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Thursday Apr 18, 2024
Monday, 6 March 2017 00:29 - - {{hitsCtrl.values.hits}}
From left: Dr. Harsha Cabral PC (Chairman, Tokyo Cement), Dan De Silva (Forensic Accountant Matson Driscoll & Damica Ltd., Singapore), Deepthi Lokuarachchi (CEO – HNB Assurance PLC and HNB General Insurance Ltd.) and Faizal Salieh (Non-Executive Independent Director of HNB General Insurance Ltd
Having directors who are not affiliated with the company’s top executives and who are not involved in the operations of the company is an essential feature of Board effectiveness. In the last 10 years the number and importance of Non-Executive Independent Directors (or ‘NEIDs’) in Sri Lankan companies has grown significantly. What is the role and purpose of NEIDs? Why do you need one? Do they have a lot to contribute or are they appointed to just tick the box?
The Sri Lanka Institute of Directors (SLID) in association with HNB General Insurance Ltd. held an Evening Forum on 22 February at the Cinnamon Grand Hotel on this subject. It drew more than 50 participants which included senior company directors from various business fields in an interactive discussion session.
SLID Deputy Chairman Rasakanth Rasiah delivered the opening remarks welcoming the participants to the event with a brief introduction to SLID’s purpose and activities.
The keynote speaker, Dr. Harsha Cabral PC, explained that a NEID is a full member of a company’s board of directors and stands responsible as part of the board for the success of the company. In contrast to executive directors, NEIDs do not have executive responsibilities and are not an employee of the company. He went on to explain that there is no distinction in law between executive directors and non-executive directors. In fact, the Companies Act No. 7 of 2007 simply defines a director as any person occupying the position of director, whatever name they are called.
“Nowhere in the Companies Act will you find the word executive director, non-executive director, independent director nor non-independent director. Because of this, the same duties, responsibilities and indeed potential liabilities apply equally to executive and non-executive directors. A director does not need to know the entirety of the Act but should know the important features that will have an impact on him/her,” he said.
The definition of the various types of directors, such as executive directors, non-executive directors, nominee directors, alternate directors etc., will be in a company’s Articles of Association but it may not define independent directors, which comes from the corporate governance regime. It is not in the Company Law. Dr. Cabral explained that all companies are governed by the Companies Act and the Registrar of Companies. If the company is listed, it will fall under the Securities regime which is above the Registrar of Companies. In addition to what is in the Companies Act, when the company is listed the company falls within the securities regime and comes under the Securities and Exchange Commission Rules and Regulations, and the Colombo Stock Exchange Listing Rules.
He further said, “The corporate governance for the banking sector has another regime – banking sector supervision and non-bank supervision – where the corporate governance directives are much higher. There the role played by a director per se whether independent or otherwise is quite high. You have to maintain certain amount of dignity and standards and have to be approved by the regulator. Anyone cannot be a director in the banking sector. The unfortunate thing is under Sri Lankan law, although we have followed the best mechanisms all over the world, to become a director you do not require a qualification. Section 214 describes how you can remove a director and it also sets out the qualifications that you require to be a director – over the age of 18 years and not insane. The removal is if you are charged of certain offences.”
Mandatory and voluntary code
The listing rules have a mandatory and voluntary code. Under the mandatory code it is set out that 1/4th of directors should be non-executive directors and 1/3rd of that should be independent. The definition of independence is given in the code. Requirement under mandatory code is minimal but the voluntary code, which is being currently upgraded by the SEC and the Institute of Chartered Accountants, is very wide. Therefore the non-executive independent directors stems from the mandatory code of the listing rules. While the focus of non-executive directors is often on listed companies, their value within private companies – and even smaller private companies – is increasingly recognised.
The role of the NEID is from the Companies Act which treats all directors equally. “Therefore, a NEID cannot take up the position that because he/she is non-executive and independent and attends Board meetings once a month he/she should be treated in a different manner,” he stressed. A director has additional powers than a shareholder. A director is privy to information that a shareholder does not have access to such as Board minutes, reports.
The NEIDs won’t be involved with day-to-day activities of the company but has the right to request for any information. The company cannot withhold any information on the basis that the director is non-executive and independent. Both executive and NEID have the same rights. He noted that as a director, NEIDs can request for information that shareholders cannot. They should request for additional information if they don’t have sufficient information to make a decision and if they do not have the required expertise and knowledge to ask for a third party expert opinion – section 190. By doing so, they can lend an independent and objective perspective to the board’s decision making. He advised directors to keep a copy of this advice, even an email is sufficient.
The duties and responsibilities of directors are set out in the Companies Act of which there are 10 sections that all directors should know. The most important being, section 187 – directors should act in the best interest of the company, section 188 – all directors should comply with the provisions of the Companies Act and the company Articles of Association and section 189 – the standard of care that is expected of a director. Together with sections 190 to 200 the conflict of interest issues.
“There are two more important sections, 219 and 220 which set out how a director should act in a situation of serious loss of capital and winding up of the company. If they don’t act in that manner a director will be personally liable and there may be criminal liability as well and at times a director might have to go to jail. There is a lot of responsibility cast on directors,” he emphasised.
Dr. Cabral mentioned that there are ways to minimise that situation such as insurance – section 218 allows for directors insurance and indemnity. The company will pay for the D&O insurance (Directors & Officers liability insurance) that specifically sets out the situations that will be covered.
An NEID is appointed to look after the best interest of the company. There is a debate on this rule that the NEID is appointed to the board with the blessing of the major shareholder. Whilst this is true, it is the shareholders who appoint all directors, so the majority shareholder votes too. There are two jurisdictions in the world – China where the majority shareholder cannot vote in the appointment of NEIDs, and in India, which is a trickier situation, where independent directors are nominated by a panel in the Government, which he stated Sri Lanka should avoid. NEIDs are appointed to Boards because of their expertise. They are paid only the directors fee and do not receive any of the other perks, nor are they under obligation to the major shareholder or the powerful shareholders. Dr. Cabral advised NEIDs to make sure that their voice is heard at Board meetings. He advised NEIDs to speak up and not to keep silent if they do not agree. If the NEID’s expertise is being ignored by the Board, then it is time for the NEID to exit. “Don’t be afraid to quit,” he said.
Speaking further he stated, “In the event the NEID does not agree to a decision – even if he/she is the only person – he/she can dissent. An executive director cannot as he/she is under obligation to the major shareholder. An independent director is not. They are independent and don’t rely on the company for income. Even if the Board decision is to go ahead, the NEID should ensure that his/her dissent is properly recorded in the minutes. If at a later date the decision turns sour and the directors’ end in court the Judge may look at the NEID differently as he/she had dissented and it is on records. This has still not been tested in Sri Lanka but has been done in other jurisdictions.”
‘External’ oversight
Many businesses will not instinctively welcome this sort of ‘external’ oversight and challenge. As a company grows, however, this form of challenge from a ‘critical friend’ can be a positive force, aiding the performance of the executive directors and the Board as a whole. It can also help to protect and enhance the governance and performance of the organisation as a whole. That’s good news for shareholders, staff, customers and other stakeholders: for that reason it’s often external shareholders, keen to protect their interests, who will encourage companies to appoint one or more non-executive independent directors.
The guest speaker for the evening Dan De Silva (Forensic Accountant, Matson Driscoll&Damica Ltd., Singapore) spoke about business interruption and the low penetration rate of business interruption insurance in Sri Lanka. He had been involved in calculating the claims that were made by businesses which were affected by the floods in May 2016 in Colombo and realised that the companies had little understanding of the risk. He stated that directors need to understand the need for such a cover.
The interactive panel discussion that followed was moderated by Faizal Salieh (Non-Executive Independent Director of HNB General Insurance Ltd.) with Dr. Harsha Cabral PC (Chairman, Tokyo Cement), Deepthi Lokuarachchi (CEO – HNB Assurance PLC and HNB General Insurance Ltd.) and Dan De Silva (Forensic Accountant Matson Driscoll &Damica Ltd., Singapore).
Faizal Salieh commenced the panel discussion saying, “The Board is the most important instrument or organ of corporate governance. NEIDs should be independent in reality and in practice as well as in public perception. They should be not only independent to meet legislative or the Stock Exchange’s listing requirements but be also truly independent in thought and action,” and he posed the question to Dr. Cabral, “Given the nebulous position of the law with regard to the roles and responsibilities of NEIDs how should a Board, in order to be effective in practice, set about drawing value from its NEIDs?”
In reply Dr. Cabral said that NEIDs are there to work in the best interest of the company. Even independent directors are permitted to purchase 1% of the share capital in the company. He believes that when a director has shares in a company there is a vested interest. He personally does not have a single share in any of the companies where he is an NEID. A majority shareholder will have certain vested interest when making a decision. Whereas the independent director should think of the best interest of the company and the company alone and not looking after anyone’s interest whether it be the majority or minority. The NEID is appointed by the shareholders per se to look after the interests of the company for one and with the corporate governance issues coming up to also look after the interests of the world at large. The corporate governance regime states that if you are above 70 years of age you can’t be a director but it is at the discretion of the company, but in banks and non-bank financial institutions the upper threshold on the age limit cannot be exceeded. Even without the skill to read or write you can become a director. Therefore, if you put the wrong people on the Board it will be a disaster.
He further said, “It is clearly set out in the Companies Act and the corporate governance mechanisms that when you are a director this is how you should act, which is in the best interest of the company. Since the Act was introduced 10 years ago there haven’t been any cases where NEIDs have been treated lightly or differently to executive directors. The only issue is that if in a decision that is challenged, if you have voted against, you may be treated differently. It is up to the individual to see that you are consciously making that decision and whether you have acted properly and not in a negligent manner and have taken the best interest of the company as the paramount feature of your decision.”
Criminal liability and civil liability
Another important feature he said is that as a NEID you should keep in mind in the Companies Act is that there are 133 sections which attract criminal liability and 34 sections where civil liability is attracted. As a NEID you should be aware that the shareholders, majority or minority, your employees and other stakeholders, creditors, lending institutions and the world at large can have cases against you. Most cases are on oppression and mismanagement under the Companies Act where you find derivative action where even a shareholder of 1% can take you to court.
You must act in an honest, dignified manner and make sure that all your decisions are backed by proper opinion, you have relied on expertise even if you don’t know a certain area you have received expert opinion and if you don’t agree make sure that your dissent is properly recorded please ensure that all your minutes are properly certified (at the next Board Meeting) as minutes are taken as a contemporaneous record. Maybe 5-10 years later you can rely on them.
In response to the same question which the moderator posed to the audience, senior company director Vijaya Malalsekera stated that the starting point should be the Nomination Committee. Because your nomination committee will look at the expertise required and look at appointing independent directors from that expertise. The problem is that you cannot separate the responsibility of executive and non-executive independent directors; once you are on the Board you are a director. Continued on Page 16
Rasiah from the audience queried from De Silva about the premiums that need to be paid for the Business Interruption cover. De Silva explained that the problem with the premiums is that the Broker/Underwriter does not understand and are not sure what they are insuring so they come up with a number to safeguard themselves. Their calculation is based on a number based on what the company provides. If you require the correct number then you need to customise and decide what you want to cover. It is about knowing what you want to cover. Deepal Lokuarachchi explained that you need to select the right kind of cover and the provider. He went on to share that over the last 15 years there has been growing demand for Business Interruption Insurance. During the networking before this evening’s program commenced he had queried from the audience and many of the directors did not have an understanding of Business Interruption insurance. He stated that this insurance cover will ensure that the business is continued uninterrupted during a calamity. The most recent being the devastating flood that Colombo experienced in May 2016. Lion Brewery and Coca Cola are companies that generate significant revenue from the market. Both companies had the Business Interruption Insurance cover. But there were other companies who did not have this cover.
Lokuarachchi further stated that directors have a responsibility to ensure the going concern nature of the business. At the same time not only continue with the business but also need to recognise that there are stakeholders other than the shareholders who are interested in the company such as creditors, suppliers etc.
“As Dr. Cabral pointed out earlier in his keynote speech, you are supposed to act in the best interest of the organisation. Part of this is that as directors you have to assess the risk that affects the company and which would actually affect the going concern nature of the business. If something were to interrupt your business and you were to lose revenue and if you can’t service you debts and cover interest costs, then the going concern nature of your business gets interrupted. At that point if you have the Business Interruption Cover then you will have some level of comfort. The best interest principle apart from the governance aspect also extends to ensure that the going concern nature of the business is continued.”
He explained, “The rationale behind including the topic of business interruption with directors’ responsibility. Drawing from Dr. Cabral’s presentation and Dan De Silva’s presentation there is a correlation between the two. On the face of it, it doesn’t look as if they connect to each other but from an insurance point of view it does. From his personal knowledge and experience it goes hand in hand on the best interest principle, the going concern nature of the business as well as on the insurance element.”
Lokuarachchi advised the directors “never consider what you spend on insurance as a waste as you won’t recover it in that year but there will be a time at which insurance will be helpful. You need to get the right kind of policy, the right kind of company and the right kind of coverage for your business.”
Salieh then posed the question: “NEIDs don’t have an executive role in the company nor can they censure executive actions. The liability on a Board director is said to arise on account of his/her conduct, act or omission and not merely on account of position or holding office in the company. On the other hand, regulators everywhere are today requiring all directors to exercise greater diligence, vigilance and due care with regard to the company’s strategic decisions, business plans, systems and processes and performance. How can the Board comprising of both executive and non-executive directors mitigate directors’ liability? Is there a business judgement rule or are there provisions in the law such as exculpation and indemnification provisions or should one look at D & O insurance for this?”
Lokuarachchi explained that there are two aspects: The criminal and civil elements. In criminal liability there is no provision for a proxy. In the civil element of liability a proxy is allowed so it is something you can contract out to an insurance company under a D & O policy. In his personal experience he was involved in developing D&O policies when they were first introduced and in the marketing of them. But what is important is that since the Company Act was introduced many international players have come into the market and they have continually refined the terms of the policy. Based on the fundamental principle of ‘Presumed innocent until proven guilty’ the insurance companies now provide indemnity against defending an investigation which is covered under the D&O policy. This would entail you to get the best legal defence and legal facilities including cash for a bail bond.
Moving the discussions forward Salieh posed the question: “Business behaviour, most of the time, tends to be dictated by business profits and personal benefits. There’s a point of view that the more NEIDs are on a Board, the less likely the Board as a whole knows about the company, its business and industry. Conversely, the more directors know about the company’s business, organisation, strategies, markets, competitors, technology, etc, the less independent they become. How can a NEID balance all of this and effectively carry out his/her role on the Board?” He also asked Dr. Cabral for his views on the draft amendments proposed to the SEC Act with regard to the qualifications of a director as would be determined by the SEC. Dr. Cabral commented that the draft SEC Act has so many new features and comments from professional bodies had been received. He shared his Golden Tips for directors as follows:
Dr. Cabral reiterated that an independent director is appointed for his expertise. He advised that before accepting an invitation to a Board the NEID should check on the company, ask for the previous five year annual reports, carryout a market survey whether the particular company is good to join. You have been invited because of your expertise, and once you are on the Board you are not looking at the interest of the majority or minority shareholder but looking at the best interest of the company as a whole.
The Moderator quipped, “A lot depends on the Chairperson of the Board with regard to setting the right tone from the top and creating the right culture and climate in the Boardroom for NEIDs to function and contribute effectively towards the Board processes and performance,” and asked, “Should the Chairperson of a listed company be an independent director?” Dr. Cabral replied that the best case scenario internationally is to have the Chairperson independent but unfortunately we do not see that in Sri Lanka.
Drawing from global best practices, Salieh posed the question, “Do you think that the independent directors on a Board where the Chairperson is not an independent director should meet separately at least once a year without the executive directors and the Chairperson and report to the Shareholders annually that such meetings have been held?” Dr. Cabral stated that this is being included in the new voluntary code that is being drafted where there will be a Senior Independent Director who meets other NEIDs separately and can be the channel for shareholders.
Dr. Cabral agreed with Vijaya Malalasekera who pointed out that there was a heavy burden placed on independent directors, of which he has voiced his concerns at the committee as well.
In answer to NDB Bank Director Kirmali Fernando’s statement with regard to related party transactions (RPT)and whether the RPT committee should meet more often Cabral agreed that RPT Committees are important but the issue was that for other companies whether they should meet that often as this was previously under the purview of the Audit Committee. If being on the Board there is a conflict of interest the director should state that he has an interest and not participate in the decision making.
The moderator, Salieh concluded the discussion by saying that the cost of compliance is beginning to emerge as a new business cost and all companies will have to underwrite it. NEIDs are an integral part of the good governance process and we all believe that good governance should be embedded in the DNA and business model of a company and integrated with its business strategy and not viewed as a mere compliance requirement. He thanked the keynote speaker, panellists and the audience for an interesting and informative discussion.
The closing remarks were delivered by SLID CEO Chamindā de Silva who thanked SLIDs annual corporate partners Dialog Enterprise, DIMO Technology, Ms. Linea Aqua, Janashakthi Insurance and BoardPac, annual print media partner Wijeya Newspapers, annual magazine partner Echelon and the participants for attending the event. The evening concluded with networking opportunity with cheese and wine served, organised by HNB General Insurance.
