PART 2: Executive Duties & Dispute Resolution
We focused attention in Part1 of this article on the risks and rewards associated with being an executive director or senior manager. We noted that an executive’s management style and quality of decision making can have profoundly positive or negative effects on an organisation and everyone associated with it.
For these reasons, legal and corporate governance systems have evolved and been adapted over time to regulate the conduct and behaviour of corporate leaders. This is essential to protect the financial and moral well-being of those who are directly or indirectly affected by an executive’s conduct.
Directors and their responsibilities
In addition to labour legislation, the conduct and behaviour of executives who are also directors and office bearers of a company are governed by other statutes and governance rules. These are collectively designed to subject them to greater degrees of restraint and legal accountability.
Sources of rights and duties
Directors’ rights and duties derive from three main sources:
- the Companies Act
- the company’s Memorandum of Incorporation
- the common law.
The theme which is common to all these sources is to hold executives to account to those they serve. It does this by setting various standards of conduct against which executives can be assessed and judged. The purpose is to deter the regrettable tendency to abuse power and thus to limit the scope for “corporate tyranny” in its various guises in organisations.
The underlying principles are that the company is a separate legal entity, distinct from its owners, and a director stands in a fiduciary relationship in relation to the company. This requires the director (the fiduciary) to act in good faith and to act in the best interests of the company (the beneficiary) at all times. The duty derives from the relationship of trust which the director is required to demonstrate in fulfilling the duties as a director.
Directors must act independently in the best interests of the company. They must avoid a conflict of interest, maintain an unfettered discretion and act with care and skill.
Care and skill
The more difficult aspect of a director’s fiduciary duties relates to the standards by which care and skill are measured. It will be self-evident that these measures overlap with the employment law dimension of an executive director’s relationship with the company- which is also his employer. Three key guidelines for applying this duty in practice were established in a UK case back in 1925, namely that a director:
- need not exhibit a greater degree of skill than may reasonably be expected of a person of his knowledge and experience;
- is not bound to give continuous attention to the affairs of the company and is thus not bound to attend all meetings – though he ought to attend when he reasonably is able to do so; and
- is justified in trusting an official of the company to perform his or her duties honestly, in the absence of grounds for suspicion.
Test for a Director’s duty of care
It will be evident from this case that it sets a subjective test for the duty of care. However, the test has evolved over time to be more of a combination of a subjective and an objective test. Just to clarify the difference between the two tests:
- The subjective test considers whether that individual acted reasonably in the circumstances.
- The objective test considers whether how a reasonable person in that individual’s position would have acted in the same circumstances.
This was expressed in two more recent UK cases in 1991 and 1994. It relates to conduct which ‘may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and … the general knowledge, skill and experience that that director has’.
Companies Act 71 of 2008
The Companies Act sets out to codify the common law in various sections.
Section 76(3) requires a director to exercise his or her 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 that may be reasonably expected of a person in carrying out the same functions in relation to the company as those carried out by that director; and
- having the general knowledge, skill and experience of that director.
Section 76(4) states that a director is regarded as having fulfilled the ‘best interests’ and the ‘duty of care’ duties if the director:
- has taken reasonably diligent steps to be informed about the matter, and
- had no material personal financial interest in the matter, or disclosed it, and
- had a rational basis for believing the decision was in the best interests of the company.
Section 76(4) (b) allows directors to rely on:
- employees reasonably believed to be reliable and competent
- external professional persons also considered capable
- board committees (unless the director has reason to doubt their competence)
- persons to whom the board may reasonably have delegated one or more of its functions
- information, reports and other data prepared by persons delegated to do so.
Directors are also bound by numerous other statutory duties which include to:
- declare interests in the contract of the company
- avoid insider trading and unfair competition
- comply with restrictions on taking loans from the company.
Directors’ personal liability
Section 77 exposes directors to personal liability if they fail to fulfil their duties as required by common law or statute. They may take out Directors’ Liability Insurance to cover them for the consequences of their ordinary negligence – but not for any intentional or grossly negligent act. The five categories of liability are for:
- breach of the common-law fiduciary duty of good faith
- failure to perform with due care and skill
- knowingly acting when not properly authorised
- being a party to an act or omission calculated to defraud a creditor, shareholder, or employee
- being party to the issue of false or misleading financial statements
- having been at a meeting or participated in a decision without voting to the contrary which led to a contravention of the Act.
Types of director and executive disputes
There is a wide range of issues which could cause disputes with directors and executives.
They usually consist of a mix of corporate governance and employment contractual issues.
Corporate governance issues
These sorts of disputes usually have to do with the executive’s relationship with the various stakeholders who have an interest in the organisation. They include-
- Disputes among corporate officers: auditing, conflict of interest or remuneration issues.
- Disputes among investors (shareholders and/or bondholders): share valuations, a proposed takeover, acquisition or disposal of company assets.
- Disputes between shareholders and the company: voting rights or dividend payments.
Employment contractual issues
An executive also has the same labour law rights and obligations in terms of the Labour Relations Act as other employees. This exposes the executive employee to potential disputes arising from –
- Misconduct: Allegations of misconduct such as dishonesty, violence, sexual harassment or breach of rules relating to directors Ð corporate governance, Company’s Act, common law fiduciary duties, etc.
- Negligence: Failure to properly exercise the duty of care required of a senior employee and a director.
- Incapacity: Incompetence, inability to provide appropriate leadership, inability to perform to the standards of performance expected of a senior employee, failure to achieve company targets and objectives, poor judgement and decision making, etc.
Effective dispute resolution
As mentioned in Part 1, conflict and disputes at senior level are bad news for a company. For this reason, it’s essential to have an effective dispute resolution system in place which can deal with problems at executive and senior management levels quickly, effectively – and discreetly. There are several options available for the resolution of executive disputes. These include referring an unfair labour practice or dismissal dispute to the CCMA or relevant bargaining council, an application to the Labour Court for a variety of forms of relief, private mediation or arbitration, or a negotiated settlement.
The LRA procedures, Labour Court, CCMA and bargaining councils
Section 138(1) of the LRA contains the mandate to commissioners:
“The commissioner may conduct the arbitration in a manner that the commissioner considers appropriate in order to determine the dispute fairly and quickly, but must deal with the substantive merits of the dispute with the minimum of legal formalities.”
The LRA’s Dismissal Code’s key principle
The introduction to the LRA’s Code of Good Practice: Dismissal describes the key principles for dealing with dismissal disputes as follows –
“The key principle in this Code is that employers and employees should treat one another with mutual respect. A premium is placed on both employment justice and efficient operation of the business. While employees should be protected from arbitrary action, employers are entitled to satisfactory conduct and work performance from their employees.”
This principle seeks to strike an appropriate balance between the often conflicting notions of fairness and efficiency. The emphasis in the case of ordinary employees is on the fairness dimension. In the case of executives and senior managers, the emphasis is much more inclined towards efficiency. This is because executives and senior executives are deemed to be more self-sufficient then more junior employees. They are expected to have the knowledge, skills and experience to conduct themselves in an appropriate manner and to perform their tasks with little or no supervision. It follows that they take far more accountability for their own performance compared with junior employees who are less able to fend for themselves – and thus need greater protection from the law.
The statutory dispute resolution processes tend to focus on fairness because the majority of their claims involve mostly more junior or “vulnerable” employees. The issues at hand also tend to be less complicated that the often complex issues which can be involved in determining a dispute involving an executive. For this reason it is often preferable to consider alternatives to the statutory procedures.
It is self-evident that the win-lose consequence of going the litigation route often precludes the prospects of mutually acceptable outcomes. In contrast, the alternative option of concluding a negotiated settlement offers far greater prospects for better quality outcomes. The prospects of success are greatly improved if the parties agree to use the services of an experienced commercial mediator to facilitate the negotiation process.
Private mediation or arbitration
Most executive disputes are settled outside the courts and the CCMA. This is because the nature of the disputes is usually complex and high risk. The most common processes used to resolve disputes at this level are:
- in-house negotiations
- threats of legal action to induce negotiation
- negotiations between parties with external lawyer assistance
- negotiations between external lawyers on behalf of parties
- fact-finding investigations on allegations of misconduct
- arbitration on alleged misconduct issues.
Typical contents of settlement agreements
The terms of an agreed settlement should be properly recorded in a formal settlement agreement which is signed and legally binding on the parties. The typical contents of a settlement agreement include some or all of the following elements:
- payment of agreed settlement amount
- accrued contractual entitlements
- exercise of share sales or options
- release or partial retention of restraint of trade agreements
- public communication
- full and final.
The duties and responsibilities of executives are complex. The consequences of their actions and failures can extend far beyond the legal dimensions. And there will always be cases in which a delinquent executive must suffer the harsh penalties and consequences for wilful or negligent breach of the duties connected with higher office. The law and society expects and deserves nothing less to preserve the integrity and trust in our systems of legal and corporate governance.
There are equally those cases in which there are compelling reasons to use creative processes to resolve and settle disputes at executive and senior management levels in an organisation. If used appropriately, they can deliver constructive outcomes which strike a balance between the legal rights of individual executives, the public’s right for corporate leaders to be held accountable and the preservation of reputations and relationships.
T Wixley & G Everingham Corporate Governance 3 Ed (2010)