The impact the directors duties set out in the company

The purpose of this paper is to explore the impact the ‘directors duties’ set out in the company in the country will have on entrepreneurial pursuits within corporations. Specifically we will be looking at whether these duties are a hindrance to entrepreneurship and innovation.

The paper will focus on corporate governance since the way companies are directed and controlled following principles such as transparency, accountability and integrity rules and regulations are generally formulated to ensure good governance, and the directors duties set out in the law are basically in support of this.

According to Sir Adrian Cadbury (1992) “Corporate Governance is concerned with holding the balance between economic and social goals. The Governance framework is in place to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society."

The Scope of the assignment will be;

To briefly discuss what is a company

Introduction to the Companies Act in Sri Lanka

To identify the Directors duties imposed by the Companies Act in Sri Lanka

Discuss whether these duties imposed by law are a hindrance to entrepreneurial pursuits within corporations

Nature of companies

Companies are artificial creations, and the characteristics now taken for granted have come into being gradually over the years. The different forms of associations that came into being to pursue business goals have taken a degree of formality leading to the formations of companies as we know them today.

The law recognizes a variety of company structures including sole traders, partnerships, public and private companies, trading cooperatives, trusts and joint ventures. They can be categorized as public, private, listed, family, government and ‘not for profit’ organizations. Companies also fall in to the categories of sole- proprietorship, limited liability or unlimited liability.

Stake holders – who are they?

A stake holder is a person, group, organization or system who affects or can be affected by an organizations actions (Wikipedia), and include ;

Shareholders

Customers

Employees

Business partners

Financiers

Competitors

Politicians

Media

Regulating Authorities

Other Business Leaders

Government

Good Corporate Governance

There is no single model for governance, however it is well recognized that there are common elements in a good governance framework, these include; responsibility of having strong foundations for management and oversight of the company, directors duties, board structure and organization, the rights of shareholders, recognition of the role of other stake holders, adherence to disclosure and transparency, ethics and risk management. The seven interrelated pillars of governance are

Executive Directors

Non-executive Directors

Board committees

Senior Management

Internal auditing

External auditing

Shareholders

Companies Act in Sri Lanka

Company Law in Sri Lanka can be traced back to 1853. Currently the companies Act No.7 of 2007 govern the regulation and conduct of companies in Sri Lanka. The act replaces the Companies Act No.17 of 1982 which was based on the English companies Act of 1948.

The act introduced several new concepts to the Company Law of Sri Lanka. It has shifted the foundation of Sri Lanka’s company law away from English law and practice, and is based primarily on New Zealand Companies Act of 1993 and the Canadian business corporations Act. In certain areas of the act hybrid principles of law have been introduced.

The new act seeks to simplify and rationalize company law in Sri Lanka by focusing on procedures and content. The major changes introduced by the act are;

The act makes the incorporations of companies easier and less expensive

Simplifies the requirements for internal operating procedures of companies

Simplifies the contents of law through the codification of legal principles in many areas where the common law was complicated, especially with regard to rights and duties of shareholders.

Who is a director?

The new companies act defines a director based on the substantive functions performed by individuals in respect of the company. It brings a wide group of persons within the definition of director, not merely based on the designation.

Role of Directors

Boards of Directors are collective organs and not a legal person. The shareholders individually and collectively rely on directors to run the business affairs of the company. They are managed by the board or under the supervision of the board subject to the articles of the company. The Act gives the board powers for that purpose. Directors in turn are accountable to the shareholders, stakeholders and the environment at large.

Boards usually consist of executive and non-executive directors. Law makes no distinction between executive and non-executive directors and both are held to the same standard.

Duties of Directors

The duty of the director is owed to the company and consists of fiduciary, statutory and duty of care & skill, broadly it encompasses the following four areas;

Duty to act in good faith in the best interests of the company

Duty to act with care and diligence

Duty to avoid a conflict in the position of a director and/ or any interest a director might have

A range of duties that prohibit the misuse of information obtained by directors

Duties of Directors imposed by the Companies Act in Sri Lanka

The law relating to the duties of directors were previously governed by common law – the new act attempts to address this problem by codifying the fundamental principles that govern the duties of directors. The fundamental duties being;

Section 187: Duty of directors to act in good faith and in the interests of company

The act requires that every person that exercises powers or performs duties as a director to act in good faith of the company (section 187), in what he believes to be the interests of the company.

Section 188: Directors to comply with Act and company's articles

A director of a company shall not act or agree to the company acting in a manner that contravenes any provisions of this Act, or the provisions contained in the articles of the company.

Section 189: Directors standard of care

A person exercising powers or performing duties as a director of a company

a.     shall not act in a manner which is reckless or grossly negligent; and

b.     shall exercise the degree of skill and care that may reasonably be expected of a person of his knowledge and experience.

Section 190: Use of information and advice

A director of a company may rely on reports, statements, and 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;

b.     a professional adviser or expert in relation to matters which the director believes to be within the person's professional or expert competence;

c.     any other director or committee of directors in which the director did not serve, in relation to matters within the directors or committee's designated authority.

Section 219: Duty of directors on insolvency

A director has a duty to call a meeting of the board if he believes the company is unable to pay its debt, to consider whether an application should be made to court for the winding up of the company

Section 220: Duty of directors on serious loss of capital

If at any time a director is of the view that the net assets of the company are less than half of its stated capital, the board shall within twenty days call an Emergency General meeting of the company to be held.

The other areas covered by the law include the definition of the term “directors"; their role and their rights. It also lays down strict disclosure requirements expected from directors including the disclosure of interests in transactions with the company, interests in shares and remuneration received.

The new duties on directors in respect of action required where the company is faced with financial difficulty means that failure to comply with these responsibilities can lead to severe criminal sanctions, disqualification, and in certain cases, the obligation to provide restitution.

Are the duties of directors set out by the Companies Act a hindrance to entrepreneurial pursuit within corporations?

I do not think that the duties of directors set out by the companies Act is a hindrance to entrepreneurial pursuits within corporations. This is because the purpose of the law is to promote good corporate governance, and considering that corporate governance occupies the centre piece of the corporate world good corporate governance can only further business interests not hinder them.

The main reason for the renewed interest in corporate governance could be traced back to the corporate disasters in the US and around the world. The most famous being the Enron and WorldCom. In Sri Lanka the financial collapse of Golden Key and the difficulties faced by Seylan Bank had the most impact and resulted in the central bank having to intervene.

The main reason for the failure of these companies could be attributed to poor corporate governance and lack of accountability by those in positions of power. This demonstrates that ‘Directors duties’ if adhered to properly will not hinder innovation but rather promote the interest of the company and lead to sustenance of the company.

It is stated that the purpose of the law is to prevent injustice from reigning. Justice is achieved only when injustice is absent.

“They oblige him only to abstain from harming others. They violate neither his personality, his liberty nor his property. They safeguard all of these. They are defensive; they defend equally the rights of all." Frederick Bastiat, The Law, 1850.

This shows that the law can be no hindrance if you are doing the correct thing in accordance with the law of the country since the purpose of the enactment of laws is to prevent harmful or illegal activities.

It is important to note that there is nothing in the act which would affect operations of a company or is damaging to its survival. The Act only enforces good corporate governance and considering that a significant proportion of multinational companies will only conduct business with organizations committed to principles of good governance - companies complying with principles of corporate governance would experience a considerable increase in foreign investment.

The ‘Duties’ provide assurance to investors and shareholders that the directors and the organization were safeguarding their interests. This is important because without investors a company cannot survive leave alone innovate.

The enactment of the new companies act came during a significant period in Sri Lanka when a number of reputed companies in the banking and financial sector collapsed. This being attributed to poor corporate governance the enactment of the New Companies Act can be seen as a start to reinforce the level of governance in the entire corporate sector from the viewpoint of a legislative framework.

The responsibilities of directors in their day to day operations have been extended by the new act. Sections 219 and 220 of the New Act focus on the wellbeing of the company and directors are under a contractual obligation to consider whether the company can pay its debts. In the even the company is not in a position to pay its debts a number of remedial measures should be taken by the directors. Failure to comply with the regulation would mean that the directors will be held liable. This extension of directors' duties and responsibilities would aid the corporate sector to enhance the level of governance.

Some say that improving the level of corporate governance would be a barrier toward the growth of the corporate sector because the organizations and the Management would be under greater scrutiny. Though there would be some checks and balances to unrestrained unethical growth when you consider the overall benefit of improving the level of corporate governance, the benefits outweigh the costs as seen through experience.

Corporate governance is fundamental to attract investment, to promote sustainable business development, expansion to international markets, corporate image building, community and social welfare and many other aspects related with achieving business goals.

Conclusion

An important aspect of corporate governance is to ensure the accountability of certain individuals in an organization through mechanisms that try to reduce or eliminate the principal-agent problem. This is achieved through the imposition of ‘Duties of Directors’ in the new company’s act of Sri Lanka.

The act in no manner hinders the operations of an organization that conducts business in line with the laws of the country, therefore is no hindrance to directors to be entrepreneurial in their decision making. It only compels the decision makers to act with responsibility and accountability to its stakeholders.

A good corporate governance system results in economic efficiency and focuses shareholders' welfare.