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.
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