GREATER DUTY OF SKILL BY THE DIRECTORS OF A BANK

Friday, August 22, 2003
  • SHARE THIS ARTICLE

by Claire Tucker

In Terms of the South African Law the Directors of a bank owe a greater duty of skill and care than that owed, in terms of the Common Law by the Directors of other companies.

INTRODUCTIONThe Banks Act (1) which governs the operation and stewardship of banks in South Africa is leading the way in introducing benchmarks against which the exercise of the duty of skill and care owed by directors can be judged.

THE COMMON LAW POSITIONThe common law position with respect to the duty of skill and care owed by directors was set out in the case of Fisheries Development Corporation of SA Ltd v Jorgenson. (2) Aspects of this position can be summarised as follows:

The extent of a director’s duty of care and skill depends on the nature of the company’s business and on any obligations assumed by or assigned to him or her;

There is a difference between the skill level expected from an executive director and a non-executive director;

A director is not expected to have special business acumen or expertise;

He or she is expected to exercise the care which can reasonably be expected of a person with his or her knowledge and experience.
In South Africa, in contrast to many other jurisdictions, there hasn’t been a push for a statutory codification of the duties of directors. However, there have been moves in certain clearly demarcated industries to deal in statute with the nature of the duties owed by directors to the entity they direct. This is an affirmation of the first aspect of the duty of skill and care that was set out in the Fisheries Development Corporation case, namely that the extent of a director’s duty of care and skill depends on the nature of the company’s business and on any obligations assumed by or assigned to him or her. It follows that the director of a bank, charged with the stewardship of depositor’s funds, may be expected to exercise a greater degree of skill and care than the director of a furniture company.

THE BANKS ACT AND REGULATIONS
In South Africa, registration as a public company is a prerequisite for registration as a bank. Therefore, directors of a bank are bound both by the requirements of company law and by the specific requirements of the banking statutes. The Banks Regulations (3) deal with the duty of skill and care owed by the directors of a bank. However, to understand the approach taken in these regulations it is necessary to understand how the Banks Act as a whole approaches the fiduciary duties owed by directors. This is dealt with in section 60 of the Banks Act.

Section 60 of the Banks Act

In the ordinary course, in terms of South African law a director owes both a fiduciary duty and a duty of skill and care to the company and not to third parties (such as creditors) (4). However, section 60 of the Banks Act, while asserting that each director of a bank or controlling company stands in a fiduciary relationship to the bank or controlling company, as the case may be, of which he or she is a director, also provides that "fiduciary relationship" must be interpreted as acting in the "best interests and for the benefit of the bank and its depositors".
Section 60 does not create a direct fiduciary relationship between each director of a bank and the depositors in the bank. This section requires that the fiduciary relationship between the bank and the director of the bank be interpreted as incorporating a duty to act in the best interests of depositors. This is nonetheless a significant change in the ordinary nature of the fiduciary duty which requires that the director of a company must act exclusively in the best interests of the company itself (5). Section 60 does not suggest how directors of a bank should resolve conflicts between the best interests of the banks and the best interests of the depositors, and an amendment to this section is currently being debated in Parliament.
The amendment removes direct duty towards depositors and will replace the ambiguous provision that is presently in the Banks Act with the following requirement:

"(...) a director, chief executive officer or executive officer of a bank shall, in the performance of his or her functions in respect of that bank, observe such guidelines and comply with such requirements as may be prescribed under section 90(1)(b)."

Such a provision, if it is enacted, would result in an expansion of the existing Banks Regulations to create a code of conduct that sets out the manner in which directors must conduct themselves. Such an approach is similar to the approach that is followed with respect to the directors of banks in many other jurisdictions (6).

Regulation 39 of the Banks RegulationsThe existing Banks Regulations seek to elaborate on the duty owed by the directors of a bank to depositors. The main way in which this is done is by expanding on the approach to the duty of skill and care followed in the Fisheries Development case.

Regulation 39(1) requires every director of a bank or controlling company to "acquire a basic knowledge and understanding of the conduct of the business of a bank and the laws and customs that govern the activities of such institution." Thus, the Banks Regulations set a specific standard of skill that is required of all directors whether executive or non-executive. The distinction is not, however, done away with completely and regulation 39(1) acknowledges that there will be differences in the skill and knowledge base of different members of the board of directors.

Regulation 39(2) provides that:

"All directors and executive officers of a bank or of a controlling company shall perform their functions with diligence and care and with such degree of competence as can reasonably be expected from persons with their knowledge and experience."

The duty of skill and care, therefore, is both a common law duty and a statutory duty.

In determining whether a director has carried out his or her duties with skill and care, the manner in which the director has carried out the statutory duties placed on the director by the Banks Act and the Banks Regulations would be relevant. For example, failure to acquire the basic knowledge required in regulation 39(1), or a failure to submit accurate annual reports in terms of regulation 39(4) could be used to show that the director has failed to carry out his or her duties with the level of care required.

Regulation 39(3) of the Banks Regulations flows from the notion introduced in section 60(2) of the Banks Act, that every director of a bank is required to exercise his or her powers in the best interests of depositors, but goes further and places a specific duty in this regard on a director of a bank. It provides:

"In view of the fact that the primary source of funds administered and utilised by a bank in the conduct of its business is deposits loaned to it by the general public, it shall be the duty of every director and executive officer of a bank to ensure that risks that are necessarily taken by such a bank in the conduct of its business are managed in a prudent manner."

The regulation does not state to whom the director owes this duty: is it to the company/bank; to depositors; or is it a statutory duty which the Registrar of Banks can enforce in the manner provided in the Banks Act. The most logical interpretation (and the one which disrupts existing law as little as possible) is that this is an aspect of the fiduciary duty, owed to the shareholders of the bank.

The Banks Regulations contain a number of provisions aimed at ensuring risk is managed in a prudent manner by the directors of a bank (7). A failure to adhere to all of the provisions of the Banks Act and the Banks Regulations regarding risk management could be used to show that the directors of a bank have failed to manage risk in a prudent manner. This could give rise to an action by the shareholders of the bank / the bank against the directors personally, based on a breach of the fiduciary duties.

CONCLUSION
The King Report on Corporate Governance in South Africa 2002 discusses many of the provisions of the Banks Regulations that are discussed above and recommends that legislation should place similar duties on directors in other industries (8).

1. Act No 94 of 1990.2. 1980 (4) SA 156 (W) 165.3. The Banks Regulations (published in Government Gazette no. 21726 of 8 November 2000).4. Meskin, Henochsberg on the Companies Act (1994) 467, Parke v Daily News Ltd [1962] Ch 927 at 963, Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC ER 1120 (CA).5. Hahlo "South African Company Law" 5th ed (1999) 293. See also Botha "Directors’ Fiduciary Duties to Bondholders? Some relationships between corporate financial management and fiduciary law" (1993) 5 SA Merc LJ 28.
6. For example the "Approved Persons Regime" enacted in terms of the UK Financial Services and Markets Act, 2000 which sets out a code of practice and the statutory statement of principles of directors’ duties which is being incorporated into UK law.
7. For example: regulation 39(4) requiring the directors of a bank to (collectively) carry out certain investigations on an annual basis regarding the internal risk management controls instituted by the bank; regulation 47 regarding the independent compliance function that a bank is required to establish as part of its risk management framework; and regulation 48 regarding the controls a bank must institute to protect against market abuse and financial fraud.
8. See pages 42 and 170-175 of the King Report