For all its undoubted merits, South Africa’s new Companies Act 71 of 2008 is far from flawless. There are some startling omissions from the Act.
For example, section 76 of the Act is a concise statement of the duties of directors and the standard of conduct expected of them.
It is surprising to find that, in section 76, the Act does not say that a director is obliged to exercise an independent judgment – even though this duty has been an accepted aspect of directors’ duties since the early days of company law.
The nature of the office of director
It is vital for the economy that investors, local and international, have confidence that companies are managed competently – and that appropriate rules are enshrined in law.
A core aspect of the law in this regard is the duties imposed on company directors.
It is fundamental that, in law, a director is not a mere employee of the company who works under instruction and must do as he is told.
A director is not hired by the company, but is voted onto the board of directorsby a resolution passed at a shareholders’ meeting.
Having been appointed, a director is in a trustee-like position. What does this mean?
In a trust, the trustees of a trust have the power to manage trust money or property for the benefit of the trust beneficiaries– and must exercise those managerial powers in the best interests of the beneficiaries, and not for their own benefit or enrichment. In deciding what is in the interests of the beneficiaries, the trustee must bring an independent mind to bear.
A trustee would be in breach of his legal duties if he or she allowed himself to be dictated to in this regard by co-trustees or anyone else.
Like a trustee, a director is vested with the power to manage funds and assets belonging to other persons– the company and its shareholders – and in exercising that power, a director (like a trustee) must act in what he or she believes to be in the best interests of the company and its shareholders – and (like a trustee) must bring an independent mind to bear in this regard and must not meekly go along with the views of co-directors or anyone else.
Thus, where South Africa’s new Companies Acts states in section 76 that a director –
“must act in the best interests of the company”
the Act does not go far enough because this provision fails to convey that a director must bring an independent mind to bearon what is in the interests of the company.
Thus, for example, where a resolution is put to the board of directors that the company should act in a particular way, and the directors, individually, are required to vote for or against that resolution, the law requires that each director should ask him or herself – what do I believe is in the best interests of the company – and cast a vote accordingly.
Clearly, a director who unthinkingly casts his vote in line with the votes of the other directors would breach his legal duty. If the actions of the company in accordance with that vote turned out to infringe the law or to be financially disastrous for the company, it would be no defence for that director to plead that he merely went along with the majority opinion at a board meeting – or that he voted as he was instructed to do.
The United Kingdom Companies Act is explicit on this principle
Less obviously, a director who votes in accordance with advice taken from an outsider (for example, the company’s accountants or financial advisers) without applying his own mind to the issue at stake would be in breach of his duty to bring an independent mind to bear.
This principle is of current concern in the United Kingdom.
On 20 March 2018 the British Government published a Consultation Paper titled Insolvency and Corporate Governance which inter alia poses the question whether “directors are commissioning and using professional advice with a proper awareness of their duties as directors and the requirement to apply an independent mind”.
The Consultation Paper poses a hypothetical situation of a company becoming insolvent and thereafter being liquidated, in a situation where –
“its directors used external professional advisers, including accountants and consultants to help take key decisions but [where questions later arose] about whether they had considered this advice through the prism of their wider directors’ duties and the requirement to apply an independent mind.”
Unlike South Africa’s Companies Act which is silent on the issue, the United Kingdom Companies Act of 2006 explicitly provides in section 173 that –
“A director of a company must exercise independent judgment.”
The concern, inherent in the Consultation Paper, referred to above, is that directors may blindly, or in a blinkered fashion, follow the advice given by consultants who have a narrow area of expertise without the directors applying an independent judgment as to whether that advice took proper account of the broad duties that the law imposes on directors.
The duty of directors of a company that is insolvent or threatened with insolvency
This consideration becomes particularly crucial where the company is, or may be, insolvent, because the law has strict rules as to how such a company must apply its limited and strained financial resources.
A company in such a situation is not, for example, permitted to pay certain of its creditors in preference to others. And there are severe restrictions on a company’s continuing to carry on business when it is already insolvent.
Directors are required to know the rules of company law in this regard and if they act in breach of the law, it would be no defence for them to say that they simply went along with what the company’s accountants or financial consultants had advised them to do.
Directors who fail in this or any other aspect of their duties will be exposed to the weighty consequences imposed by the Companies Act for a breach of their duties.