Corporate Governance 2024 Comparisons

The principal forms of corporate/business organisations in Puerto Rico are “corporations” and “limited liability companies” (LLCs) – the latter having gained popularity among business owners given the particular advantages they offer, including:

• the freedom to structure management (ie, member-managed, manager-managed, or with a centralised management structure such as board-managed);
• not being required to file and disclose financial statements with the Puerto Rico Department of State;
• enjoying streamlined corporate formalities; and
• having the option to be taxed as a pass-through entity or as a regular corporation.

Please note that although there are publicly traded companies organised under the laws of Puerto Rico that trade in national stock markets (ie, NYSE and AMEX) and over-the-counter markets (ie, NASDAQ), this chapter will not cover corporate governance requirements applicable to publicly traded companies under United States federal securities laws and regulations and applicable securities exchanges rules and regulations.

There are two main sources of corporate governance requirements.

• Legal sources: Puerto Rico Corporations and LLCs are subject to the requirements of the Puerto Rico General Corporations Act of 2009, as amended (the “Corporations Act”) and regulations published under it, as well as case law from the Puerto Rico Supreme Court. It is important to note that the Corporations Act is modelled after the Delaware General Corporation Law, and that the Puerto Rico Supreme Court has stated that judicial decisions from Delaware courts in connection with the interpretation of the Delaware General Corporation Law shall be highly persuasive and illustrative before Puerto Rican courts. This principle of interpretation has not been expressly extended by the Puerto Rico Supreme Court to Delaware court decisions interpreting the Delaware Limited Liability Company Act (the “Delaware LLC Act”); however, it seems highly probable that the same principle would apply.       
• Organisational documents: A corporation’s or LLC’s organisational documents are an important source of corporate governance requirements. A corporation’s articles of incorporation, by-laws and shareholders’ agreement may include particular provisions regarding voting requirements, transfer restrictions, meetings and shareholder rights, among others. Note that although a shareholders’ agreement is an important source of corporate governance for corporations, the Corporations Act does not impose on a corporation or its shareholders the obligation to adopt such a document.

Although the Corporations Act has default provisions applicable to LLCs, an LLC’s limited liability company agreement is the principal source of corporate governance requirements. This is because one of the LLC’s principal benefits is the freedom provided to the members in determining the governance structure of the company, the formalities (if any) that shall be required, and ultimately how the company is managed.

Under Puerto Rico law, the Corporations Act does not impose on the members of an LLC the obligation to adopt a limited liability company agreement. However, unlike Delaware law, which includes oral, written or implied forms of a limited liability company agreement, the Corporations Act defines the limited liability company agreement as a written agreement. If no limited liability company agreement is adopted, the LLC will be subject to the default provisions contained in the Corporations Act. For the purpose of this publication, the authors will treat LLCs as if a limited liability company agreement had been adopted.

Puerto Rican publicly traded companies registered with the Securities and Exchange Commission are subject to regulations promulgated under the Securities Act of 1933 and the Securities Exchange Act of 1934, and to such other rules and corporate governance requirements imposed by the exchanges in which their securities are traded.

A recent development in corporate governance is the amendment of the Corporations Act in December 2015 to allow for the organisation, merger and/or conversion of public benefit corporations (“Benefit Corporations”) in Puerto Rico. Benefit Corporations that are organised under the Corporations Act are required to file annual reports and social benefit reports, setting forth the public benefit provided by the corporation.

One of the advantages of organising a Benefit Corporation is that its directors, in making their determinations, are allowed to consider factors other than the best interests of its shareholders (for example, they are allowed to take into consideration, among other things, the general public benefit pursued, the best interests of its employees and the community at large). In addition, directors of Benefit Corporations shall not be liable for any damages caused due to decisions made in good faith and in pursuit of the general public benefit set forth in the certificate of incorporation.

Additionally, in 2017, the Supreme Court of Puerto Rico decided that, in order to require that a corporation liquidate any assets still owned by it after the three-year period granted by the Corporations Act following dissolution has elapsed, the interested party must request that the court appoint one or more of the directors of the corporation to be trustees, or appoint one or more persons to be receivers, of and for the corporation, to take charge of the corporation’s property, as provided under Article 9.09 of the Corporations Act.

A major challenge in Puerto Rico is that the majority of private companies in the country are closely held family businesses that generally do not have the sophistication of larger businesses with regard to matters of corporate governance. Thus, given the nature of these companies, corporate governance formalities are not always strictly followed or enforced, and this may cause difficulties or problems when attempting to execute certain types of transactions, such as obtaining commercial financing or a merger and acquisition of an ongoing concern. 

Another significant challenge for most closely held family businesses is the adoption and successful implementation of an orderly plan of succession that will smoothly transfer the management of the business from one generation to the next. Often, these companies are founded and managed by one individual who may not take the time to nurture or identify another person or persons to succeed them after their retirement or death. The lack of a generational transition plan has resulted in the termination of many successful businesses in Puerto Rico.

Due to their flexibility regarding governance, LLCs offer family and small businesses the ability to reduce recurring governance and other formalities.

As a result of the COVID-19 pandemic, and despite already being permitted under the Corporations Act, there has been an increase in questions and/or requests to update by-laws, limited liability company agreements and organisational documents to allow for remote meetings of shareholders, members, directors and managers.

In addition to existing regulations concerning the use of natural resources that extend from federal to local law (for example, regarding air and water pollution) which vary depending on the industry sector, Act 33-2019 adopted a new public policy to:

• address climate change;
• reduce and mitigate the effects of greenhouse gas emissions;
• address deforestation on the island;
• promote a sustainable economy; and
• incentivise renewable energy sources, as part of the government’s energy diversification and transformation policies under Act 82-2010 (Renewable Energy and Diversification) and Act 17-2019 (Energy Public Policy Act), among others. 

Likewise, as previously mentioned in 2.1 Hot Topics in Corporate Governance, in December 2015, the Puerto Rican government enacted Act 233-2015, which amended the Corporations Act to allow the creation of public benefit corporations. Public benefit corporations are required, among other things, to file annual reports and social benefit reports regarding:

• environmental matters (product cycle management, reduction of waste and residues, use of clean technologies, reduction of a negative environmental footprint, and responsible use of natural resources);
• corporate operations (information transparency, economic impact in the communities where the corporation operates, and health and safety initiatives); and
• human capital (policies and practices against discrimination, elimination of work violence, and development of human capital).

Also, the reports must set out the public benefits that the entity brings to the community in which it operates.

In addition, a significant number of companies practise various levels of corporate social responsibility. Generally, Puerto Rican companies and business leaders are actively involved in an array of non-profit entities that provide a wide variety of services and benefits to local communities.

As a general rule, corporations are managed by or under the direction of a board of directors. This notwithstanding, the certificate of incorporation for certain types of corporations (eg, close corporations and non-profit corporations) could establish a different management structure, in which case the person or group of persons designated in the certificate of incorporation would assume all of the powers and responsibilities traditionally granted to the board of directors. Furthermore, the certificate of incorporation may grant to the board of directors the power to execute management agreements – provided, however, that the terms of such management agreement may not exceed three years. It is important to note that the board of directors of a corporation generally does not engage in or manage the daily operations of the corporation; instead, such responsibilities are delegated by the board of directors to the officers that it appoints. 

Contrary to a corporation, an LLC is member-managed by default; however, the limited liability company agreement may provide for a centralised management structure similar to that of a corporation (ie, a board of managers and officers). As the name implies, in a member-managed LLC the members are responsible for the day-to-day operations of the company. In certain instances, the members may decide to appoint a manager, who does not have to be a member, to oversee the day-to-day operations of the company.

As previously mentioned, Delaware case law is highly persuasive in Puerto Rico. Although the Puerto Rico Supreme Court has yet to express itself on the following matter, it is important to note that the Delaware Chancery Court has stated in Obied v Hogan, WL 3356851 (2016) that the choice of management structure chosen by the members shall have consequences when drawing case law as an analogy in order to solve a controversy. For example:

• if the members adopted a board of managers structure, corporate law may be applied by a court of law; or
• if the members adopted a member-managed structure, general partnership law may be applied by analogy in deciding the particular controversy.

The board of directors of a Puerto Rican corporation is responsible for making key decisions and providing strategic direction to the corporation. Some of the major decisions made by the board of directors include the following:

• appointment of officers – the board appoints the Chief Executive Officer (CEO) and/or President, the secretary and any other officers of the corporation, and evaluates their performance regularly;
• financial oversight – the board reviews and approves the company’s financial statements, budgets and major financial transactions;
• stock-related decisions – the board makes decisions related to dividends, stock issuances or repurchases;
• extraordinary transactions – the board evaluates and approves extraordinary transactions (such as potential mergers, acquisitions or divestitures, sale of substantially all or all of the corporate assets, or the dissolution or liquidation of the corporation) and recommends any such transaction to the shareholders of the corporation for their consideration and approval; and
• legal and regulatory compliance – the board ensures compliance with applicable laws, regulations and corporate governance.

The governance structure of a Puerto Rican LLC is generally set forth in the limited liability company agreement. The LLC can be member-managed, manager-managed or can even adopt a more traditional corporate board structure. Where the limited liability company agreement is silent, the holders of a majority of the company’s membership interest shall control, but any member can bind the company before a third party.

The decision-making process for a board of directors and/or other governing bodies typically occurs through one of two methods:

• meetings; or
• written consent.

The Corporations Act does not impose a statutory requirement to hold a minimum number of board of directors’ meetings, nor does it provide or establish specific guidelines as to how to conduct the order of business in a board meeting. The Corporations Act simply requires, unless otherwise stated in the certificate of incorporation or the by-laws, that the board of directors’ meeting be held in person or by electronic means of communication (such as telephone or video conferences) provided that all members of the board of directors assisting such meeting can listen to each other simultaneously.

Furthermore, unless prohibited by the corporation’s by-laws, any action required or permitted to be taken at any meeting of the board of directors may be taken without a meeting, if all members of the board of directors consent thereto in writing, and such consents are filed with the minutes of the proceedings of the board of directors. Thus, any rules governing the meetings of the board of directors, such as minimum notification periods, frequency of meetings and quorum, are most commonly specified in the corporation’s by-laws.

The Corporations Act does not govern the meetings of the members of an LLC, nor does it provide or establish rules governing the structure or process for the meetings of the members or any governing body. Given that the Corporations Act does not require that a meeting of the management body of an LLC be held, such requirements are generally established in the company’s limited liability company agreement.

A typical board structure of a Puerto Rican corporation consists of one or more natural persons who are elected to act as directors of the corporation by the shareholders. In a standard board structure, all directors are elected for a one-year term, and shareholders vote for the entire board at the annual meeting.

However, a Puerto Rican corporation may choose to implement a staggered board structure, where the board is divided into multiple classes, with each class serving a different term length. For example, the board may be divided into three classes, where one class is elected for a one-year term, another for a two-year term, and the third for a three-year term. Each year, shareholders vote to elect directors for the class that is up for election, and this process is repeated over the years. The purpose of a staggered board structure is to provide continuity and stability to the corporation’s leadership.

In the case of an LLC, if the limited liability company agreement provides for a board structure, one salient difference is that a legal entity can be a member of the board of an LLC.

In a Puerto Rican corporation, there are no set roles for directors; nevertheless, if the corporation is so structured through its by-laws and/or certificate of incorporation, directors may hold various offices with particular roles, such as the following.

• The chairman of the board is usually responsible for leading board meetings and setting the agenda, and often acts as a liaison between the board and senior management.
• The vice-chairman is a senior board member who supports the chairman of the board, and may step in to fulfil their duties in their absence. The vice-chairman often plays a leadership role in board committees and provides guidance to other directors.
• The secretary of the board of directors of a Puerto Rican corporation must be present at all meetings of the board of directors and take minutes of the discussions and decisions taken at any such meetings.
• Committee chairs – directors may serve as chairs of various board committees, such as the Audit Committee, Compensation Committee and Nominating Committee. Committee chairs are responsible for leading committee meetings, overseeing specific areas of corporate governance and making recommendations to the full board.

The only requirement is that directors be natural persons of legal age. There are no composition requirements, such as regarding independent directors, etc.

The members of the board of directors of a corporation are elected annually by a majority vote of the shareholders present at the annual meeting of shareholders, in person or via proxy, who have the right to vote at such meeting. It is important to note that the certificate of incorporation may provide for the creation of a staggered board with two or three groups of directors, who may serve for a period of one to three years. In a staggered board, only one group of directors will be elected at each annual meeting of shareholders. Through its articles of incorporation and/or it by-laws, a Puerto Rico Corporation may establish other restrictions or requirements for directors.

In a non-staggered board of directors, any one director or the whole board of directors may be removed with or without cause by the holders of a majority of the shares entitled to vote for the election of directors.

In a staggered board of directors, shareholders may only remove a director for just cause, unless otherwise provided in the certificate of incorporation. Furthermore, if the certificate of incorporation authorises cumulative voting, no director may be removed if the cumulative votes against their removal are sufficient to elect such director as a member of the board of directors.

In the event of a vacancy as a result of the removal, resignation or death of a director, the remaining members of the board of directors may designate a director without seeking the approval of the shareholders. A director designated to the board of directors in such a fashion shall serve for the remainder of the former director’s term.

Unless otherwise specified in the certificate of incorporation or by-laws, the officers of a corporation are appointed by the board of directors without the need to seek the consent of the shareholders. The board of directors has the exclusive power to appoint and remove corporate officers as they deem to be in the best interests of the corporation.

The members of an LLC may choose to appoint a manager or a group of managers who will have the rights and responsibilities provided in the limited liability company agreement. The authors note that the Corporations Act does not directly address the removal of the manager of an LLC; however, a manager may be removed by the members holding a majority interest in the LLC.

Although there are no legal requirements for Puerto Rico corporations to have an independent director(s), under the Corporations Act, independent directors are considered objective and free from conflicts of interest that could compromise their judgement, and there are rules and requirements related to the independence of directors and the management of potential conflicts of interest. These rules aim to ensure that directors act in the best interest of the corporation and its shareholders. Among the most salient key considerations are the duty of loyalty and the duty of care, which are discussed in further detail in 4.6 Legal Duties of Directors/Officers.

The directors and officers of a corporation are bound by three principal legal obligations:

• to act pursuant to the objectives and purposes of the corporation;
• to perform their duties with the care and attention that a reasonable and competent person would exercise under similar circumstances (“duty of care”); and
• to act in a just manner and exercise their powers with the utmost loyalty and in the best interests of the corporation and its shareholders (“duty of loyalty”).

The duty of care includes responsibilities such as:

• the duty to monitor; and
• the duty to make enquiries.

The duty of loyalty imposes upon directors and officers the obligation to act in the best interest of the corporation and its shareholders, setting aside their own personal interests. In order to comply with this duty of loyalty, the directors and officers must avoid transactions that may result in a conflict of interest with the corporation. The directors and officers of a corporation should not engage in or become involved with businesses that compete with the corporation, nor should they use material non-public information for their personal gain.

The Corporations Act expressly extends the duties set forth above to the members and managers of LLCs. 

A director will be found to have violated their duty of care where a plaintiff is able to prove that the actions of the director were grossly negligent. To establish that the director was grossly negligent, the plaintiff must first overcome the presumption provided by the “business judgement rule” – ie, the presumption that in making a decision, the director was informed and acted in good faith and in what they believed were the best interests of the corporation.

Furthermore, the business judgement rule provides that the plaintiff must prove that a reasonable commercial basis for the director’s decision did not exist. The underlying purpose of the business judgement rule is to allow directors and officers to make reasonable business decisions without holding them responsible for the success or failure of each venture.

Where the presumption established by the business judgement rule is overcome, the implicated directors are subject to the “entire fairness” judicial standard of review, under which a director must show that the decision was taken with the utmost good faith and that it was inherently fair to the shareholders.

Notwithstanding the foregoing, a corporation’s certificate of incorporation may include a provision limiting or eliminating the monetary responsibility of a director or officer for breaching their fiduciary duties, with the exception of the duty of loyalty and acts or omissions done in bad faith.

Fiduciary duties are owed to the corporation and shareholders. In the case of LLCs, members and managers are subject to the same fiduciary duties as the directors, officers and shareholders of a Puerto Rico Corporation.

Regularly, in terms of fiduciary duties, the board or management body is required to take into consideration the interests of the entity itself and of its shareholders or members. That said, through the certificate of incorporation or by-laws (for corporations), and especially in the limited liability company agreement (for LLCs), other interests may be agreed upon for consideration by the board or management body. As previously mentioned, in the case of a Benefit Corporation, directors, in making their determinations, are allowed to consider factors other than the best interests of the shareholders; for example, they are allowed to take into consideration the general public benefit being pursued, the best interests of the employees and the community at large (among other things).

Excluding derivative suits, shareholders may bring a direct lawsuit against directors and officers if they can demonstrate that they suffered harm individually as a result of the breach of fiduciary duties. This typically requires a showing of personal loss or injury separate from the harm suffered by the corporation as a whole. The responsible directors and officers can be held liable for their breach of fiduciary duties through various means, which may include the following.

• Monetary damages – directors and officers found to have breached their fiduciary duties can be held personally liable for monetary damages. This may include compensating the corporation, shareholders or other affected parties for any financial losses incurred as a result of the breach.
• Injunctive relief – courts can issue injunctions to prevent the continuation of the wrongful conduct or to require specific actions to rectify the breach and protect the interests of the corporation or affected parties.
• Rescission or restoration – in cases where the breach involved a transaction or action that harmed the corporation or its stakeholders, the court may order the rescission or undoing of the transaction or the restoration of the corporation to its prior condition.
• Removal or disqualification – in extreme cases of breach of fiduciary duties, the court may even order the removal of directors or officers from their positions.

See 4.6 Legal Duties of Directors/Officers. Breaches of the limited liability company agreement by a member or manager may also be enforced against them.

The Corporations Act does not impose any limitations on the compensation of directors. Unless otherwise specified in the certificate of incorporation or the by-laws, the board of directors has the authority to determine the compensation to be paid to the officers and directors of the corporation. The Corporations Act does not specifically address this matter in connection with LLCs.

See 4.10 Approvals and Restrictions Concerning Payments to Directors/Officers.

Except for certain extraordinary matters (such as a merger or consolidation, the sale of all or substantially all of the assets, or dissolution) for which shareholder approval is required, generally shareholders do not have corporate governance responsibilities in corporations.

Notwithstanding the foregoing, in situations where a majority shareholder has a conflict of interest with respect to a corporate matter, the Corporations Act imposes upon the controlling shareholder a duty of loyalty. In the case of LLCs, the Corporations Act establishes that members are bound by the same duty of loyalty to the LLC and to the other members as established for directors, officers and shareholders of a corporation. For LLCs, the Corporations Act allows for different responsibilities to be agreed upon in the limited liability company agreement.

One of the basics tenets of corporate law under the Corporations Act is that the business of a corporation shall be managed by or under the direction of a board of directors. Thus, shareholders are generally not involved in the direct management of the corporation. The principal exception to this occurs in the context of close corporations, in which the shareholders may be primarily responsible for the operation and management of the entities, if such governance structure is so provided for in the articles of incorporation.

Nonetheless, shareholders have the right and the power to elect the board of directors, as well as the right to vote on and approve extraordinary transactions, such as:

• any amendment to the certificate of incorporation or the by-laws;
• a merger, consolidation or conversion;
• the sale of all or a substantial amount of the assets of the corporation; or
• a dissolution.

Contrary to corporations, LLCs are regularly managed in a decentralised fashion by their members (similar to partnerships) and members actively participate in the operation and management of the LLC. The Corporations Act provides that unless otherwise established in the limited liability company agreement, the LLC will be managed by the members owning more than 50% of the equity interests in the LLC.

Notwithstanding the foregoing, the members may choose to implement a centralised management structure, similar to that of a corporation, including the election of a board of managers and the appointment of officers. In such case, the members need to specify in the LLC’s limited liability company agreement the particular requirements regarding the management structure, including what rights they wish to retain for themselves and wish to not delegate to the LLC’s board of managers and officers.

The Corporations Act requires that corporations hold an annual meeting of shareholders, and allows the board of directors to convene special meetings of shareholders to discuss and take action on particular matters. The Corporations Act further provides that the notification period for an annual or special meeting must be no less than ten days and no more than 60 days prior to such meeting. If the notification is for a special meeting, the purpose of that meeting must also be disclosed in the notification.

In addition, the by-laws of the corporation may establish additional rules regarding who may convene special shareholder meetings. For example, they could provide that the shareholders holding a majority of the voting rights may convene a special meeting. In annual and special meetings, the shareholders have the right to vote (either in person or via proxy) on the matters brought before them. The Corporations Act also allows for participation via electronic methods. 

Contrary to corporations, LLCs are not statutorily required to hold annual or special member meetings; thus, the establishment of such meetings and the rules governing them are subject to the discretion of the members or as otherwise stated in the limited liability company agreement.

A shareholder may present a direct action against the corporation and its management alleging that they have suffered damages as an individual shareholder.

Additionally, shareholders (and, in certain situations, creditors) may pursue derivative actions against management. In a derivative action, a shareholder or group of shareholders pursues a claim on behalf of the corporation where the directors or officers of the corporation fail to do so or violate one or more of their fiduciary duties. This inaction on the part of management typically takes place where the directors or officers of the corporation are responsible for the damages alleged under the derivative action.

It is important to note that under a derivative action, any relief or award granted by the courts shall be for the sole benefit of the corporation and not of the shareholder(s) who initiated the action. In the case of an LLC, the Corporations Act expressly states that only a current member of the LLC may file a derivative suit.

See 1.3 Corporate Governance Requirements for Companies With Publicly Traded Shares.

There is no statutory requirement for private companies regarding corporate governance disclosures to private parties, besides compilation of the company’s organisational documents (such as the certificate of incorporation and by-laws), the shareholders’ agreement (if adopted), the certificate of organisation and the limited liability company agreement, available to the shareholders and members of the corporation and/or LLC. See also 7. Audit, Risk and Internal Controls.

However, the Corporations Act requires that all corporations file an annual report to the Puerto Rico Department of State, detailing, among other things, the identity of at least two officers and/or directors of the corporation. The Corporations Act does not require such disclosure for LLCs with the Puerto Rico Department of State. Such annual reports are available to the public through the Department of State’s website. However, no other requirement for public disclosure on websites exists in Puerto Rico.

See 6.1 Financial Reporting.

In addition to annual reports as discussed in 6.1 Financial Reporting, corporations and LLCs have to register the following with the Puerto Rico Department of State:

• the certificate of incorporation or organisation; and
• amendments, mergers, consolidations and dissolutions.

Additionally, corporations and LLCs are now obligated to file their existence or dissolution with the Registry of Legal Entities. Such filings, including annual reports, are publicly available.

Failure to make such filings would result in such acts being regarded as having not taken place. Not presenting the annual reports or not paying annual dues may result in the cancellation of the entity.

Under the Corporations Act, corporations with an annual business volume in excess of USD3 million are required to file with the Puerto Rico Department of State an audited balance sheet, together with their annual report. LLCs are not required to file financial reports with the Puerto Rico Department of State.

Under Delaware case law, which, as previously indicated, is highly persuasive in Puerto Rico, directors have certain requirements and responsibilities regarding risk management and internal controls.

While Delaware courts generally afford directors considerable discretion in managing the affairs of the corporation pursuant to the business judgement rule, directors are expected to fulfil their duties of care and loyalty, which encompass risk oversight and internal controls. This involves:

• understanding and assessing the major risks the corporation faces;
• ensuring that appropriate risk management and internal control systems are in place; and
• periodically reviewing the effectiveness of these systems.

Internal controls are systems, processes and policies designed to:

• safeguard the corporation’s assets;
• promote accurate financial reporting; and
• ensure compliance with applicable laws and regulations.