Duties Of Directors - Deloitte

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Duties of DirectorsApril 2013

The question of corporate governance as it pertains to directors is a very wide-ranging topic. Thisbooklet is intended to provide general guidance in this regard only, and does not purport to cover allpossible issues relating to the topic. For specific guidance, we suggest you contact Deloitte & Touche.Deloitte & Touche cannot accept responsibility for loss occasioned to any person acting orrefraining from action as a result of any material in this publication.ReferencesAudit committees combined code guidance, Sir Robert Smith, 2003Banks Act of 1990Companies Act 71 of 2008Insurance Act 53 of 1998JSE Securities Exchange, South Africa Listings RequirementsJSE Securities Exchange, South Africa Insider Trading booklet, 2001King Report on Corporate Governance for South Africa 2009Law of South Africa, WA Joubert & JA Faris, Butterworths, 2002Long-Term Insurance Act 52 of 1998Review of the role and effectiveness of non-executive directors, Derek Higgs 2003Financial Markets Act 19 of 2012Companies and other business structures in South Africa, Davis et al, 20092

ContentsPreface1. What is a Director?1.2 Prescribed officers1.3 The legal status of a director1.4 The different types of directors1.5 Personal characteristics of an effective director2. Appointment of a director2.1 Who qualifies as a director?2.2 The legal mechanics of appointment2.3 What a new director should be told3. Director conduct3.1 The standard of directors’ conduct3.2 Conflicts of interest3.3 Liability of directors3.4 Apportionment of damages3.5 Insider trading4. The workings of the board of directors4.1 Composition of the full board4.2 The implicit duties of the board4.3 Meetings of directors4.4 Important roles of the board4.6 Relationships within the company4.7 Communication with stakeholders5. The powers of the board of directors5.1 How can a director bind the company?5.2 Reservation of powers5.3 Which powers are restricted?5.4 Effectiveness of company actions and the role of the CIPC6. Remunerating directors6.1 The director’s right to remuneration6.2 Remuneration policy6.3 What type of remuneration is appropriate?6.4 Employment contracts, severance and retirement benefits6.5 Disclosure of directors’ remuneration7. Assessment, removal and resignation7.1 Assessment of performance7.2 Why a director may be removed7.3 Rotation of directors7.4 Vacancies on the board7.5 The legal mechanics of removal7.6 Formalities when a director resigns8. Financial institutions8.1 Directors of banks8.2 Directors of insurance companies9. Contact ties of Directors3

PrefaceA key feature of the Companies Act, 2008(the Act) is that it clearly emphasises theresponsibility and accountability of directors.Recent international and local jurisprudence alsounderline the demanding standard of conductthat is expected of company directors, all ofwhich South African company directors woulddo well to take very thorough notice of.The Act reduces the company’s reliance onthe regulator, the Companies and IntellectualProperty Commission (CIPC). Althoughcompanies still have to comply with variousadministrative processes to inform the CIPCof its decisions (for example the appointmentof directors, changing of auditors, change ofyear end, amendment of the Memorandumof Incorporation, etc.), the validity of thesedecisions are generally not dependent on theapproval of the CIPC. In most instances, thecompany’s decision is effective immediately andit merely needs to inform the CIPC of decisionsor actions. However, in a few instances the effectof the decision is delayed until the necessaryNotices have been ‘filed’ with the CIPC. ‘Filing’in terms of the new Act simply means that theNotice had been received by the CIPC (recordedin the CIPC’s computer system, or the date onwhich registered or other mail is received by theCIPC). The CIPC is not required to approve or vetany decisions or actions of the company.The counter balance to the diminished role ofthe regulator is greater emphasis on the role ofthe directors of the company. The constructionis that by accepting their appointment to theposition, directors tacitly indicate that they willperform their duties to a certain standard, and itis a reasonable assumption of the shareholdersthat every individual director will apply his or4her particular skills, experience and intelligenceappropriately and to the best advantage of thecompany. In this regard, the Act subscribes tothe “enlightened shareholder value approach”– which requires that directors are obliged topromote the success of the company in thecollective best interest of shareholders. Thisincludes, as appropriate, the company’s needto take account of the legitimate interests ofother stakeholders including among others, thecommunity, employees, customers and suppliers.Also, the social responsibility of the company(and the directors) was noted in Minister ofWater Affairs and Forestry v Stilfontein GoldMining Company Limited and others 2006 (5) SA333 (W), emphasising the broader responsibilityof the directors and the company. In this casethe court made direct reference to the KingCode, which is interpreted by some as evidencethat the King Code has de facto become part ofthe duties of directors.The Act codifies the standard of directors’conduct in section 76. The standard sets the barvery high for directors, with personal liabilitywhere the company suffers loss or damage asa result of the director’s conduct not meetingthe prescribed standard. The intention of thelegislature seems to be to confirm the commonlaw duties and to encourage directors to acthonestly and to bear responsibility for theiractions - directors should be accountable toshareholders and other stakeholders for theirdecisions and their actions on behalf of theinanimate company. With the standard set sohigh, the unintended consequence may bethat directors would not be prepared to take

difficult decisions or expose the company to risk.Since calculated risk taking and risk exposureform an integral part of any business, the Actincludes a number of provisions to ensure thatdirectors are allowed to act reasonably withoutconstant fear of personal exposure to liabilityclaims. In this regard, the Act has codifiedthe business judgement rule, and provides forthe indemnification of directors under certaincircumstances, as well as the possibility to insurethe company and its directors against liabilityclaims in certain circumstances.The Act makes no specific distinction betweenthe responsibilities of executive, non-executiveor independent non-executive directors (in orderto understand the distinction between differenttypes of directors we turn to the King Reportof Governance for South Africa, 2009 (King III)for guidance). The codified standard appliesto all directors. In CyberScene Ltd and others viKiosk Internet and Information (Pty) Ltd 2000 (3)SA 806 (C) the court confirmed that a directorstands in a fiduciary relationship to the companyof which he or she is a director, even if he or sheis a non-executive director.In terms of this standard a director (or other personto whom section 76 applies), must exercise his orher powers and perform his or her functions: in good faith and for a proper purpose; in the best interest of the company; and with the degree of care, skill and diligencethat may reasonably be expected of a personcarrying out the same functions and having thegeneral knowledge, skill and experience of thatparticular director.In essence, the Act combines the common lawfiduciary duty and the duty of care and skill. Thiscodified standard applies in addition to, and notin substitution of the common law duties of adirector. In fact, the body of case law dealingwith the director’s fiduciary duty and the duty ofcare and skill remains applicable.All directors are bound by their fiduciary dutyand the duty of care and skill. The codifiedstandard of conduct applies equally to allthe directors of the company. Of course, it istrite that not all directors have the same skilland experience, and not all directors have asimilar understanding of the functioning of thecompany. This raises the question as to what isexpected of different types of directors when itcomes to their duties. In this regard, the court,in Fisheries Development Corporation of SA Ltdv AWJ Investments (Pty) Ltd 1980 (4) SA 156 (W)made it clear that the test is applied differently todifferent types of directors. The court concludedthat the extent of a director’s duty of care andskill depends on the nature of the company’sbusiness, that our law does not require a directorto have special business acumen, and thatdirectors may assume that officials will performtheir duties honestly.The test for the duty of care and skill ascontained in the Act provides for a customisedapplication of the test with respect to eachindividual director – in each instance both theobjective part of the test (measured against aperson carrying out the same functions as thatdirector), as well as the subjective element of thetest (measured against a person having the sameknowledge, skill and experience as that director)will be applied. Thus, even though all directorshave the same duties, the measurement againstthe standard of conduct will account for thepersonal circumstances of each director.As stated above, the Act also codifies thebusiness judgment rule. In terms of this rule adirector will not be held liable if he or she tookreasonable diligent steps to become informedabout the subject matter, did not have a personalfinancial interest (or declared such a conflictinginterest) and the director had a rational basis tobelieve that the decision was in the best interestof the company at the time.Duties of Directors5

In discharging any board or board committeeduty, a director is entitled to rely on one ormore employees of the company, legal counsel,accountants or other professional persons, or acommittee of the board of which the director isnot a member. The director, however, does nottransfer the liability of the director imposed by thisact onto such employee, nor can a director blindlyrely on the advice of employees or advisors.In a recent Australian judgment, AustralianSecurities and Investments Commission vHealey [2011] FCA 717, commonly referred toas the Centro case, the court re-emphasisedthe responsibility of every director (includingnon-executive directors) to pay appropriateattention to the business of the company, and togive any advice due consideration and exercisehis or her own judgment in the light thereof.This case is relevant to directors of South Africancompanies, because the new Act indicatesthat a court, when interpreting or applyingthe provisions of the Act, may consider foreigncompany law.In this case the non-executive Chairman, sixother non-executive directors and the ChiefFinancial Officer of the Centro Property Group(“Centro”) faced allegations by the AustralianSecurities and Investments Commission that theyhad contravened sections of the CorporationsAct 2001 arising from their approval of theconsolidated financial statements of Centro,which incorrectly reflected substantial short-termborrowings as “non-current liabilities”. Similar toour Companies Act, the Australian CorporationsAct also requires the board to approve thefinancial statements.6The relevant detail facts are that the 2007 financialstatements of Centro Properties Group failed todisclose, or properly disclose, significant matters.The statements failed to disclose some AUS 1.5billion of short-term liabilities by classifying themas non-current liabilities, and failed to discloseguarantees of short-term liabilities of an associatedcompany of about US 1.75 billion that had beengiven after the balance sheet date, but beforeapproval of the statements.The central question in those proceeding werewhether directors of substantial publicly listedentities are required to apply their own minds to,and carry out a careful review of, the proposedfinancial statements and the proposed directors’report, to determine that the informationthey contain is consistent with the director’sknowledge of the company’s affairs, and thatthey do not omit material matters known tothem or material matters that should be knownto them. In short, the question was to whatextent reliance may be placed on the auditcommittee and the finance team.

In analysing the director’s duty of care and skill,the court commented that:“all directors must carefully read andunderstand financial statements before theyform the opinions which are to be expressed. Such a reading and understanding wouldrequire the director to consider whether thefinancial statements were consistent with his orher own knowledge of the company’s financialposition. This accumulated knowledge arisesfrom a number of responsibilities a directorhas in carrying out the role and function of adirector. These include the following: a director should acquire at least a rudimentaryunderstanding of the business of thecorporation and become familiar with thefundamentals of the business in which thecorporation is engaged; a director should keep informed about theactivities of the corporation; whilst not required to have a detailedawareness of day-to-day activities, a directorshould monitor the corporate affairs andpolicies; a director should maintain familiarity withthe financial status of the corporation by aregular review and understanding of financialstatements; a director, whilst not an auditor, should stillhave a questioning mind.”Several statements were made in which itbecame apparent that every director is expectedto apply his or her own mind to the issues athand. Even though directors may rely on theguidance and advice of other board committees,employees and advisors, they nevertheless needto pay attention and apply an enquiring mind tothe responsibilities placed upon him or her.“ . a director is not relieved of the duty to payattention to the company’s affairs which mightreasonably be expected to attract inquiry, evenoutside the area of the director’s expertise.”“ Whether, for instance, a director wentthrough the financial statements ‘line by line’,he is not thereby taking all reasonable steps,if the director in doing so is not focussed forhimself upon the task and considering forhimself the statutory requirements and applyingthe knowledge he has of the affairs of thecompany”.A key statement made by the judge is as follows:“Nothing I decide in this case should indicatethat directors are required to have infiniteknowledge or ability. Directors are entitled todelegate to others the preparation of books andaccounts and the carrying on of the day-to-dayaffairs of the company. What each directoris expected to do is to take a diligent andintelligent interest in the information available tohim or her, to understand that information, andapply an enquiring mind to the responsibilitiesplaced upon him or her.”The court concluded that in the Centro caseeach director failed to exercise the degree ofcare and diligence required by law in the courseof their review of the financial statements, andas such can be held liable for the losses sufferedby that company as a result of their failure tocomply with their duties.Duties of Directors7

South African case law echoes the findings ofthe Centro judgment. In Fisheries DevelopmentCorporation of SA Ltd v AWJ Investments (Pty)Ltd 1980 (4) SA 156 (W) the court stated that:“Nowhere are [the director’s] duties andqualifications listed as being equal to those of anauditor or accountant. Nor is he required to havespecial business acumen or expertise, or singularability or intelligence, or even experience in thebusiness of the company. He is neverthelessexpected to exercise the care which canreasonably be expected of a person with hisknowledge and experience. a director is notliable for mere errors of judgment. In respect ofall duties that may properly be left to some otherofficial, a director is, in the absence of groundsfor suspicion, justified in trusting that official toperform such duties honestly. He is entitled toaccept and rely on the judgment, informationand advice of the management, unless thereare proper reasons for querying such. Similarly,he is not expected to examine entries in thecompany’s books. Obviously, a directorexercising reasonable care would not acceptinformation and advice blindly. He would acceptit, and he would be entitled to rely on it, but hewould give it due consideration and exercise hisown judgment in the light thereof”.8How do these judgments affect the positionof directors (especially non-executive directors)where the audit committee considered complexfinancial reports? Are non-executive directorsnevertheless expected to review such reportsand vote on applicable resolutions? The answerseems to be ‘yes’. The obligation to approvethe financial statements of the company restsequally on each director. As such, every directorhas to study the relevant reports, and ensure forhimself that the content of the report confirmsand coincides with his view of the business.No director is entitled to blindly rely on theconclusions of the audit committee, the financeteam or other experts.These judgements emphasise the fact that thedecision to accept appointment to the boardof a company should not be taken lightly. Adirector cannot uncritically rely on the officialsof the company, or on the other members ofthe board for the decisions of the company,but needs to be confident that he or she isable to pay adequate personal attention to thebusiness of the company. Even though directorsare entitled to rely of the guidance and advicefrom employees, advisors and other boardcommittees, each director is obliged to applytheir own mind (i.e. bring their own skill andexperience to bear) to the facts at hand. Theyare not entitled to blindly rely on advice. Whateach director is expected to do is to ensure thatthey make a concerted effort to understand thebusiness of the company and the informationplaced in front of them, and to apply anenquiring mind to such information.

1. What is a Director?“At common law, once a person accepts appointment as adirector, he becomes a fiduciary in relation to thecompany and is obliged to display the utmost good faithtowards the company and in his dealings on its behalf.”Howard v Herrigel 1991 2 SA 660 (A) 678The term “director” has been defined in law. TheCompanies Act, 2008 (the Act) defines a director as:“A member of the board of a company.,or an alternate director of a company andincludes any person occupying the position ofdirector or alternate director, by whatever namedesignated”.In terms of section 66 of the Act, the businessand affairs of a company must be managed byor under the direction of its board, which hasthe authority to exercise all of the powers andperform any of the functions of the company.The powers of the board may be limitedby specific provisions of the Act or by thecompany’s Memorandum of Incorporation.It is interesting to note that the definition of adirector includes not only those individuals thatare appointed to the board of the company (aswell as alternate directors), but also “any personoccupying the position of director or alternatedirector, by whatever name designated”. Theeffect of this wide definition is that the provisionswill apply not only to members of the board, butalso to “de facto” directors.“A de facto director is a person who assumesto act as a director. He is held out as a directorby the company, and claims and purportsto be a director, although never actually orvalidly appointed as such. To establish that aperson is a de facto director of a company, it isnecessary to plead and prove that he undertookthe functions in relation to the company whichcould properly be discharged only by a director.”Re Hydrodam (Corby) Ltd [1994] 2 BCLC (Ch);[1994] BCC 161 at 183The Act requires private companies andpersonal liability companies to appoint at leastone director, whereas public companies, stateowned companies and non-profit companies arerequired to appoint at least three directors. Thisnumber would be in addition to the number ofdirectors required where an audit committeeand/or social and ethics committee is required(see 2.2 below).Duties of Directors9

It should be noted that this is the minimumrequirement. Given the complexities of running acorporate, it may be necessary to appoint moredirectors. Furthermore, where companies applythe governance principles set out in the KingReport on Governance for South Africa (KingIII), it may be necessary to have more than theminimum number of directors.In general terms, the directors of a companyare those individuals empowered by theMemorandum of Incorporation of that companyto determine its strategic direction. As aconsequence of the nature of a company, beinga lifeless corporate entity, human interventionis required to direct its actions and thereforedetermine its identity.The directors are entrusted by the shareholdersof the company with the ultimate responsibilityfor the functioning of the company. Whilesome of the day-to-day running of thecompany is generally delegated to some levelof management, the responsibility for the actscommitted in the name of the company restswith the directors.1.2 Prescribed officersPrescribed officers include every person, bywhatever title the office is designated, that: exercises general executive control over andmanagement of the whole, or a significantportion, of the business and activities of thecompany; or regularly participates to a material degree inthe exercise of general executive control overand management of the whole, or a significantportion, of the business and activities of thecompany.Most of the provisions in the Act pertaining todirectors apply equally to prescribed officers.The Act determines that prescribed officersare required to perform their functions andexercise their duties to the standard of conductas it applies to directors. Prescribed officerswill be subject to the same liability provisionsas it applies to directors. As is the case withdirectors, the remuneration paid to prescribedofficers must be disclosed in the annual financialstatements. The following provisions, interalia applicable to directors, will also apply toprescribed officers: Section 69 – Ineligibility and disqualification ofpersons to be directors or prescribed officers; Section 75 – Directors’ personal financialinterest; Section 76 – Standards of directors’ conduct; Section 77 – Liability of directors andprescribed officers; Section 78 – Indemnification and directors’insurance; and Section 30(4) and 30(5) – Disclosure ofremuneration.A person will be a prescribed officer regardless ofany title or office they are designated.10

Although it is not a legislative requirement, it isrecommended that the board records the namesof all those individuals which are regarded asprescribed officers. The list of names will benecessary, among other requirements, when thecompany has to disclose the remuneration paidto or receivable by its prescribed officers in theannual financial statements.Note that regardless of whether a companyhas officially identified a particular individualas a prescribed officer or not, that person maynevertheless be classified as a prescribed officer tothe extent that the person’s role in the companymeets the definition.In order to determine who the prescribed officersof the company are, one will have to applya certain degree of judgment. Managementwill have to consider all the relevant provisionsof the definition, such as “general executivemanagement” and “control” and “significantportion of the business and activities” in thecontext of their specific company in order toidentify the prescribed officers of the company.functioning of the company. Where a person isresponsible for implementing specific decisions ofthe board, he will in all likelihood not be regardedas a prescribed officer, as the exercise of thosefunctions will not be equated with executivemanagement or control. Further, the company willhave to determine, in its particular circumstancesand in view of the company’s structure, whichparts of the company, if any, are regarded as asignificant portions of the company.Not every division or business unit will necessarilybe regarded as a significant portion of thebusiness, and only persons that exercise generalexecutive control over or management of asignificant portion of the company are regarded asprescribed officers.A person does not have to be employed by aparticular company to be classified as a prescribedofficer of the company.The meaning of general executive control andmanagement needs to be determined in view ofthe organisational and governance structure ofthe company. Executive control and managementshould be distinguished from ordinary controland management carried out in the day to dayDuties of Directors11

The intention of the legislature seems to be toclassify as prescribed officers those individualsthat are not appointed to the board of thecompany (thus, they are not directors) butnevertheless act with the same authority asthat of a director (executive management andcontrol). In an earlier draft of the Regulations,a prescribed officer was defined as anyone thathas a significant impact on the management andadministration of the company. This definitionwas much wider and included most of the(senior) management of a company. However,the definition in the final Regulations limits thescope to only those individuals that exercise“executive” management and control – thiswould limit the prescribed officers to only thoseindividuals that have executive authority inthe company, and it would exclude ordinarymanagers, even senior managers (depending ofcourse on the organisational and governancestructure of the company). Persons may beclassified as prescribed officers under thefollowing circumstances: A member of a company’s executivecommittee The senior financial manager in a companythat does not have a financial director A chief executive officer Regional manager (eg “Africa manager: Sales”)A company secretary that performs the rolecontemplated in King III (i.e. advising the boardbut not taking decisions on behalf of the board)would generally not be classified as a prescribedofficer. Also, persons that perform an importantoperational role, but not general executivemanagement and control functions, would notbe prescribed officers.121.3 The legal status of a directorThe Act assigns to directors the authority toperform all the functions and exercise all thepowers of the company. It sets out the minimumstandard of conduct, and provides for personalliability where a director does not perform tothe said standard. The Act does not specificallycomment on the legal status of a director.Where no express contract has been enteredinto between the company and its directors, theprovisions contained in the Act and the company’sMemorandum of Incorporation are generallyviewed as guiding the terms of the relationshipthat the director has with the company.Directors have been alternately viewed as trustees,agents, managers and caretakers of the companiesthey serve. Whatever the view taken, a directoroccupies a position of trust within the company.1.4 The different types of directorsIn law there is no real distinction betweenthe different categories of directors. Thus, forpurposes of the Act, all directors are requiredto comply with the relevant provisions, andmeet the required standard of conduct whenperforming their functions and duties.It is an established practice, however, to classifydirectors according to their different roles on theboard. King III has provided definitions for eachtype of director.The classification of directors becomes particularlyimportant when determining the appropriatemembership of specialist board committees,and when making disclosures of the directors’remuneration in the company’s annual report.

Executive directorInvolvement in the day-to-day management ofthe company or being in the full-time salariedemployment of the company (or its subsidiary) orboth, defines the director as executive.An executive director, through his or her privilegedposition, has an intimate knowledge of theworkings of the company. There can, therefore,be an imbalance in the amount and quality ofinformation regarding the company’s affairspossessed by executive and non-executive directors.Executive directors carry an added responsibility.They are entrusted with ensuring that theinformation laid before the board by managementis an accurate reflection of their understanding ofthe affairs of the company.King III highlights the fact that executivedirectors need to strike a balance between theirmanagement of the company, and their fiduciaryduties and concomitant independent state ofmind required when serving on the board. Theexecutive director needs to ask himself “Is thisright for the company?”, and not “Is this right forthe management of the company?”Non-executive directorThe non-executive director plays an important rolein providing objective judgement independent ofmanagement on issues facing the company.Not being involved in the management of thecompany defines the director as non-executive.Non-executive directors are independent ofmanagement on all issues including strategy,performance, sustainability, resources,transformation, diversity, employment equity,standards of conduct and evaluation of performance.The non-executive directors should meet fromtime to time without the executive directors toconsider the performance and actions of executivemanagement.An individual in the full-time employment of theholding company is also considered a non-executivedirector of a subsidiary company unless theindividual, by conduct or executive authority, isinvolved in the day-to-day

in the CIPC’s computer system, or the date on which registered or other mail is received by the CIPC). The CIPC is not required to approve or vet any decisions or actions of the company. The counter balance to the diminished role of the regulator is greater emphasis on the role of

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