupting the board’s ability to function and/or alienating highly performing executive team members or fellow board members, and continues to do so after coaching?
The board chair, nominating and governance committee chair, independent lead director, CEO, or some combination thereof, should consider confronting the board member about the negative impact he or she is having and asking him or her to resign.
Any such conversation should be preceded by a reasonable investigation and should have the backing of other key board members.
Although these conversations are almost always difficult, they often achieve the desired result.
Board Seat “Designees.” If the director occupies a board seat on behalf of a venture capital firm or other shareholder, rather than having the resignation conversation with the board member, it may be best to approach another officer or principal of the investor and ask for a new board designee.
The author has seen this work first hand where a credible argument was made that the investor’s return on investment was being jeopardized by its board designee.
Depending on the circumstances, the board or CEO might even consider asking the venture capital firm, or other holder of the board seat right, to relinquish it entirely.
The author has seen this approach succeed where the investment wasn’t recent and the investor had confidence in the company’s management and strategic direction. Any general counsel advocating this approach and seeing it succeed deserves a bonus!
If the problem director is a founder or other large shareholder who is not keeping pace with the company’s board needs, and the company doesn’t already have a board member evaluation process, putting one in place may be the best way to convince that person that it’s time to resign.
It may take a while to implement, but confronting a board member with a resoundingly negative 360 peer review is likely to facilitate the “we feel you should resign” discussion.
Call a Special Meeting of Shareholders. All states allow for all or some part of a board of directors to call a special meeting of shareholders, including for the purpose of electing or removing directors.
While this is generally not an approach taken by publicly traded companies, or even private companies with many shareholders and a significant profile, it is certainly an option to be considered and discussed with experienced counsel under the right circumstances.
This option is more complicated, and may be foreclosed, where directors are elected by specific classes of securities or where contractual board seat rights or restrictive bylaws or articles provisions are involved.
Executive Committee or Special Operations Committee. Another less common approach to getting around a difficult director is for the board to create an “executive committee” or “special operations committee” empowered to take all actions that the entire board could take and to appoint several or all board members to the committee except for the problem director.
Under Washington law and Delaware law, the excluded director is entitled to receive information about the activities and decisions of the committee. A board should consult with experienced counsel before taking this path, as procedural or substantive missteps could lead to additional difficulties.
Judicial Removal. In very limited circumstances involving fraud or other criminal behavior, some states allow a shareholder or board to seek judicial removal of a director, but this is generally not a practical or even viable solution.
These rules and procedures vary from state to state.
Under Delaware law, for example, the Delaware Court of Chancery may remove a director if he or she has been convicted of a felony in connection with his or her duties as a director or has committed a breach of the duty of loyalty. The court must also find that:
the director did not act in good faith regarding the act for which he or she was convicted, and
it must remove the director in order to avoid irreparable harm to the corporation.
Under the Model Business Corporations Act, a court can remove a director in a suit filed by the corporation or by shareholders suing on behalf of the corporation. To remove the director, the court must find that, among other things, the director:
engaged in fraudulent conduct,
grossly abused his or her position, or
“intentionally inflicted harm” on the corporation.
For all practical purposes, judicial removal is only a viable option in extreme circumstances.
Preventative Corporate Governance
By now, it should be clear that, in this area of law, an ounce of prevention is worth a pound of cure. Unfortunately, startups and other small-to-medium sized companies that are potentially most vulnerable to board dysfunctions also tend to have the most lax board structures and processes. When the board consists of two or three friends or founders, it seems like over-kill to establish a board member evaluation process or a Nominating and Governance Committee.
But a board is a board, and establishing minimum standards up front can create a solid governance platform for growth and may prevent some problems before they start. Counsel play a key role in helping their corporate clients understand the importance and benefits of good corporate governance.
Run a Tight Ship. As scientists sometimes say, “nature abhors a vacuum.” Well, more accurately, nature loves a vacuum – it loves to fill them. The same can be said of some dysfunctional behaviors – they are opportunistic and will exploit weaknesses.
Failing to timely and clearly schedule meetings, confirm attendance and distribute meeting documents will tempt less inspired or more poorly organized directors to miss those meetings or show up unprepared.
Loosely defined meeting agendas and poorly run meetings are an invitation to easily distracted or highly opinionated directors to take things in unproductive directions.
Sloppy board materials and sloppy management presentations can ignite tensions and conflict by surfacing otherwise latent difficult personalities. The CEO must ensure that management always shines when presenting to the board verbally or in writing.
Well-run companies provide all new board members with orientation materials describing the role of a board, the duties of its individual directors, the commitment required, and the company’s expectations for directors both inside and outside the board room.
These materials should focus on the positive by describing what a highly functioning board looks like, how it works, and what it can achieve. They also should include, however, a short list of potentially damaging director-level shortcomings to be avoided.
Board Chair Effectiveness. Board chairs need to be knowledgeable about board meeting best practices and should consider training with a coach. A good board chair maximizes board effectiveness by ensuring that meetings run smoothly, generate vibrant, focused discussions, and stay on agenda.
This requires thoughtful preparation, a command of parliamentary procedure (e.g., Robert’s Rules of Order), and a strong personality. Without being overly confrontational, the chair must use procedure, judgment and diplomacy to prevent individual directors from hijacking meetings with irrelevant ideas and unimportant minutia.
If a director is stuck on an idea after the board has already moved on from the issue, the chair needs to know when to ask, “Is this a concern for anyone else?” If the answer is no, the chair should end the discussion and move to the next item.
Rather than allowing a chronic naysayer to dominate and prolong a discussion, the chair must know when to solicit other opinions in the room by asking, “Can we hear from anyone who supports the proposal?”
Parliamentary procedure, even when imperfectly employed, can and should be used to timely cut off discussions, take votes, or table items as appropriate. The chair is empowered to run the meeting and must do so, lest others fill the vacuum.
An HR Process for the Board. Every company needs to establish an “HR-like” function for its board – a process for establishing criteria for service, setting performance standards, assessing performance against those standards, and providing performance feedback.
The board as a whole, or through a committee, should establish and periodically revisit its criteria for membership – the skills, background, education, training and experience necessary to serve effectively in light of the company’s business model and objectives.
Every board should also set performance expectations for its board members and implement a thoughtful annual review process to measure and communicate performance against those standards. Templates and white papers on how to do this can be found online and there are plenty of qualified third-party consultants that can help establish excellent processes for a fee.
Smaller boards struggle with when to, or even whether to, establish board evaluation processes. Boards weighing this issue should consider starting out with a less involved, less scientific approach and improve it over time.
The initial focus should be on optimizing board performance rather than identifying and correcting dysfunctions. If problems arise later, the board has a familiar process in place that can also serve a more remedial function.
Nominating and Governance Committee. Again, with the caveat in mind that not all companies have the luxury of freely choosing all of their directors based on pre-determined criteria, the best way to avoid problems in the board room is to carefully vet prospective members.
Since 2002 and the enactment of Sarbanes-Oxley, companies have increasingly relied on Nominating and Governance Committees to monitor and maintain board and committee functions and to manage and control board member recruitment, nomination and evaluation processes.
Establishing a Nominating and Governance Committee often makes sense even for smaller, privately held companies as a bulwark against board dysfunctions before they take root. And having a separate committee charged with designing and implementing an annual review process provides greater legitimacy and persuasiveness when review findings suggest that an individual director is causing more harm than good.
Conclusion.
Dealing with board dysfunctions involves a thorny mix of legal, governance and personal relationship issues. Because of the place boards of directors hold in business and society, this can be intimidating territory for counsel.
But given the legal and governance nuances involved, these issues also provide important opportunities for counsel to provide unique and valuable guidance to their corporate clients.
Paul Swegle has served as general counsel to numerous tech companies and advises a dozen others as outside counsel. He has completed $12+ billion of financings and M&A deals, including growing and selling startups to public companies ING, Capital One, Nortek, and Abbott.
Paul has authored two authoritative and practical business law books, available for preview and purchase here:
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