On 27 June 2008 the Companies Bill was released for public comment. This article is based on that version of the Bill.
The world has changed drastically since 1973 when the present Companies Act was passed. No longer can we allow those who abuse their power and rob innocent shareholders of their hard earned money to walk free and not be called to account! Okay, this may sound a bit dramatic, but the bottom line is that those entrusted with the leadership of an organisation must know and fulfill their duties.
The current situation
Presently the rights and obligations of a director are imposed by the Companies Act, the articles of association of a company and the common law. A director is required to act in good faith, act independently, with the degree of care, diligence and skill that may reasonably be expected from a person of his/her knowledge and experience, within the scope of authority as prescribed by the memorandum and articles of association of a company, and as a member of the board.
The King Committee’s code of corporate practices and conduct elaborates on the duties and obligations of a director; and those affected by the King Code include JSE listed companies, banks, financial and insurance entities and public sector enterprises governed by the Public Finance Management Act. Mervyn King, convener of the King Commission has made no secret of the fact that the King Commission has never supported the idea of making the King Report statutory. The third King report is expected to be released towards the end of this year and is also based on a comply or explain philosophy, rather than a comply or else philosophy.
What does the Companies Bill say?
In addition to encouraging entrepreneurship and high standards of corporate governance, amongst other things, another purpose of the Companies Bill is to balance the rights and obligations of shareholders and directors and also to encourage the efficient and responsible management of a company. In terms of the Bill a company’s governing document is the memorandum of incorporation (no longer the memorandum and articles of association), which is consistently referred to throughout the Bill. The memorandum of incorporation should serve as a higher standard than legislation and should allow for smoother governance processes. It is intended for the memorandum of incorporation to be binding between the company and each shareholder, between or among the shareholders and between the company and each director or officer of the company and any person serving as a member of the audit committee or any other committee of the board. This document may only be amended in terms of a court order or by virtue of a special resolution.
The Board of Directors
The Bill provides for the business and affairs of a company to be managed by or under the direction of its board. The board has the authority to perform any of the functions of the company except to the extent that the Companies Act or memorandum of incorporation provides otherwise. A private company or personal liability company requires at least one director whilst a public company or a non-profit company requires at least three directors. These minimum numbers may be increased in a company’s memorandum of incorporation. Should a company at any time fail to have the requisite minimum number of directors, the authority of the board will not be limited or negated, neither will anything done by the board or the company be invalidated. A company must have at least one director resident in the Republic.
The memorandum of incorporation may also provide for:
- the direct appointment or removal of one or more directors by any person who is named in, or determined in terms of, the memorandum of incorporation;
- a person to be an ex officio director as a consequence of holding an office, title, designation or similar status;
- the appointment or election of alternate directors; and
- shareholders of profit companies (other than state owned entities) to elect at least 50% of directors and at least 50% of any alternate directors.
The first directors of a company are the incorporators. The board may comprise directors that are permanent, alternate, temporary or ex officio, all with common duties and liabilities.
A person becomes a director of a company when that person has been appointed or elected or holds an office, title, designation or similar status entitling that person to serve as a director; and has all the powers, functions and duties of any director and is subject to all of the liabilities of any director. The memorandum of incorporation may limit the powers and functions of the ex officio director, but not the duties and liabilities.
Directors may be remunerated for their services unless provided otherwise in the memorandum of incorporation. However, remuneration may only be paid in accordance with a special resolution approved by the shareholders within the previous two years. The practicality of this clause may certainly prove a challenge, and will undoubtedly serve as yet another reason to make the position of a South African director somewhat unattractive.
A director may be appointed for an indefinite term unless otherwise stipulated in the memorandum of incorporation. An indefinite term of office really does go against basic corporate governance principles, so hopefully this provision is excluded from the final Act. Unless the memorandum of incorporation provides otherwise, a board may also appoint a director on a temporary basis, and such temporary director will have all the powers, functions and duties of a director and be subject to all of the liabilities of any other director of the company.
This version of the Bill also provides for the Minister to appoint a “prescribed officer” within a company. The rest remains a mystery as the Minister is yet to publish regulations in this regard.
Provisions for filling vacancies on a board and removal of directors are also dealt with and it is a requirement that, within ten business days after a person ceases to be a director, a company must file a notice in that regard.
Who may not be a director?
Juristic persons, unemancipated minors (or persons under similar legal disability) or anyone who does not satisfy any qualification set out in the memorandum of incorporation are ineligible to be a director.
Unless exempt by a court on application, you may not be a director, ex officio director, alternate director, temporary director or prescribed officer if:
- a court has prohibited you from accepting a directorship position;
- you are an unrehabilitated insolvent;
- you are prohibited in terms of any public regulation to be a director of the company;
- you have been removed from an office of trust on the grounds of misconduct, involving dishonesty; or
- you have been convicted in the Republic or elsewhere, and imprisoned without the option of a fine, or fined more than the prescribed amount, for theft, fraud, forgery, perjury or an offence (involving fraud, misrepresentation or dishonesty, in connection with the promotion, formation or management of a company, or in connection with ineligibility or disqualification to serve as a director or probation in terms of a court order).
The final of the grounds for disqualification mentioned above prevails for a period of five years from the date of removal from office or completion of the sentence imposed, however, it may be extended for a further five year period if a court believes it is in the interests of protecting the public, on application by the Companies Commission.
Exception to the rule
Despite being disqualified, a person may act as a director of a private company if all the shares of that company are held by that disqualified person alone, and persons related to that disqualified person and each such person has consented in writing to that person being a director of the company. The Companies Commission is empowered to establish and maintain a public register of persons that are disqualified from serving as a director, and are subject to an order of probation as a director. This register will clearly be cause for concern from a human rights perspective.
The directors may appoint any number of board committees it deems fit, and delegate any authority to a committee. Unlike the King Report, the Bill does not stipulate the types of board committees required. Unless limited by the memorandum of incorporation or a resolution establishing a committee, a person that is not a director of the board may be appointed to a committee; that person is not allowed to vote on a matter and must not fulfill any of the ineligibility and disqualification criteria established for directors. Although a committee of the board has the full authority of the board in respect of the matter referred to it, it must be understood that a board may delegate authority but never accountability!
The drafters have closed the loop of possible uncertainty by further providing that the creation of a committee, delegation of any power to a committee or action taken by a committee does not alone satisfy or constitute compliance by a director with the required duty of a director owed to a company.
It is therefore recommended that a board ensure that clearly documented mandates are provided to board committees and, furthermore, ensure that a proper reporting framework is instituted to facilitate reporting by board committees to the board. An overarching board charter clearly stating the principles of, and intention behind, delegation to board committees would also diminish uncertainty and the danger of something falling through the cracks.
Meetings by video conference or web cam?
The Companies Bill promised simplicity, efficiency and convenience, and one of the ways in which it is meeting this promise is by allowing for the conduct of board meetings by electronic communication or for some of the directors to participate in a meeting by electronic communication. To every company secretary, the worry of forming a quorum for a meeting is always prevalent and this provision is most certainly welcomed. The proviso is that the electronic communication facility employed ordinarily enables all persons participating in that meeting to communicate concurrently with each other without an intermediary, and to participate effectively in the meeting. The definition of electronic communication relied upon is that which may be found in the Electronic Communications and Transactions Act, which simply defines electronic communication as ‘communication by means of data message’. A data message is further defined as data generated, sent, received or stored by electronic means and includes voice, where the voice is used in an automated transaction and a stored record.
Requirements for notification of and the conduct of board meetings are stipulated in the Bill with the option of further or alternate requirements being captured in the memorandum of incorporation. The Bill also sets out requirements for the drafting of minutes of meetings and provides that any minutes of a meeting, or a resolution, signed by the chairperson of the meeting, or by the chairperson of the next meeting of the board, is evidence of the proceedings of that meeting, or adoption of that resolution, as the case may be.
Duty to disclose a conflict of interest
The requirement and process to be followed in respect of disclosure of interest is clearly set out in the Bill. In terms of section 75, if a director of a company has a personal financial interest in respect of a matter to be considered by the board, or knows that a related person has a personal financial interest in the matter, the director:
- must disclose the interest and its general nature before the matter is considered at the meeting;
- must disclose to the meeting any material information relating to the matter, and known to the director;
- may disclose any observations or pertinent insights relating to the matter if requested to do so by the other directors;
- if present at the meeting, must leave the meeting immediately after making the disclosure; and
- must not take part in the consideration of the matter except to the extent of being requested to disclose observations by the other directors
While the director is required to recuse himself/herself, he/she is to be regarded as present for the purposes of constituting a quorum and is not to be regarded as being present at the meeting for the purpose of determining whether a resolution has sufficient support to be adopted and must not execute any document on behalf of the company in relation to the matter unless specifically requested or directed to do so by the board.
If a director acquires a personal financial interest in an agreement or matter in which the company has a material interest or knows that a related person has acquired a personal financial interest in such a matter, after the agreement or other matter has been approved by the company, the director must promptly disclose to the board the nature and extent of that interest and the material circumstances relating to the director or related person’s acquisition of that interest.
A decision by the board or a transaction or agreement approved by the board or company is valid despite any personal financial interest of a director or person related to a director if it was approved in the manner explained above or has been ratified by an ordinary resolution of the shareholders. Any interested person may apply to court to have a transaction or agreement approved by the board or shareholders declared valid as the case may be, despite the failure of the director to satisfy the requirements explained above.
Standards of conduct
The Bill includes a detailed section on the standards of directors’ conduct and also codifies the common law relating to directors’ duties. It precludes an abuse of power in that a director must not use his position or any information obtained while acting in the capacity of director to gain an advantage personally or for another person other than the company or a wholly owned subsidiary of the company; or knowingly to cause harm to the company or a subsidiary of the company. Furthermore, the director must communicate to the board at the earliest practicable opportunity any information that comes to the director’s attention, unless the director reasonably believes that the information is immaterial to the company or generally available to the public, or is known to the other directors; or is bound not to disclose that information by a legal or ethical obligation of confidentiality.
Act in the best interests of the Company with the requisite care, skill and diligence
A director is required to exercise his powers and perform his functions as director in good faith and for proper purpose, in the best interests of the company and with the degree of care, skill and diligence that may reasonably be expected of a person carrying out the same functions in relation to the company as those carried out by that director, and having the general knowledge, skill and experience of that director.
A director would be considered to be acting in the best interests of the company with the requisite degree of care, skill and diligence if he had taken reasonably diligent steps to become informed about the matter.
He/she would also be acting in the best interests of the company if either he/she 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 or he/she declared the interest in respect of section 75 discussed above.
Furthermore he/she would be considered to be exercising care, skill and diligence if he/she made a decision, or supported a 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. A director is entitled to rely on the performance of one or more employees of a company whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, recommendations, reports or statements, including financial statements and other financial data, prepared or presented by any of the above persons. This reliance is extended to 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 within the particular person’s professional or expert competence; or as to which a particular person merits confidence; or 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 director may also rely on the performance of any person 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 delegatable under applicable law.
Liability of directors
In terms of this section of the Bill, liability extends to an alternate director, prescribed officer or member of a board committee or of the audit committee of the board. Interestingly enough, it does not cover ex officio directors.
If a director breaches his/her fiduciary duty (duty to disclose personal interests, abuses power, does not act in good faith and for proper purpose in the best interests of the company) he/she will be liable for any loss, damage or costs sustained by the company as a consequence of any breach by the director.
If a director fails to exercise the requisite due care, skill and diligence or breaches any other provision of either the Companies Act or the memorandum of incorporation, he/she will be delictually liable for any loss, damage or cost sustained by the company as a result of the breach.
Broadly speaking, a director will be liable for direct or indirect loss, damage or costs sustained by the company if:
- he/she acts beyond the scope of his/her authority;
- he/she allowed the company to carry on business with the knowledge that it was being conducted recklessly, negligently and fraudulently or with the knowledge that the company traded under insolvent circumstances (see section 22);
- being party to an act or omission of the company despite knowing that the act or omission was calculated to defraud a creditor, employee or shareholder or had another fraudulent purpose;
- he/she signed, consented to or authorised any financial statements, prospectus or written statement that is false, misleading or untrue. Here the director’s knowledge and the materiality of the misrepresentation would be factors for consideration in assessing the liability of the director;
- failing to vote against or participating in the issue of unauthorised shares, the issue of authorised securities, the granting of options, the provision of financial assistance, approval of a distribution, acquisition by the company of its shares or that of its holding company or allotment by the company in contravention of the Companies Act.
Liability extends jointly and severally but a director does have at his disposal a mechanism to apply to court to set aside a decision of the board for which he/she may be held liable. The court has the discretion to set aside the decision in whole or in part, and to make any further order, for example, rectify the decision, reverse a transaction and even indemnify the director for the costs of the proceeding. Recovery of loss, damage or costs is limited to a prescription period of three years after the act or omission that gave rise to that liability.
Section 78 limits the extent to which a company may indemnify a director.
The role of a director is very onerous and is to be regarded in a positively serious light. Anyone accepting such an appointment must at all times ensure that they are fully aware of their rights, duties and obligations, and ensure that every question in their mind is answered prior to taking a decision.
Melanie Naidoo, BProc, LLB, is an Admitted Attorney and the Head of Legal and Governance, SAICA.