Owners of an incorporated family business sometimes forget that, under the default rules of corporate law, the board of directors, not the shareholders or the chief executive officer, has the power to manage the business and affairs of the corporation. It is important for the owners of a family corporation to acknowledge that principle when the officers attempt to exercise corporate powers in a legally binding manner or when the owners engage in business succession planning. A recent case under Delaware corporate law illustrates how broad and robust the principle of board supremacy can be.
In Re WeWork Litigation: Facts
On August 21, 2020, the Court of Chancery in the State of Delaware issued a decision involving a business called The We Company, a Delaware corporation (the "Company"). The question at issue was whether the Company's management could refuse to disclose to members of the Company's board of directors any privileged communications between the Company's executives and the Company's attorneys. The court held that the Company's management could not withhold such information from the directors.
As the court laid out the facts, the (ongoing) litigation arose out of a transaction under which a faction of stockholders, referred to as "Softbank," offered to provide a loan and other consideration to the Company, in exchange for voting control. The Company's board of directors formed a committee of two directors (the "Special Committee") to negotiate and oversee the transaction for the Company.
After Softbank gained voting control of the Company, the board appointed an individual chosen by Softbank to serve as CEO. A short time later, however, the Special Committee alleged that Softbank breached its obligations under the transaction. The Special Committee caused the Company to bring a lawsuit against Softbank for the alleged breaches.
Softbank opposed the Company's lawsuit and urged the Company's board to take steps to end the lawsuit. In response, the Company's board of directors authorized the Company's management to retain a search firm to find two disinterested candidates to be appointed as temporary members of the board and constitute a new committee (the "New Committee"). The board empowered the New Committee to investigate whether the Special Committee had proper authority to cause the Company to pursue the lawsuit against Softbank.
The New Committee eventually reported that the Special Committee had exceeded its authority, and, based on that determination, the New Committee directed the Company's legal department to cause the Company to file a motion in court for leave to voluntarily dismiss the lawsuit.
The Special Committee sought to oppose the motion to dismiss and, still acting on behalf of the Company, asked management to provide the Special Committee with records of privileged communications among members of management, in-house counsel, and outside counsel about the decision to appoint temporary directors and form the New Committee. When management refused to disclosed the privileged communications, the Special Committee asked the court to order management to provide the information.
In Re WeWork Litigation: Holding
The court found that the specific question at issue, whether management could withhold privileged communications from members of the board, was a matter of first impression. Nevertheless, the court was unreserved in its holding that management cannot unilaterally withhold such information from members of the board. In its opinion, the court wrote that the board, not management, is responsible for overseeing the affairs of a corporation and that allowing management to shield the Company's privileged information from the board would turn corporate law on its head.
The court cited section 140(a) of Delaware's General Business Corporation Law, which says, "The business and affairs of every corporation…shall be managed by or under the direction of a board of directors, except as may be otherwise provided [under the statutes] or in its certificate of incorporation." Note that the rule giving the board of directors authority to control the management of a corporation can be altered under Delaware law, but only as set forth in the corporation's certificate (a/k/a articles) of incorporation.
The rule is similar under corporate law in most other states. For example, the ABA's Model Business Corporations Act says, "Except as may be provided in [a shareholders' agreement] and subject to any limitation in the articles of incorporation permitted by [statute], all corporate powers shall be exercised by or under the authority of the board of directors, and the business and affairs of the corporation shall be managed by or under the direction, and subject to the oversight, of the board of directors."
How This Information Can Help
1. Under default rules, the operations of a family corporation are controlled by the board of directors, not the shareholders or the officers. Therefore, if the president or chief executive officer of a family corporation proposes to take an action that is a matter of disagreement among the owners, the board of directors can make a binding decision to authorize or prevent that action. If the owners of a family corporation wish to limit the board's power, they can do so in the corporation's articles of incorporation (or, in some cases, by executing a shareholders' agreement).
2. When owners of an incorporated family business engage in succession planning, they can provide for a well-constituted board of directors to oversee the family member (or outsider) whom they select as successor president or chief executive officer. In that way, they will not be granting too much power to one person. In the alternative, if they wish to grant special powers to the shareholders or the executives under their succession plan, they can do so by limiting the powers of the board in specific ways that are set forth in the corporation's articles of incorporation.