Businesses enter into the different types of contracts every day. For example, service and supply companies frequently use standard, boilerplate contracts for their customers. However, aside from these routine kinds of agreements, companies must also enter into significant commercial transactions from time-to-time. Whether or not a transaction would be deemed consequential enough to require board of director approval depends on the corporate laws of your state of incorporation. A common statutory threshold is that if the corporation is considering entering into any agreement that would be deemed outside the ordinary course of business, the board should approve it beforehand.
The board of directors has a fiduciary duty to protect the best interests of the company and its shareholders. Certain significant transactions can have profound effects on the company, its operations, and its profitability. Board approval of these transactions ensures that there is a process by which the directors examine, discuss, and assess the pending transaction to the extent necessary to make an informed decision and vote accordingly. Furthermore, it is always possible that a transaction that seemed advisable (or noncontroversial) at the time it was approved could ultimately result in some adverse consequence for the company or a conflict with a shareholder; in this instance, the board’s prior conscientious consideration and approval of that transaction could serve as a shield to potential liability. In other words, it’s better for the board to be safe than sorry.
Determining what constitutes a significant commercial transaction does not involve any particular magic. This can vary by industry or by the individual company involved. However, using the ordinary course standard, management should have a pretty good idea of whether a corporate action (such as entering into a contract) would be consistent with the company’s regular conduct. The board might also identify a transaction as significant if it requires an unusually large expense; commitment; or disposition of assets, or if it involves a potential conflict of interest. Commercial agreements such as property leases, loan agreements, purchase or sale agreements, service agreements, supply agreements, licensing agreements, manufacturing agreements, outsourcing agreements, and any contracts with affiliated parties (shareholders, directors, or officers, for example) often fall into these categories.
While some contracts might not technically require board consent under state law, they could still be significant enough for their approval to be beyond the corporate powers of the company’s officers, employees, or other representatives. For example, there may be provisions in the company’s bylaws or in the individual employment agreements of certain officers that allow such persons to conduct day-to-day business on behalf of the company, but also require them to seek board approval for switching suppliers, taking on new clients, committing to a large project, or any other transaction that those documents deem to be important enough to require board approval.
When considering a significant agreement, the company’s management (including any relevant legal representatives) should present the board with any draft contracts and ancillary documents that the company will be expected to become a party to in connection with the entire transaction. In addition, the relevant departments should provide the directors with any pertinent company information (including financials, projections, or other reports) that would be germane to their analysis. The directors should have all information at their disposal so that they can make an informed decision.
Unless your board of directors has allocated the approval of significant commercial contracts to one of its committees or subcommittees, then it can go ahead and provide its consent through various means. One option is for the board to approve the agreement at a regularly-scheduled meeting; another is for the board to call a special meeting specifically for this purpose. In either case, the board will have to comply with notice and recordkeeping requirements under state law.
A more convenient alternative could be for the board to provide its consent in writing, since no physical meeting would be required. However, before the board pursues this option, the company or its legal counsel should carefully consult the company’s bylaws and the corporate statutes in your state to determine whether or not the consent must be signed unanimously and can be executed in counterparts. For any transaction approved by a written board consent, the company should ensure that its management has provided the directors with all relevant documents and information that they would have otherwise received in connection with a regular or special meeting. Furthermore, the text of the written consent should contain as much relevant background and detail as possible in order to substantiate the board’s final determination.
For examples of board resolutions approving various corporate actions (including entering into commercial contracts), see The Corporate Records Handbook.
The company should also determine whether or not any corporate governance documents or contracts require shareholder consent for significant commercial transactions. The company and its counsel should review the articles of incorporation (called a certificate of incorporation in some states), stockholders’ agreements (if any), and loan documents (if any), together with any outstanding promissory notes, options, warrants, or other relevant contracts, for any provisions that would mandate shareholder approval for these agreements. In such cases, the board could streamline the process by coordinating to have all information and materials relating to the proposed transaction presented to both the shareholders and the board concurrently; then, the board and the shareholders could simultaneously either vote for or against the transaction at the same regular or special meeting, or sign a joint written consent of the shareholders and the board in favor of the same.