Business Page September 2nd, 2001


Limits to Directors' Powers

 

Introduction

As the economy continues to confront a range of increasingly difficult challenges threatening the survival of an increasing number of our companies, the quality and performance of company directors will be severely tested. So far but for one exception, our public companies, financial institutions and insurance companies have managed to weather the economic storm. But with no early end to the economic downturn in sight, these companies need more than luck to survive intact. Paradoxically, economic difficulties provide the imperative for directors to review the entire operations and take some of the tougher decisions which better times may have allowed them to avoid. Sometimes if the business is operating in an industry or sector which clearly has no future, even the most skilled and experienced team of directors and its complement of managers cannot prevent its ultimate demise. Indeed, one of the skills of a director is to know when to close a division, department, operating unit or indeed the entire business.

Anyone can be a director

The law does not expect directors to be geniuses and with a few exceptions set out in the Companies Act 1991, just about anyone can be appointed a director. The exceptions include persons under the age of eighteen years of age, persons of unsound mind, an undischarged bankrupt, and anyone found by the Court on an application by the Registrar to be unfit to be concerned in the management of a public company. For example, any person who was a director of two companies that went insolvent within a five-year period could be removed in this manner.

While it is relatively simple to become a director and while the law relating to companies avoids unnecessary and burdensome interference in how directors manage the affairs of the company, it does not distinguish between the responsibilities of directors of public and private companies. The law entrusts the responsibility for the management of the business and affairs of the company to the directors. Although a separate legal entity, a company does not exist physically and therefore the management of its affairs must be entrusted to its directors. Particularly but certainly not unique to the public sector, directors appear to have quite a wrong idea of their duties and responsibilities. 'Management of the affairs' does not give them the right to executive action unless they are service directors in which case they have two very separate and distinct roles.

Duties

Readers will be familiar with the ubiquitous "any other duties to be assigned from time to time" in job descriptions. With such a caveat here is a list of the broad duties of the Board:

To ensure that the company has a top management competent to run it.

To set yardsticks of performance using strategic measures such as return on investments, increasing shareholder value, allocation of capital etc;

To ensure that there is a long, medium and short terms plans and budget to achieve the company's vision, mission, goals and objectives.

Notwithstanding the fact that the law does not require directors to bring with them any special skill, they are required to display reasonable care in the dispatch of the company's business. Lindley M.R in Lagunas Nitrate Co. v Lagunas Syndicate (1899) 2 Ch, noted that:

"If directors act within their powers, if they act with such care as is reasonably to be expected from them, having regard to their knowledge and experience and if they act honestly for the benefit of the company they represent, they discharge both their equitable as well as their legal duty to the company"

Failure to exercise such a duty of skill and care can make directors liable both jointly and severally. Directors who have acted recklessly or fraudulently in their duties can be made personally liable for the consequences of their actions and specific standards of care and diligence are set by the legislation. These standards are higher for executive as against non-executives. Executive directors are required to exercise the care, diligence and skill of a reasonably prudent person in comparable circumstances. Non-executives are required to exercise care, diligence and skill that a reasonably prudent person would expect from a person of the director's knowledge and experience. In practice however, shareholders expect the non-executive directors to keep a close eye on the full-time directors and this is why good corporate practice requires that heads of Board Committees such as Audit and Compensation to be non-executive.

It is universally agreed that directors must act bona fide in the interest of the company and there has been some controversy whether this means acting exclusively in the interest of shareholders. The case of Parke v Daily News Ltd. (1962) CH 927, imposed serious limitations on the ability of directors to further the interest of persons other than shareholders. The court decided that the Board's sole duty is to shareholders and they ought not to consider themselves as owing any similar duty to employees. This ruling has been partly superceded by the Companies Act 1991 which expressly provides that in determining what are the best interests of the company, a director must have regard to the interests of the company's employees in general as well as to the interests of its shareholders.

One particularly misunderstood issue arises in the case of a director nominated by a particular group such as the Consumers Association. While the director may wish to advance that interest, at all times he has to remember that his first duty as director is to the company. If there is no conflict, there is no problem but otherwise, his duty is to protect the company even if he offends his interest group.

Lenders' directors

The Act makes provision for the articles of the company to allow for the appointment of a maximum of one third of the board of directors by third parties (non-members) such as debenture holders. Previously, appointment was the sole preserve of shareholders. This provision allows for the exercise of greater influence in the governance of the company by non-equity capital providers and can therefore be regarded as an incentive for investors. So far, none of the creditors and debenture holders has insisted on the implementation of this provision. If companies and in particular private, family companies had to contend with truly independent directors many of them would have been spared the disaster which now faces them.

Management

While the theory of the director's role is simple enough, directors often intervene in the company's management to an extent that usurps and undermines the authority on the executive. Even though it is beneficial to have a range of skills among the directors, it is important to recognise that non-executive directors are not there as engineers, lawyers or accountants. Any properly managed company will have on its staff or access to such skills in a professional capacity. The non-executive is naturally expected to raise the relevant questions and ask for the appropriate information and contributing his skills and expertise to strategic planning. He is not there to upstage the executive or worse to give them instructions. As a general rule the directors act collectively and he cannot therefore go into the company demanding information or action as an individual director.

Directors' intervention in the operational management of the company has a number of costly consequences. It inhibits managerial initiative, de-motivates members of management who become uncertain of their real functions and creates excuses for executive management's own under-performance. It also sets unfortunate precedents as far as established systems and procedures are concerned. These systems and procedures are there for the good order of the entire company. If directors can flout them so can everyone.

Conclusion

The role of directors cannot be separated from the question of governance at the societal level. Understandably, citizens and taxpayers expect public officials to conform to principles and practices of good governance. But good governance is not only for national and local government. Shareholder democracy is lagging by far the issue in the wider community but if we are serious about a Stock Exchange, the efficient allocation and use of resources and the protection of the rights of shareholders, then those now enjoying the exalted position as directors need to understand more clearly the limits to their power. Perhaps the private sector needs to lead the way.