Boards of California nonprofit public benefit corporations may take actions by voting at meetings or by the unanimous written consent of all directors. Generally, a unanimous written consent takes the form of a document detailing a board action or actions signed by all the directors then in office. This document may also be signed in counterparts, that is, each director may sign on a copy of the document (i.e., a counterpart) rather than on one original document, and the action will be validly taken once all the signed counterparts are confirmed.
Typically, the Secretary of the corporation is responsible for collecting all the counterparts, which may be sent to the Secretary by fax or email (e.g., scanned copy). Particularly for important actions, it would be good practice for the Secretary to collect all counterparts with original, wet signatures (rather than the faxed or emailed copies). The written consents should be maintained along with the board meeting minutes in the board's minute book.
From a governance perspective, it is generally encouraged that a board take action by voting at a duly held meeting for various reasons including encouraging more thorough discussion than might otherwise take place without talking face-to-face or via conference call. Unanimous written consents should therefore not replace a board’s responsibility and duty to conduct meetings or have discussions but it can provide an attractive option when unusual circumstances arise that may otherwise prevent the board from taking acting at a meeting. Additionally, the higher voting requirement of unanimous approval, in particular, may bring some assurance to other board members and outsiders that the action at issue has an appropriate level of board support.
While the concept of unanimous written consent seems generally straightforward, there are certain circumstances that pose challenges to the process such as approving a transaction in which a director has a material financial interest (in such capacity, an “interested director”). This becomes all the more challenging if half of the directors or more are interested directors. Unfortunately, California law is not explicit as to whether an action could be approved via written consent under those circumstances. Here, we take a closer look at the California provisions at play to hopefully shed some light on best practices for organizations struggling with this issue.
Interested Director Transactions
Where a proposed action to be taken involves an interested director, as defined in California Corporations Code Section 5233(a), the interested director's consent is neither included nor required for the unanimous written consent where all of the following three requirements in Corporations Code Section 5211(b) are met:
- One of the self-dealing safe harbor rules in Corporations Code Section 5233(d)(2) and (3) are met;
- The establishment of those facts is included in the written consent or in other records of the corporation; and
- The noninterested directors approve the action by a vote that is sufficient without counting the votes of the interested directors.
Requirement 1 – Self-dealing Safe Harbor Rules
The first requirement for a valid unanimous written consent of a transaction with an interested director turns to the procedural mechanisms that would otherwise be encouraged if the transaction were instead approved at a meeting. A transaction with an interested director is generally considered a “self-dealing transaction” unless it falls under one of the three safe harbor provisions provided for in the California Corporations Code Section 5233(d). These safe harbor provisions, if met, give the presumption that the transaction was appropriately approved by the Board as fair and reasonable as to the corporation and furthermore prevent a court from granting certain remedies such as requiring the interested director to pay to the corporation for any profits made from the transaction or return of any of any property lost to the corporation as a result of the transactions (see CCC Section 5233(h)). For purposes of a valid unanimous written consent, an organization must satisfy either subsection (2) or (3) of the three safe harbors in Section 5233(d) (reproduced below, emphasis added):
(1) The Attorney General, or the court in an action in which the Attorney General is an indispensable party, has approved the transaction before or after it was consummated; or
(2) The following facts are established:
(A) The corporation entered into the transaction for its own benefit;
(B) The transaction was fair and reasonable as to the corporation at the time the corporation entered into the transaction;
(C) Prior to consummating the transaction or any part thereof the board authorized or approved the transaction in good faith by a vote of a majority of the directors then in office without counting the vote of the interested director or directors, and with knowledge of the material facts concerning the transaction and the director's interest in the transaction. Except as provided in paragraph (3) of this subdivision, action by a committee of the board shall not satisfy this paragraph; and
(D) (i) Prior to authorizing or approving the transaction the board considered and in good faith determined after reasonable investigation under the circumstances that the corporation could not have obtained a more advantageous arrangement with reasonable effort under the circumstances or (ii) the corporation in fact could not have obtained a more advantageous arrangement with reasonable effort under the circumstances; or
(3) The following facts are established:
(A) A committee or person authorized by the board approved the transaction in a manner consistent with the standards set forth in paragraph (2) of this subdivision;
(B) It was not reasonably practicable to obtain approval of the board prior to entering into the transaction; and
(C) The board, after determining in good faith that the conditions of subparagraphs (A) and (B) of this paragraph were satisfied, ratified the transaction at its next meeting by a vote of the majority of the directors then in office without counting the vote of the interested director or directors.
The second safe harbor listed in Section 5233(d)(2) is particularly important for purposes of this article. Section 5233(d)(2) provides a safe harbor if, among other things, the board approves that transaction by a vote of a majority of the directors then in office without counting the vote of the interested director or directors. The difficult question then is whether this safe harbor can apply when at least half of the board is composed of interested directors. For example, if there were 10 directors on a board and 6 directors were interested directors in a proposed transaction, could the 4 remaining directors approve the transaction and meet the safe harbor requirement? I believe the answer is "no."
Some have interpreted Section 5233(d)(2)(C) to mean that a board need only look at the number of noninterested directors for purposes of defining the numerical threshold that constitutes “a majority of directors then in office.” Therefore, in our hypothetical, this interpretation means that the 4 noninterested directors could approve the transaction by written consent so long as a majority of the 4 noninterested directors approved (i.e., at least 3 of the 4 noninterested directors). I disagree with that interpretation. I read Section 5233(d)(2)(C) as describing a two-step process. First, the Board must look to all directors, regardless of whether he or she is an interested director, for purposes of defining the numerical threshold that constitutes “a majority of directors then in office.” Then, when the Board votes, it cannot include any votes by interested directors for meeting that numerical threshold. Therefore, in our hypothetical, this means the organization needs an affirmative written consent by at least 6 of the 10 directors then in office to constitute “a majority of directors then in office.” However, because the organization only has 4 noninterested directors, it cannot practically meet this requirement.
Requirement 2 – Establishment of Facts on Record
The second requirement for a valid unanimous written consent focuses on proper recordation of the transaction. This requirement essentially means the written consent should be drafted to adequately evidence that the safe harbor provisions were met. For example, if relying upon the safe harbor in Section 5233(d)(2), the consent should mirror the statutory provisions by, for example:
- Explaining why the board considered the transaction to be for the corporation's own benefit (see CCC Section 5233(d)(2)(A);
- Explaining why the board considered the transaction to be fair and reasonable as to the corporation (see CCC Section 5233(d)(2)(B);
- Documenting the material facts concerning the transaction and the director's interest in the transaction (see CCC Section 5233(d)(2)(C); and
- Explaining why the corporation could not have obtained a more advantageous arrangement with reasonable effort under the circumstances (the federal regulations for obtaining a rebuttable presumption of reasonableness may be helpful here) (see CCC Section 5233(d)(2)(D)).
Such considerations and their explanations are fundamentals to ensuring directors are acting with due care and loyalty to the organization when a transaction involves an interested director and that voting directors understand what exactly is being voted on. Additionally, although the safe harbors help to protect an organization from certain legal penalties, they do not prevent someone from challenging the validity of that action whether in a court of law, by investigation, or through public criticism for which the organization’s documentation can be an important defense.
Requirement 3 – Sufficient Board Approval Without Counting Interested Directors
The third requirement for a valid unanimous written consent focuses again on how a board should determine a sufficient vote by requiring approval by the noninterested directors by a vote that is sufficient without counting the votes of the interested directors. It is important to note that this requirement was drafted after the provisions related to self-dealing transactions which did not expressly contemplate how self-dealing rules under Section 5233(d) would apply to the unanimous written consent procedure. Thus, this third requirement, though sounding repetitive, reiterates that the board must meet the applicable legal requirements to constitute a board action which here, include not only those provisions related to self-dealing transactions but also those provisions related to a unanimous written consent.
In some situations, there may appear to be no meaningful difference. For example, assuming our interpretation of Section 5233(d)(2)(C) as discussed above applies, an organization with a 10-person board must first establish there are at least 6 noninterested directors who can vote on the transaction at issue in order to satisfy Section 5233(d)(2)(C). If there are 6 noninterested directors and all 6 approve the transaction through unanimous written consent, it appears a sufficient quorum and vote has occurred for a valid unanimous written consent.
However, the conclusion changes if, for example, a 10-person board has 8 noninterested directors and only 6 noninterested directors consented to the transaction. The hypothetical organization here has met the voting requirements under Section 5233(d)(2)(C) which requires a majority of all directors in office to meet quorum (i.e., at least 6 directors of the 10-person board) and approval by a majority of the noninterested directors for a board action (i.e., at least 5 of the 8 noninterested directors). However, Section 5233(d)(2)(C) only addresses actions taken at a meeting. Therefore, the self-dealing rules must be understood with consideration of the unanimous written consent rules which, when taken together, mean a sufficient vote occurs by unanimous written consent when: (i) the number of noninterested directors who can vote on the transaction is at least equal to the number of directors that would be required to satisfy a quorum of a majority of all directors in office (i.e., at least 6 directors of the 10-person board) and (ii) the transaction is approved in writing by all of the noninterested directors who can vote on the transaction (i.e., in this hypothetical, all 8 noninterested directors).
With all the increased scrutiny on financial transactions between nonprofits and their directors (Financial Transactions With Your Board: Who is Looking?), it becomes imperative to approve such transactions in a lawful and thoughtful manner. Ideally, such transactions should be appropriately vetted, discussed, deliberated, and voted upon at a meeting. Where it becomes necessary to vote on the transaction by unanimous written consent, boards should follow the requirements to the letter. And where the requirements are not clear, it may pay to take the conservative approach.
- Emily Chan & Gene Takagi