South Africa: King Code And Developments In Corporate Governance

Last Updated: 4 November 2010
Article by Dave Walker and Ina Meiring

The First King Report on Corporate Governance ("First Report") was published in 1994 by the Institute of Directors in response to the increasing concern over corporate failures and the perceived need for a formal code of corporate governance. It sought to assist companies and their directors by providing a comprehensive set of principles and guidelines to codify, clarify and (in certain circumstances) expand upon the common law principles of corporate governance.

The Second King Report ("King II") was finalised in March 2002 and both reviewed and expanded on the First Report.

The Third King Code and Report on Corporate Governance was released on 1 September 2009 ("King III"), and became effective on 1 March 2010. It was prompted by a number of developments that had occurred since the release of King II, including the publication of the new Companies Act 71 of 2008 ("new Companies Act"). The Code sets out a number of governance principles that should be read together with the Report, which contains best practice recommendations on each principle. The Institute of Directors has also issued various Practice Notes to assist companies in implementing the Code.

In a change of approach, King III moves from a "comply or explain" to an "apply or explain" approach. Companies may therefore deviate from a suggested practice and still comply with the overarching corporate governance principles of fairness, accountability, responsibility and transparency. Proper compliance will nevertheless require an explanation of how the principles and recommendations were applied, or if not applied, the reasons for not doing so.

Significantly, King III will apply to all legal entities irrespective of their manner or form of incorporation or establishment and whether or not they are listed. The drafters intend that entities will aspire to apply King III on the basis that if its principles are adhered to, then the entity will have practised good governance.

The listings requirements of the Johannesburg Stock Exchange have been amended to mandate compliance with certain provisions of King III in respect of all financial years commencing on or after 1 March 2010. However, the new requirement that any director that participates in a share incentive/option scheme will not be regarded as "independent", will only apply to listed companies from 1 April 2011. All other changes to the JSE listings requirements as a result of King III apply to listed companies from 1 April 2010.

Duties and responsibilities of directors

The most significant recent development for directors and officers has, undoubtedly, been the promulgation in 2008 of what is now the new Companies Act.

The new Companies Act completely rewrites South African company law legislation, and contains the first statutory codification of South Africa's directors' duties, which have historically only been embodied in the common law. The new Companies Act also regulates the liability of directors and provides much needed clarity in respect of the ability of companies to indemnify their directors and purchase directors' and officers' insurance.

A significant feature of the new Companies Act is the formal extension of the application of "directors' duties" to persons other than directors. This is done by introducing the concept of a prescribed officer. The term "director" is defined to include "prescribed officers", on the basis that prescribed officers are subject to the same duties and liabilities as directors. In the draft regulations (published on 22 December 2009), persons who are not directors, but who nevertheless have general executive authority over various aspects of the company's business (e.g. finance, operations), regardless of their title, are regarded as "prescribed officers".

The new Companies Act sets out certain standards of directors' conduct, which include elements of the traditional common law fiduciary duties and the duty to act with care and skill.

Under the new Companies Act, a director must:

(a) not use the position of director, or any information obtained while acting in the capacity of a director to

(i) gain an advantage for the director, or for another person other than the company or a wholly-owned subsidiary of the company; or

(ii) knowingly cause harm to the company or a subsidiary of the company; and

(b) communicate to the board at the earliest practicable opportunity any information that comes to the director's attention, unless the director

(i) reasonably believes that the information is immaterial to the company; or generally available to the public, or known to the other directors; or

(ii) is bound not to disclose that information by a legal or ethical obligation of confidentiality.

In addition, a director must exercise the powers and perform the functions of director:

  • in good faith and for a proper purpose;
  • in the best interests of the company; and
  • with the degree of care, skill and diligence that may reasonably be expected of a person (i) carrying out the same functions in relation to the company as those carried out by that director; and (ii) having the general knowledge, skill and experience of that director.

These duties are not materially different from the common law duties.

The new Companies Act provides some comfort to directors through the introduction of a presumption of compliance if certain factors are met, which provides that a director will have satisfied the obligations regarding acting in the best interests of the company and with the necessary degree of care, skill and experience if:

  • the director has taken reasonably diligent steps to become informed about the matter;
  • either (i) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a personal financial interest in the matter; or (ii) the director complied with the requirements regarding the disclosure of such interests; and
  • the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company.

As a further comfort to directors, the new Companies Act specifically provides that the directors are, in certain circumstances, entitled to rely on the advice of employees, professional advisors and other committees of the board.

The new Companies Act sets out in detail the bases upon which a director may be held liable for his conduct. These are:

  • liability in accordance with the principles of the common law relating to breach of a fiduciary duty for any loss, damages or costs sustained by the company as a consequence of any breach by the director of a duty relating to (i) disclosure of director's financial interests; (ii) the duty not to use information of the company to gain an advantage; and (iii) the duty to act in good faith and for a proper purpose and in the best interests of the company; and
  • in accordance with the principles of the common law relating to delict (i.e. tort) for any loss, damages or costs sustained by the company as a consequence of any breach by the director of (ii) the duty to act with care, skill and diligence; (ii) any other provision of the new Companies Act; and (iii) any provisions of the company's Memorandum of Incorporation.

The new Companies Act also sets out certain specific acts that will give rise to director liability, such as (i) acting in the name of the company despite knowing that the director lacked the authority to do so; and (ii) signing, consenting or authorising, the publication of any financial statements that were false or misleading in any material respect. Importantly, the test for knowledge is both subjective and objective, and includes, in addition to actual knowledge, knowledge which the director ought to have had.

If directors are liable, their liability is joint and several with others who are liable on the same basis. Proceedings to recover any loss may not be commenced more than three years after the act or omission that gave rise to that liability.

The underlying principle of King III, the common law and the new Companies Act is that directors should act not only in accordance with the letter of the law, but also in accordance with the spirit of their fiduciary duties. There is no doubt that new legislation in South Africa poses certain new risks for directors, although steps have been taken to protect non-conflicted directors who act in good faith. It remains to be seen whether shareholders will use this new legislation to apply a higher level of scrutiny to the conduct of directors.

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.

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