Co-op directors held to high standards - Management Tip

Rural Cooperatives, Sept-Oct, 2002 by James Baarda

Editor's note: In the last issue we examined the circle of seven responsibilities that all directors have. This second article in a series of three discusses standards of conduct applied to directors and the sources of legal liability imposed on directors when they don't meet the standards. It concludes with a discussion of protections for individual directors against personal liability. Just as responsibilities can be divided into seven distinct, yet related, items, standards of conduct, liabilities and responses can be viewed in seven steps.

1. Directors' roles in perspective

A number of responsibilities are imposed on a cooperative board of directors, but where do individual directors fit in? Four perspectives of directors' roles help identify board and individual director responsibilities. Starting with the broadest perspective and narrowing the view to the individual director gives the following breakdown.

The cooperative is a business organization, almost always a corporation. All of the substantial rules governing cooperative directors come from corporate law.

The cooperative is a very special kind of corporation. Cooperatives operate according to appropriate cooperative rules or principles. These unique cooperative attributes define cooperatives' unique objectives, they require specialized income distribution and financing techniques, they impose unusual decisions on the board of directors and they give cooperative directors "something else to think about."

Narrowing the perspective further, the board of directors acts as a body. The power to act on behalf of the cooperative is given to the board of directors as a body, not to individual directors. No special power is given to an individual board member to act officially. As an individual, a board member has no greater authority than an ordinary cooperative member. The board derives its authority from the incorporation statutes, articles of incorporation, bylaws, and the members. These all identify the board of directors as the governing body.

This perspective further defines an individual director's participation in the cooperative. Decisions are board of director decisions, so an individual director must be able to work effectively within the dynamics of the board to influence board decisions. The board as a whole will be effective only if procedures, committee structures and interaction is conducive to good decision-making. If a director objects to a decision, it is imperative that a negative vote be recorded, otherwise the director will be held to have agreed with the decision.

Responsibilities, standards of conduct and possible liabilities fall on board members as individuals. If the standards of conduct are not met, individual directors may be liable to shareholders and members, to the cooperative, to creditors, to patrons and to the public through civil or criminal laws. What are the standards of conduct by which directors are measured?

2. Standards of conduct

Standards of conduct for corporate directors have been developed over many years by judicial decisions and legislative action. Although cooperative directors face numerous special problems, no separate set of standards has ever been developed for cooperative directors. Therefore, corporate rules generally apply to cooperative directors.

Standards applicable to cooperative directors (as is the case with corporate directors) are usually divided into three "duties." These are summaries of many decisions and statutes and are stated in general terms in this article. The three duties are "duty of obedience," "duty of care" and "duty of loyalty."

3. Duty of obedience

The term "duty of obedience" sounds odd but is logical when explained. The duty means first that directors must perform their roles in conformity with the statutes and terms of the cooperative's documented requirements for the directors. The authority given to the board of directors is defined, as is the purpose of the cooperative. Acts beyond those limits are "ultra vires" and are not authorized.

Neither may the board make decisions that are either themselves illegal or that will cause the cooperative to do something illegal. The duty of obedience also implies that the board should mandate necessary records and record-keeping, internal procedures, policies and compliance programs, then supervise the process to the extent necessary to protect the cooperative from illegal or improper actions.

4. Duty of care

The duty of care, also called the duty of diligence, has developed in judicial decisions but is also found in many corporate statutes. Statutes typically describe the duty of care in three parts: good faith, prudence and judgment.

Directors are required to act in good faith in all circumstances. Directors must also exercise care that an ordinary person in a like position would in similar situations. Finally, a director must make decisions for the cooperative in a manner that he or she reasonably believes to be in the best interests of the cooperative. Directors have the highest obligation to the cooperative and stand in a relationship of trust--a fiduciary relationship. Good faith, conscientious care and best judgments are expected of each and every director.