Corporate Governance and Director Duties

Corporate governance can be defined as set of rules or guidelines for company boards and similar bodies. Today these rules cover a variety of matters: from director duties to disclosures relating to prevention of slave labour.

The initial premise of corporate governance seems to have been the need to address a conflict of interest. The perceived conflict arises because, with reference to larger (or, rather, non-closely held) companies, the management is often distinct from company ownership. To address the conflict, the following two principles of corporate governance exist: directors must act in the best interests of the company and must disclose any conflict of interest.

Corporate governance also often includes a set of specific directors’ duties and obligates the directors to take certain interests into account, often including stakeholders’ interests where ‘stakeholders’ are company employees or contractors.
Where directors commit wrongs against the company, one possible claimant is the company itself. However, statutes now also give power to the shareholders to commence claims against directors, subject to certain conditions being met. Such claims by shareholders are known as derivative claims and may be particularly compelling where some form of oppression on minority shareholders may exist.

It is easy to imagine the practical scenarios where directors’ loyalty to the company may be tested. Take the case where company shareholders can be seen as falling into two distinct groups: “short-term investors” and “long term sponsors”. The directors appointed by the former group could well be focused solely on the bottom line in the latest accounting results, whilst the directors appointed by the latter group might favour growth and investment. The directors would be well advised to act carefully and seek advice where a decision may be controversial.

Some agreements set out very precise requirements; and here again, it may be prudent, on the one hand, to carefully negotiate the provisions and, on the other hand, to seek advice in complex circumstances.

We should note that corporate governance rules differ significantly by jurisdiction. A simplistic example that the promoters of SME companies may find surprising is the treatment of director loans. Some jurisdictions certainly allow for director loans to be made; but other jurisdictions prohibit director loans as a matter of principle. Of course, even those jurisdictions that allow director loan often make such loan subject to controls, such as additional approvals and disclosures. Director loans could also be characterised as outright income for tax purposes.

As the company grows, so does the burden of corporate governance. For example, larger companies are required to disclose pay ratio (management’s pay to employees’ pay), explain compliance on duties to ‘stakeholders’ or on company’s engagement with the employees.

Corporate governance burden is also at an increased level for public companies and banks. For example, stock exchange rulebooks may require that the board includes non-executive directors, that various board committees are established (such as an audit or remuneration committee). There will also be the need for additional disclosures and corporate approvals, such as with regard to significant transactions. The applicable rules are often tailored to the listing segment, which less requirements applicable to junior markets.
A related trend has been for jurisdictions to promote various corporate governance codes. Compliance with such codes might not be necessary but departure from the guidelines could require a specific explanation in various disclosures. This mechanism is often referred to as “comply or explain” principle.