Every few years, we feel it is important to remind boards of the role of board committee charters. With the new year upon us, there is no better time than now. It is incumbent on all boards on an annual basis to take a step back, take a critical look and assess their committee structure, corporation charters and performance to determine whether the committee is prepared and equipped with the requisite power and authority for the challenge of the new year.
Often, the most ignored governing documents for any organization with a governing board are the committee charters. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis.
A charter not only protects noncommittee members from liability but also imposes that liability on the committee members. For directors, one of the most important protections from liability is the state-law right of reliance of directors upon committees of directors of which they are not members. However, a director may rely upon a committee only for matters within the committee’s designated authority, which the director reasonably believes merits confidence. The committee to which such authority is delegated has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, and not opposed to, the best interest of the organization.
Accordingly, committee charters should be in writing. More importantly, these charters should be periodically reviewed and discussed by directors. At a minimum, committee charters should be reviewed annually by the board. Therefore, care should be taken in reviewing, discussing and drafting any committee charter to balance both:
- The interest of noncommittee members to be protected from liability for the matters delegated
- The competing interest of committee members not to be subjected to unreasonable risk of liability.
Someone familiar with the legal rights and obligations of directors should lead the review and discussion of charters. This is often a regular function of a governance committee (which if not a standing committee is typically party of an organization’s nominating committee). An organization and its individual directors should review the charters of committees with the following questions in mind:
Is the legal nature (i.e., executive, oversight, recommendation or advisory) of the committee clear from the writing or charter?
Each committee charter should establish the committee’s legal nature or type, which is often in a purpose clause. Committees may be executive, oversight or recommendation. The most common of the three being oversight.
- An executive committee has all authority to act on behalf of the board during intervals between meetings of the board. For the charter of an executive committee, typical language in a purpose or similar clause would read, “the executive committee will have and exercise the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board.” Typically, any action or authorization by an executive committee is to be effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs. Executive committees are very common in nonprofit organizations but less common in publicly held and privately held for-profit corporations.
- An oversight committee, such as the audit, compensation or nominating/governance committee, generally “carries out” all authority of the board with respect to their matters of responsibility. The carry-out oversight committee is the result of the Sarbanes-Oxley Act and subsequently SEC, NYSE and NASDAQ rules requiring that oversight of the financial statement preparation and audit process and of executive compensation be by a committee composed of, or otherwise by, independent directors. For the charter of a carry-out oversight committee, typical language in a purpose or similar clause would read, “the audit committee will carry out the board’s oversight responsibilities for the integrity of the organization’s financial statements and reports.” As a result, the actions of these two committees are effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs by not less than majority vote of those directors having no financial or personal interest in such matter.
- A recommendation committee assists the board in reviewing certain matters, but only makes recommendations to the board as to appropriate action. For the charter of a recommendation committee, typical language in a purpose or similar clause would read “the committee will assist the board by reviewing … and recommending some action for the board’s consideration.” Accordingly, any act of the committee is not the act or authorization of the board unless the board affirmatively approves or authorizes such action.
- An advisory committee is not a statutory committee of the board but only advisory to it.
If the committee is properly composed, the right of reliance entitles noncommittee directors to rely upon an executive, oversight or recommendation committee, but not an advisory committee because advisory committees are not statutory.
Is it clear who the committee’s voting members are and, if so, are they directors?
Under most states’ laws, directors are entitled to rely upon committees only if the committee is composed of directors. This does not mean there cannot be nonvoting members of committees, such as nondirector officers, but only those members who are directors may have the right to vote. Voting members, accordingly, must have all rights to receive notice, attend, present and consider matters, vote and otherwise participate in any proceedings of the committee. Nonvoting members are sometimes entitled to be present in person, to present matters for consideration and to take part in consideration of any business by the committee at any meeting of the committee, but nonvoting members cannot be counted for purposes of a quorum nor for purposes of voting or otherwise in any way for purposes of authorizing any act or other transaction of business by such committee.
Is it clear who can call meetings, what notice is required, how meetings can be held, and what constitutes actions of the committee?
Although not legally required, it is recommended that each committee’s charter contain provisions as to how it conducts its proceedings, such as who can call meetings, the notice requirements for meetings and how meetings can be held (including written consents in lieu of meetings).
Are specific responsibilities of the committee stated and, if so, do the stated responsibilities reflect the balance of both (1) the interest of noncommittee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability?
The most important provisions of a committee’s charter are the committee’s responsibilities. These should be written in terms of what is expected of the committee keeping in mind the balance of both (1) the interest of noncommittee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability.
An example of responsibilities of an executive committee include: transacting all of the business of the organization and exercising the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board.
An example of responsibilities of a “carry-out” oversight committee, such as an audit committee, include: carrying out the board’s oversight responsibilities for the integrity of the organization’s financial statements and reports. This includes (1) retaining and terminating the organization’s public accounting firm responsible for auditing, and providing an audit report on the organization’s financial statements; and (2) approving the scope of all auditing services and the compensation and other terms of engagement of the external auditor.
An example of responsibilities of a recommendation committee, such as a finance committee, include: periodically before each fiscal year or other appropriate period review making changes in proposed operating and capital budgets of the organization and recommending to the board adoption of those budgets for such period.
Is it clear whether the committee has authority to have, at the organization’s expense, independent advisors?
One of the most important authorities of any oversight committee is the right to retain, at the organization’s expense, such independent counsel or other advisors as it deems appropriate. This is particularly important for “carry-out” oversight committees. Typically, this may not be an express authority of an executive or recommendation committee and is infrequently an express authority of an advisory committee.
Is the committee required to evaluate itself, its composition, the performance of its members and the provisions of its charter?
Self-evaluations by the committee of its proceedings, as well as the skills and experience of its members, are important to the governance of not only the committee but also the board and the organization itself. Typically, a committee should conduct a periodic evaluation of the provisions of its charter, its performance under those provisions and each committee member’s contribution to the committee’s performance.
How can the charter be amended?
Finally, each committee charter is a governing document of the board as a whole, and it may not be amended except by the board. Still, committees must evaluate their charter and make recommendations to the entire board to amend the charter when necessary. This is especially true if the committee over the past year has found itself lacking the proper authority or direction on an issue.
Evaluating and answering these questions at the beginning of each year will ensure that all committee charters are current and properly structured. Further, such a review will ensure that all directors are aware of the authority that is delegated to each committee and to understand whether he or she may rely on that committee for a particular issue that the board is facing.