DENEYS REITZ CORPORATE MERGERS AND ACQUISITIONS SEMINAR 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS _________________________________________________________________________________ Introduction It has been suggested that provisions of the new Companies Act of 2008 (the “2008 Act”) may trigger flight from boardrooms because careless behaviour could have catastrophic implications not only for the company, but also for the directors, as seen in the collapse of Enron, Leisurenet and the like. These worries are not well founded as the 2008 Act mostly records existing common law duties and stipulates that its provisions be interpreted in accordance with our existing law. The present Companies Act of 1973 (the “1973 Act”) does not contain clear, express rules regarding the duties and responsibilities of directors. To date, that has been largely left to the common law and the King Code. The 2008 Act partly codifies the existing common law duties of directors, following the trend in other countries, although some other countries have chosen to legislate to Page 2 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS the exclusion of the common law, which South Africa has chosen not to do. The good news for directors is that, on the whole, the duties as codified are no different from their current duties under the common law or those codified under the 1973 Act, such as the prohibition against reckless trading. Directors will be able to look up most of their duties with a mere glance at the 2008 Act, without having to read through complicated texts on the subject. Under the 2008 Act, a private company or a personal liability company must appoint at least one director, whilst a public company or non-profit company must have at least three directors. Interestingly, the 2008 Act also provides that a company’s memorandum of incorporation (which is to replace its existing memorandum and articles of association) may allow for the direct appointment and removal of one or more directors by any person specifically nominated in that document. It is conceivable that, for example, third party funders to the company could appoint and remove directors by virtue of the terms of the memorandum of incorporation. A significant development in regard to the management of companies and the protection of investors relates to the tightening up of liability provisions. The board must act in the best interests of the company. In terms of our common law, this would have equated to the best interests of shareholders, but the 2008 Act’s stated purpose is to promote compliance with the Bill of Rights as provided for in the Constitution, thereby widening what should be understood as the best interests of the company. Importantly, the 2008 Act defines “director” as meaning members of the board of directors, alternate directors and persons occupying the position of a director, regardless of their designation. And certain provisions of the 2008 Act apply to a wider definition of “director”. The purpose of this paper is to consider: • the wider definition of “director”, to identify those individuals who were not traditionally grouped with directors but will be put in that camp for the purposes of certain sections; • the core duties of directors and prescribed officers set out in the 2008 Act; Page 3 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS • the provisions of the 2008 Act that provide for instances in which directors and prescribed officers may be held liable; and • instances in which one may indemnify directors against certain conduct and take out appropriate insurance cover to shield the company against costs incurred as a result of directors being held liable for their actions. The wider definition of “director” Although the provisions of the 2008 Act in regard to duties of directors, liability, indemnification and insurance may sound familiar, the devil is in the detail. The 2008 Act states that a “director” includes alternate directors, “prescribed officers” and board committee members (including audit committee members), regardless of whether those persons are appointed board members. The most significant category included in this grouping is prescribed officers. The draft regulations to the 2008 Act, which were released by the Department of Trade and Industry at the end of last year, provide that a prescribed officer includes a host of individuals who were previously not included in the director grouping. According to the draft regulations, a person is a prescribed officer if that individual: • has general executive authority over the company (for example the President, Chief Executive Officer, Managing Director, Executive Director and similar office-holders); • has general responsibility for the financial management of the company (for example the Treasurer, Chief Financial Officer, Chief Accounting Officer and similar office-holders); • has general responsibility for the management of the legal affairs of the company (such as the General Secretary, General Counsel and similar office-holders); • has general managerial authority over the operations of the company (for instance the Chief Operating Officer or a similar office-holder); or • directly or indirectly exercises or significantly influences the exercise of control over the general management and administration of whole or a significant portion of the business and activities of the company. Page 4 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS The result is an extension of responsibilities and liability to individuals who were previously not held to account. Chief executive officers, chief financial officers, chief operating officers, head in-house legal counsel and company secretaries will be grouped with directors for purposes of the same duties and liabilities of directors under the 2008 Act. This is significantly different to the present position under the 1973 Act which does not extend its provisions to these individuals. The core duties The 2008 Act sets out the core duties of directors. These provisions are also applicable to alternate directors, prescribed officers and board committee members. Section 76 provides that these individuals must: • not abuse their position or any information obtained whilst in that position; • communicate to the board any information that comes to his or her attention, unless he or she is bound not to make that disclosure by virtue of a legal or ethical obligation or that information is either immaterial or generally available to the public; • exercise his or her powers: o in good faith and for a proper purpose; o in the best interests of the company; o 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 (which is important in regard to the extended definition of director); and having the general knowledge, skill and experience of that director. Page 5 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS The recent Supreme Court of Appeal decision in Da Silva v CH Chemicals (Proprietary) Limited is a good example of the application of our existing laws by our courts and can be used to illustrate the application of the duties set out in the 2008 Act. CH Chemicals sued Da Silva for the disgorgement of profits, alternatively for payment of damages, arising from the alleged breaches of his duties as managing director. The court referred to the well known rules of company law that directors have a duty to exercise their powers in good faith, in the best interests of the company and that they cannot make a secret profit or place themselves in a position where their duties to the company conflict with their personal interests. Section 76 provides for precisely that. Section 76(3) provides that directors must exercise their powers and functions “in good faith and for a proper purpose” and “in the best interests of the company”. Also, section 76(2)(b) compels a director to communicate all material information relating to the company to the board at the earliest opportunity, except for instances in which the information is immaterial, available to the public or where an obligation of confidentiality prevents him from disclosing such information. These provisions are in line with the principles stated in the Da Silva case and cases such as this will be considered to give content to the meaning of the new law. Section 76 also introduces a new defence available to all who are subject to its provisions. The defence, which was developed in America more than 170 years ago, is known as the “business judgment rule” and has the effect of curbing liability. It provides that a director should not be held liable for decisions that led to undesirable commercial results, where such decisions were made in good faith, with care and on an informed basis, which the director believed were in the interests of the company. It also provides that a director may rely on information provided by company employees and other experts retained by the company. The objective of the rule in the American context is to limit litigation and judicial scrutiny of decisions taken within the private business sector, allowing the company to determine its appetite for risk. It will be interesting to see what effect it has in South Africa. Page 6 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS Liability provisions The liability provisions of the 2008 Act are equally applicable to alternate directors, prescribed officers and board committee members. In summary, section 77 provides that a director may be held liable for any loss, damages or costs sustained by the company, in accordance with the principles of the common law: • relating to breach of fiduciary duties – as a consequence of any breach by the director of certain of the codified duties; or • relating to delict – as a consequence of any breach by the director of a certain codified duty or any provisions of the Act or the company’s memorandum of incorporation. It also provides a number of specific instances in which a director will be held strictly liable. These include deliberate breach of authority, reckless, grossly negligent and fraudulent conduct, and trading whilst insolvent. Also, signing false or misleading financial statements and prospectuses. Strict liability also attaches if a director fails to vote against a wide range of resolutions of the board which contravene various specified sections of the 2008 Act. For example, directors may be held liable if they authorise a “distribution” (which includes the payment of dividends) or a share buy- back where the company fails to meet the solvency and liquidity tests that are applicable to that type of corporate action. Another provision that is of practical importance is section 75. That section provides that if any director has a personal financial interest in respect of a matter to be considered by the board, the general nature of that interest must be disclosed at the meeting together with any known material information relating to the matter. After disclosing the interest, the director must leave the meeting and not participate in the consideration of the matter or in any vote, nor sign any document relating to the matter unless specifically requested to do so by the board. Any breach of these provisions could lead to personal liability under section 77. Taking this into account, it follows that the minutes of board and committee meetings will be important. Those minutes must include details of any disclosures, objections and concerns raised by those present and any vote cast against Page 7 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS decisions should be carefully noted. If there are, in the opinion of the directors, specific rational grounds for a decision, that information should be minuted. If a director disagrees with any decision, not only should they vote against the decision, that vote must be properly recorded. Section 77 of the 2008 Act contains provisions similar to section 248 of the 1973 Act in that in any proceedings against a director, other than for wilful misconduct or wilful breach of trust, the court may relieve a director from any liability if it appears to the court that: • the director is or may be liable, but has acted honestly and reasonably; or • having regard to all the circumstances of the case, including those connected with the appointment of the director, it would be fair to excuse the director. Given the reference to the term “honestly” in the first leg of this section, it is obvious that a court cannot relieve a director from liability that was incurred due to fraudulent conduct on the part of that director. Claims under section 77 must be brought within three years of the act or omission giving rise to liability. Although that time line is the same as specified in the Prescription Act which contains the general time bars for the institution of legal proceedings, the 2008 Act contains no provisions relating to the delay of the date from which prescription starts to run dependent on the knowledge of the claimant. So it seems to matter not that the claimants become aware of the acts or omissions in question only at some later time. Indemnification and insurance As with the sections dealing with the core duties and liabilities, the indemnity and insurance provisions are applicable to alternate directors, prescribed officers and board committee members. Section 78 of the 2008 Act provides that companies will be able to take out indemnity insurance to protect a director against any expense or liability for which the company is allowed to indemnify its directors. A company will also be permitted to take out insurance in its own favour against any expenses that the company may advance to one of its directors or for which the company is Page 8 CORPORATE MERGERS AND ACQUISITIONS SEMINAR – 12 AUGUST 2010 CORPORATE GOVERNANCE: IMPLICATIONS OF THE 2008 ACT FOR DIRECTORS AND PRESCRIBED OFFICERS permitted to indemnify a director. A company cannot indemnify a director against claims based upon deliberate breach of authority, reckless or grossly negligent conduct, fraudulent and wilful misconduct. In addition, the company cannot excuse the breach of fiduciary duties by a director and any provision in an agreement, the memorandum of incorporation or rules of a company is void to the extent that it purports to do so. As would be expected, a company will not be allowed to pay a fine imposed on one of its directors as a result of being convicted of an offence in terms of any national legislation. Conclusion The provisions of the 2008 Act are positive in the sense that the public will be better protected from unscrupulous and supine management and governance. Business must, however, be alive to the fact that the playing fields have changed and that steps will need to be taken to manage exposure. Insurance companies will need to determine their appetite for risk and whether they are willing to extend cover to indemnify alternate directors, prescribed officers and board committee members and, if so, the terms upon which such insurance will be offered. Individuals will also need to carefully consider accepting not only directorship appointments, but positions that will land them in the public officer camp. After all, the 2008 Act has extended its provisions to various individuals who were previously not hit by the 1973 Act. It is also critical for key individuals to familiarise themselves with their responsibilities. Ignorance of the law will be no excuse. STEPHEN KENNEDY-GOOD ASSOCIATE DENEYS REITZ INC.