South Africa: Duties Of A Non-Executive Director

Last Updated: 12 July 2002
Article by Matthew Ash

A Non-Executive Director Always Retains The Duty To Direct The Company With Reasonable Skill And Diligence

Since the Myburgh inquiry into the failure of Regal Treasury Private Bank, playing bowls on a hot Sunday afternoon will never be quite the same. The Commissioner was scathing in his criticism of the role (or rather the lack of it) played by the non-executive directors in the discharge of their duties at Regal, seemingly suggesting that their eyes were on a different ball altogether. In view of the recently issued King II report, it is worth taking a closer look at the position of non-executive directors.

All too often in circumstances of corporate failures one hears the plaintive pleading of directors as to lack of culpabibility by reason of the fact that they were "non-executive" - as if to say that the blame for corporate failure must always lie at the feet of the executive team. Indeed, in one such recent highly publicized failure, a non-executive director of the failed company (himself the Chairman of the major shareholder) made it clear on national television that the responsible executive directors were made to assume responsibility and that no blame for the failure could be attributed to non-executive directors. The comment by the interviewer that the non-executive directors nevertheless seemed happy to have accepted directors' fees drew no response.

Unsurprisingly, the Companies Act makes no distinction between executive and non-executive directors insofar as fiduciary duties is concerned. A director is a director, and in taking up such appointment the person concerned accepts responsibilities that cannot be abrogated to others. This echoes the trite principle that a company and its shareholders are entitled to rely on the full measure of experience, training and talents that the board possesses in the successful prosecution of the company's business. If ever there is a process in the conduct of the affairs of a company that must always add value, it is the direction to be given to the corporation by all of the company's directors.

This was confirmed by Judge Goldstone in the Appeal Court judgement of Howard v Herrigel and Another NNO 1991 (2) SA 660 (A). Although in terms of the specific facts of the case the non-executive director Mr Howard was not found to have acted recklessly or fraudulently as a director of the failed company, the Court found it 'unhelpful and even misleading' to distinguish between executive and non-executive directors when trying to determine their duties towards the company or whether some specific or affirmative action is required for them. There is no statutory distinction, and at common law where a person accepts a directorship, that person accepts a fiduciary responsibility in respect of the company.

The Court recognized that the application of this general rule to any particular director must depend on the particular circumstances of each particular case, and one such circumstance that might be taken into account is whether that person is in the full time employment of the company. But the Court reiterated that the mere fact that the person may have been a non-executive director does not mean that the person's duties are less onerous than they would have been had the person been an executive director.

Of cardinal importance is the director's access to information required for the proper directing of the company and its business, and the reliance that the person is entitled to place on reports received from others. This is particularly relevant to those companies where the full board meets every quarter and non-executive directors are mostly reliant on the information contained in the board papers circulated to them shortly before the meeting.

One of the core fiduciary duties any director owes to his or her company is the duty to exercise reasonable skill and diligence. Having regard to recent pronouncements from the Bench, recent comments by Commissioners, and the recommendations of King II, for a director to accept board papers at face value may no longer be sufficiently diligent. Traditionally, non-executive directors enjoy their positions as representatives of the interests of major shareholders or by virtue of their status in the business world (in which case they may also represent the interests of those shareholders who are attracted to invest in the company by virtue of the participation of such luminaries). As such, they play the role of watch-dog, and it would not be sufficient for them to supinely accept what is dished up for them once a quarter.

Sufficient diligence may now entail the proper analysis by every director of the information being furnished. For example, the critical financial information for the previous three months should be available for the full board meeting each quarter (not least from the management accounts that the executive team would use all the time). By applying simple analytical ratios to that information, the directors would very easily be able to see the direction in which their company is going. Indeed, close monitoring of an accounts receivable turnover ratio might have helped to prevent some of the more spectacular corporate failures of late, or at least sound off the warning bells at an early stage.

The ratios to be used would be those that are applied for the analysis of any financial statements - ratios that indicate short term liquidity, capital structure and long term solvency, operating efficiency and profitability, and market ratios. None of these ratios are beyond the understanding or appreciation of any reasonably diligent person. That being so, the onus lies on the non-executive director to familiarize himself or herself with the business and finances of the company, and to start asking the right questions.

The answers to those questions may be discomforting. It is at that point that the mettle of the non-executive director is truly tested. If the company's auditors or executive team are not giving satisfactory answers (remembering that whether the answer is satisfactory or not may be tested later in a court against the benchmark of a reasonable director), the non-executive director must press for an adequate or proper explanation. If that is not forthcoming, it then time to blow the whistle to place the facts on record and bail out.

The prospective liability for non-executive directors lies under the well-known Section 424 of the Companies Act. But the picture has become more somber. Last month a judgment was handed down in the the Witwatersrand Local Division in the so-called 'Cellular Calls' case (Kalinko v Nisbet & Others), where, amongst other things, the traditional Foss v Harbottle rule was dealt a hammer blow, and a shareholder was given leave to sue directors for damages allegedly suffered as a consequence of dimunition in value of shareholding flowing from the directors' alleged wrongful conduct. This opens the possibility of non-executive directors being pursued by aggrieved shareholders for a liability that was previously thought not to exist.

Such directors cannot be so pursued if they are at pains to conduct themselves objectively, reasonably, diligently and openly in all their dealings with their company.

The content of this article is intended to provide a guide to the subject matter.Specialist advice should be sought about your specific circumstances.

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