Avoiding Risk when Serving as an Advisory Board MemberI am a fan of advisory boards when family-owned companies are transitioning from a board of directors consisting solely of family members. It is a good way to test the waters before moving to a board of directors that includes independent (non-family) members in a fiduciary capacity. I am also a fan of individuals who are willing to serve as members of advisory boards. They play an important role in the life of a family-owned company by bringing new perspective and business expertise. Typically, advisory board members find the work rewarding. However, the role is not without risk.

Although a member of a corporation’s advisory board does not owe statutory fiduciary duties to the corporation or its shareholders, she may unintentionally adopt such duties if, by her actions, she becomes a de facto director of the corporation. In addition, if the corporation and advisory board adopt an engagement letter that spells out the advisory board’s functions, members of the advisory board may be subject to liability if they stray from the boundaries set out in the engagement letter.

If an advisory board member begins to act as a member of the board of directors, she will be considered a “de facto” director. A de facto director’s actions are binding on the corporation so far as third persons are concerned and, thus, an advisory board member who becomes a de facto director would likely owe fiduciary duties like those of an actual director. In order to avoid the danger of an advisory board member becoming a de facto director, each member of the advisory board should take care to avoid taking on responsibilities and performing functions reserved for the board of directors.

If a corporation and its advisory board wish to shield the advisory board members from the various fiduciary duties and potential liabilities of a legal board of directors they should adopt an engagement letter that clearly delineates the advisory board’s roles and the standards by which those roles are to be performed. The letter should also make clear that the advisory board is not to perform roles reserved for the board of directors. The letter should require that the advisory board keep certain legal matters confidential. Lastly, while any indemnification provision included in a corporation’s certificate of incorporation typically does not cover the advisory board, the corporation may (and should) contract to provide indemnification to advisory board members for liability that may arise from their service.

The following is a suggested list of provisions to be included in the engagement letter:

  • The advisory board should not be referred to as a “board” but instead an “advisory committee” or other appropriate title.
  • The advisory board does not have decision-making powers or voting authority.
  • The recommendations of the advisory board are not binding and are subject to review by the corporation’s board of directors.
  • The advisory board should hold meetings separate from the board of directors.
  • Advisory board members should not be counted in determining whether a quorum is present at board of director meetings.

In addition to adopting an engagement letter, the corporation and its advisory board may wish to adopt certain behavioral safeguards. For example, advisory board members should not be informally referred to as “directors” or “the board,” but as “advisors” or another appropriate term. Also, when decisions are made by the board of directors after discussion with the advisory board, resolutions should be adopted by the directors and the meeting minutes should reflect that the advisory board members did not participate in the vote. These suggestions can help ensure that the advisory board remains in a purely advisory role without any semblance to the contrary.

The Importance of Dividend Policies for Family-Owned BusinessesIn our family business practice, we commonly see conflicts between shareholders who are active in the business and shareholders who are not active in the business. The conflict usually arises from the relatively rich compensation paid to the active shareholders (in the forms of salary, bonuses and other benefits) versus the relatively paltry dividends paid to the inactive shareholders. Of course, what is “rich” and what is “paltry” is often in the eye of the beholder. Without question, though, a lack of investment liquidity is a genuine concern for a family business owner who is not active in the family’s business.

It is important for family business owners to recognize that every business has a dividend policy—regardless of whether the directors and shareholders have ever even discussed one. What the company does with excess cash is its dividend policy. Does the company re-invest excess cash to grow the business? Does the company reduce debt or make an acquisition? Does the company repurchase shares? Or does the company pay dividends? If a family-owned business pays above market compensation to family employees, or purchases vehicles and vacation homes for the use of family members who are not active in the business, the company is in reality paying dividends to the family members who receive these payments or other benefits. How the company allocates excess cash flow among the various alternatives makes up its dividend policy.

In some cases, the board or controlling shareholders may make dividend decisions for the wrong reasons. Deferring dividend payments to keep money away from younger generation shareholders, or to avoid making distributions to certain minority shareholders, may lead to family conflicts and potentially legal disputes. Not paying dividends for the purpose of acquiring non-operating assets in the business, or to enable the controlling shareholder to pursue personal projects in the business, may also lead to problems.

There is no rule of thumb for how much a family business should distribute in the form of dividends. However, we find that family business owners who have thoughtful discussions about setting a realistic dividend policy, and who then follow their policy, are less likely to have conflicts.  In addition, paying dividends allows family business owners to invest assets outside of the business and diversify their portfolios.

Different family businesses will have different approaches to dividend policies. One approach is for the owners to set the expectation that all shareholders—regardless of whether they are active in the business—are entitled to receive a certain return on their investment each year. The shareholders, acting through the board of directors, can then direct management to operate the business accordingly. This approach tends to focus management’s attention on generating sufficient earnings and cash flow to meet the owners’ expectations. Outside consultants may be helpful in advising business owners on how to set realistic expectations and policies.

Implementing a dividend policy is a good way to minimize conflicts among business owners–and the key to establishing a well-functioning dividend policy that is open and encourages candid communication among the family business owners.

How to Protect Your Family-Owned Business from Environmental LiabilityEnvironmental liability can pose a significant danger to any business, with enforcement penalties and clean-up costs reaching into the hundreds of thousands, if not millions, of dollars, but family-owned businesses may be especially at risk if they are not well-equipped to comply with environmental regulations and assess potential environmental risks.

There are a few steps family-owned businesses can take to help avoid costly environmental liability:

1. Always perform a Phase 1 Environmental Site Assessment before purchasing property.

A Phase 1 Environmental Site Assessment (or “Phase 1”), following the ASTM standards, should be performed before your family business purchases a piece of property. This site assessment will help to determine if the site in question is potentially contaminated and assess other environmental risks associated with the property. Even if a Phase 1 has been conducted on the property in the past, it is good practice to request a new assessment, as the Phase 1 should be less than one year old at the time of acquisition of the property and certain sections of the Phase 1 may need to be updated if more than 180 days old.

Not only is a Phase 1 an important information-gathering exercise, it can also shield you from certain types of liability in the future. Under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), otherwise known as “Superfund,” liability for environmental contamination can be imposed on any current owner or operator of a contaminated property, even if the contamination at issue was not attributable to their actions. However, an owner can avoid liability under CERCLA through the Innocent Landowner Defense or Bona Fide Prospective Purchaser Defense. Both of these defenses require that the owner, at the time of purchase, undertook “all appropriate inquiries” before taking title to the property.

A properly conducted Phase 1, demonstrating that there was no contamination found on the property at the time of acquisition, is sufficient evidence to prove that the owner took “all appropriate inquiries” before taking title. If a statutorily compliant Phase 1 was not completed before the owner took title to the contaminated property, these defenses cannot be utilized and business owners may find themselves facing steep clean-up costs.

2. Voluntarily disclose and promptly correct environmental violations.

Another tool at your disposal to avoid costly environmental liability is EPA’s eDisclosure process. Under EPA’s eDisclosure policy, regulated entities are encouraged to “voluntarily discover, promptly disclose, expeditiously correct, and take steps to prevent recurrence of environmental violations.” Using the online eDisclosure system, businesses can easily disclose and resolve civil violations. If all of EPA’s conditions under the self-disclosure policy are met, certain penalties will be waived by the EPA.

To fall within the scope of this policy, a family-owned business must: (1) Register in the eDisclosure system, (2) self-disclose within 21 days of discovering a violation, and (3) submit an online Compliance Certification, describing how noncompliance was corrected, within 60 days of submitting the initial online Audit Policy disclosure (or within 90 days if qualified to submit a Small Business Compliance Policy disclosure). While it might seem counter-intuitive to disclose your company’s own violations to EPA, the eDisclosure policy ensures that voluntary disclosure, accompanied by prompt correction of the violation, will result in little or no penalty—a boon to the regulated and the regulator alike.

3. Take advantage of free resources to ensure compliance with environmental regulations.

A number of excellent free resources are available to assist businesses in complying with complicated environmental laws. The Small Business Environmental Assistance Program provides an email and telephone hotline that certain businesses can use to get quick answers to their environmental questions. This program also provides information on industry trade associations that can provide businesses with information and assistance in complying with environmental regulations that affect their industry. Each state also has a Small Business Compliance Assistance Program and contact person to aid in compliance with state regulations. Finally, the EPA compiles information on Compliance Assistance Centers, categorized by industry, that helps businesses understand and comply with environmental laws. By utilizing these resources, family-owned businesses can lower the risk of noncompliance and environmental liability at little to no cost.

Please contact us if you have questions about or need more information on environmental compliance for your family business.