Elon Musk, Corporations, and Removal of Directors and Officers

In the last year, Elon Musk (the CEO of Tesla and SpaceX) has had a turbulent year. He called a hero diver who helped rescue the Thailand youth soccer team a pedophile; he published false and misleading information about Tesla going private; he smoked weed with Joe Rogan; and the list goes on and on. Despite all of these challenges, shareholders voted to retain him as chairman in June before his voluntary relinquishment of the role last October. The whole situation has brought up several questions in the media about why, how, and when a corporation should remove a director or officer? Elon Musk’s corporation is not located in Arizona, and we are not suggesting that we think he should or should not be removed, but if he worked at an Arizona corporation, the following information could prove useful to company shareholders.

A corporation is considered by law to be its own unique entity, separate from those who own it.
It can be taxed, sued, enter into contractual agreements, etc. A corporation is owned by its shareholders. While the shareholders do not usually oversee major policies and decisions of the corporation, they have the most important job of all, selecting the board of directors who do make those decisions. If the shareholders are unhappy with the direction of the corporation, they may take steps to do something about it and change the board.

Fortunately, your corporation will probably live on despite changes in the board. This article discusses some of the ins and outs of removing and electing new shareholders in Arizona. If you are a shareholder who is unhappy with the way your corporation is being led, then don’t rely on this article alone. Removing a corporate director can be simple and straightforward, but it can also be extremely problematic and difficult depending on the unique circumstances of your corporation, especially its bylaws.

When should shareholders attempt to remove a director or other board member from their position?

Shareholders may consider removing directors and other board members under a number of circumstances, especially when the circumstances involve any kind of breach of a director’s or officer’s fiduciary duties to the corporation. Such duties require directors and officers to engage in fair dealing, disclose and avoid any impropriety of self-dealing or self-interest, and act in utmost good faith on behalf of the corporation.

Board members are expected to demonstrate exemplary behavior and uphold their fiduciary duties to the corporation, but that isn’t to say that they are expected to be perfect. Here are a few of the most common scenarios that prompt shareholders to make changes within the board:

Loyalty

Board members and officers owe a duty of loyalty to the corporation and its shareholders. This means that the directors are expected to put the best interests of the corporation above their own. The most common way the duty of loyalty owed to the corporation is breached is when a director or officer creates a conflict of interest. For example, if a director is in charge of hiring a contractor for a corporation development project and chooses his brother for the job, there is a good chance that he has created a conflict of interest, placing his own interests above that of the corporation.

Under the doctrine of corporate opportunity, neither directors nor officers may usurp business opportunities for their own personal profit. Any type of conflict of interest, effort to compete with the corporation, or secret profiting from the corporation’s dealings will suggest breach of the duty of loyalty and may prompt shareholders to replace the director with another.

Due Care

The duty of care is well established by the Arizona Business Corporations Act, which requires directors and officers to carry out their duties in good faith, to act in a manner that they reasonably believe is in the company’s best interest, and always to be reasonable. It follows that a director or officer’s duty of care involves a type of “negligence” standard. However, this standard is always subject to the business judgment rule described below.

Under A.R.S. §§ 10-830 and 10-842, directors and officers will not be considered to have breached their duty of care if they show that their actions were carried out in good faith, that they reasonably believed those actions were in the company’s best interest, and that a reasonable director or officer in their shoes could have done the same thing. This is called the business judgment rule. If a shareholder objects to a director or officer’s conduct and brings a derivative lawsuit on behalf of the corporation to sue such director or officer, then the shareholder will generally be required to demonstrate by clear and convincing evidence that such individual failed to perform their duties to rebut the presumption that they did under the business judgment rule.

It is important to distinguish between suing directors or officers and merely removing them from their position. Even though making a showing of negligence by clear and convincing evidence is a high bar to meet for legal action, doing so is probably not necessary to simply remove a director or officer, but this may vary depending on your corporation’s unique bylaws. Generally, shareholders may make changes in the board for any reason, regardless of whether the shareholder’s duty of care is breached. But when such a breach is made, removal might be a good idea.

Obedience

The duty of obedience requires directors and officers to act in accordance with the corporation’s bylaws, articles of incorporation, and any other documents that govern how the corporation is run. The duty of obedience also requires directors and officers to adhere to all applicable laws and regulations as well. When a director or officer is not obedient to the corporation’s rules or to any municipal, state, or federal law or regulation, it might be a good idea to remove them from their position. Remember, failing to follow small procedures is often an indicator that a director or officer is willing to be disobedient to more significant rules and laws that can land your corporation in serious trouble.

Unethical Behavior

Any other type of unethical behavior by a director or officer might indicate a need to remove them from their position. This could entail making immoral statements to the public or in private on social media, committing any fraudulent activities, misusing corporate funds, disclosing secret information about the corporation to the public, engaging in insider trading, creating a hostile environment during board meetings, causing sexual harassment, etc.

What governs the process of removing corporate directors and officers?

Generally, the articles of incorporation, bylaws, or other corporate documents such as the code of ethics and conduct will govern the justification and process for removing directors or officers from their position. For example, bylaws are often drafted in such a way that a board is elected by shareholders. The board will then be in control of appointing and removing directors and/or officers. This structure indirectly gives shareholders influence over the board, but prevents the shareholders from directly voting off a director or officer. If the board wants to remove any individual from a director or officer position, then their bylaws will often require a majority vote. Sometimes, however, the bylaws will require a unanimous, super-majority, or a two-thirds majority vote for removal. Because there are so many possibilities, it is critical that corporate bylaws are drafted carefully and in the best interest of the corporation. If you need help interpreting or applying any of your bylaws or articles of incorporation, (or drafting new ones) then give us a call today.

What law governs removal of directors and officers in Arizona?

In the absence of applicable corporate bylaws, Arizona statutory law will govern the removal of officers, directors, and non-profit board members. Such laws are found generally in A.R.S. §§ 10-808, 10-809, 10-2013, 10-3808, and 10-3809.

Removal of directors by shareholders

If a shareholder wants to remove a director, then he or she must generally follow A.R.S. § 10-808 in the absence of corporate bylaws for removal. Generally, § 10-808 states the following:

Shareholders can remove a director with or without cause, so long as the articles of incorporation or bylaws do not state otherwise.

When a director is elected by the shareholders, only the shareholders of the voting group who elected the director may participate in his or her removal.

If less than the entire board is removed, then a director will not be removed when the number of votes sufficient to elect the director under cumulative voting is voted against the director’s removal.

In order for shareholders to remove a director, they must hold a meeting and the notice for the meeting must state that the purpose of the meeting is to remove the director. (This ensures that shareholders will understand the stakes involved and prioritize attending the meeting.)

Removal of a director by judicial proceeding

If a corporation or its shareholders want to remove a director through a judicial proceeding, then they may only do so by following A.R.S. § 10-809. Generally, § 10-809 states the following:

The corporation or at least 10 percent of its shareholders may commence in a legal proceeding to remove the director of their corporation in county or state court when 1) the director engaged in fraudulent conduct or intentional criminal conduct with respect to the corporation and 2) removal is in the best interest of the corporation.

The court can also bar a director from reelection for a period of less than five years.

Unless the corporation elects to become a party plaintiff, then the shareholders must also make the corporation a defendant.

Can I remove a board member from a non-profit organization?

Rules governing the removal of non-profit board of directors and officers in Arizona are found in A.R.S. §§ 10-2013, 10-3808, and 10-3809. While we will not go into the details of nonprofit corporations in this article, it is important to know that the laws regarding removal can be quite complex and vary greatly depending on a foundation’s bylaws. Click on the statutory links above for more information on Arizona’s default rules for removal of board members and officers. For more help navigating this complex area of law, contact our office today.

How do I remove a director or officer in an S-Corporation?

Generally, removal for directors and officers in an S-Corp is the same as removal in a normal Arizona corporation. If you have any questions about removal under your S-Corp’s bylaws, contact our office today.

Can an officer simply resign?

Usually, but the process might vary depending on corporate bylaws. Under the Arizona default rules found in A.R.S. §10-843, an officer may resign at any time by delivering notice to the corporation and will be effective when the notice is delivered, unless the notice specifies a later date. When a resignation is made for a later date, the board of directors may fill the vacancy in the meantime as long as the appointee doesn’t take office until the effective date of the prior officer’s resignation. As long as the bylaws don’t state otherwise, a board of directors may remove an officer at any time with or without cause.

Conclusion

Deciding to remove a board member is a critical decision to make and should generally be a majority decision that has been thought through very carefully. Depending on your articles of incorporation and bylaws, attempting to remove a director or officer could result in dragged-out arguments and even lawsuits. Oftentimes, a director will not go down without a fight. For this reason, you must make sure you are following Arizona state law and your corporate bylaws. Additionally, make sure that your reasons for removal are based upon documented facts, rather than subjective opinions. For additional help and questions regarding removal of corporate directors and officers, contact one of our experienced business attorneys today.

Approved By:

Brad Denton – Denton Peterson, PC

1930 N Arboleda #200
Mesa, AZ 85213

Office: 480-325-9900
Email: brad@dentonpeterson.com
Website: dentonpeterson.com

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