Tag Archives: corporate governance

COMMON LAW DIRECTOR DUTIES II


We discussed two common law duties in the last post, today we cover the remaining duties.

The next key duty of directors is that they should exercise unfettered and independent discretion and judgement.

Directors should exercise objective and unbiased judgement on the affairs of the company independently from management and any shareholders, but with sufficient information to enable a proper and objective assessment to be made. The director should not be influenced by any other party interested in the outcome of the decision. Put another way the director should be making his own decisions rather than simply implementing the instructions/commands from stakeholders. This flows from the concept that it is the director who is both personally and criminally liable for performance of the duty of care and good faith to the company. I have seen many fall foul of this common law duty in Board rooms. Some directors try to flow with anything that the Group CEO or the most powerful principle wants. This may be due to the fact that they want to stay on the Board and fear jeopardizing their income or they derive some social value form regarded as a compliant director.

 A corollary of this is that even when directors depend on information from experts, consultants and other members of the company for information, they still need to exercise their minds and make unfettered decisions.  The directors have to be very familiar with the governing documents and business model of the organization

The other common law duty is that directors should avoid having their persona interests conflict with those of the organization. A related duty is the disclosure and management of any potential conflicts. The personal interests of a director; or of people closely associated with that director, should not take precedence over the interests of the company.

 This implies that in their responsibilities to the company they should not put their own interests before the organization. This can happen, for example, in State Owned Entities where directors can vote to pay themselves very high board sitting fees when the entity is loss making. Similarly directors should not in any way misappropriate corporate opportunities due to the company as well as improperly competing with the company.

Similarly a director should not make any secret profits or possible incidental profits at the expense of the company or accept profit from third parties using their position as directors.

These common law duties are quite onerous and should be carefully considered before and during Board services. They can be detrimental to your wealth creation if you are found liable personally for violating them. Many people in NGO voluntary corporate Boards usually take these casually not realizing that they are still responsible legally even if they are not paid.

I hope this discussion has been enlightening and helps you in your fiduciary duties.

COMMON LAW DUTIES OF DIRECTORS


In a previous blog we discussed the legal duties of Corporate Directors. In the next few blogs we dig deeper into Common Law duties of directors. Common law duties are separate from statutory duties as codified by the Law although some common law duties may have been included into the Code. Where some duties in common law have been codified into law, then the law takes precedence. Where there has been no codification of the common law duties, these common law duties are still legally expected to be complied with. It is therefore important for any director to be aware of these duties.

1. A director should act only in the best interests of the company. This means that they should act in a manner that benefits the company as a whole and bona fides towards the company interests. This common law duty normally entails three key aspects namely:

  • must make all decisions and act solely for the benefit of the organization. The primary principal for directors is the company itself. Not the appointing authority or any other party. This duty is owed to the company as a legal persona.
  • may not use or disclose any confidential information for their own personal benefit or for anyone other than the organization
  • must promote the success of the company for the benefit of the members whereby success is viewed as long term increase in value. In doing so a director must consider holistically a multiplicity of factors including the likely long-term consequences of any decision on all stakeholders. This is also captured in the King IV as the stakeholder inclusivity concept. In some jurisdictions e.g. in the UK, the law also specifies the need for protecting the corporate reputation and the need for acting fairly towards all shareholders.

2. A director should not act beyond the limitations of powers and should act for a proper purpose which means a director should always act within the ambit of their authority. This directors’ duty may be distilled into two aspects namely:

  • may not exercise the powers granted to them for any unauthorized and improper purpose and for any ulterior motive. These powers are exercised for the good of the company and not for the benefit of the director himself. This speaks to the intended purposes by both law and the memoranda of incorporation.
  • may not exceed their powers and may only use them for the purposes for which they were granted. This is a way for controlling power of directors. This power is generally granted by law and or by the corporate constitutional documents and agreements. A director has to be familiar with these as they outline and detail any limits to a director’s decision-making powers. Directors must act in accordance with this, and only exercise their powers for the purposes for which they were given. If these powers are exceeded, then decisions may be reversed, transactions may be voided, and may leave the directors liable to pay for any financial losses to the company. In the South African context, the directors powers derive from the Company Act 2008 and not from the company’s Memorandum of Incorporation.

This duty is distinct from the duty of good faith, although they operate cumulatively implying that a director who may have acted in good faith can be found to have not exercised his powers for a proper purpose.

In the next blog post we take a look at the next two common law duties.

REPRESENTATIVE DIRECTORS


The organisation’s directors are normally appointed by shareholders at the recommendation of the Board’s Nominations Committee. However certain directors are appointed by a particular stakeholder.  By way of Memorandum of Incorporation some shareholders with a certain equity holding may be permitted to appoint directors. In some cases providers of capital or debt like banks may through contract appoint directors. In Group Corporate structures, companies may appoint either employees or directors to the subsidiary Boards. In NGOs there may be some stakeholders with the right to appoint directors.  All these directors who are appointed by a particular shareholder are referred to as representative directors since they are appointed ostensibly to represent the interest of that stakeholder.

These representative directors create numerous complexities which need to be managed. The appointing party would want to view the director as representing their interests and so would like to direct them in a way they should vote or decide while on the Board. However this conflicts with the fiduciary role of the director that clearly expects the director to make decisions ONLY in the best interests of the company and to act independently. Representative directors should be cautious as they can suffer personal criminal and civil litigation for their decisions while on the Board. The appointing authority may not suffer the same fate. There are cases where the appointing stakeholder needs to be careful to avoid being considered a “deemed” de facto director and be held criminally liable for the decisions of the director they “control”.

In the Fisheries Development Corporation of SA Ltd case the court found that “A director in that capacity is not the servant or agent of a shareholder who votes for or otherwise procures his appointment to the board ….The director’s duty is to observe the utmost good faith towards the company, and in discharging that duty he is required to exercise independent judgement and to take decisions according to the best interests of the company as his principal. He may in fact be representing the interests of the person who nominated him, and he may even be the servant or agent of that person, but, in carrying out his duties as a director, he is in law obliged to serve the best interests of the company to the exclusion of the interests of any such nominator, employer or principal.” (Fisheries Development Corporation of SA Ltd vs Jorgensen and Another; Fisheries Development Corporation of SA Ltd vs AWJ Investments (Pty) Limited and Others 1980 (4) SA 156 (W) on pages 158 and 164)

An example is that a director appointed to a subsidiary board may be expected to vote for a dividend declaration by the Holding Company BUT this may not be in the best interests of the subsidiary company on whose Board she serves. The law requires that director to vote in the best interests of the Company even if she may suffer sanction from her employer. To avoid this conflict the appointing stakeholder, the director and the company must agree on format of handling this conflict in a was that does not violate the law.

I once served on the Board of a non profit organization where the principal expected directors to make decisions in his interest and not in the interests of the company. It was a painful experience until I chose to resign as the working relationship was no longer tenable. He literally wanted me to serve as a simple proxy while he remained the decision maker. Some NGOs may view representative directors as spokespersons for the principal who makes the decision without carrying the legal liability.

One more time let me emphasize that the legal position is that the representative director once appointed has the company as his principal and not the appointing person.

The Corporate Governance Network gives the following guidance for these representative directors:

• Understand your fiduciary responsibilities as directors

• Ensure that appropriate training is received on governance and directors’ legal duties

• Establish at the outset what the appointing company expects from you in your role as directors and, agree, with each of the parties involved, what may and may not be divulged, also bearing in mind the provisos of the Law. If, at the outset, the appointing company expects you as the director to breach your fiduciary duty, then it is prudent to decline the appointment

• Understand what process you should follow when faced with a dissenting view from the board on which you serve

• Ensuring that you have access to legal advice at the Company’s expense.

DISSENT IN BOARDROOM


The Board is charged with the responsibility of making decisions that guide the company. In the process there will be occasion for disagreement. This is healthy. A board that is always in agreement probably lacks robust debate. The usual result is poor decisions. The Board should aim for consensus after healthy debate.

Some people avoid confrontation on issues. So they simply give in, this is unwise in view of the legal responsibilities that directors carry. Other directors want to please executives to the extent that they would rather acquiesce with whatever is tabled even if outside the Board they would disagree. I remember a matter that came to debate on a Board I served on years ago. The majority of the non executive directors disagreed with management. However when the matter was put to a vote, one non exec abstained from the critical vote. Although he was as opposed to the management position as all the others, he did not want to be viewed as being disloyal especially to the CE. Abstention cannot be viewed as being opposed to a decision.

Disagreement may be minor or significant. The aim of the Board lead by the Chair is to have sufficient debate and inquiry into the matter leading to an agreed position. Sometimes however there is significant ad irreconcilable disagreements of opinion. This leads to dissent.  Dissent does not mean disloyalty but implies that the director takes her fiduciary responsibilities seriously.

I should highlight that dissent should not be based on avoiding business risks as business entails taking risks to achieve its goals. Some directors are so risk averse that they can easily sabotage any attempt to grow the business. This rejection of any initiative is not in the best interests of the organization as it affects the possibility of growth. Businesses always take calculated risk.

Most significant differences occur  in any of the following matters:

  • Disagreement on whether the objectives of certain courses of action are consistent with the strategic vision of the organization
  • Disagreements on whether to declare dividends or not when the organization is not compliant with statutory regulations.
  • Disagreements in implementation of certain projects on the basis of perceived risk. This can be reduced if the organization has clearly defined and agreed risk appetite and risk tolerance levels.
  • Disagreements on ethics and principles within certain transactions
  • Disagreement on fundamental issues such as fraudulent, reckless, grossly negligent or unlawful conduct.

If the matter is important but not fatal and yet the director feels strongly on it, he may insist on his dissension being formally recognized in the minutes. If the director feels that the matter of disagreement is not resolved but Board decides to go against him in a fundamental matter, after due discussion and arguing his case with factual information supported by independent professional advice, he may have to opt to resign.

In one Board the CE agreed to a resolution which he later unilaterally disregarded. When NED met they agreed to take a strong stand against the CE. However in the meeting, the majority softened. The matter was so material in my view that I dissented and ended up resigning from that Board formally in writing having expressed factually and accurately my reason for dissenting. A few months later the highly regulated organization was placed under business rescue by the regulators over the same matter.

Board members should be able to express their views effectively without being disagreeable or hostile. The key principle is always to act rationally in the best interest of the organization as a juristic person in its own right.

CONFLICT OF INTEREST


All corporate board members have fiduciary duties and a duty of loyalty (care and skill) to the corporations they oversee. If one of the directors chooses to take action that benefits them at the detriment of the firm, they are harming the company with a conflict of interest.

A conflict of interest involves a person or entity that has two relationships competing with each other for the person’s loyalty, such that serving one interest results in working against the other interest. The person’s vested interests raise a question of whether their actions, judgment, and/or decision-making can be unbiased. In a conflict of interest a director chooses personal gain over duties to the organization in which they are a director, or exploits their position for personal gain in some way.

Directors need to manage conflict of interests as these can lead to the transactions and decisions being nullified. It may even lead to prosecution.

Some conflict of interest is fundamental ad pervasive and therefore has to be avoided by a resignation e.g. if a director holds significant shares in a competitor, the conflict of interests will persist making his duty impossible. In that case the a director decides whether to dispose of the equity or to resign form the Board.

In some cases the conflict is temporal and so can be managed. For example if a director holds shares in a company bidding for a once off contract, the director can manage the conflict of interest by declaring his interest and recusing himself from the decision- making process for this contract.

Within the Companies Act (2008) Section 75 there are some specific conflict of interest situations which must be addressed and managed in accordance to the Act. A director must be knowledgeable of these situations and manage himself accordingly.

A conflict of interest must be declared when the matter comes up on the Agenda. The affected directors should make a full disclosure and contribute to the matter without lobbying. Immediately after that he should leave the meeting that will deliberate on the matter.

Some people erroneously believe that by simply declaring the interest they have fulfilled the obligation to manage the conflict of interest. I was once acquainted with an organization in which most of the service contracts awarded by the Company were to the Group CEO’s siblings. The belief in the organization was that since the GCEO had informed everyone of the interest, then everything was okay.

Some conflict of interest matters may not be material enough to be a problem statutorily but they may case a perception challenge that can damage the company’s reputation. For example if an executive director disposes shares that he owned just before a massive loss of stock prize based on an options contract that was due, this may be legitimate but it still cases reputational risks. A disinterested observer would be concerned.

Directors have a fiduciary responsibility to disclose conflicts of interest and to act with unfettered discretion. Where directors breach this duty they stand to attract civil and criminal sanction. Conflicts of interest have the potential to damage the company as any board decision taken in which a director has an undisclosed personal financial interest is void.

LEGAL DUTIES OF CORPORATE DIRECTORS


In common law, corporate directors have a twofold responsibility to the company namely fiduciary duties (duty to act in good faith and in the best interests of the company) and duty of care. This is the bedrock of corporate governance. In South Africa, the Companies Act 71 (2008) has codified the legal duties of directors that would draw legal sanction if not complied with. King IV like any other Code of Corporate Governance advocates for members of governing bodies to acquaint themselves fully and comply with the Law.

This section 76 of the Act that makes discusses the responsibilities of directors, is so critical and clear that I will just post its extract here.

“(2) A director of a company must—

(a) not use the position of director, or any information obtained while acting in the capacity of a director—

(i) to gain an advantage for the director, or for another person other than the company or a wholly-owned subsidiary of the company; or

(ii) to knowingly cause harm to the company or a subsidiary of the company; and

(b) communicate to the board at the earliest practicable opportunity any information that comes to the director’s attention, unless the director—

(i) reasonably believes that the information is—

(aa) immaterial to the company; or

(bb) generally available to the public, or known to the other directors; or

(ii) is bound not to disclose that information by a legal or ethical obligation of

confidentiality.

(3) Subject to subsections (4) and (5), a director of a company, when acting in that capacity, must exercise the powers and perform the functions of director—

(a) in good faith and for a proper purpose;

(b) in the best interests of the company; and

(c) with the degree of care, skill and diligence that may reasonably be expected of a person—

(i) carrying out the same functions in relation to the company as those carried out by that director; and

(ii) having the general knowledge, skill and experience of that director.”

In terms of the Act, a director has a duty to act in the best interests of the company, implying that he/she shall not use their position or information to, for example, gain advantage for anyone other than the company and/or cause harm to the company.

The fiduciary duties impose the following subsidiary duties on the director:  

  • A duty not to exceed his powers
  • A duty the exercise his powers for a proper purpose
  • A duty to maintain an unfettered discretion
  • A duty not to compete with the company
  • A duty to avoid a conflict between a director’s interests and the interests of the company


In terms of the duty of care and skill, the Act requires that he/she acts with care, skill and diligence that may reasonably expected from someone

  • Fulfilling his/her functions and
  • Having his/her knowledge, skill and experience

This imposes a requirement for a member of the governing body to continuously improve herself and keep informed about developments in corporate governance space. The Institute of Directors runs a number of corporate governance courses and seminars to help directors in terms of continuous professional development. It is important for directors to upskill themselves and stay current in terms of skill, knowledge.

Governing Body’s Corporate Functions


The Governing Body has a critical function as the focal point for corporate governance. The Board is responsible for the results expected out of an effectively functioning corporate governance system.  They are responsible for an ethical culture, good performance of the organization, effective control and legitimacy. The Board cannot pass the buck to management. The GB is also responsible for setting up committees to ensure effective supervisory role of the Body but it will remain accountable and responsible for all the functions that it delegates to those committees. So a governing body member cannot assume that they are safe simply because they delegated. They still have to exercise their minds on recommendations brought by the committees. The GB does not simply rubber stamp the recommendations of the committees. That is why there should be sufficient numbers of the governing body outside the committee to be able to interrogate and approve the recommendations of the committees. For example at some point I sat on a Board which had the majority of the governing body members being part of the audit committee. The result was that only two members of the Board were not on that committee, so the decisions of the audit committee when brought to te Board were difficult to engage robustly because the majority already had passed them. Thankfully after a Board evaluation, this process was corrected.

The Governing Body is responsible to set the vision and culture within the organization. It carefully considers the direction that the organization will take, the industries and the business model. It is also responsible to ensure a culture that enables the vision.

The Board is responsible for approving the strategy, policy and business planning. The Body must take seriously the interrogation of the strategy being presented. I remember as a Board member being part of a 5 year strategy planning session weekend. After the two days of presentations with minimal engagement form the Board, we were done. As the convener moved to close the meeting, I inquired as to the process of strategy approval. The convener who was an executive in the organization indicated that the strategy would be deemed approved since the governing body members were part of the strategy session. At that stage I moved to oppose the approval of the strategy. The organization was in the process of a major acquisition that would change the whole trajectory of the business and yet throughout the strategy making process there was no mention of this transaction and its impact on the organization. I argued that the management was taking the Board for granted and so were doing the strategy just for compliance sine the default strategy on the ground would be completely different. In my view this strategy was a misrepresentation of the actual reality on the ground. There was shock in the meeting as all eyes turned to the executive chairman who had sat quietly through the meeting. After an awkward moment the charismatic executive chair agreed with me and proposed that we reduce the strategy to a one year strategy reviewable within the year once the transaction goes through. My other objection was based on the view that being present in the strategy session does not take away the need for the GB to interrogate and approve the strategy.

The Governing Body is responsible for the appointment of the CEO who will be responsible for the appointment of the executive Team. It should remain clear that the CEO though a member of the GB is fully accountable for organizational performance to the GB. Some CEOs act as if they are primarily accountable to shareholders and not the GB. And some GB acquiesces to this. The Governing Body should also ensure that there is adequate succession planning within the organization.

At some point I served on a GB of an organization where the chair ran everything in the organization such that the CEO though competent could not do anything. The Chair should not usurp the role of the CEO. Sometimes this leads to a cold ear or even hot war between the two. These two roles are complementary even though the CEO reports to the Board. They should be cordial but frank discussions between the two.

The final function of the GB is to oversee the execution of the strategy and the policies in place. The GB should hold the CEO accountable for execution. Business succeeds on the basis of the discipline of execution. It is amazing that one often sees in the Board pack feedback that is vague and immeasurable. For example I have seen some Board packs where a matter remained on the pack for the whole year as pending. No one drove accountability for execution. This is a Board failure.

The Governing Body should execute its functions without fear or favor but with fairness.

corporate directors’ challenges


Business by definition requires taking up risk in order to exploit opportunities for growth. This creates another challenge of estimating the risk that can be taken within a growth strategy to increases value.

I remember one Board on which I sat struggling to decide whether to assume the risk of investing in an industry that we had no core competencies. It looked lucrative but the Board after much discussion; decided that we had no risk appetite for this kind of investment. subsequent events proved that our decision then was wise. But at the point of making the decision we also had an apprehension that we could be missing a great opportunity.

The balance between risk appetite which is normally driven by the executives to grow the business and risk tolerance which is normally fronted by the Board needs to be struck. The Board should not unnecessarily be too conservative and still expect returns on investment. and yet it should not be too risky that it destroys value.

Related to the previous dilemma is the fact that one chooses to either have organizational performance and growth or choose compliance with corporate governance codes and regulatory requirements through form filling. Compliance has to be balanced with performance. Some Boards are too focused on complying with boundaries imposed by regulators and codes that they dare not take any risks to growth the business. Acting in the best interests of the organization-which is one of the key roles of the Board – means that the Board should take appropriate risks to ensure sustainability and viability of the corporation. Viable sustainability and business continuity are critical aspects that require mindful consideration rather than just form filling to ensure compliance.

Governing bodies have to manage the often conflicting interests of the stakeholders. Often the interests of the equity shareholders and of other stakeholders may conflict. These will need to be managed. While equity providers are keen to see returns on investment, other stakeholders like the surrounding communities are keen to see meaningful investment in the community. After all the community is the ultimate licensor of the business. If the community withdraws its support and license the organization cannot be sustainable in that area. A more challenging dilemma for governing bodies is when the interests of the shareholders like a desire for dividend declaration, conflicts with the interests of the corporate. In cases like this directors have a legal obligation to serve the interests of the corporation. The moral hazard is that by choosing the interests of the organization, the governing body risks the censure of the shareholders since they serve at the pleasure of the shareholders.

The final challenge is that of speaking up and expressing a contrarian view without being perceived as toxic. It’s easy to drift into groupthink because members want to fit in. The desire to please others can cause a member to suppress their divergent view which would have been beneficial to the organization. It’s important for the governing body to allow for robust discussion and to entertain divergent views. It’s better to have a diversity of opinion rather than to have uniformity at all times. Learning to disagree and expressing a divergent point of view without being disagreeable is critical.

Despite all these challenges it is fulfilling to see an organization grow and thrive as the governing body works closely with management.

CORPORATE DIRECTORS’ dilemma


Challenges that Corporate Directors Face

While governing corporations is an interesting proposition, directors often have to make difficult choices and trade offs. Some times they have to make judgment calls with minimal information. In the next two posts I discuss some of the challenges governing boards have to deal with.

The challenge of being involved enough in the business to understand its model and be able to supervise without micromanaging or being too involved in operational matters. I want to emphasize the fact that the role of the governing body is to set, approve and monitor execution BUT not to be the executives. If the directors get too hands-on and become heavily involved in operational matters, they can easily get their hands dirty. As a consequence of too much involvement they lose the objectivity required of directors. Unless of course the directors are executive directors. So the governing body has to balance the need for proximity to business dealings with the need to have an arms length relationship with the organization that engenders objectivity. The Board must remain as “external insiders” to achieve this.

A related challenge is that the governing body should be adequately informed for them to be able to make sound decisions and yet as externals they rarely have sufficient information. To complicate matters the Board is dependent on information provided by the very management they are supervising. The net result is that if the governing body does not maintain professional skepticism it can be provided with information that places it in a position where it simply rubber stamps the desires of management. This in my view means that the governing body has no effective control of the organization. It is important for members of the governing body to be sufficiently informed and aware of the industry within which the company operates. A director needs to keep informed from independent sources. I remember one Company had a public relation department that ensured great press coverage keeping the Board happy. Years later disgruntled executives exposed a scheme whereby the PR Department bribed journalists to provide raving reviews.

Non executives directors are by definition not full time staffers and therefore not in constant touch with the organization. This poses the challenge of what to monitor and how exactly to monitor it. They have to be sufficiently in touch to have a feel of what’s happening internally without setting up a spy system. The related challenge is how much access can one have to middle and higher level executives without undermining the role of the CEO.

These challenges are real and need to be navigated in a balanced manner.

debunking some corporate leadership myths


In the last blog we established that the governing body (or board of directors for corporates) has legal responsibilities to exercise leadership over the organization or else face the possibility of legal liability as censure.

A common mistaken assumption is that if one is a Trustee or Board member of  a non governmental organization without pay, then they are exempt from legal liability. This is untrue. Your legal responsibility and the resultant liability exist irrespective of whether you are paid or acting pro bono. That is why it is important to demonstrate competency and skill in your directorship. Many directors or Trustees operate on the basis of herd mentality. In other words they flow with the team especially in the non profit sector. However this does not absolve you of personal liability.

A director should exhibit independence of thought, professional skepticism and competency in analyzing and discussing matters for the good of the organization – and I dare say for the director’s good as well since board negligence can lead to litigation. In SA in particular a director may be hauled before the courts and designated as a delinquent director. The case of the former SAA Chair is a case in point. Once designated as delinquent you can easily be barred from serving as a director for a period ranging from 7 years to for life.

It should be emphasized that while the Board acts corporately as a Team, each director personally owes the organization a duty of care and duty of good faith. The painful part of this potential liability is that since its joint and several, litigants prefer targeting the wealthier Board members to recover the full amount. After all the wealthier board members are likely to have more to lose from a potential litigation. If invited onto a Board do a due diligence on both the organization and the other Board members to ensure you limit your exposure.

Some people feel that they are covered by Directors indemnity insurance. Tis insurance will not cover for willful misconduct, breach of trust, reckless trading, acting outside your range of authority and being party to fraud. It is therefore important for directors not to take comfort in so called indemnity insurance. If you serve on a governing body, govern or if it is impossible to do so consider resigning.

I once served on a Board of a financial institution. At some point the CEO openly ignored the Board’s decision on a critical matter that was detrimental to the interests of the organizations because of an emotional bond to an executive who was destroying value. When the Board could not take a meaningful position to correct the anomaly and it became evident that the CEO was overbearing on the Board, I opted to resign. In my resignation letter I clearly explained my reasons for resigning. At times we need to make decisions based on principle.

When you structure your business corporately, be aware that the moment you have a minority shareholder or a substantial public interest in your business or potential impact on the community by your business then corporate governance issues kick in. Many SME bring on board smaller equity partners and continue to operate as if they are sole owners. The moment you issue shares to another party, you now have responsibilities to those shareholders to consider in every corporate decision you make.

In the next blog we will discuss the matter of ethical and effective leadership.