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Two perspectives of a company


Some have asked in bewilderment why the governing body (or Board) of an organization should act primarily in the best interests of the company itself and why they owe the duty of good faith (fiduciary duties) primarily to the company itself. The answer lies in the two schools of thought on what a company is?

One school of thought is that a company is an asset or property owned by the shareholders. Those who hold to this view expect the Board (or governing body) to be accountable to the owners namely the shareholders. This is the view that seems prevalent in State Owned Enterprises where governments generally as shareholders treat the entity as a property of government and so the Corporate Boards are beholden to either the Minister or Permanent Secretary. In effect this official becomes a default Board in and of himself. With this view in mind, the Board would always act with the shareholders’ interests at heart. They seek the best interests of the shareholders and not the best interests of the organization. The example of how SAA was run during the term of a former Chair who has now been reprimanded by the courts is a case in point.

A moderated view is that the company is an asset of the shareholders which the Board stewards on their behalf while taking into consideration the interests of other stakeholders. This is called the enlightened shareholder approach to corporate governance. This view of the organization is not accommodated in King IV. It may be acceptable only if the organization’s equity is owned by one person – although the interests of other stakeholders would still suffer.

The second perspective of a company is that it is a separate juristic entity with its own legal existence and rights independent of the shareholders. In this view the organization owes its existence to numerous stakeholders who provide different forms of capital for it to exist. Contrary to the previous view of only financial capital being the one considered, this view recognizes financial, social, environment, intellectual, human and manufactured capital as necessary for the existence of the organization. The stakeholders become the final licensors of the organization. This is called a stakeholder inclusive approach. Within this view the Board stewards the organization with the knowledge that they are accountable to all the stakeholders and not just the providers of financial capital (shareholders).

The following two quotes from the King IV report encapsulates this concept:

“King IV advocates a stakeholder-inclusive approach, in which the governing body takes account of the legitimate and reasonable needs, interest, and expectations of all material stakeholders in the execution of its duties in the best interest of the organisation over time.”

“Instead of prioritising the interests of providers of financial capital, the governing body gives parity to all sources of value creation.”

I recently read a SCA judgment which underlines this aspect of a company being an entity and not simply a property of the shareholders.  It was the case of Steinhoff minority shareholders who wanted to be compensated for lost value in the company due to alleged negligence of the Board. The Supreme Court of Appeal rejected this as it held that the shareholders had no right to lay this complaint as this was supposed to be done by the aggrieved party who was the company itself. A corollary was that the shareholders would get double compensation if the court ruled in their favor since, if and when the Company sued the directors and recovered the prejudice the shareholders would recover their value. The court on the basis of a rich legal heritage in the matter held that the loss of value in the Company would be a loss to the Company as an entity and not necessarily a loss to the shareholders. The underlying argument was that the company is to be viewed primarily as a legal entity with the right to sue and be sued as a juristic person with a separate existence from the shareholders. It is important to note that this judgement did not absolve the Board and management of Steinhoff of any wrongdoing. They may still have to face their day on court in that matter.

Shareholders normally revert to this argument when it suits them. For example the issue of the indebtedness of the company being separated from the wealth of the shareholder speaks to this concept. Often shareholders have often been heard to say, “I am not my company.” So this argument cuts both ways.

The contemporary view of corporate governance is that the company is a legal entity in and of itself and does not exists simply as an extension of the shareholders. That is why the governing body acts in the best interests of the organization.

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.

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.

The Business Judgement rule


Business Judgement Rule

The key legal roles as discussed in the previous post of the governing body consist primarily of the fiduciary duty and the duty of care and skill towards the company. We stated that if a director fails on this duty, she may be prosecuted.

The South African Companies Act Ch 71 of 2008 introduced a way of establishing that these duties have been satisfactorily met. This is through the business judgement rule. It recognizes that business by nature is assuming risk in return for reward. Consequently some risk undertaken will not be controllable resulting in failure. Directors cannot be judged negligent simply because the desired strategy or goal failed. They should be judged instead based on the process followed in making the decision. That is the essence of the business judgement rule.

It is a two edged sword in that if complied with, it provides protection to directors BUT if violated it becomes basis of litigation against the directors.

In terms of the Act in Section 76 (4) a director is considered to have complied with the duty of care and skill if he satisfies the following:

“(a) will have satisfied the obligations of subsection (3) (b) and (c) if—

(i) the director has taken reasonably diligent steps to become informed about the matter; (Directors have a responsibility to seek and get information from management and not simply and passively rely on board packs. They make decisions based on being fully informed. The diligence to pursue information is the responsibility of the director. In my view it’s better to not make a decisions if information is inadequate. This also requires Directors to study the Board pack in time and get any required information before the Board meeting. By the time of the Board meeting, the director should have taken “diligent steps to become informed”.

(ii) either—

(aa) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a personal financial interest in the matter; ( The emphasis is to avoid a conflict of interest both personally and in terms of the director’s relationships. Some corporate governance experts insist that the director should find a way to satisfy the aspect of relatives not having a personal financial interest before the Board meeting as well. King IV deals with conflict of interest in the broader sense rather than the narrower sense used by the State here. It’s prudent for directors to work at the higher standard of the King IV Code. We shall discuss the issue of Conflict of Interest in a separate post later )

(bb) the director complied with the requirements of section 75 with respect to any

interest contemplated in subparagraph (aa); and

(b) is entitled to rely on—

(iii) the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company;  (“The minutes of the meeting must also reflect the material points of the discussion that took place and explain why the decision was taken. These minutes must reflect an accurate view of the discussion at the time rather than simply being a justification for the decisions taken. It is also not sufficient to merely record the outcome, without the rationale for the decision being documented. Directors also have an important responsibility to ensure that minutes of meetings appropriately capture the discussions and points of view of both the board and individual directors. Where directors dissent, this should also be recorded.” Source: CGN Guidance Note on Business Judgement Rule.} and

(i) the performance by any of the persons—

(aa) referred to in subsection (5); or

(bb) to whom the board may reasonably have delegated, formally or informally by

course of conduct, the authority or duty to perform one or more of the board’s

functions that are delegable under applicable law; and

(ii) any information, opinions, recommendations, reports or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (5).

(5) To the extent contemplated in subsection (4) (b), a director is entitled to rely on—

(a) one or more employees of the company whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided;

(b) legal counsel, accountants, or other professional persons retained by the company, the board or a committee as to matters involving skills or expertise that the director reasonably believes are matters—

(i) within the particular person’s professional or expert competence; or

(ii) as to which the particular person merits confidence; or

(c) a committee of the board of which the director is not a member, unless the director has reason to believe that the actions of the committee do not merit confidence.”

The IoDSA CGN Guidance note on the Business Judgement Rule provides clarification on the matter of reliance on other persons or committees as follows:

“In considering what information to rely on, directors should consider both the quality and relevance of the information. The quality of the information refers to the robustness of the process that the information goes through before it reaches the board and speaks to its credibility. The relevance of the information refers to what information was considered necessary to present to the board and what the process was of determining what information was relevant to the board’s decision and what was not. Where directors discover inconsistencies in the information presented to them, the directors have a responsibility to probe these inconsistencies and obtain appropriate answers and explanations. These inconsistencies may also be indicative of a lack of an appropriate process to ensure that directors receive the relevant information which is of a high quality.”

The Board can delegate wok but cannot delegate accountability and responsibility for its decisions. I remember having to vote against the recommendations of one of the Board committees because I was not comfortable with it. It is however unusual to go against the recommendations of a committee unless there are significant gaps in the way it handled the matter. My point here is mainly that the directors have finally accountability for approving recommendations and so cannot claim they were simply going on the basis of expert opinion. The expert can also be wrong.

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.

board designations


The Governing Body (GB) is responsible for the governance of an organization. Companies Act (2008, Section 66 (1)) vests the governing body (board of directors) with the legal responsibility and accountability for the management of the organization.

King IV endorses a unitary governing body consisting of executive (employees of the company) and non-executive members (independent external members). In contrast a two-tier system of corporate governance has two boards namely a management board and a supervisory board.

A unitary governing body does recognize the role of an Executive Committee which is responsible under the CEO for executive functions but accounts to the Governing Body through the CEO.

Executive Directors are involved in the day-to-day management of the company or being in the full-time salaried employment of the company (or its subsidiary) or both defines the director as executive.  King IV advocates for the independent directors being the majority of the GB. It also provides for at least two executive directors namely the CEO and at least one other executive director. Unlike King III, the current Code does not prescribe who the other executive director should be.

Non Executive Directors (NED) are not involved in the management of the company and are independent of management on all issues including strategy, performance, sustainability, resources, transformation, diversity, employment equity, standards of conduct and evaluation of performance. An individual in the full-time employment of the holding company is also considered a non-executive director of a subsidiary company unless the individual, by conduct or executive authority, is involved in the day-to-day management of the subsidiary.

According to King IV some non executive directors may be considered as independent if there is no interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making in the best interests of the organisation.  Independence should be both in fact and in perception of a reasonably informed outsider.

King III puts it in more detail as follows: An independent director should be independent in character and judgement and there should be no relationship or circumstances which are likely to affect, or could appear to affect this independence. Independence is the absence of undue influence and bias which can be affected by the intensity of the relationship between the director and the company rather than any particular fact such as length of service or age.

The Companies Act (2008) does not use the terms ‘executive’, ‘non-executive’ or ‘independent non-executive’ directors. In fact at law both executive and non-executive directors are treated equally in terms of statutory accountability. It reminds me of a situation where an executive director in an NGO wanted only non executive directors listed in a litigation case against the organizations because of a faulty belief that as an executive he was exempt.

It is critical to understand that at law and in accordance with the fiduciary duties of directors, all directors should exhibit independence of thought and action in the exercise of their duties irrespective of the designation according to Codes of Governance. An executive and/or representative directors should put the interests of the organization above the desires of the shareholders or any other parties. Shareholders and principals often make the mistake of imposing their views on the representative director BUT the director has statutory and personal liability for his/her actions and decisions. S/He cannot cite the instructions or expectations of the principal as a defence at law. A member of the GB must act independently and in the best interests of the organization itself.

From the foregoing, it follows that the board designations we use are often misleading in that they imply some members should be independent while others should not. As we have seen all should demonstrate an independence of mind and action.

corporate leadership


I am preparing for certification in Corporate Governance with IoDSA. In that process I will be sharing my thoughts on corporate governance based on the King IV Report and the South African Companies Act 2008. While this is primarily as part of my studies, I certainly hope that this will help some of my readers. I have served on numerous Boards over my time and so will use some of my experiences to illustrate concepts.

In the next few posts we start be interrogating the definition of corporate governance. Many definitions have been proferred but I believe that the King IV Report one is quite succinct and user friendly.

“Corporate Governance -is the exercise of ethical and effective leadership by the governing body towards achievement of the following governance outcomes: ethical culture, good performance, effective control and legitimacy.” King IV Report

The corporate governance is really an exercise of leadership by the governing Board (Board of Directors, Trustees etc). This definition clearly places the leadership responsibility of the corporation in the hands of the directors.

Leadership of the organization is not vested in the shareholders or the management. It is vested in the Board.

I remember reading of a business leader and major shareholder who claimed that he employed and paid the Board and so he was not going to be hamstrung by the Board. I have also heard sentiments expressed in non governmental organizations that the Board is simply advisory. This is a major misunderstanding. The Board exercises leadership of the organization.

Leadership means to govern, direct, control within the context of fiduciary duties of the directors/trustees (members of governing body) to the body corporate. Fiduciary duties refer to the duty of acting in good faith towards the organization. Put in another way fiduciary duty means a legal obligation of one party (the governing body) to act in the best interest of another (the company) when entrusted with the care of the corporate’s assets.

The primary responsibility of the governing body is to act in the best interests of the organization AND not necessarily in the best interests of the shareholders.

Remember that the organization is a separate legal person from the shareholders.  

When the interests of shareholders and the organizations diverge, the Governing Body is legally bound to act in the best interests of the organization.

(We will examine this duty in depth later on)

From the foregoing it is clear that the leadership of the organization does not lie in the management or the shareholders. But actually lies in the governing body i.e. the body of directors or trustees. Shareholders entrust the leadership to the directors while directors appoint and are responsible for management to whom they delegate certain leadership responsibilities. Yet many governing bodies do not actually exercise leadership of the organization.

To emphasize the leadership responsibility of the governing body of organizations, notice that at law, the legal liability of the organization is broken down as follows: shareholders’ liability is limited to their shareholding, management’s liability is limited to their levels of authorizations or negligence WHILE the liability of the Board members is unlimited.

In other words the greatest legal liability for a corporate body’s failure lies with the Board members both individually and jointly.

As an aside it is important for Board members not to treat their responsibilities lightly as they can expose their personal wealth at risk for the liability coming from their Board seating.

I once served on the Board of a non governmental organization which had a rental dispute with its landlord and was in arrears. As directors we were sued in our personal capacity while the management (who in effect were responsible for the delinquency) were not included in the litigation. Fortunately we managed to negotiate and get the organization to pay its obligations. If it had failed to do that all the Board members were to be personally liable for the organizations’ rentals.

It is also important to be cautious about the Board seats that you accept. Do proper due diligence. Otherwise you are putting your own wealth at risk if you seat on a Board that does not exercise leadership on the organization

In the next post we will take a closer look at the nature of this leadership.