Today I would like to direct some attention to the aspect of company directors or board members. Many private companies globally sometimes appoint directors with very little knowledge of the implications of what they are doing, and oftentimes the directors themselves accept appointment without understanding what they are entering into. Many people do not know that the directorship title is associated with so many duties and responsibilities with corresponding risks that sometimes outweigh the financial benefits, status quo, networking, friendship etc. that attract people to such roles.
For public companies, usually the kind and status of people who get appointed to such roles make people assume that they know all that relates to the role, since public limited companies are much larger than most private ones. This however has not eliminated the kind of disasters we sometimes witness resulting from board malfunction even in the big corporations. But what are the critical issues that relate to directors and boards of companies? What should shareholders take into account while appointing directors, and what should the appointees or potential appointees themselves know and consider before accepting the appointments?
Can we take a look at what I think are principal issues?
- Legalities surrounding appointment, accountability and remuneration. Generally, directors are appointed and are also dismissed by shareholders. Some boards can appoint directors but cannot dismiss them. Minimum age restrictions exist and these are stated in laws of respective countries, with some being 16, 18 etc. This implies that you cannot appoint underage folks as directors. Most laws also prohibit appointing people who are bankrupt, insane, has been or is the auditor of the company, or someone disqualified due to other reasons such as qualifications in articles etc. Formal acceptance of appointment is vital but even without this, exercising significant influence or acting like a director can be construed as being a director by fact (with the legal aspect validated later) for the company. Directors then appoint chairman, board committees, company secretary, etc. So, this is not something you can easily walk into and out of as you desire. Do you understand? Shareholders also determine remuneration of the directors.
- Duties and responsibilities. The duties and responsibilities of directors of companies fall under both general law (fiduciary duties) and under the companies act (statutory duties). Directors owe duty to the shareholders, the company, and indirectly the act. These duties and responsibilities could be diverse as prescribed under the respective laws, but include preparing and filing statutory docs, calling meetings including annual meeting of shareholders, binding the company on dealings with other parties, maintaining records of the company, making strategic and operational decisions for the company, promoting the company while acting within powers and exercising independent judgment with care, skill and diligence. Directors are also responsible for maintaining confidentiality for the company, compliance to laws about health and safety, environment, etc., including anti-corruption and anti-money laundering. They articulate and promote the vision, mission and values of the company, and are responsibility to relevant stakeholders. In highly regulated industries such as banking, insurance, defense, pharmaceuticals etc. other duties and responsibilities might be additional.
- Exercising reasonable skill, care and diligence while avoiding conflict of interest. All company directors are required to act with skill, care and diligence and also avoid conflict of interest. The laws do not desire any form of outright foolishness or stupidity including brazen selfishness for directors. Do you know and understand this? This is mainly due to the fact that limited companies tend to bring in the public, in many ways, and have much greater impact on the economy and society generally. Doing silly things in a company could cost directors so dearly and this could even include jail terms. Is this something you would like to have a taste of? Certainly not! Directors are meant to act honestly and in the best interest of the company, while exercising reasonable skill, care and diligence in the process. They should act with utmost good faith (uberrima fides), use power for proper purpose, not create risk and loss for the company, ensure liquidity and solvency and comply with the relevant acts. They can only exercise their rights and powers within limits and with caution. Directors should avoid direct or indirect conflict of interest, making undue gain or advantage to self, relatives, associates etc., or having interest in transactions or arrangements with the company. They also cannot assign their office to anyone else. They have to carry their own cross. Do you appreciate the gravity of this?
- Breaches and reliefs including indemnifications. Now, there are provisions in the law that make directors liable for certain breaches, and also deals with how they can get out of such situations in some cases depending on what they have done anyway. The law is a bit balanced and does not allow an innocent soul to be punished anyhow. Ok? Nevertheless, directors could be held liable for several things such as fraudulent acts, non-compliance to the law etc. Non-executive directors (those not involved in the day to day management of the company) may have some reprieve if proven that they were not aware of such dealings. This is a form of relief. Breaches could result into injunction, termination of directorship, compensation and damages demanded from directors, imprisonment and others. Reliefs may be granted through court if found that he/she acted reasonably and honesty. Other relief options could include ratification of the said problematic actions of directors by shareholders, insurance, and also indemnification by the company. However, the company is not under obligation to indemnify. Don’t you think some of these issues could be good fodder for the courts and the learned friends? You could waste a lot of time and money if you are not smart.
- Situations where companies are in insolvency or bankruptcy. Another principal issue directors should know is that in situations where the company is under administration, receivership or liquidation etc., additional responsibilities could be required of directors, and also directors’ powers could be limited at the same time. For examples, directors are expected to make adequate consultations to get the business out of trouble. They are not expected to overtrade or continue with wrongful trading, because they could be ordered by court to contribute to the pool of assets for compensating aggrieved parties such as creditors if found that directors acted wrongly and with neglect. Directors’ duties in such cases could be modified to act in the best interest of creditors. There is also what is called misfeasance, which relates to directors wrongly applying company assets, retaining company assets or wrongly exercising authority. Giving wrong opinion on the financial status of the company, failure to file details of reconstructions, failure to file with the registrar court orders in respect of creditors’ arrangements, approving distributions to shareholders during such times of bankruptcy etc. could attract very punitive actions against directors.
- Oversight of management. The fact that directors oversee management of the company is another principal issue that cannot be ignored. Directors work through delegation of authority to management. They work through management to implement plans, strategies, policies, internal controls etc. They monitor and evaluate management over time and take corrective decisions and actions accordingly. Directors communicate with management and also take responsibility for overseeing risk management, financial reporting, safeguarding assets of the company etc. Any director should be wary of some of this delegated authority because it could be grossly misused and abused, and yet shareholders demand accountability from directors. Shareholders are going to roast directors and not management in most cases because directors appoint, oversee and fire management. As directors you cannot wash your hands entirely from management misdeeds and poor performance because in the law you have the capacity and mandate to replace them. Don’t you? So, beware my dear director!
- Importance of knowledge, information and capabilities. To potential directors, let me state this. Ignorance could destroy you as a director. If you have been invited to be a board member in an industry where you have no clue at all, you better watch or consult before you accept such appointments. The thing is this; unless you can quickly gear up and learn to be an effective director, you could be led in any direction. Executive directors could mislead you as you are opaque. Non-executive directors might be asleep when executive directors do wonders in the company. As a director you will still be held accountable, and you cannot simply say sheepishly that you did not know. Just imagine yourself putting a defense in an embarrassing way before the annual general meeting, or before the courts of law. Your entire reputation could go for small things like this.
- Effective and ineffective boards. Board non-competence could lead to board failure and subsequent company failure. Reasons for potential board failures need to be identified early by shareholders and addressed. The composition of the board is vital, and shareholders should know that bringing any person to the board for the sake of it, could be detrimental or even disastrous. Several aspects such as board composition, balance, proper debate in the boardroom, reasonably frequent change of directors, regular development reviews of directors, externally facilitated board effectiveness reviews, good board leadership, avoidance of one or two dominant but toxic members, fraudulent actions not acted on by boards etc., are critical to board success or failure. Failure to investigate problems, failure to inspire new corporate culture or promote research and product development could all cause quite some problems to deal with. Clueless and ineffective boards could result into revenues plummeting at free will, inability to save costs, making and implementing the worst strategic decisions, uncontrolled and unprofitable acquisitions and investments etc. Don’t you agree with me? This is another principal issue that directors and shareholders should know.
- Boards are ultimately responsible for the success or failures of companies. This is a hard statement I’m making in this blog and I know that some people could react to this. It is a dangerous statement and yet it’s true. Looking at things in the medium and long-term, boards take ultimate responsibility for success (or the opposite of it) in the companies that they are responsible for. Don’t blame the CEO for nothing. Ok? Don’t also blame the employees and other unseen forces. In the first place, it’s the board that hires a clueless or ill-fitting CEO. The same board should be able to see within two or three years that the CEO is inappropriate and hence take required replacement steps. The board should be able to see around the corner. It should be strategic so that there is no strategic void in the company, which could result in catastrophic business failure. If you must fail, fail quickly and in a cost effective way and move on. Boards should support the CEO, challenge him and direct him. A good and responsible board cannot be a puppet of the CEO and play along. So, dear board members, you simply cannot easily wash your hands and yap around pointing a single finger at someone while four of the fingers are pointing back at you!
Ok. I think we have had enough about this topic for today. Sincerely, haven’t we shared some very useful information for directors and also shareholders? There should be minimum waste of precious resources invested in companies. Company failures have to be avoided and directors including shareholders play a critical role in this respect. I’m simply trying to improve this role through the above points.
Thanks for reading the blog, and have a fantabulous new week!
The Wise Entrepreneur