How to Be an Effective Board Member for a Private Company

I. Introduction

A corporate director is a trusted fiduciary of the company responsible for working collaboratively with the other members of the board of directors of the company (the “Board”) and company management to serve the best interests of the company and its stockholders. This article highlights best practices and key considerations in fulfilling the role of director for a private company, including a high-level look at fiduciary duties and conflicts of interest.

II. Fiduciary Duties and the Business Judgment Rule

The legal standard for a director’s responsibilities on a Board starts with the director’s fiduciary duties — the duties of care, loyalty, and oversight. The Board is tasked with providing strategic guidance on sensitive topics that are critical for the company’s growth and success.

The Duty of Care requires directors of the company to act with “such care as an ordinarily prudent person in a like position would use under similar circumstances, and in a manner that such director believes to be in the best interests of the company.” This means:

• Directors must take time to become informed with respect to the material elements of a proposed action and be satisfied that they have been given the necessary relevant information in connection with a decision.
• Directors may rely upon advisors and employees of the company when discharging their duty of care, as long as the directors reasonably believe that the individuals they are relying upon are acting within the individuals’ professional or expert competence.

For example, a director who takes time to adequately review relevant materials about a prospective vendor for a material contract before voting to enter into such agreement has discharged t duty of care, so long as the director believes that the contract is in the best interests of the company.

The Duty of Loyalty “prohibits self-dealing and taking of corporate opportunities by directors and requires directors to put the interests of the company and its stockholders above their own interests.” This means:

• The Duty of Loyalty includes a duty of candor to other directors, which means that interested directors must disclose to the Board any conflicts of interest concerning a matter on which the Board proposes to vote.
• The Board may ratify a self-interested transaction if (1) the material facts as to the director’s interest as to the transaction are disclosed or known to the Board, and a majority of the disinterested directors vote in good faith to authorize the transaction; (2) the material facts as to the director’s interest as to the transaction are disclosed or known to the shareholders and a majority of the shareholders vote in good faith to approve the transaction; or (3) the transaction is fair as to the company at the time it was authorized.

For example, if the Board is set to approve a new lease for additional office space and a director fails to disclose that such director owns the property management company that is leasing the building to the company, the director has breached the duty of loyalty.

The Duty of Oversight requires directors to “exercise proper oversight over the company and to implement a system of controls that is sufficient to allow them to perform their oversight responsibilities.” This means:

• In fulfilling their Duty of Oversight, officers and directors must (1) “rigorously” exercise oversight by monitoring the company’s operations, legal compliance, and financial performance; (2) make a good faith effort to put in place reasonable information systems to obtain the information necessary to ensure such oversight and reporting of material risks; and (3) address or report “red flags” indicating that the company could suffer harm.

For example, if the directors of a company, in bad faith, choose to ignore evidence that an officer is stealing money from the company, the directors have breached their duty of oversight.

The Business Judgment Rule is the standard used by courts to review actions taken by the Board.

• Under the Business Judgment Rule, directors will have discharged their duties to the company and its stockholders if their actions were taken (1) in good faith and in the absence of a personal interest that conflicts with the general interests of the shareholders; (2) on a fully informed basis; and (3) with due deliberation.
• The Business Judgment Rule focuses on the decision-making process that was utilized by the directors, rather than the outcome of such decision.

A court will presume that a Board’s decision was correct if the decision was arrived at using a proper process.

III. Conflicts of Interests

A conflict of interest arises where a director may benefit from a set of business decisions, even if there is only a chance of self-dealing. Conflicts of interests related to directors most often arise when (1) a director is affiliated with a stockholder of a company or (2) when a director serves on the boards of other companies in the same sector or industry. Directors are not prohibited from serving on the Board if they have a conflict of interest. However, if a director does have a conflict of interest, that conflict must be disclosed to the Board in a complete and timely manner.

Examples of conflict-of-interest scenarios:

• A director has a financial interest in an entity with which the company may be entering into a transaction. The director could be deemed to have a conflict of interest, even if the director may not directly benefit from such transaction.
• A director serves on the Board of two companies, and the same corporate opportunity is available to both companies. Because the director owes fiduciary duties to both companies and such duties may not align with each other, the director should disclose the circumstances as a conflict of interest.
• The Board is determining equity compensation for a serving director.

In the event of such conflicts of interest, if the Board would have a quorum without such conflicted director present, then the director should (in addition to disclosing the conflict to the other members of the Board) recuse from the decision-making process. However, a director may not recuse if such recusal would result in a lack of quorum. The participation of an interested director in a vote would not render the vote invalid under laws governing corporations, such as the Delaware General Corporation Law. Additionally, recusal is not permitted to avoid signing a unanimous written consent.

IV. Six Ways to Be an Effective Director

1. If you are asked to serve on the Board of a company, disclose any preexisting Board membership of similar companies prior to accepting any such offer.
2. Prepare for Board meetings by reviewing carefully all pre-meeting materials and be prepared with any questions and points of view on the topics on the agenda. Being prepared and informed is part of your fiduciary duty.
3. Actively participate in all Board meetings by asking questions and engaging in discussions on meeting topics.
4. If you are aware of a potential conflict of interest with respect to a pending Board action, disclose the conflict to the Board.
5. Board meetings are typically quarterly. Make yourself available to company management in between Board meetings for informal consultations and discussions to advance the company’s business and affairs.
6. Keep the best interests of the company and the stockholders as the central theme of your decision-making process, not only in connection with formal Board actions but also when engaging with company management and other company stakeholders outside of Board meetings.

V. Conclusion

Serving as a director of a private company is both a privilege and a significant responsibility. At its core, Board service requires an ongoing commitment to the fiduciary duties of care, loyalty, and oversight. Directors must come to meetings prepared, engage thoughtfully in discussions, and ensure that robust information systems are in place to identify and address potential risks. By understanding the legal framework that governs Board conduct and embracing practical habits of effective directorship, Board members can provide meaningful strategic guidance while protecting the interests of the company and its stockholders. Ultimately, effective Board service is not measured solely by individual decisions, but by a consistent pattern of good faith, informed deliberation, and focus on the company’s long-term success.

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