A Practical Guide to Directorships

Recently a few of our clients' staff were appointed to the board of companies acquired by the clients. We were approached by the staff to advise on their rights, duties and obligations as directors.
This article endeavours to discuss the essentials of being an effective director, whether you have been appointed by your employer to the board of one of its subsidiaries or you have accepted the role of the director in a company, even if you are one of its shareholders. We will discuss what the law sets out as your legal rights, duties and obligations and what they mean on a practical day-to-day basis.
Being a director is more than just a title - they need to be both risk-managers and responsible risk-takers to enable companies to grow and survive. Directors are the representative of the company and shareholder, and answer to them. Even if you are also the main shareholder, as a director you’ll have legal responsibilities to actively monitor the management of your company and may face serious penalties if things go wrong.
Although the article addresses directly the directors, the practical day-to-day conduct applies equally to trustees.
 ...So before you take up a directorship

What are the Legal requirements and best practice re directorships?

•  Directors have a legal duty to “act in good faith and in the best interests of the company” (Section 131 of the Companies Act 1993).
• The Institute of Directors’ Code of Practice indicates that a systematic review of the performance of individual directors (including the chairman) and of the board as a whole helps address weaknesses, increases skill levels and demonstrates a commitment to accountability.
• The New Zealand Principles for Corporate Governance include fostering high ethical standards and having a balance of independence, skills, knowledge, experience and perspectives among directors so the board works effectively.

What does that mean practically?

1)  Most importantly, make sure you have the time, as you're going to need a lot of it initially!

• Critically reading weighty board reports and drawing conclusions from what is being presented requires time and effort in addition to travel and spikes in board activities during strategy setting, budgets and forecasts settings.

2)  Get to know the company and its markets

• Understanding the company cashflow cycle - how cash is converted into products and services and back to cash is critical in ascertaining where, how and what types of risks arise and how the management addresses these.
• Understanding the skills, experiences, attitudes & risk appetites of key management staff will help you assess the residual risk levels that the board is exposed to.
• Review the company accounts, forecasts and constitutional documents. Get some independent opinions where ever necessary.

3)  Understand the responsibilities a directorship involves

• Ask the chairman and other directors what skills and focus the board is expecting you to bring. Can you do that?
• You’ll be in a governance not management role. Learn what the difference involves. This is critical - all too often the confusion between the two roles results in directors acting as managers. Not only it undermines the managers but also prevents the board members to do their roles effectively.
• Become familiar with the legislation your company operates within. You may be personally responsible and liable for decisions made.
• Ask about Directors and Officers Insurance and any prior or existing claims. Otherwise you may be personally liable.
• Become familiar with Companies Act requirements such as preparing and filing annual reports and returns, as well as director responsibilities. when you are working with other board members and management

...When you are working with other board members and management

1) Remember the big picture

• Always keep in mind the long term strategy. If the company hasn't got one - then get one! And benchmark all decisions on whether they facilitate meeting long term goals. How will what’s happening internally and externally affect what you need to achieve? Check the details, but don’t get caught up in them.

2) Do more than tick the boxes

• Make sure you comply with the law, but think, question and challenge too.
• Apply your skills and experience to help your company act honestly and with integrity.

3) Look for the bad news

• Even the best companies stumble sometimes. Check those regular reports management are giving you and keep an eye out for changes that might signal a problem. Follow-up and find out more. And don’t wait until the board meeting to ask questions. Work with the Chief Executive and management to ensure the right information comes to the board - ensuring that you are only working the governance function. Too often directors get involved in management undermining both the management and the governance function.

4) Ensure the board minutes are an accurate record

• Board and committee minutes are an official record of company proceedings. They are discoverable in legal proceedings and courts will treat the contents of minutes as highly relevant. You should make sure the minutes reflect what occurred in the meeting, especially key decisions and difficult and complicated issues facing the company. Minutes are signed off by directors as a true and accurate record of the meeting.

5) Learn from the annual review

• All boards should regularly review their performance, preferably annually. The review should be led by the chairman. Consider getting a proper board appraisal function in place!
• The review should assess skills – both peer and self-review is important as well as external input/advice.
• Online appraisal tools such as the Institute of Directors’ Better Boards tool can help with the process.

 ...when you are making decisions

What are the Legal requirements and best practice re directorships?

•  Directors can rely on information and professional or expert advice, but only if they act in good faith, make proper inquiries or have no knowledge that such reliance is unwarranted (Section 138 of the Companies Act).
• The general requirement to act in good faith and best interests (Section 131) can apply to parent companies too, but only if permitted by their constitution (Section 131).
• Sections 139–149 of the Companies Act spell out the requirements for transactions involving self-interest and Section 4 defines the solvency test.

 What does that mean practically?

​1) Apply your understanding of the company and the environment it works in

• Make sure you’re familiar with key legislative requirements in your industry and the environment the business operates within.

2) Ask questions

• Prepare by reading papers before the meetings, get advice, test, fail and learn quickly.
• How does what your company is planning to do fit with its own policies, for example, key ones such as lending and credit policies and liquidity and provisioning.

3) Don’t rely on the same people all the time

• Be alert to the risks of groupthink and think for yourself. You are required to exercise your independent objective judgment and not be railroaded by others.
• Don’t rely on others to make decisions for you. Often times, board members act either like possums in headlights or paralysis by analysis and the management is forced to make decisions in order to act!
• Directors are able to seek their own advice independent of management and may wish to do so, on problematic or critical strategic decisions, but you still have to make up your own mind.

4) Be aware of possible conflicts of interest

• Make sure any conflicts you personally have are officially recorded. All companies should have an Interests Register and a process for managing potential conflicts. This is absolutely key!
• Where you have an ‘interest’ in a transaction, you need to be able to show how your company (or your parent company if your constitution allows this) benefits and gets fair value from it.
• Check if your company constitution allows related party transactions (transactions between related companies). If so, do any special conditions apply and are they in the best interests of your company? Related party transactions are also likely to be material to investors and should be disclosed in any disclosure documents.
• Ensure you have a good understanding about what falls within the definition of a related party.

5) Apply the solvency test

• This is required when entering into certain transactions and before making distributions to shareholders.
• You may need to sign a solvency certificate and be able to provide the reasons for your opinion that the company meets the solvency test.
• If you don’t know, ask. here’s why: best practice and legal requirements.
• Get the company's accountants involved or call your Core Business Services advisor.

 ...when you sign off financial statements

What are the Legal requirements and best practice re directorships?

• Directors have a legal duty to exercise their powers and duties with the care, diligence and skill that a reasonable director would exercise. This includes taking steps to ensure you are properly informed about the financial position of the company and ensuring you understand your responsibilities taken on behalf of the company (Sections 135–137 of the Companies Act 1993).
• New Zealand Corporate Governance principles include that boards should demand integrity both in financial reporting and in the timeliness and balance of disclosures on the company’s affairs.
• The Guidance note: Disclosing non-GAAP financial information outlines the factors to consider if using non-standard financial reporting. This is available on www.fma.govt.nz

What does that mean practically?

1)  Read them

• Make sure you’re familiar with how to read the key statements – the balance sheet, income statement (profit and loss) and cash flow.
• Check financial statements are consistent with other documents management has produced and not just the documents, they reflect the key events during the financial year.
• Check the disclosures: What are the most significant areas of judgment? Are these reasonable and clearly disclosed? • Are there significant uncertainties about the on-going viability of the business that need to be disclosed?
• Do the maths, mistakes can creep in. It is not acceptable to be wise after the event.

2)  Don’t sign off anything you’re not comfortable with

• Read the director’s representation letter carefully and ask the auditors to highlight any matters specific to your business.
• Be alert to what the external auditors say – get them to explain if you’re not sure. Remember auditors are only providing an independent opinion on the accounts – you’re still responsible for signing the accounts as accurate. here’s why: best practice and legal requirements

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 ...when things go wrong

What are the Legal requirements and best practice re directorships?

• Directors have a duty under the Companies Act 1993 to not cause or allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s creditors (Section 135). This is in addition to the general duty to act in good faith and in the best interests of the company.
• In addition, the first principle in New Zealand’s Corporate Governance Principles is to observe and foster high ethical standards

What does that mean practically?

1)  Keep an eye out for warning signs

• Problems might range from conflicts within the board or with management through to severe and serious issues such as fraud or insolvency.
• Monitor financial forecasts. Check underlying assumptions and consider whether they are realistic. Confirm whether the forecasting function is sophisticated enough to monitor residual risks.

2)  Find out who to go to

• Talk with your chairman and management including your Chief Financial Officer.
• Get external advice from lawyers, auditors and other advisers. If the issue is serious don’t rely on company advisers – get your own legal advice.
• Alert the Financial Markets Authority if you feel investment offers are illegal or the securities laws have been breached. Contact the Serious Fraud Office if you suspect fraud.
• Belong to a relevant membership organisation such as the Institute of Directors. This will help you develop networks you can use for mentoring and support.

 ...If your company becomes insolvent

What are the Legal requirements and best practice re directorships?

• Directors can be held liable for reckless trading, incurring an obligation without reasonable grounds to believe the company can perform the obligation, and negligent trading (Sections 135, 136 and 137 of the Companies Act 1993).
• Criminal cases that have been brought against directors by FMA have included those where directors failed to disclose to investors that their companies were unable to pay their debts when they fell due.

What does that mean practically?

1)  Stop trading

• If your company can’t pay its debts when they are due you must prevent your company from further trading or you may be liable for civil penalties, compensation proceedings or criminal charges.
• If you have a sound forecasting function in place, you will know that between 6 to 12 months in advance! Consider plans for overcoming the cashflow crises and get advice from lawyers about the best time to stop trading.

2)  If you can’t refinance or obtain funding to recapitalize, appoint the right person to take control

• It’s critical the board, not management makes the appointment. Make sure the insolvency expert is proficient and competent to advise and does not have any conflicts of interest.
• Generally your options will be to appoint a voluntary administrator or liquidator.
• It’s important to understand that if you go into voluntary administration or liquidation you’ll lose control of the company.
• Receivership generally occurs when a secured creditor appoints a receiver to try to recover money. Directors’ powers will depend on the powers of the receiver.

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3 ) Understand you’ll still have obligations

• You’ll need to assist the external administrator by providing books and other records.
• You may also need to meet with the administrator, attend creditor meetings or even be summoned to attend Court

Key message

The key message here is that your essential duties and responsibilities as a director are to:

• be honest
• act with integrity
• act in the best interests of the company at all times
• have the right mix of skills and experience
• understand risk and be responsive to risks and conflicts
• ask the hard questions until you are satisfied you can make a decision.

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Disclaimer
The above publication discusses business issues generally and is not intended to be specific advice. Whilst every effort has been made to provide valuable, useful information, Core Business Services Ltd, any related suppliers, associated companies & practices accept no responsibility or any form of liability from reliance upon or the use of its contents. Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only. Please do consult with your advisor or call this firm for information / advise specific to your circumstances before finalising any particular course of action.