Corporate governance, defined as "…the system by which companies are directed and controlled… 1" is principally concerned with the issues of the ownership, control and accountability of the company. In other words a set of rules that define the relationships between shareholders, managers, creditors, the government, employees and other internal and external stakeholders in respect to their rights and responsibilities. Alternatively it can simply be described as the system by which companies are directed and controlled.
The issue that has prompted much academic debate is the issue regarding the separation of power between controller (management) and that of the ownership (the shareholders). Unlike the modus operandi of corporate company personality in such countries as France and Germany, the United Kingdom differs to the extent that a director does not have to be a natural person 2 This tenet of company law rests on the basic question of how directors can be accountable to shareholders for their actions. This has been termed the 'quest for stockholder democracy' 3.
Thus the mere proposition of the term corporate governanance challenges the ambit of conventional business administration. In the UK it operates under the aegis of the 1985 Companies Act. The general ethos garnered from such committees that have addressed this issue in the UK, such as the Cadbury Committee 4, the Greenbury Committee of 1995 5 and the Hampel Report of 1998 6 has been one of self-regulation and internal discipline rather than any fundamental of the status quo vis-à-vis the freedom in which directors operate without intrusive external control 7.
This attitude generally prevailed on the other side of the Atlantic until the Enron debacle utterly transformed the corporate landscape. This was a scandal of gargantuan proportions. A contemporary description of the time, chronicled it as a "…a fitting epitaph to the bubble decade of the 1990s… 8 " , with the potential to undermine "…the integrity of the entire system for channeling savings into investment…just as America's debts to foreigners and its own consumers indebtedness have reached unsustainable levels… 9 " It has led to major upheaval in the US, notably the Sarbanes-Oxley law, which oversaw the introduction of an accountancy oversight board as its core value.
As a corollary, the European Union, has almost by default been galvanized to address the issue of corporate accountability within its own parameters. As Mark Tran remarked, "…Once the US started overhauling corporate governance practices, the rest of the world was forced to go some way to meeting these new best practices… 10 "
By producing the Winter Report 11 , Frits Bolkestein, an Internal Market Commissioner rather hubristically proclaimed that "…[w]e have a unique opportunity in the European Union, as we move towards the integration of our capital markets by 2005, to put into place the best corporate governance standards in the world. We should seize the moment. Why is this so important? The Enron scandals have shown that undermining of investor confidence seriously damages the development of capital markets and subsequently economic growth… 12 "
Despite the issue of corporate governance being of vast importance to shareholders, the solution to this simple desire for more democracy and greater accountability has proven to be problematic. Perhaps the principle reason why this transition to greater shareholder participation has not happened the way idealists had envisioned is for the simple reason that Gower suggests: basically 'Athenian style democracy is not particularly appropriate for public companies 13 .
Further attempts at increasing shareholder democracy have foundered because, although desirous in a pluralistic market system, greater information for shareholders and stricter requirement that shareholders ratify managerial decisions has not led to a broader plain of decision making. Gower observes that to make a truly informed decision, shareholders need inter alia sufficient knowledge to fully appreciate the information; a large enough shareholding to influence the decision and the desire to resort to the courts to see their wishes enforced . 14
Whilst the first two prerequisites of informed decision making are often met, shareholders often lack the will to enforce their wishes through litigation. The reason for this is that institutional investors usually represent large shareholding bodies. These investors tend to shy from litigation, preferring to re-allocate their share resources.
Other problems encountered by the ownership of public companies in having their wishes enforced include the exorbitant cost of litigation in the UK. It takes a brave investor to take on the corporate might of entrenched directors interests.
This contrasts with the situation in the U.S. where investors have been more pro-active in tackling such issues as so called fat cat directors pay packets in the federal courts. The Sarbanes-Oxley law has created a new accountancy watchdog, while Wall Street firms have been obliged to invest over $400 (£245m) to finance independent research for retail investors. Rattled by the howls of outrage from an already critical global community aimed at the Bush administration, fines of $5m (£3.2m) and 20 years prison penalties are part of the package for directors of companies intentionally producing fraudulent accounts of their companies assets 15
Significantly, the new act bears testimony to the corporate globalisation that big business must now operate in. Referring to the new act Alex Cohen, securities lawyer in the London office of law firm Latham and Watkins, observed that: "[t]he Act does not distinguish between US and non-US issuers." 16
This lack of membership activism within the structure of UK corporate governance is to be regretted. As Gower remarks, the Government seems unwilling to bear the burden of allocating a more powerful watchdog body over the governance of company affairs. He cites the DTI as one option that could be used as a greater enforcement measure against errant company directors who fail to pay heed to the wishes of the general membership .17
It is the above lacuna which the Sarbanes-Oxley Act seeks to address in the perceived autonomy of board-members and directors of the corporate behemoths in the US from any form of accountability from ordinary shareholders and stakeholders. What we are left with in these terms between corporate regulation UK style and corporate regulation US style is a stark choice between 'the blunt instrument' 18 of the US regulatory model or the "…measured response to the post-Enron era…" 19
Thus the mere proposition of the term corporate governanance challenges the ambit of conventional business administration. In the UK it operates under the aegis of the 1985 Companies Act. The general ethos garnered from such committees that have addressed this issue in the UK, such as the Cadbury Committee 4, the Greenbury Committee of 1995 5 and the Hampel Report of 1998 6 has been one of self-regulation and internal discipline rather than any fundamental of the status quo vis-à-vis the freedom in which directors operate without intrusive external control 7.
This attitude generally prevailed on the other side of the Atlantic until the Enron debacle utterly transformed the corporate landscape. This was a scandal of gargantuan proportions. A contemporary description of the time, chronicled it as a "…a fitting epitaph to the bubble decade of the 1990s… 8 " , with the potential to undermine "…the integrity of the entire system for channeling savings into investment…just as America's debts to foreigners and its own consumers indebtedness have reached unsustainable levels… 9 " It has led to major upheaval in the US, notably the Sarbanes-Oxley law, which oversaw the introduction of an accountancy oversight board as its core value.
As a corollary, the European Union, has almost by default been galvanized to address the issue of corporate accountability within its own parameters. As Mark Tran remarked, "…Once the US started overhauling corporate governance practices, the rest of the world was forced to go some way to meeting these new best practices… 10 "
By producing the Winter Report 11 , Frits Bolkestein, an Internal Market Commissioner rather hubristically proclaimed that "…[w]e have a unique opportunity in the European Union, as we move towards the integration of our capital markets by 2005, to put into place the best corporate governance standards in the world. We should seize the moment. Why is this so important? The Enron scandals have shown that undermining of investor confidence seriously damages the development of capital markets and subsequently economic growth… 12 "
Despite the issue of corporate governance being of vast importance to shareholders, the solution to this simple desire for more democracy and greater accountability has proven to be problematic. Perhaps the principle reason why this transition to greater shareholder participation has not happened the way idealists had envisioned is for the simple reason that Gower suggests: basically 'Athenian style democracy is not particularly appropriate for public companies 13 .
Further attempts at increasing shareholder democracy have foundered because, although desirous in a pluralistic market system, greater information for shareholders and stricter requirement that shareholders ratify managerial decisions has not led to a broader plain of decision making. Gower observes that to make a truly informed decision, shareholders need inter alia sufficient knowledge to fully appreciate the information; a large enough shareholding to influence the decision and the desire to resort to the courts to see their wishes enforced . 14
Whilst the first two prerequisites of informed decision making are often met, shareholders often lack the will to enforce their wishes through litigation. The reason for this is that institutional investors usually represent large shareholding bodies. These investors tend to shy from litigation, preferring to re-allocate their share resources.
Other problems encountered by the ownership of public companies in having their wishes enforced include the exorbitant cost of litigation in the UK. It takes a brave investor to take on the corporate might of entrenched directors interests.
This contrasts with the situation in the U.S. where investors have been more pro-active in tackling such issues as so called fat cat directors pay packets in the federal courts. The Sarbanes-Oxley law has created a new accountancy watchdog, while Wall Street firms have been obliged to invest over $400 (£245m) to finance independent research for retail investors. Rattled by the howls of outrage from an already critical global community aimed at the Bush administration, fines of $5m (£3.2m) and 20 years prison penalties are part of the package for directors of companies intentionally producing fraudulent accounts of their companies assets 15
Significantly, the new act bears testimony to the corporate globalisation that big business must now operate in. Referring to the new act Alex Cohen, securities lawyer in the London office of law firm Latham and Watkins, observed that: "[t]he Act does not distinguish between US and non-US issuers." 16
This lack of membership activism within the structure of UK corporate governance is to be regretted. As Gower remarks, the Government seems unwilling to bear the burden of allocating a more powerful watchdog body over the governance of company affairs. He cites the DTI as one option that could be used as a greater enforcement measure against errant company directors who fail to pay heed to the wishes of the general membership .17
It is the above lacuna which the Sarbanes-Oxley Act seeks to address in the perceived autonomy of board-members and directors of the corporate behemoths in the US from any form of accountability from ordinary shareholders and stakeholders. What we are left with in these terms between corporate regulation UK style and corporate regulation US style is a stark choice between 'the blunt instrument' 18 of the US regulatory model or the "…measured response to the post-Enron era…" 19
The various aspects of corporate governance, such as responsibility, controllability of management and especially that of accountability to shareholders and stakeholders needs further examination. Director's are in position's of trust within companies and therefore they owe the company certain fiduciary duties. Accordingly any conflicting ancillary purposes therefore must not deflect this power to act 20
The difficulty, especially in Europe is synthesizing an effective corporate governance regime without disturbing the tenuous equilibrium that prevails in an already unwieldy consensus as to the best route forward regarding big business operations within the EU. This is difficult, especially when entrepreneurial flair is comparatively at a premium in the EU. According to Peter Montagnon, The Winter Report reacts to this tenuous by proposing what he calls 'light touch' regulation of corporate affairs 21 .
The EU is further hampered in this respect by the fact that Europe is not a single-track economy lint the UK or indeed the US. The last thing the EU zone requires right now is further regulation! But here's the rub. The centralized and bureaucratic ridden Commission cannot loosen its grip lest it itself loses influence. Thus according to Montagnon,he less centalization, the more that stakeholders in the EU zone can feel a sense of ownership in their own market system.
In this regard the balance must be found whereby high levels of flair and entrepreneurial skills are allowed to flourish whilst maintaing a market equilibrium. As Montagnon acknowledges however, the tendency is to cover everything in a veneer of red-tape and regulations. One way to perhaps avoid the seemingly inevitable would he proposes to encourage each member state to create its own national code and companies should comply or disclose their reasons for non-compliance. This is the basis on which the UK regulatory market functions 22 .
Higgs builds on already widely accepted guidelines recommended by the Hampel Report. According to this report a director is required to "…act in good faith in the interests of the company and for a proper purpose; and to exercise care and skill. These are derived from common law and are common to all directors. The duties are owed to the company, meaning generally the shareholders collectively, both present and future, not the shareholders at a given point in time… 23 " This is embodied in the UK by the fact that company directors must act bona fides in the best interests of their company. These duties are an amalgamation of several different elements. It is submitted that this analysis is too narrow and suffers from the overly lax English approach. There are surely wider interests at stake than merely the individual shareholder? .24
Strictly speaking, the director's duty is to the company not to the shareholder's 25. The large variety of stakeholders however requires a well-balanced approach however to the various interests related to a company. The company itself has the prime responsibility of recognizing these interests and of ensuring that all these interests are met in an appropriate way through implementing an effective system of corporate governance.
Whilst it is true that in the UK, directors owe no duty the employees of the company, 26 nevertheless there are provisions that mean that employees share obliquely in the patronage of corporate decision making. 27 At the same time that the Statute giveth it also taketh away…section 309(2) of the same act 28 means that employees have no locus standi. In this regard they are merely shadows in the boardroom decision-making process.
It is the companies and associations of industries and professionals therefore which have the prime responsibility for setting and implementing rules and principles of corporate governance through their Articles of Association, Codes of Conduct and through the application auditing and accounting standards. This reflects the way that the UK has refrained from following the US route to corporate regulation, opting instead for greater flexibility and thus underpinning the general ethos of laissez faire in regard to the new era of regulatory intrusion into the boardroom ushered in from the US. The UK has had its own financial debacles in respect of Marconi, BAE Systems and Cable & Wireless. It is suggested that this reflects an air of complacency within the realm of the DTI and CBI.
At all times the ultimate objective of ensuring the essential level of transparency and stakeholder protection in an environment conducive to the corporate sector should be observed. Weight should be given to the interests of the directors, shareholders, employees and other stakeholders. A sound corporate governance system should provide effective protection for shareholders and creditors, so that they can assure themselves of getting a return on investment. It should also help to create an environment conducive to the efficient and accountable running of the business. Assuming that it can avoid the pitfalls of over-regulation and stifling red-tape, the Winter Report may offer a compromise between the lax British attitude of 'if it ain't broke, don't fix it' and the US 'sledgehammer' 29 approach to internal shenanigans.
The more modern practical approach is that propagated by the Cadbury 30 and Greenbury Committees 31 . Both advocated greater roles for non-executive members who can act as the eyes and ears for shareholders in the boardroom. Perhaps they could act as the vanguard for shareholders' best interests instead of the present role of directors who seem more interested in their own self-aggrandizement.
Most of the director's duties in the UK are regulated by the Companies Act 1985, although this Act does not impose a duty of good faith or competence. A director should not allow their personal interests and their duty to the company to conflict. According to the proper purposes rule, if a director applies himself to purposes other than to those which his powers were conferred, it may constitute a breach of his fiduciary duty. According to Hoffman LJ, "…if a director chooses to participate in the management of the company and exercise powers on its behalf, he owes a duty to act bone fide in the interests of the company. He must exercise his powers solely for the purpose for which it was conferred…" 32
Any misapplication of the proper purpose presumption does not require dishonest intent 33 .If the director does make personal gain from information he obtained in his position as director, then he will be obliged to account to the company for any profit he made, unless he has fully disclosed all the relevant facts to the members of the company and obtained their approval by ordinary resolution at a general meeting. Most companies articles 34 , do contain a provision allowing director's to have personal interest's separate from the company, and to keep any profits made, provided they disclose all details to the company members and are not cheating the company in any way 35 .The difficulty, especially in Europe is synthesizing an effective corporate governance regime without disturbing the tenuous equilibrium that prevails in an already unwieldy consensus as to the best route forward regarding big business operations within the EU. This is difficult, especially when entrepreneurial flair is comparatively at a premium in the EU. According to Peter Montagnon, The Winter Report reacts to this tenuous by proposing what he calls 'light touch' regulation of corporate affairs 21 .
The EU is further hampered in this respect by the fact that Europe is not a single-track economy lint the UK or indeed the US. The last thing the EU zone requires right now is further regulation! But here's the rub. The centralized and bureaucratic ridden Commission cannot loosen its grip lest it itself loses influence. Thus according to Montagnon,he less centalization, the more that stakeholders in the EU zone can feel a sense of ownership in their own market system.
In this regard the balance must be found whereby high levels of flair and entrepreneurial skills are allowed to flourish whilst maintaing a market equilibrium. As Montagnon acknowledges however, the tendency is to cover everything in a veneer of red-tape and regulations. One way to perhaps avoid the seemingly inevitable would he proposes to encourage each member state to create its own national code and companies should comply or disclose their reasons for non-compliance. This is the basis on which the UK regulatory market functions 22 .
Higgs builds on already widely accepted guidelines recommended by the Hampel Report. According to this report a director is required to "…act in good faith in the interests of the company and for a proper purpose; and to exercise care and skill. These are derived from common law and are common to all directors. The duties are owed to the company, meaning generally the shareholders collectively, both present and future, not the shareholders at a given point in time… 23 " This is embodied in the UK by the fact that company directors must act bona fides in the best interests of their company. These duties are an amalgamation of several different elements. It is submitted that this analysis is too narrow and suffers from the overly lax English approach. There are surely wider interests at stake than merely the individual shareholder? .24
Strictly speaking, the director's duty is to the company not to the shareholder's 25. The large variety of stakeholders however requires a well-balanced approach however to the various interests related to a company. The company itself has the prime responsibility of recognizing these interests and of ensuring that all these interests are met in an appropriate way through implementing an effective system of corporate governance.
Whilst it is true that in the UK, directors owe no duty the employees of the company, 26 nevertheless there are provisions that mean that employees share obliquely in the patronage of corporate decision making. 27 At the same time that the Statute giveth it also taketh away…section 309(2) of the same act 28 means that employees have no locus standi. In this regard they are merely shadows in the boardroom decision-making process.
It is the companies and associations of industries and professionals therefore which have the prime responsibility for setting and implementing rules and principles of corporate governance through their Articles of Association, Codes of Conduct and through the application auditing and accounting standards. This reflects the way that the UK has refrained from following the US route to corporate regulation, opting instead for greater flexibility and thus underpinning the general ethos of laissez faire in regard to the new era of regulatory intrusion into the boardroom ushered in from the US. The UK has had its own financial debacles in respect of Marconi, BAE Systems and Cable & Wireless. It is suggested that this reflects an air of complacency within the realm of the DTI and CBI.
At all times the ultimate objective of ensuring the essential level of transparency and stakeholder protection in an environment conducive to the corporate sector should be observed. Weight should be given to the interests of the directors, shareholders, employees and other stakeholders. A sound corporate governance system should provide effective protection for shareholders and creditors, so that they can assure themselves of getting a return on investment. It should also help to create an environment conducive to the efficient and accountable running of the business. Assuming that it can avoid the pitfalls of over-regulation and stifling red-tape, the Winter Report may offer a compromise between the lax British attitude of 'if it ain't broke, don't fix it' and the US 'sledgehammer' 29 approach to internal shenanigans.
The more modern practical approach is that propagated by the Cadbury 30 and Greenbury Committees 31 . Both advocated greater roles for non-executive members who can act as the eyes and ears for shareholders in the boardroom. Perhaps they could act as the vanguard for shareholders' best interests instead of the present role of directors who seem more interested in their own self-aggrandizement.
Most of the director's duties in the UK are regulated by the Companies Act 1985, although this Act does not impose a duty of good faith or competence. A director should not allow their personal interests and their duty to the company to conflict. According to the proper purposes rule, if a director applies himself to purposes other than to those which his powers were conferred, it may constitute a breach of his fiduciary duty. According to Hoffman LJ, "…if a director chooses to participate in the management of the company and exercise powers on its behalf, he owes a duty to act bone fide in the interests of the company. He must exercise his powers solely for the purpose for which it was conferred…" 32
Directors' owe a general duty of good faith to the company. This means that directors are expected to act loyally toward what they perceive is in the best interests of the company. This necessitates that a director must act 'bone fide' or in what they themselves believe to be is in the interests of the company 36 Therefore directors should only exercise the powers they have been given by the articles of the company and they should only use those powers for the purposes for which they were given. This is a fact specific duty. It is not therefore essential that a director acts with abstract good intentions. Rather it is to the short and long-term benefit to which he should turn his attention .37
Directors are expected to exercise the degree of competence that could reasonably be expected from someone with their degree of knowledge and skill. 38 This is a common law presumption applied incrementally to existing statutory law. The standard of skill required of directors is judged on a subjective basis, whereas the standard of care is judged on an objective basis. A director is required to exercise the degree of care, which a reasonable person would exercise on his own behalf. According to Gower's 39 this level of duty of care and skill must conform to that of a reasonably diligent person who has
(i) that skill and knowledge expected of an experienced person in that office and
(ii) the general knowledge, skill and experience that the particular director has.
This appears to apply an objective standard for the former requirement whilst the latter example imports a subjective element into the director's ability.
It is important to distinguish between the requirement of good faith or loyalty and that of the expectation of care and skill. The former demand a fiduciary relationship between director and shareholder and director, which is akin to that expected of trustees. According to Goulding this has a subjective element in that it is what the director thought at the time that any decision was made 40 .The emphasis is therefore on caution and prudence. The latter requirement however recognizes that a director's duties encompass operating in a commercial market that demands an element of risk when maximizing shareholder profit. The Proper purpose rule places a strong objective element on the behavior of a director. Therefore a director must act fairly between different shareholders within the company. 41 The separate tests, although somewhat artificial if applied mechanically allow the court to distinguish more easily the various capacities of a director when making an overall decision regarding liability and for this reason serve a useful purpose as separate tests.
While a company is solvent, its directors do not owe strictly defined fiduciary duties to the company's creditors, but are placed under a statutory obligation to consider the interests of employees. The duty of directors to take into account the interests of creditors is indirectly enforced through the rules which call for the directors to maintain capital levels, and which impose personal liability for fraudulent trading and wrongful trading immediately before liquidation. The traditional rule is: Directors have no fiduciary duties towards creditors during the day-to-day operations of a company. 42
Traditionally, the Directors fiduciary duty is limited to the shareholders and only the shareholders. This traditional rule is modified, but not reversed, in the instance of insolvency 43. An actual petition for bankruptcy need not be filed, either voluntarily or involuntarily, for the traditional rules regarding the fiduciary duties of Directors to expand to include creditors. Mere insolvency is sufficient. Once a company is no longer solvent, the Directors acquire new fiduciary duties towards the creditors but continue to have the established fiduciary duties towards stockholders . 44
Under the Companies Act 1993 Directors do not owe duties directly to the creditors of a company. Directors owe duties to the company itself and a liquidator, receiver or creditor of a company can only enforce those duties in the name of the company. As receivers principally act for the debenture holder that appointed them (usually the bank) which will have access to guarantees in respect of any shortfall, actions against Directors in the company name for reckless trading are usually brought by a liquidator on behalf of unsecured creditors.
Judicial dicta complements legislative provisions. When a company approaches insolvency, the interests of shareholders are supplemented or even overtaken by those of its creditors. 45 Whilst the West Mercia Case does not presume absolute priority for creditors, a director should not take action that would leave a creditor in a worse situation than if they had not taken action. The rationale behind this case allows creditors to overreach the demands of shareholders through the mechanism of liquidation .46
Once a company is in liquidation, a creditor can bring an action against the Directors, in the company's name under S.301 (1) of the Companies Act 1993, but any order for damages in respect of reckless trading will be made in favour of the company and will be available to the general body of creditors and opposed to a specific creditor. The relevant Directors duties under the Companies Act 1993 are sections 135 (reckless trading) and section 136 (executive Directors who will have varying degrees in involvement of the day to day running of the business duty in relation to obligations). Under section 135, Director must not agree, cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of a serious loss to the company's creditors.
The description "reckless trading" has come under some criticism as being misleading as the actual test involved. The reality is that the test is closer to negligence than recklessness and Courts approach the conduct of a Director on the basis of what an ordinary prudent Director or Manager would have done in the same situation. In other words, would have an ordinary prudent Director continued to trade the business in the same circumstances.
Common law precedent in this area highlights how the dichotomy between creditors interests and that of the company breakdown under pressure from litigation involving liquidation. Company directors are severely subscribed by law from disposing of their company's assets in such circumstances. According to Gower it will in any case be in any companies' interests that directors perform their duties honestly and scrupulously, as ultimately it will be the shareholders and therefore the company that will suffer if it becomes subject to further bad publicity and possible litigation . 47 The directors' duties should in this respect be concerned with those having the ultimate financial stake in the company. Once the directors lose financial control, it will be hard for them to justify promoting the interest of the company above that of the creditors.
Fortunately for the Bush administration, the 'Enron factor' failed to haunt the President through his term in the Whitehouse in the manner that the specter of Monica Lewinski's lips seemed to define the final years Bill Clinton's tenure. Ironically, the vocal baying of America's critics may have encouraged the administration to take radical steps to address the cliché of 'corporate sleaze' that dominated the newspapers at the time. Whilst Europe and the UK may have found the balance to regulate the competing strains of economic success, it would be an irony if a committed libertarian such as President Bush presided over the suffocation of US business regulation.
No comments:
Post a Comment