Business Governance Documents: What Are They and What Do They Do?
June 3, 2022
This month, we discuss business governance documents. Many business owners overlook these, but these pivotal documents can often protect a company from disputes or steer a company directly into litigation. It therefore behooves business owners to prepare and deliberate over thorough business governance documents.
What are Governance Documents?
Governance documents are agreements that set forth company operations, company management, the rights and duties of the owner(s), voting standards, and more. Subject to some limitations, these agreements afford the business owner(s) vast leeway in structuring the company. The Texas Business Organizations Code, the body of law that governs business organizations and disputes arising directly therefrom, provides default rules that a governance document may override while limiting certain contractual freedoms. For example, a governance document may set forth the titles and authorities of company officers, the procedures by which the business may hire employees, and the protocols for ownership to make major decisions. By contrast, although governance documents may influence the extent of owners’ liability, in most cases these documents cannot completely disclaim all liability. In the event of litigation, a court may well strike as unenforceable such provision in a governance document. When drafting governing documents, the drafter should keep in mind the legal limitations of their agreement.
What Kinds of Governance Documents Exist?
Several kinds of governance documents exist. Each business entity type calls for a different governance document. For example, a limited liability company’s governing document is an operating agreement or company agreement, and a limited liability partnership’s governing document is a partnership agreement. A corporation’s governing document is a set of bylaws and/or a shareholders’ agreement. The shareholders of a close corporation, a privately owned corporation without publicly traded shares, may adopt a shareholders’ agreement in lieu of bylaws. Notwithstanding the entity type of the business, governance documents generally seek to accomplish similar goals: to regulate the management and operations of the business.
Although all governance documents generally seek to accomplish similar objectives, deploying the incorrect type of governing document can adversely impact a business and worsen disputes. Suppose, for example, that a corporation adopts an operating agreement as its governance document. As the governing document of an LLC, the operating agreement will likely name the business owners and officers, respectively, as “members” and “managers” rather than as shareholders and directors, the proper terms for corporate owners and officers, even though the company’s certificate of formation named directors rather than “managers.” Suppose further that a dispute erupts among the shareholders and a shareholder resigns his or her management position. Because the company adopted an improper governance document, it is not clear whether the governance document awarded each officer a second and separate position of “manager” in addition to the “director” position awarded by the company’s certificate of formation or whether these are one and the same. Therefore, the resigning officer may claim that he or she relinquished the “manager” position but not the director position. This scenario can easily devolve into heated disputes and costly litigation.
Why and When Should I Draft Governance Documents?
In addition to organizing the company, governance documents can anticipate disputes and complications. For example, companies often approach me shortly after a heated and complex dispute. Such businesses will often request to draft new governance documents that anticipate problems similar to that outlined above. With the assistance of thoughtful and thorough legal counsel, the business can prepare new documents that establish mandatory guidelines for resolving buyout disputes, share valuation disputes, resignation disputes, and more. Skilled counsel will also prepare exhibits that clear any doubt regarding owners’ rights and ownership interests by requiring the signature of each owner upon a separate, succinct document attached to the governance document. Oftentimes, business owners discount the important of governance documents and may not appreciate their value until a costly lawsuit or heated dispute has already stricken the company. Although a business should ideally prepare its governing documents at formation, a company can adopt or amend governing documents at any time and should prepare or correct governing documents as soon as practicably possible in order to regulate against disputes and other liabilities.
Diab Law Firm, PLLC