Tuesday, July 7, 2009

The Duties of Non-Executive Directors

Earlier discussions on corporate governance norms have raised questions about the role of independent non-executive directors in maintaining appropriate standards of governance. In this context, a recent Australian judgment indicates the nature of duties which a non-executive director may be required to discharge.

Australian Securities and Investment Commission v. MacDonald involved a situation where the Australian market regulator, ASIC, alleged certain malpractices in the form of misinformation being given to the market regulator by the board of the defendant company. ASIC alleged “that a Draft ASX Announcement was approved at the 15 February 2001 Meeting of the JHIL board of directors and that it contained a number of statements to the effect that the Foundation would have sufficient funds to meet all legitimate Asbestos Claims, that it was fully funded and provided certainty for people with legitimate Asbestos Claims. ASIC alleged that those statements were false or misleading and that the directors were in breach of (their duties)…

Among the many issues raised were those concerning the duty of care imposed on executive and non-executive directors; as well as those pertaining to the extent to which non-executive directors could rely while exercising their duties on the information given to them from others. The Court noted at the outset that the position in relation to non-executive directors was unclear. Non-executive directors were undoubtedly subject to similar fiduciary duties as executive directors such as the duty to act in good faith and for proper purposes, duties of no conflict etc. Nonetheless, there was considerable uncertainty in determining how these duties applied to non-executive directors. Quoting from a leading Australian textbook, it was noted:

For a non-executive director case law has supplied no objective standard of the reasonably competent company director analogous to the reasonably competent member of a particular profession or trade, such as architect, solicitor, physician or builder, against whom the conduct of a director can be measured when determining whether there has been a breach of the duty of care, diligence and skill. Part of the reason is the absence of any shared body of detailed expert knowledge of what is involved in the directing of companies. The diversity of companies and varieties of business endeavour are such as to allow uniformity of standards only on very general matters.

The Court however went on to hold that all directors, including non-executive ones, should have known that there was a possibility that the statements in the Announcement were false and/or misleading. Significantly, the Court decided that non-executive directors could not simply rely on the information provided by the management or by the executive directors. “This was a key statement in relation to a highly significant restructure of the James Hardie group. Management having brought the matter to the board, none of them was entitled to abdicate responsibility by delegating his or her duty to a fellow director.” Thus, the Court seems to have imposed a duty of care on non-executive directors which cannot be satisfied simply by relying on information provided to them by others. What exactly is the content of this duty is a question not conclusively answered.

Nonetheless, the ASIC has described the decision as “a landmark decision in Australian corporate governance”; and it appears that non-executive directors will not be held to have satisfied their duties by arguing that they relied in good faith on certain information provided to them. Particularly when the information concerns an important management decision, there appears to be a duty on non-executive directors to confirm the veracity of the information independently.


Umakanth Varottil said...

Thanks Mihir, for highlighting the importance of this judgment. This could, however, be contrasted with the statutory position in Singapore where the Companies Act expressly permits directors to rely on information provided by company employees or advisors, but under limited circumstances after having exercised due diligence. For ease of reference, Sec. 157C of the Singapore Companies Act is extracted below:

Use of information and advice
157C. —(1) Subject to subsection (2), a director of a company may, when exercising powers or performing duties as a director, rely on reports, statements, financial data and other information prepared or supplied, and on professional or expert advice given, by any of the following persons:

(a) an employee of the company whom the director believes on reasonable grounds to be reliable and competent in relation to the matters concerned;

(b) a professional adviser or an expert in relation to matters which the director believes on reasonable grounds to be within the person’s professional or expert competence;

(c) any other director or any committee of directors upon which the director did not serve in relation to matters within that other director’s or committee’s designated authority.

(2) Subsection (1) shall apply to a director only if the director —

(a) acts in good faith;

(b) makes proper inquiry where the need for inquiry is indicated by the circumstances; and

(c) has no knowledge that such reliance is unwarranted.

Karthik Seshadri said...

Readers may also be interested in following the path taken by the case involving a very large Retail Chain called "Subiksha" which is now pending the Madras High Court. This case involves questions pertaining to the role played by certain non executive and/or independent directors. There has been a lot of coverage of this case in the newspapers of late.

Pushkar Raj Chandna said...


It is heartening to know that the government has taken an initiative to provide protection to Independent Director’s by coming up with amendment to the companies act.

The ID’s in the present scenario of corporate governance in India are being appointed by the promoters/ CEOs, who are very powerful in the corporate world and thus the likelihood of theirs (ID’s) being independence is very unlikely. The protection as being suggested will be very short lived and will not provide a long term solution to the problem. We have to look for an holistic solution to these issue and the IDs need to be “empowered” rather than being protected. I would call it as bill for “EMPOWEREMENT OF IDs” . IDs need to be empowered or their roles well redefined to have a say in the CEOs succession, rather than CEOs appointing the IDs.

It is also pertinent to note here that many of the IDs (high official from government/ public sector) are being appointed by many companies immediately just after they retire from the active service, which also raises questions on IDs independence. It is a fact , the service rules of government provides for a “cool off period” for these high profile government employees, but hardly being implemented. One of the criterion for rejection for an IDs from this category should also form part of the qualification of the IDs for appointment.

Beside, the above it is a well known fact that Indian shareholders are not proactive and are not able to assert themselves in discharging their role. It these category of people who are the most sufferer, when the company like Satyam or their CEOs indulge in unlawful activities. Shareholder activism is hardly heard off in India, but for recent few cases. It is essential that Indian shareholder also need to be empowered to discharge their role in tandem so as to bring about good corporate governancein the country.

Furthermore, "Whistle Blowing Act" need to be strengthened.