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South Africa: Directors’ duties (7 of 8) – dealing with CEO misconduct and poor performance

13 May 2024
– 9 Minute Read

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Overview

  • Most terminations of a CEO’s employment occur when the board forms a view that the CEO is failing to perform to the standard required by the board. This is usually occasioned by the company’s performance in failing to meet the targets that have been set or underperforming when compared to its peers. The procedure for dealing with poor performance by a CEO is different from that which applies to more junior employees.
  • Misconduct cases against CEOs and senior executives are rare. When they do arise, the question is what procedure should be adopted. In many instances the CEO and executive contracts will incorporate the company’s policies and procedures into the contract which would include the disciplinary procedure. The board will accordingly need to be guided by the company’s disciplinary procedure in determining the process to be followed.

This is the seventh in a series of articles on the duties of directors in relation to employment, employment law and employee benefits. Senior consultant Graham Damant, has discussed these issues at length with Bowmans’ partner Chris Todd in two ‘Value of Knowing’ podcasts. The first (on our website here) covers what boards in South Africa need to know about employment, employment law and employee benefits to meet their fiduciary duties avoid liability. The second (on our website here here) highlights the obligations and duties of boards in South Africa in relation to CEOs. Subscribe to’ The value of Knowing’ podcast on Apple Podcasts or Spotify.

Misconduct cases against CEOs and senior executives are rare. When they do arise, the question is what procedure should be adopted. The Labour Relations Act envisages the adoption of a much more informal process of disciplinary enquiry as was the case under the old Act that regulated labour relations.

The old Act followed a criminal justice-type model where a case was conducted on an adversarial system in front of an independent chairperson. It involved an investigation into the conduct of an employee and an opportunity to state a case. This could be done by way of an exchange in writing and could be conducted by any member of the board or a board committee.

Many companies, particularly larger companies, have retained this criminal justice-type model of disciplinary procedure. In this case, there is usually no reason why the same procedure should not be applicable to a CEO or other senior executives. In many instances the CEO and executive contracts will incorporate the company’s policies and procedures into the contract which would include the disciplinary procedure.

The board will accordingly need to be guided by the company’s disciplinary procedure in determining the process to be followed. The first issue is determining who will chair the enquiry. Here the options are an entirely independent chairperson (usually an advocate or a lawyer), a sub-committee of the board, or a member of the board. Whoever is selected will only be mandated to make a finding of fact and guilt as to whether the misconduct occurred or not.

On the issue of sanction, the board itself will need to decide whether the conduct has resulted in a breach of the trust and confidence required and whether dismissal is the appropriate sanction or not. The board members would not be discharging their fiduciary duties if they delegated the determination of whether the trust relationship had been broken to a third party.

It is also necessary to determine who will lead the board’s case. This requires the calling of witnesses and the placing of documents before the chairperson. Usually, this would be someone within the company. Given that such person is likely to be subordinate to the CEO this can give rise to difficulties. In many cases it is easier to delegate the task to an outside lawyer.

In the event that the board is not contractually bound to adopt a formal disciplinary process, it can adopt a less formal process that does not involve an adversarial type of process. If the facts are not complex and are not likely to be in dispute the board can adopt a process where the allegations are presented in writing and the CEO is given an opportunity to respond in writing.

Alternatively, a chairperson can be appointed and mandated to adopt an inquisitorial approach and call for documents and witnesses themself. In an inquisitorial approach, the chairperson questions the witnesses themself. The chairperson puts the different versions to the witnesses called and then examines the witness in relation to the version put forward. The witnesses’ version would be put to the CEO and they would be given an opportunity to respond. Where there are disputes of facts, the chairperson will have to make a finding as to which version of the facts is more probable.

In the event of a guilty finding, and in determining sanction, the board will need to consider the severity of the conduct, the seniority of the position held, the judgment and integrity required of persons who hold these positions and then determine whether they still have trust and confidence in the CEO. If not, it would be appropriate to dismiss the CEO.

Most terminations of a CEO’s employment occur when the board forms a view that the CEO is failing to perform to the standard required by the board. This is usually occasioned by the company’s performance in failing to meet the targets that have been set or underperforming when compared to its peers. Poor performance can take many forms.

In some instances, the performance can be so poor that it can be categorised as a dereliction of duties or negligence. So, for instance, if a company’s financial performance is misstated because of inadequate controls or because controls that were in place were breached, this could constitute negligence or dereliction of duties. In that case, a misconduct enquiry would be warranted.

In some cases, the poor performance can be attributable to the adoption of a wrong strategy. Here the issue becomes more difficult as usually the CEO and their team prepare the strategy which is then presented to the board and adopted by the board. Because the board has adopted this strategy it is also accountable for the poor performance of the company. However, there are degrees of accountability. The board members do not have the same deep level of insight into the company or the industry in which the company operates and accordingly are heavily reliant on the CEO and their team to advise on the best strategy. The CEO can still be held accountable for the adoption of a poor strategy even if it has been endorsed by the board.

In some cases, poor performance can be caused by poor implementation of the strategy. In this event, the CEO is accountable.

In some instances, the poor performance can be attributable to members or a member of the executive team. The CEO is expected to select the right people for their executive team, to measure their performance, to take corrective action and, where necessary, to terminate the employment of non-performing executives. It is not the board’s responsibility to deal with non-performing executives who report to the CEO and the board should in fact refrain from doing so.

It is therefore not a defence for the CEO to blame poor performance on members of the executive team. Our courts have held that the CEO’s performance can be measured by the performance of the company as a whole. If the company is performing poorly (particularly in relation to its peers), the CEO can be held accountable. The market conditions must be taken into consideration, but the CEO is nevertheless expected to navigate difficult market conditions with a view to ensuring that the company remains profitable.

It is necessary that the board adopts a fair procedure in dealing with the termination of a CEO’s employment due to a failure to perform. For ordinary employees, the expectation is that they will be performance managed prior to termination of employment. Performance management requires that they are informed of the levels of performance required of them, the areas where they are failing to perform, the remedial steps required and the assistance that would be afforded to meet the required standard, and the time they will be afforded to meet the level of performance required. Failure to achieve the required level of performance by the specified time will result in dismissal.

With a CEO, the courts have not required this process. The CEO is required to know the level of performance required of them, to recognise that they are not performing to the required level and to remedy any failure to perform themselves. The board is not expected to performance manage the CEO and is often ill-equipped to do so. The board is not expected to put the CEO on terms and afford them a time period in which to remedy poor performance.

The courts do, however, require that a CEO be afforded an opportunity to state a case prior to dismissal. The question then is what format an investigation or enquiry into poor performance should take. Unless the company has a specific procedure that is applicable to dealing with poor performance, the board would be free to adopt a process that is appropriate in the circumstances.

In most instances, the facts that are indicative of poor performance should be self-evident. They are usually based on statistics that are indicative of the company’s financial performance or indicative of the performance of particular areas of the company.

An appropriate process would be for the CEO to be given the facts on which the board relies to allege non-performance in written format and for the CEO to be invited to forward any reasons as to why this should not be regarded as poor performance on their part, or to put forward any mitigating circumstances. The submissions would be considered by either a board member or a sub-committee of the board to whom responsibility has been delegated. The board member or committee would then make a recommendation to the board as to whether the CEO’s employment should be terminated.

As the CEO is often a member of the board and a board member has the right to be heard by the board prior to removal, the CEO should be afforded an opportunity to address the board on findings before a dismissal and removal from the board is given effect to.

All articles in the series: