Friday, June 20, 2008

The Companies Bill, which is to replace both the existing Companies Act and the Close Corporations Act in 2010, has evoked howls of protests over its provisions for the liabilities of directors of companies.

The main criticism is that the provisions will militate against people accepting the appointment as a director of a company, especially as a non-executive director, because the risk of personal financial liability for breach of a whole host of its provisions is simply too great relative to the rather modest directors’ fees.

The third and most recent draft of the Bill has been approved by the Cabinet and referred to Parliament for consideration. While it is not yet publicly available, its duties and liabilities of directors provisions are not expected to change much, because they accord with international best practice and are, in most instances, regarded as fundamental pillars of sound corporate governance.

There are two fundamental reasons for this relatively new approach of governments towards directors:

Firstly, we have witnessed the emergence of the private sector as a key player in industries which were hitherto either monopolised or dominated by State-owned entities, such as power, telecommunications and transport.

Unfortunately, the increased role and influence of the multi-national corporation has led to abuse of power by certain of their directors, to the severe detriment of the public at large.  In reaction, the regulators have considerably increased corporations’ disclosure of information while imposing more stringent accounting requirements and rules on how companies, and directors in particular, discharge their duties and responsibilities to investors and third parties with whom they transact.

In short, transparency and corporate governance now play a pivotal role in modern business practice.

Secondly, there has been a fundamental policy shift by government in that the criminal sanction for contraventions of the Companies Act will be almost entirely replaced by a system of administrative fines and, more importantly, by civil sanctions in the form of personal financial liability being placed on the offender.

Our current Act contains over 120 provisions which levy criminal sanctions on directors. The Bill reduces this number to a handful of the most serious offences. Thus, Government is now willing to considerably relax its control over the manner in which the private sector conducts business; self-regulation is preferred to State intervention.

Accordingly, directors will have greater powers and flexibility than ever before as to how they manage their companies.

However, with increased powers comes increased responsibility and accountability.  Directors cannot have their cake and eat it. If they are found wanting in the proper discharge of their increased powers and duties, the punishment must be meaningful and serve as a real deterrent to any future misconduct. Financial sanctions should prove to be more of a deterrent than criminal sanctions, which have been largely ineffectual.

It is difficult to argue against this approach. It is, after all, sound in principle. The difficulty facing the legislature is to strike a careful balance between adequate sanctions and over-exposure to financial risk. This is vital, particularly because there is already a dearth of non-executive directors with the necessary experience and skills in South Africa.

The duties and liabilities of directors are governed by both common law and statute. The former derives from historical sources (mainly of Roman-Dutch and English origins), augmented and developed by our courts through case law. The main statute is the Companies Act.  The common law may only be changed by statute or by our courts.

A director's duties are diverse and numerous, making it impossible to lay down hard and fast rules to govern every conceivable situation. Each matter must be judged on its own merits.  This is among the reasons why the common law plays a significant role in the governance of directors.
The common law duties which a director owes a company are a unique set of obligations which are not regulated by the Acto or by contract.  These duties are owed by the director to his company alone (and to no one else, including individual shareholders) and are therefore mainly protective of the company.

Directors are either executive or non-executive; a distinction that lies in a director's level of involvement in the day‑to‑day management of the company. Apart from the different degrees of care and skill arising from specialist skills and/or the degree of involvement in daily management, there is no difference in law between the duties and liabilities of executive directors and non‑executive directors.

The next article in this series will deal with the common law duties of directors.

Carl Stein is a director at Bowman Gilfillan.