The internet is a wonderful tool. So is a chainsaw, until it’s used to trim your fingernails. Entrepreneurs are understandably skeptical about spending money on something as mundane as form bylaws when hundreds of examples are available at the click of a mouse. In many cases, that approach works out fine. When it doesn’t however, entrepreneurs run the risk of losing the protections of the corporate shield by not having appropriate provisions in their bylaws.
Bylaws are actually a contract between the corporation and its shareholders. This point is often overlooked when selecting a corporation as the business form, rather than, for example, a limited liability company (LLC) format, which uses an Operating Agreement as the governing document rather than bylaws. For a corporation that will have more than a single shareholder, the bylaws provide critical promises and standards that define the relationships among the shareholders, officers and directors. Bylaws are an important tool to prevent piercing the corporate veil in single shareholder corporations, but that is a subject for another time.
The FDIC’s litigation against bank officers and directors during the recent financial crisis was some of the most intense, technical corporate litigation in memory. This litigation occurred against a backdrop of extraordinary hostility against the financial community, particularly bankers. With the fall of Lehman Brothers in the fall of 2008 and the domino effect on subprime lenders, bankers were the targets of vitriol normally reserved for visiting teams in Philadelphia. One court opinion, denying a motion brought by defendant officers and directors, made a very strong statement about the losses the banking industry had inflicted upon the American taxpayers. The fact that the Federal Deposit Insurance Fund, which the FDIC uses to protect deposits in failed banks, is actually funded by member banks, not taxes, was an inconvenient fact that didn’t make the cut in the opinion.
Since these FDIC cases largely turn on the interpretation of state corporate law, current case law is fertile ground for shareholders who feel they have been treated unfairly or who question the business decisions of officers and directors, particularly when potential defendants serve in dual capacities as officers and directors. Recently, a federal court ruled that corporate officers serving on a bank board were subject to the standard of care for officers — even when casting votes as directors — for actions the court deemed not to be corporate policy matters. FDIC v. Dodson, et al., No. 4:13-cv-416-MW-CAS (N.D. Fla. Feb. 27, 2014). Anyone who doubts the animus directed to corporate officers and directors should review the Yates memo from the Department of Justice which focuses on individual liability for corporate wrongs. (My colleague, Nicole Deese Newlon, is working on a separate article about the Yates memo).
So what should an entrepreneur do when considering bylaws for a corporation? The obvious answer is hire a good transaction lawyer who will work to understand the specific business and goals (personalities, product or service, growth, acquisition, exit strategies) to develop a set of bylaws to meet the company’s specific needs. As the company changes, the bylaws should be reviewed for possible amendments and revisions. Lest someone think this is a shameless self-serving position, litigation involving and the trial of poorly drafted, ambiguous documents is extremely lucrative as much of the time is spent trying to prove the meaning or ”spirit” (code word for expensive dispute) of the deal.
Is this all form over substance? Let’s consider one tangible example: indemnity provisions. A provision that specifies that officers and directors shall be indemnified to the fullest extent allowed by law, including the advancement of defense costs, may be the difference between an officer or director self-funding the defense of a claim or investigation rather than having those costs at least advanced by the corporation, with perhaps no repayment obligation. In contrast, if investor shareholders are ceding daily control to others, they may want to insist that the bylaws require the officers and directors to pay defense costs and seek recovery only upon a successful defense, to avoid having the investors’ money used to defend against claims they might bring against ethically challenged officers or directors. The” get it off the internet’ approach doesn’t take into account the practical and individualized needs of each corporation.
On the other hand, if you feel more comfortable hurtling down the mountain roads, texting your autobiography and wondering what that smoke is in your rear view mirror (assuming you haven’t discarded that useless impediment to your full view forward), there are millions of forms on the internet just waiting for someone to fill in the blanks.
John E. “Sean” Johnson is a partner with Johnson & Cassidy, P.A. in Tampa, Florida. A substantial part of his business and commercial litigation practice involves defending bank directors and officers in suits brought by the FDIC in its receivership capacity. Recently, Sean was named the Best Lawyers 2016© Tampa Litigation – Banking and Finance “Lawyer of the Year” for Tampa, an annual recognition given to only one lawyer in each community for a given practice area. Sean can be reached at (813) 699-4859, or by visiting www.jclaw.com.