Part 1: Thinking about Directorship – unpacking the duties of directors

Thinking about Directorship – Directors Duties.

Having worked with a range of types of organisations across a number of different countries (mainly in Sub-Saharan Africa) one of the key areas of convergence in the vast majority of corporate legislation (and governance codes) internationally is around the duties and responsibilities of directors and officers of companies (and generally other organisations). The twin duties include an implied (or explicit) fiduciary duty and the triple responsibility to act with care, skill and diligence.

To unpack these, firstly the concept of fiduciary duty is essentially the same as that used to describe the role of a trustee – this is the highest standard of care at either equity or law. The roots of the word “fiduciary” originate in the mindset of a father looking after their child – the terms originates from the Latin fiducarius that means “to hold in trust”, this in turn is a derivative of fides meaning trust. As such it is both a legal relationship and a moral or ethical relationship based on confidence and trust between two or more different parties. “A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence” (Bristol and West Building Society v Mothew (1998).

The areas of convergence between various legal jurisdictions result in the following similarities:

  • Directors owe duties to the organisation and not to individual shareholders, employees or creditors outside exceptional circumstances;
  • Directors’ core duty is to remain loyal to the company, and to avoid conflicts of interest;
  • Directors are expected to display a high standard of care skill and diligence;
  • Directors are expected to act in good faith to promote the success of the organisation.

To put it bluntly any director or officer in a company is in essence looking after the property of someone else – it is not theirs, regardless of whether they are a shareholder of the entity in question. To clarify a key point relating to the nature of ownership is vital to understand before progressing. An so called ‘owner’ of an organisation (a shareholder) holds a share in the business but does not own the things that organisation owns – these are owned by the organisation. This point may seem blatantly obvious when put in such a straightforward manner but the main issue is how directors, many of whom are also shareholders, behave – they tend to behave as if they own the stuff the organisation owns as opposed to behaving as if they merely hold a share in the business and thus have not direct claim on the actual assets of the organisation. This misunderstanding (or misbehaving to be more accurate) has significant effects.

The phrase that most accurately represents a fiduciary duty is that of “acting in the best interests of the entity” alongside the requirement to act in good faith. Ultimately this becomes the test of a director (or trustee) did they, and were they seen to be, acting in the best interests of the organisation?

The second legal duty and responsibility of directors (and prescribed officers) of a company is to act with the required care skill and diligence in the performing of this fiduciary duty. The fiduciary duty creates the core reason for acting – the central motivation that should drive the thinking and behaviour of directors – the triple duty of care; skill and diligence start to provide some indication of how this duty is to be carried out. The specifics of what leaders in organisations should do daily are not spelt out in the legislative framework – it is left up to the interpretation of the leaders themselves. Many leaders miss this point when they look too intently to legislation to define exactly what they as leaders should be doing.

To unpack these concepts further it is also vital to understand the relationship between the various parties involved in this organisational cluster – there are basically three separate parties with very different interests, responsibilities and rights. This separation of parties is an essential concept in understanding the way organisations work.

  1. The organisation is like a “new born baby” it cannot look after itself, cannot make decisions, and cannot do anything by itself. This is because it is inanimate; the only life in an organisation is the life of the people in the organisation. Another critical characteristic of an organisation is that it is theoretically immortal – this means that it will (should) outlast the people who started it as well as the people who are currently running it. This is a very important fact since it implies that the “interests” of the organisation are “continual” and need to be described, defined and implemented in a way that reflects this continuity. Obviously because an organisation is inanimate its “interests” are actually the interests of those both owning it and directing it – this is where governance comes in to manage the tension between the interests of these 2nd and 3rd parties to the separation of persons equation;
  2. Shareholders. Shareholding in a company has, at one level, a very simple objective – the long-term maximisation of value. This is the primary reason why people ‘own’ businesses or corporations – they want to see the value of their shareholding grow and grow and grow (over time). There are obviously a whole range of other “interests” that shareholders may have including; self actualisation, application of their technical skills, increased freedom etc but these are, from a “structural” point of view secondary to the primary interest of maximising the value of their shareholding. Shareholding strategies can however be split into two primary directions based on the way that value is “realised” by holding shares in a company. There are two primary ways to realise value from shares (i) increased in share value, and (ii) dividend income. A shareholding strategy would typically reflect the emphasis of either of the two. Shareholders will desire an aggressive growth strategy to maximise share value – the implication would be that often growing cash flows would be continually reinvested into the organisation to facilitate/drive this growth; the net result would be limited declaration of profit and dividends. The alternative shareholding strategy would be to maximise dividend payouts by less aggressive growth and more emphasis on maintenance of market position and income, more pressure for implementation of cost cutting efficiencies on operations (and the like) – in other words maximising the declared profits and dividends that could be paid out. Clarification (and a common understanding among a diverse group of shareholders) of the shareholding strategy – at some point between these two extremes is essential to ensure that an appropriate mandate can be provided to those responsible for achieving this objective. This is where the third part comes in;
  3. Directors (and prescribed officers) of an organisation are those tasked with or mandated to operate the organisation in such a way that it achieves the ultimate objective of the owners. This may sound simplistic but in essence this is the role of directors – it encompasses, to some degree, the twin, yet divergent, responsibilities of agency and stewardship. Many consider the director the “agent” agent of the shareholder but they do also act as trustee or steward of the organisation. An often used illustration is that of looking after someone who has been incapacitated. In this case the person looking after such a person needs to both make decisions and take actions that are in the best interests of the person who is in the incapacitated position. The same is true of a director – remember that a corporation is an inanimate entity, unable to take care of itself – and yet it is also the nature of corporations to have the “interests” of a number of different parties wrapped up in it. The interests of employees, suppliers, customers and in some cases the public at large have their ‘interests” intimately linked with the well-being of the corporation. A director in “acting in the best interests of the company” (as an agent and trustee) therefore needs to take into account all the stakeholders in the company – who often have competing interests and agendas. This need to “take into account” is linked to a duty of transparency as well as to the duty to act with the necessary care, skill and diligence to properly perform and carry out their duties in an effective way.

In short the biggest difference between the interests of shareholders and directors is that a shareholding interest is “selfish” (for the maximisation of value), whilst the directorship “interest” or “mandate” is self-less (to act in and be shown to be acting in the best interests of another – the company comprising of all its stakeholders). This in itself is one of the biggest challenges for leaders (owner/managers) of organisation – to get the balance right between the differing interests of their divergent roles – this is where both robust strategy and thorough governance help.

Part 1: Thinking about Directorship – introducing the duties of directors

Part 2: Thinking about Directorship – unpacking care, skill and diligence (a challenge to the current mindset)

Part 3: Thinking about Directorship – beyond duties to the disciplines of directors

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