PART ONE: POTENTIAL LIABILITY OF BOARD MEMBERS TO THE CORPORATION ITSELF (OR TO SHAREHOLDERS/MEMBERS)
NEGLIGENCE: under traditional rules of corporate law, board members can be held personally liable for corporate debts if the act negligently
BUSINESS JUDGMENT RULE: Directors and officers are protected from such liability if they act reasonably and in good faith for what they believe to be the best interests of the corporation. In other words, directors are not liable for honest mistakes or errors of judgment.
The business judgment rule does not apply to the following situations: negligent management, breaches of fiduciary duty (see below), fraud, and taking actions which exceed the corporation's purposes.
HOW A DIRECTOR CAN AVOID BEING "NEGLIGENT": Inattention to business is negligence. Each director has a duty to attend meetings and to keep well informed on the status of corporation matters. Directors must familiarize themselves on the financial condition of the corporation. Board members may, however, rely on information given to them by the staff, officers, the corporation's accountants, etc. (unless they have reason to suspect that this information is wrong).
WHAT DUTIES CAN BOARD DELEGATE:
Boards of directors have ultimate responsibility for the management of the a corporations. The most important responsibility of the Board: hiring the chief executive officer.
What can be Delegated: As a practical matter, boards delegate day to day management authority to its chief executive officers and his or her staff.
What should not be Delegated: Boards should not delegate a reviews of program plans and budgets and they should delegate an evaluation of the program's effectiveness.
STATUTE GIVES INCREASED PROTECTION TO NONPROFITS: In 1986 the Florida legislature gave board members and officers of tax exempt, nonprofit corporations additional protection from liability. Now, it takes more than mere negligence to find a board member personally liable. Section 617.0834, Florida Statutes states that such officers and directors will not be personally liable for money damages unless they breached or failed to perform their duties, and this breach or failure to perform amounted to one of the following:
PURPOSE OF FIDUCIARY DUTY: The purpose of the fiduciary duty is to remove all temptation since it recognizes the weakness and frailty of human nature. A breach typically occurs where directors or officers self deal to their own benefit and to the detriment of the corporation. The affected board member in such a situation has a potential for divided loyalties
TYPES OF FIDUCIARY DUTIES: Breaches of the fiduciary duty typically arise in five contexts:
PART TWO: POTENTIAL LIABILITY OF BOARD MEMBERS TO OUTSIDE CREDITORS OF CORPORATION
Lets face it, the main reason people form corporations is so that they can undertake risky activities without having to face personal liability in case there is a lawsuit.
THE NORMAL RULE: Normally board members are immune from liability for corporate acts. The courts will only allow corporate creditors who get a court judgment to seize corporate owned property. The courts will not allow creditors to "pierce the corporate veil" so as so seize property personally owned by shareholders, members, directors, and officers.
EXCEPTION: the courts will allow creditors to "pierce the corporate veil" and seize personal assets, bank accounts, etc. where it is found that the corporation is a sham because it does not act like a corporation and it is, in fact, just the alter ego of the individuals who control it.
A MODEST PROPOSAL: FOLLOW THE "CORPORATE FORMALITIES": A corporation should, in fact, act like a corporation.
HOW DECISIONS SHOULD NOT BE MADE: Corporate decisions should not be made informally over coffee or over the telephone by two or three of the key people in the organization. Officers have no authority to act on behalf of the corporation unless the board has actually passed a resolution giving him or her such authority.
THE PROPER WAY TO MAKE DECISIONS: The only way that a corporation can legally take any action is for the board directors to pass a resolution at a meeting where a quorum is present.
PROXY VOTING IS NOT ALLOWED: Directors cannot act by proxy. The board must actually meet in order to take action. There are two exceptions: Boards can act by unanimous written consent without actually having to meet. Also, boards can meet via telephone conference call or through a tele-video conference if all of the board members participating can hear each other.
Each director is presumed to assent to board action unless the minutes show that he or she dissented or abstained.
KEEP MINUTES OF EACH MEETING AND STOPE THEM IN A CREDIBLE "MINUTE BOOK": Why bother acting like a corporation if you can't prove it later. Will you be left standing there naked when the lawsuits start to fly? Why not avoid all of that embarrassment and legal liability? Here's an novel idea: KEEP MINUTES of each meeting and store them in something that actually looks like a real minute book!!!
AVOID THE NEWSLETTER SYNDROME WHEN KEEPING MINUTES: The minutes are not the corporation newsletter. Try to limit the minutes to the essentials. By avoiding unnecessary wording you will find that minutes are a lot easier to keep (i.e. don't try to capture every word that is said at a meeting). You may, however, occasionally find it desirable to include some limited background discussion in order for the reader to understand the particular corporate action being considered by the board.
LIMIT MINUTES TO A RECORD OF FORMAL BOARD ACTION:
The threshold for inclusion, perhaps, is when someone makes a motion. If there was a vote on the motion, the minutes should tell whether or not the motion was adopted. Be sure to state who voted against the motion and who abstained. Putting in extra details into the minutes, especially names, can cause problems later on if a lawsuit if filed.
THE MINUTE BOOK: The minutes should be collected into a "minute book" (a three ring binder is recommended).
THE ROLE OF OFFICERS
Shocking News for Officers Officers have no inherent authority!!!! The only authority officers have is what is given to them by the board of directors in a Resolution or through the adoption of bylaws.
A Quick Overview of "Agency" Law.
What is an Agent: An agency relationship is formed when two persons agree that one of them (the "Agent") is to act for the benefit of the other (the "Principal").
Corporations can Only Act Through Agents: Because corporations are artificial persons, they can act only through their "agents". Anyone can become an agent of the corporation if the board of directors gives them authority. Most bylaws give titles to certain potential agents of the corporation. We call these types of agents "officers". Unless the board passes a resolution, however, the officers have no authority to do anything (other than the authority given to them, if any, in the bylaws).
Agents Face No Personal Liability, provided that he or she had proper authorization from the principal and provided that he or she was acting within the scope of his or her authority.
Officers are Potential Agents: Officers who are properly authorized, act in an agency capacity (the corporation is the "principal")
Two Type of Authority: Agent can have two possible kinds of "authority" giving them the power to legally bind the principal
* Actual Authority: Actual Authority exists where the corporation (the "Principal") expressly authorizes the Agent to take a specific action on its behalf pursuant to a resolution of the board of directors. In such cases, the agent faces no personal liability when things go wrong.
* "Apparent Authority": Even where there is no actual authority, it is possible for a former agent of the corporation to contractually bind the corporation. This occurs where the corporation (the "principal"), by its past behavior and conduct, has led innocent people to believe that a particular person had authority to take certain actions. Whenever a corporation takes authority away from a former agent it should inform the people with which it does business of the change. Where there is apparent authority, the principal may be legally bound by the actions of the former agent. The former agent, having no actual authority, could be found to be personally liable.
PART THREE: POTENTIAL LIABILITY TO THE IRS FOR UNPAID EMPLOYEE WITHHOLDING TAXES.
What happens when a nonprofit, charitable, corporation has cash flow problems and instead of paying the payroll taxes when due, they use the money to pay other bills. Under what circumstances would individual board members or staff be personally liable for the overdue payment?
OVERVIEW OF FEDERAL PAYROLL TAXES: Part of the federal social security payroll tax (FICA) is paid by the employer and part is withheld from the employee's paycheck. The part paid by the employer is a corporate and not a personal liability.
"RESPONSIBLE PERSONS" MAY FACE PERSONAL LIABILITY: The amounts collected from employees are treated differently. Their portion of FICA withholding were held by the corporation in trust for transmittal to the federal government. If the corporation cannot pay, the IRS will seek payment from the responsible directors and employees.
Responsible persons are considered those who have the power to see that the taxes are timely paid. In determining whether a person has such power, the courts have examined the following criteria, any one of which may be sufficient: (1) corporate bylaws, (2) authority to sign checks, (3) responsibility to sign employment and other tax returns, (4) authority to make payment to other creditors, (5) power to hire and fire, (6) officer status, and (7) overall supervisory control of corporate finances.
A person can be considered responsible even though he or she did not participate in the decision or did not actually authorize or write the checks to the other creditors. The test is whether the person had the power of control, not whether that power was exercised. Responsibility does not end because of failure to attend meetings.
To be liable, a responsible person must have willfully failed to make the payment. Willfulness here does not require a bad motive. It only requires a voluntary, conscious and intentional failure to pay over the withheld taxes. Willfulness exists despite a good faith expectation that the taxes would be paid later.
Often, a corporation has more than one responsible person. The government may collect the full unpaid amount from any one or from less than all. Those who pay may seek contribution from those who do not, if state law permits. Insurance coverage, whether from a corporate general liability policy or an individual directors and officers liability policy, usually is not available.
SAFETY PRECAUTIONS: To minimize the possibility of personal liability, establish a finance committee to regularly review the timely payment of all corporate tax.