A Superior Court has the authority to appoint a provisional director pursuant to California Corporations Code §308(a)¹ for a for-profit corporation and §5225(a) for a nonprofit public benefit corporation:

If a corporation has an even number of directors who are equally divided and cannot agree as to the management of its affairs, so that its activities can no longer be conducted to advantage or so that there is danger that its property, activities, or business will be impaired or lost. . . . Action for such appointment may be brought by any director or by members holding not less than 33 1/3 percent of the voting power.

Section 5225(c) requires any person bringing an action for the appointment of a provisional director for a nonprofit public benefit corporation to give notice to the Attorney General, who may intervene, and may also bring an action to appoint a provisional director pursuant to §5225(d).

Thus, unlike a receiver, a provisional director’s authority and duties are limited to overseeing the operations of a corporation to the same extent as the other directors of that corporation and as governed by the corporation's bylaws. While an equity receiver generally controls the day-to-day operations of a business, a provisional director serves a more limited role and generally helps to set policy only. While a receiver is similar to a president or owner of a business, a provisional director is merely a board member and generally has no greater authority than any other board member. However, because the board is deadlocked, and the provisional director is appointed to cast the tie breaking vote in a deadlock, the provisional director is usually the most important board member and generally acts as the board chair. In addition, while a receiver must post a bond, there is no such requirement for a provisional director.

Sections 308(c) and 5225(e) set forth the qualifications for a provisional director, which are similar to those required for a receiver:

A provisional director shall be an impartial person, who is neither a member nor a creditor of the corporation, nor related by consanguinity or affinity within the third degree according to the common law to any of the other directors of the corporation or to any judge or the court by which such provisional director is appointed.

While a provisional director is usually appointed by a civil court, a family law court also can appoint a provisional director pursuant to Family Code § 290. In such a case, the complex dynamics of a pending marital dissolution between co-owners of a corporation understandably adds additional issues to what already is usually a difficult situation.

Unlike a receiver, there is no authority giving a provisional director quasi-judicial immunity. However, §§309(c) and 5231(c) provide that a provisional director who performs the duties of a director in accordance with the provisions of those sections “shall have no liability based on any alleged failure to discharge the person’s obligations as a director.” Consequently, a provisional director usually wants the appointment order to protect the provisional director with indemnification obligations from the corporation and the shareholders, and/or coverage as an insured under existing or newly acquired directors and officers insurance. However, such officers and directors insurance does not provide protection against lawsuits that may be filed against the provisional director by other board members as such insurance normally only covers third party claims and not director or owner versus director claims. In addition, a provisional director should ensure that the business has adequate insurance coverage for other types of litigation and losses. For example, if the business is a manufacturing business, it is important that there is adequate product insurance liability. Further, if an attorney is appointed as a provisional director, the attorney needs to investigate whether his or her legal malpractice insurance will cover the attorney for claims asserted against the attorney arising out of his or her activities as a provisional director since as a director the attorney is not serving in a formal legal capacity.

A provisional director is entitled to be compensated “as shall be fixed by the court unless agreed with the corporation" (§§ 308(c) and 5225(e)). It is customary for the appointment order to specify the provisional director's compensation, which is usually paid by the corporation (oftentimes with an evergreen provision that requires the replenishment of a specified retainer) and sometimes guaranteed by the shareholders. The subsequent court order that eventually terminates the appointment of the provisional director usually confirms the compensation which has been paid to the provisional director, but without specifying the total amount of compensation that has been paid.

After appointment, the provisional director should communicate with counsel for the other directors as soon as possible, and after learning about the nature of the business and the dispute(s), schedule an initial board meeting. The provisional director should ask to receive copies of any relevant documents to review before the initial meeting, including the corporation's articles of organization, bylaws, recent board minutes, and recent financial statements.

It is generally helpful to have the corporation's attorney and the other director/owners’ attorneys present at least at the initial board meeting. It is generally not advisable to have any attorney representing one of the other board members/owners to serve as corporate counsel. Even if the provisional director is an attorney who is not serving in a legal capacity to represent the corporation, in situations where there is a significant business operation and significant disputes between the other deadlocked directors, it is advisable for the provisional director to insist that the corporation engage independent and competent corporate counsel to advise the board on significant legal matters. This effectively provides legal advice for the provisional director and provides the provisional director with an additional layer of protection.

The provisional director should work with the parties (and their counsel) in setting the initial written meeting agenda, including any topics that any of the other board members want to include. Because the provisional director is not a judge, judicial officer or serving as an attorney, ex parte communications with others are proper and oftentimes helpful (although the provisional director's communications are not protected by any privilege against non-disclosure unless the corporation's attorney is a party to the communication). At the beginning of the initial meeting, the provisional director, after introducing himself or herself and describing his or her background, should encourage some informality to lower the level of tension at board meetings. It is helpful for everyone to address each other by first names instead of salutations. Board meetings in these situations are often very contentious, and the provisional director should try to get everyone to act civil toward one another at board meetings, noting that their focus should be on the successful operation of the business and not to further escalate any ongoing litigation between the board members, who often include the owners of what is usually a closely held corporation. Similarly, because there may be ongoing litigation between the board members/owners, the provisional director should try to get the directors to deal with the corporation's future policies and activities and leave prior disputes for judicial resolution.

An impartial person, often someone who works for the provisional director, should be present to prepare written minutes, which will be considered for correction and formal adoption at the next meeting. It can be helpful to send around the minutes and future board meeting agendas before meetings for review and possible modification. It should be noted that the purpose of the minutes is merely to memorialize what is said and agreed upon at meetings in a summary fashion, and not to necessarily serve as manufactured evidence to support or rebut litigation assertions between the board members.

At or before the initial meeting, the provisional director should make sure that the corporation has independent and competent accountants who are providing regular and reliable financial information to the board, as well as independent and competent counsel. It may be necessary for the provisional director to lead the charge to replace such existing professionals if they are not independent or are not providing reliable work product.

It is recommended that board meetings be held at neutral locations, often the offices of the provisional director. It is important for the provisional director to visit the corporation's principal place of business at least once in order to become familiar with the nature and complexities of the corporation’s business and operations, and hopefully to be introduced to some of the principal employees. Holding board meeting at the corporation’s office location can be uncomfortable for employees, who can't help but wonder what is happening and whether their employment is in jeopardy.

A primary objective of the provisional director is to garner the trust and respect of the other board members, and to try to reach consensus whenever possible. Explaining why the provisional director is voting for or against something is often helpful in garnering such trust and respect. In addition, a good provisional director wants to convince the parties that he/she is truly impartial and independent. In doing so, the provisional director often has to confront exceedingly difficult decisions, such as terminating and replacing officers. Before doing so, the provisional director needs to obtain as much reliable information as possible.

While the provisional director is appointed to break deadlocks, like all directors, the provisional director has fiduciary obligations to the corporation and its shareholders, employees and creditors. A good provisional director will gradually have the officers prepare (usually with the assistance of the business' accountants) an operating budget for the current and following year and three or five year operating plans that include goals for the future growth of the business. This is especially helpful when the board is called upon to consider management and employee bonuses since failure to meet or exceed approved budgets and projections are critical to evaluating management's performance. An important consideration in determining whether such bonuses are warranted, as well as the amount of such bonuses, is business growth and profitability.

A good provisional director also will try to help the parties resolve their disputes, which may mean the eventual termination of the appointment of the provisional director. Sections 308(c) and 5225(e) provide that the provisional director serves until the board deadlock is broken or until the provisional director is removed by court order or by approval of a majority of board members. Like receivership appointments, the appointment of a provisional director can last weeks or years, with little predictability.

¹ Unless otherwise specified, all citations are to the California Corporations Code.

*David Pasternak is a member of Pasternak & Pasternak, A Law Corporation in Century City, and a founding member of the California Receivers Forum. He regularly serves as a Receiver, Provisional Director and Partition Referee, and represents others serving as such court appointees.