What is corporate governance?

The topic of corporate governance has probably never been more to the fore in business than at present, especially in the international arena.


Recent corporate failures in the USA and passing of legislation in that country to bring in more accountability of directors has only served to highlight the onerous responsibilities which are vested in directors. These responsibilities apply to not only directors of public companies but also private companies as well.

Corporate governance could be said to fall into two areas. Firstly, the requirement to comply with statutory duties, being primarily the Companies Act 1993. All directors are caught by this requirement, irrespective of the size or nature of the company or the nature of the appointment of those directors. The Companies Act does not distinguish between executive and non-executive directors. It applies to all directors. In addition to the statutory framework provided primarily by the Companies Act, there has been established an area of corporate governance best practice. This is primarily set out in New Zealand by the Code of Practice which has been promulgated by the Institute of Directors .

Okay, what is corporate governance?

It is the area of responsibility assumed by the directors as a body.

The major responsibilities of directors include:

  • Maximising benefits of the shareholders investment while protecting the company's assets;
  • Ensuring compliance with the company's Constitution as well as the common law, the Companies Act and other relevant legislation; and
  • Implementing the resolutions passed by directors and shareholders.

Who really controls the company?

This involves an analysis of the respective roles of:

  • Shareholders
  • Directors
  • Management

Because a company is an artificial person, it must be managed and represented by human agents.

The decision making powers are primarily found in two organs of the company:

  • The Board; and
  • The shareholders in General Meeting

In exercising the powers which fall within the jurisdiction of the company, either of these organs acts collectively as the company and any decision made by either of them is a decision of the company.

The powers which each may exercise are strictly defined by a long established doctrine in company law known "the division of powers".

The source of division of powers is found not in the Constitution of the company but in the Companies Act itself.

Role of the Directors:

The Companies Act provides that the business and affairs of the company must be managed by, or under the direction or supervision of the Board (section 128(1)).

The Board has all the powers necessary for managing and for supervising and directing the management of, the business and affairs of the company (section 128(2)).

Since management of the company by the Board is mandatory, it follows that the shareholders cannot themselves interfere in the management of the company but are limited to the remedy of removing the Board from office if they disagree with the decisions of the Board.

It must be emphasised that whilst one or more of the directors may be appointed by groups of shareholders or shareholder bodies, they are not delegates of that body and should not act on instructions from their appointing body as delegates. They are required to act in the best interests of the company even though those interests may, on the face of it, be contrary to the wishes or the interests of their appointing body.

On the other hand, a company may not enter into a "major transaction" unless it has first been approved by the shareholders. Certain transactions are deemed by the Companies Act to be of such importance that the decision of the directors to enter into them must be approved by the shareholders in general meeting.

It is not envisaged that the directors themselves undertake all tasks of management. In a company of any size, there must be some delegation by the directors of their powers. This right to delegate is found in section 130(1) of the Act which provides that the Board may delegate any one or more of its powers to a committee of directors, a director or employee (often the Chief Executive Officer) of the company or any other person. This rule is subject to the provisions of the Constitution which may cut down the scope of delegation of Board powers.

A number of powers cannot be delegated (despite anything which the Constitution may say to the contrary) but must be exercised by the Board itself. The powers incapable of delegation are set out in Schedule 2 of the Companies Act and relate for the most part to powers of the Board in relation to shares.

Delegation does not however absolve the Board of responsibility for the exercise of a Board of a power to a delegate. The Board remains responsible for the exercise of a delegated power as if the power had been exercised by the Board itself.

Role of Management:

As stated previously, whilst the Board is responsible for management of the company under the Act, many of the duties of management are delegated to management staff. This in many circumstances will be to the Chief Executive Officer and/or its senior staff.

It is essential to the smooth and efficient running of any company that where management responsibilities are delegated, that all parties know their roles and responsibilities including the limits of any authorities that may have been given.

The boundaries between the authority of the shareholders and the directors is generally not an issue. At the end of the day, the directors can be replaced by the shareholders if the shareholders do not like the decisions made by the Board. But it is particularly important with employed staff that they all know who has the right to do what and what decisions can be made without having to go back to the Board.

The boundaries are always set by the Board and generally based upon certain parameters. If a budget has been approved by the Board which provides for the purchase of equipment or appointment of staff within parameters, then generally those matters should not be required to come back to the Board unless they fall outside the parameters set.

In my experience, the companies which function most effectively and achieve the goals at the various levels are those companies where all of the various parties, being the shareholders, the Board and management, are all clear as to their respective roles, responsibilities and lines of authority, and stick within them.

Duties of Directors:

Let's now have a look at some of the duties of the directors. These include duties owed to the company, to shareholders and to third parties.

The duties owed to the company are as follows:

  • To act in good faith and in the best interests of the company as a whole
  • To exercise their powers for a proper purpose
  • To comply with the Companies Act and the Constitution of the company
  • To avoid reckless trading by carrying on the business of the company in a manner that does not create a substantial risk of serious loss to the company's creditors
  • Not agree to the company incurring obligations where there are no reasonable grounds to believe that the company will be able to perform the obligation when required to do so (gone are the days of shelf companies being used to enter into contracts where there is no reasonable expectation of them being able to settle them
  • Refrain from disclosing or making use of information contained in his or her capacity as a director, other than for the purposes of the company
  • Exercise reasonable care, diligence and skill

The duties owed to the directors are as follows:

  • A director is bound to take reasonable steps to ensure that the share register is properly kept;
  • A director is required to disclose all material interests in transactions or proposed transactions of the company; and
  • A director is bound to disclose to the Board a relevant interest in any shares issued by the company.

The two key obligations are however the fiduciary duty of good faith and the duty of care and skill owed to the company. The duty of good faith relates to the integrity of the directors' decisions and acts whereas the duty of care and skill relates to the standard required of a director's performance.

Duty of Good Faith:

  • Conflict of interest - avoid situations where there is a conflict between the director's personal interests and those of the company as a whole. The best interests of the company must always prevail over the director's personal interests.
  • Disclosure of interest in transactions - the director must disclose any interest in a transaction or proposed transaction - involves personal interest (business interests) of spouse, children and other family members.
  • Confidentiality - all information must be kept confidential at all times.

Duty of Care and Skill:

  • Attention to the affairs of the company
  • A duty to be informed about the financial, social and political operations within the company
  • Duty to obtain sufficient information to enable a proper decision to be made
  • The presentation to shareholders of a balanced and understandable assessment of the company's performance and position - this may involve providing information in addition to the minimum required by law
  • The directors should be aware of all statutory and regulatory requirements affecting the company and, where applicable, requirements of bodies such as the New Zealand stock exchange
  • Directors must exercise the care and skill which can reasonably be expected of a person with their expertise - that standard may differ between directors, eg. the standard expected of a professionally qualified director may be different to that of a director with no qualifications or business experience

Duties to Third Parties:

Whilst a director's duties are largely owed to the company, the interests of third parties may intrude and must be taken into account.

There is a line of authority particularly strong in New Zealand and Australia which establishes that directors owe an obligation to consider the interests of creditors in situations of insolvency or near insolvency. Probably the necessity of a duty owed separately to creditors has been met by the structures of the Companies Act 1993. Central to the protection of creditors are the rules relating to distributions and the potential personal liability of directors to repay distributions not recoverable from shareholders. In addition, while a director's duties are owed to the company, a creditor of a company in liquidation has standing under section 301 to sue for breach of duty owed by a director to the company. Thus a creditor may be able to show that the director in jeopardising the interests of creditors had acted in breach of duty of care or in breach of provisions of the Companies Act.

The above is a brief summary of the respective roles and duties of shareholders, directors and lastly management.

 

The content of this document is necessarily general and readers should seek specific advice on particular matters and not rely solely on this document.
If you would like further information on any of the topics in this document, please contact the writer or your usual Auld Brewer Mazengarb & McEwen adviser.

 

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Allen Mazengarb