This article was originally published by executiveview.com
When the new South African Companies Act comes into force in the second half of 2010 there will be greater exposure to claims against directors and officers and greater scope for all-important risk management. Insurers can play a leading role in both respects.
The standards of conduct of directors and officers have been partly codified, coupled with a clearer statement of the rights of a company to indemnify its directors and officers and to take out insurance for that purpose. Although the standards of conduct set out in the new legislation do not add much to the common law (and most of what it does add is helpful to directors), the fact that these duties are set out in a few crisp sections will make it easier for disappointed stakeholders to find the basis for a claim.
The common law principles requiring directors to exercise their powers and perform their functions in good faith and for a proper purpose, in the best interests of the company and with the proper degree of care, skill and diligence are now found in a single sub-section. The obligations of a director are mitigated by the fact that the court will take into account the knowledge, skill and experience of the director concerned and will permit a director to consult and rely upon professional advisors like legal counsel, accountants, engineers or whatever it takes to assist them to make a rational decision. If, having taken advice, the director makes the wrong decision, he or she will be excused if there was a rational basis for believing that the decision was in the best interests of the company. Boards of directors must make early decisions as to what information and reports they will rely on and what professional advisors they will call in aid in order to do their best to reach a proper decision. It will also be important to see that their decisions, the basis for their decisions and any dissent from decisions are fully minuted to give the directors maximum protection against liability to third parties. Directors and officers, insurers and their intermediaries must play an active role to ensure that proper risk management is undertaken within the boardrooms of South Africa.
A director with personal financial interests conflicting with those of the company must disclose them before any decision is made on a related transaction by the board. After giving any personal observations or pertinent insights in regard to the issue, the director must leave the board meeting whilst the transaction is discussed. Breach of this obligation may make the director liable for damages sustained by the company as a consequence. All the rules prohibiting a director from making a personal gain at the expense of a company are still there and are, to a large extent, spelt out in the new Companies Act. Whilst deliberate fraud cannot be insured, inadvertent breach of these requirements should be insurable. Policy wordings need to be enhanced where necessary to protect individual directors against specific liability to the company itself where this is insurable. The same principles apply in relation to a director who exceeds the limits of his or her authority when performing an act on behalf of the company. Similarly, personal liability can arise from a director taking part in issuing financial statements which are materially false or misleading. It will not help, for instance, to sign-off the financial statements blindly and to claim reliance on the chief financial officer or the auditors. A director must read the documents and, to the extent that they are complex, take advice from outsiders before issuing them to the public. Whilst some instances of liability refer to directors doing things "knowingly", this is an extended concept. A person who reasonably ought to have had actual knowledge of certain facts or could have investigated or taken other measures to acquire actual knowledge will be considered to have acted knowingly as if they had the knowledge itself. Supine ignorance will not be an excuse and directors must have enquiring minds and take their fiduciary duties seriously. It will also be difficult to argue for an inadvertent breach of a fiduciary duty and in order to bring the insurance policy into play.
There are other extensions to potential liability.
A director includes a "prescribed officer" who is the holder of an office that will be designated in regulations under the Act. The likelihood is that chief executives (including anyone with general executive authority, financial management, legal, general counsel, CEOs, CFOs and COOs, etc.) will be likely to be brought within the scope of directors' liability. Special appointees to board committees will also have coextensive liability. These parties are going to have to be brought within the definition of a "director" in D&O policies.
The company secretary is going to play a bigger role in the affairs of a company. Company secretaries are expected to be persons "knowledgeable and experienced in relevant laws" relating to the company. The company secretary is required to provide directors of the company, collectively and individually, with guidance as to their duties, responsibilities and powers and to make them aware of any law relevant to or affecting the company. That is a much more responsible role that exists under the existing company's legislation. Company secretaries are going to get the blame for things that go wrong and they must be explicitly included in any insurance policy covering directors and officers.
The Act has also extended the social obligations of companies and accordingly the number of affected stakeholders. A company is required to promote compliance with the South African Bill of Rights which creates a host of obligations in regard to social, economic and environmental commitment to good behaviour by the company. Companies are expected to promote the development of the South African economy and to reaffirm the concept of the company as a means of achieving economic and social benefits. Although these broad aspirations will not give rise to direct claims for breach, they will inform public policy. When testing whether a director or officer has acted in the best interests of the company, the courts will be able to look further than the question whether they have optimised the profits. For instance, a board of directors that declares dividends instead of using the money to undertake a necessary environmental clean-up may find themselves responsible for refunding any dividends that cannot be recovered from benefiting shareholders to pay for the clean-up costs.
The provisions of the new Companies Act are matched by the latest King Code on Corporate Governance in force from March 2010. The new corporate governance rules complement the new Companies Act and have coextensive commitments similar to those set out above. The Code (known as King III) will strongly influence the way that the performance of directors and officers is looked at. The Code is drafted on the basis of "apply or explain". A company bound by the Code will have to decide whether to apply the governance principles or to explain why they are not being applied. This will affect the relationship of the company with its stakeholders (including employees and trade unions) and third parties.
Laid down end-to-end, the duties and responsibilities appear onerous. That is not the intention of this article. Most of the duties are to be found in the common law and most of the responsibilities are rational in the context of a modern company in a modern democracy. Directors and officers must be familiar with their responsibilities, must take fully motivated decisions and must carefully record what they do. With proper co-operation between companies and their insurers, the risks can be managed, damage can be reduced and losses can be intelligently indemnified by proper indemnities and insurance under the guidance of a sophisticated D&O insurance market. There is no reason why that cooperation should not start immediately. It is not necessary to wait until the new Companies Act comes into force in late 2010. There is a lot that can be done before that to ensure that liabilities are managed from the outset.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
