23 Mar Don’t Be a Dinosaur: Four Ways to Modernize your Governing Documents
Most business owners only rarely look at their governing documents. Typically, an entity’s governing documents are reviewed when the entity is formed, and then only looked at again if there is some kind of structural change to the entity, such as bringing in an investor, changing the ownership structure, or preparing the entity for sale.
The term “governing documents” is not actually defined in the Texas Business Organizations Code (the “BOC”), but is used throughout the BOC to refer to, as applicable: (i) the Bylaws of a corporation, (ii) the Partnership Agreement of a partnership (including a general partnership, a limited partnership, a limited liability partnership, etc.), or (iii) the Regulations or Company Agreement of a limited liability company. The governing documents of each entity define the relationship between the owners, and control how meetings and votes are held and how ownership interests are transferred and grant certain rights and responsibilities to the governing authority of the entity (e.g. the Directors or Managers).
Even if you think your governing documents are working well, this article will examine four provisions that routinely cause trouble when they have not been updated recently. It is easy to ignore these when doing a casual review of the governing documents, but if they are not updated, they can create serious problems for a business owner.
1. Outdated Notice Methods
The notice provisions of a governing document specify how the entity will alert its owners or governing authority of certain events.
This can include notification that a special meeting or vote will be held on a particular day, notification that a certain event important to the entity has occurred, notification that a vote or decision was made in the owner’s absence, notification that an owner or governing authority has a right to take a particular action, etc. These provisions also sometimes govern how owners can formally notify the entity, or other owners, of certain events. Notice provisions are sometimes consolidated into one section of a governing document, and sometimes they are repeated (with some modifications, depending on context) throughout the document.
Notice provisions specify the exact manner in which a notice must be made in order to be official, such as by requiring hand delivery of a written notice, and when the notice is agreed to be officially given, such as upon receipt of a hand delivery. Notice that is given in any other way is not “official,” and can be ignored by the entity or the other owners. Unfortunately, too much old boilerplate language persists in today’s governing documents. We frequently see notice provisions that call for notice to be made by telegram, telex, facsimile, or other outdated modes of communication. Alternatively, some notice provisions do not reflect the actual needs of the owners, such a notice provision that declares a notice to be effective three days after deposit with the U.S. Postal Service, but several owners are located internationally and will not receive mailed notices until well after that three-day period has passed.
To remedy this problem, we recommend that all notice provisions be carefully reviewed to ensure that they match the owners’ current needs. In reviewing their provisions, owners should be able to answer all of the following questions:
– Do the notice provisions match across the governing document? And if not, are the differences intentional?
– Do the notice provisions ensure that the intended recipients will actually receive them (such as by requiring receipts or other confirmation of delivery)?
– Do the notice provisions allow for quick delivery in situations where speed is needed?
– Do the notice provisions create too big of a hurdle for the entity or the owners in giving a notice (such as the cost of personal delivery), or are their cheaper options given?
– Is the time in which a notice is deemed received by the recipient spelled out? Does this time period make sense based on the types of notification used, and where the owners are located?
2. Outdated Contact Information
In addition to specifying how notice must be made, a notice provision will also specify where notification must be made. If notice is allowed by mail, a mailing address is usually given; if notice is allowed by email, an email address is usually given; and so on. Frequently, the addresses listed in an entity’s governing documents are not updated as the owners move around. Similarly, sometimes new owners are brought into an entity and their contact information is not added at all. Or, the addresses given in a notice provision either do not match the types of notice allowed (i.e. notice is only allowed by physical mail, but only an email address is listed).
Outdated, mismatched, or incorrect contact information can be ignored by an entity for years, until there is an event that requires formal notice, and not all of the owners are seeing eye to eye. In these situations, it can be difficult to determine if proper notice was given under the governing documents, which then raises the possibility that certain actions of the entity either cannot be done or may have been done in violation of the governing documents.
To prevent this issue from occurring, we recommend that the contact information of all owners and governing persons be regularly reviewed and updated by the entity, and that these current addresses are kept as part of the governing document (via amendment or updated exhibit).
3. Outdated Meeting Rules
Many governing documents do not recognize the advances in telecommunication that have occurred over the past few years. Instead, these documents require meetings to be in person, with a certain minimum amount of advance notice (counted in days, to allow people to travel to a meeting), and sometimes with a required location (i.e. the entity’s main office). An alternative option to a meeting is a “written consent,” where a certain percentage of the owners or governing authority signs a document that contains the resolutions that would otherwise be voted on at the meeting. The issue with written consents is that they are intended for situations where no advance notice is given, and so they typically require either unanimous consent or supermajority consent, rather than the majority consent that is common at a regular meeting.
We recommend that entities review the provisions of their governing documents that address both special meetings and written consents, so that the meeting procedures match how decisions and discussions actually happen. At a minimum, we recommend that governing documents be updated to allow electronic meetings (via conference call or videoconference), and that the advance notice requirement be updated to reflect the modern methods of notice.
4. Outdated Interest Calculations
A governing document will commonly permit loans either from an owner to the entity (either independently or as part of a capital call) or from one owner to another (such as to cover another owner’s share of a capital call). Governing documents can also provide for interest to accrue on unpaid disbursements, such as in the case of an equity class with a preferred return. The interest rate specified in the governing document for these varied situations is either fixed or is pegged to a publicly available rate calculation.
In the case of a fixed rate, we recommend that owners review this set rate regularly to ensure that it still makes sense in today’s rate environment. Frequently, a governing document is designed so that loans from owners are loans of last resort and had an above-market interest rate set for these loans, so that the management would first exhaust their commercial lending options. However, as rates have risen over the last few year, these “high” fixed rates could now be viewed as preferable for the company. The rates may also be lower than what the owners could receive through a traditional investment of their funds.
In the case of a variable rate, we recommend that the source of the rate be examined on a regular basis to make sure it is still viable. For example, the LIBOR (London Inter-Bank Offered Rate) was a common rate to use in governing documents, and we see many clients whose documents reference it, even though the LIBOR was eliminated at the end of 2021. Similarly, if the governing document references an individual bank’s “prime rate,” the owners should ensure that the bank still exists and was not merged or acquired during the intervening years.
Owners that communicate and get along can usually resolve an issue with a loan rate that is no longer clear-cut, but in a situation where there is conflict between the owners, any imprecision in determining the interest rate can be a source of additional conflict and (potentially) a stumbling block towards getting the company the capital that it needs to move forward.
ABOUT THE AUTHOR: Kieran B. Wheeler is a shareholder at Rapp & Krock, PC in the Business Transactions group advising clients on corporate governance matters as well as mergers and acquisitions and other business transactions.
Rapp & Krock, PC presents the information in this article for general education purposes only. Although this article discusses legal issues, it is not legal advice. The law and the content of any linked website may have changed since this article was written, and Rapp & Krock, PC makes no warranty or guarantee about the continuing accuracy of the information presented. Use of this article does not create an attorney-client relationship, and Rapp & Krock, PC does not represent you unless and until we are expressly retained in writing.
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