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How and why to create the board of directors: Legal implications

How and why to create the board of directors: Legal implications

According to a survey by the Center for Effective Dispute Resolution (CEDR), 67% of CEOs regularly face conflict on the board. This is often due to vague legal language about responsibility and authority. Alexey Sheverdyakov, a lawyer and a member of the Moscow City Bar Association, will talk about how to minimize the possibility of such conflicts at the stage of creating the board of directors. The article was prepared on the basis of the Russian legislation, but the algorithm for creating a board of directors is similar in other CIS countries, we will mention all the differences. You can also find out how minimize legal risks for a new company in this article

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Contrary to popular belief, the need to form a board of directors (supervisory board) arises not only for companies with a turnover of billions. For example, in the West, there are such corporate governance bodies in non-profit organizations, charitable foundations, and even in startups. The thing is that with the rapid growth of the business, the load on the manager is growing, and it is more difficult for them to keep all the necessary areas in focus. This effect is called the founder’s trap. In this case, it is possible and necessary to delegate operational management functions to the board of directors. The founder can become chair of the board, or step out of the leadership role entirely, and at times this can bring direct benefits to the organization. Thus, according to a study of the practice of the board of directors in private business, the profitability of Yarmarka company in terms of EBITDA (profit before deducting certain costs) after the full transfer of power to the supervisory board increased several times.

To create a board of directors (BoD) and delegate powers to it, it is necessary to develop a package of documents (first of all, the company’s charter and regulations on the Board of Directors), which will most clearly and transparently reflect the main functions, rights, duties and responsibilities of board members. This measure will allow the founder and the rest of the shareholders to secure the business from various internal conflicts and problems. Let’s figure out what must be included in such documents.

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How and why to create the board of directors: Legal implications

The procedure for creating the board of directors

The board of directors can include any number of specialists, depending on the size of the organization and the scale of the urgent tasks. Sometimes 2–3 people are enough for a startup in the early stages, and in most Russian and European companies the council has from 9 to 11 people. According to a SpencerStuart study, about 29% of board members in Russia are foreigners. There are no direct legislative prohibitions for a citizen of another state to become a member of the board of directors of a Russian organization. However, such restrictions can be set by the company itself in the charter.

The board of directors can be formed both in LLC and in JSC. The council is elected at the general meeting of the founders / shareholders. When choosing board members, many recommend adhering to the recommendations from the Corporate Governance Code adopted in 2014 by the Central Bank of the Russian Federation. It states that the election of members of the board of directors should be carried out through a transparent procedure that allows shareholders to obtain all the necessary information about the personal and professional qualities of candidates. The composition of the council should be balanced, including in terms of qualifications, experience and business qualities.

The Board of Directors should include a sufficient number of independent directors — specialists with their own opinion, free from the influence of the owner, individual groups of founders / shareholders or other interested parties. They must play a key role in preventing internal conflicts in the company. At the same time, a candidate cannot be considered sovereign if he is directly related to an organization, significant counterparty, competitor or state. It follows from the recommendations of the Code that the total number of independent directors should be at least one third of the elected board members.

No board of directors can exist without a chairman. The chairman of the board of directors must ensure a constructive atmosphere for holding meetings of the board, free discussion of issues on the agenda, and also monitor the implementation of his decisions. He is also obliged to provide members of the Board of Directors with the information necessary for making decisions in a timely manner.

It is also worth mentioning that, as a rule, new partners mention getting a seat on the Board of Directors as a prerequisite for their financial support. Thus, with the infusion of large investments, you also automatically expand the list of members of the board. On the other hand, with smaller investors there is a perfectly legal chance to get around this rule — you can compromise and appoint them to the position of observers. They can attend meetings of the Board of Directors, but do not have the formal right to vote, which means they will not affect the distribution of power in the company.

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How and why to create the board of directors: Legal implications

Rights and obligations of members of the board of directors

The rights (as well as responsibilities) of board members must be clearly formulated and enshrined in the company’s internal documents. First of all, in the charter of the organization and the regulation on the council, which must be approved by the decision of the general meeting of founders / shareholders.

The competence of the Board of Directors is very extensive and may include:

  1. Determination of the main directions of the company’s activity;

  2. Approval of the development strategy and budget of the organization;

  3. Appointment of the general director and early termination of his powers;

  4. Preparation, convocation and holding of the general meeting of founders / shareholders;

  5. Creation of branches and opening of representative offices of the company;

  6. Approval of the organization’s internal documents (for example, reports on financial and economic activities);

  7. Overseeing other issues reflected in the charter of the organization or the regulation on the Board of Directors.

In addition, the board in the LLC can approve or reject major transactions (sale or purchase of assets). A board of directors in a joint-stock company can decide to increase the authorized capital by placing additional shares by the company. Such a corporate body can also delegate the decisions on other matters: for example, the issuance of consent to conclude certain deals (real estate transactions, obtaining and issuing a loan / credit, etc.).

The board of directors is also aimed at overseeing the resolution of conflicts of interest in the company. First of all, prevent, detect and resolve incidents between shareholders / founders and the CEO. Council members have the right to use out-of-court dispute resolution procedures, including mediation. Independent directors can also act as mediators — as an impartial party, they need to remain neutral, speak and act from the perspective of an outside observer.

The Board of Directors implements its competencies at meetings. The decisions it makes are formalized in the same way as the decisions of the general meeting of founders / shareholders — in the format of the minutes. The procedure for convening and holding meetings of the board of directors can be determined by the charter of the organization or other internal document of the company, for example, the regulation of the board. In particular, they can be convened by the chairman of the board of directors, the general director or the founder / shareholder.

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Board responsibility

The board of directors must act in the best interests of the company, exercise its rights and perform its duties reasonably and in good faith. In the meantime, council members are liable to the organization and its members for losses caused by their actions or inaction. The company, as well as individual founders / shareholders, can file a claim against a member of the Board of Directors for damages. The decisions of the board of directors can be appealed in court by the founder / shareholder.

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Procedure for re-election and termination of powers of the board of directors

The procedure for re-election and termination of powers of the council must be clearly formulated and enshrined in the company’s internal documents. First of all, in the charter of the organization and regulations on the Board of Directors. In general, the board of directors is elected by the decision of the general meeting of founders / shareholders for one year (until the next annual general meeting). But if there is a need to re-elect the council within a year, an extraordinary meeting of founders / shareholders can be held on the matter.

Early termination of the powers of the Board of Directors at an extraordinary general meeting is also possible. If the meeting of the founders / shareholders was not held on time (more than a year has passed since the last general meeting), then the powers of the Board of Directors automatically terminate, with the exception of the responsibilities for preparing, convening and holding the annual general meeting itself.

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How and why to create the board of directors: Legal implications

Differences from other countries, including the CIS countries

From a legal perspective, there are practically no significant differences in relation to the Board of Directors in Russia and other countries (including the CIS). But there are some common features of Russian councils that distinguish them from foreign collegial executive bodies. According to the SpencerStuart study, the average age of board members in our country is 55 years — the “youngest” age in comparison with international practice. At the same time, women make up only 8.4% of the total number , which is the lowest indicator among the countries of Europe and America. 29% of all directors of Russian organizations are foreigners (compared to only 8% in Italy and the USA). And there is only 36% of independent directors on the supervisory boards of domestic companies, while in the United States and Switzerland their number reaches 85% of the total number of executives. Based on these data, foreign investors and shareholders often have to adapt to the peculiarities of the Russian specifics of corporate power.

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Thus, when creating a Board of Directors, the founder and shareholders of the company must provide for all possible legal nuances to the maximum in order to protect the company from conflicts in the future. For this, it is necessary to carefully approach the issue of preparing documents that define the competence, rights, duties and responsibilities of the entire Board, as well as its individual members. In this case, you can minimize the risks by using the services of a professional lawyer with relevant experience.

 

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