Article Publication Released

A bit later than expected due to inadequacies in the postal service but my gratis copy of my article has been received and here it is!

Citation: (2011) 32(3) Company Lawyer 76

EC Green Paper on Corporate Governance

Ready for more of the same? The Green Paper published by the Commission on corporate governance for European Companies was published yesterday.
This paper aims to address three key issues... (stop me if you have heard this before)

1. Board of directors - Non-executives are needed with more skills, diversity and experience and invest sufficient time in the board
2. Shareholder monitoring - Apparently, evidence shows the majority of shareholders are apathetic and focused on short-term goals. The review wants to try and get more shareholders involved and promote long-term returns and sustainability
3. How to apply 'comply or explain' - Companies are not providing sufficient explanations for diverging from the Code

Well, point 3 is perhaps an area which needs looking at. The Combined Code in the UK has increasingly seen more and more adherence to it - see for example Grant Thornton's Corporate Governance Review -, even leading up to the crash in 2008. Despite no "one size fits all" approach there seems to be evidence of firms converging to the same model. A deeper understanding is needed of why do people adhere to the Combined Code or generally corporate governance codes around the EU? One would hypothesise that it is because it attracts investors; but is that really enough to blindly walk in to complying with the Code? I am of no doubt that there is a stronger thought process before deciding on internal governance but a review is needed.

As to boards of directors this could potentially be interesting. The first point may be for at least UK companies is that non-executives are generally experienced and knowledgeable according to a 2009 review by Grant Thornton.

With non-executives becoming more involved does this change the structure of the board and does it affect our understanding of the firm?

It would seem points one and two of the Green Paper go hand in hand. Monitoring is difficult for shareholders and so boards become a market-induced body to monitor executive management. However, if non-executives become more involved then this may incur problems at least from an agency theory perspective. Shareholders will then have to monitor the boards more rigourously and in truth are likely to incur higher agency costs to ensure they do not incur conflicts of interest or shirk responsibilities.

However, I like many others, are not a strong believer of agency theory. For one agency theory often makes the common mistake of seeing the firm as a nexus of contracts. Law however, makes it clear this is not the case. A corporation is its own legal entity with objectives generally decided by the directors.

With the board becoming more involved we seem to be converging away from agency theory, closer to stewardship theory and resource dependency theory. It seems the biggest and boldest move would be to confirm the status of the company and the board as the principal according to agency theory with executive management as the agents.

Shareholders are not well placed to monitor who generally spread risk by having a diverse portfolio of investments and are not concerned enough to monitor any one individual firm. Instead of getting shareholders more involved we should be looking for ways to keep them investing whilst removing levels of direct involvement. This could be done through higher shareholder representation on the board for example.

One issue that needs to be rigorously addressed will be fiduciary law no matter what changes take place. Fiduciary law itself can be explained by agency theory and thus may be problematic if different economic theory such as stewardship can explain the firm.

With non-executives increasing their involvement how will this impact on their liability? Will it be necessary to have clearly defined duties depending on the type of director you are? Increased liability of course, is met with significant opposition and their resistance is usually enough to deter any significant changes.

Non-executives themselves are often executives of other companies. With suggestions of increased time commitment this may have an impact on the people capable of taking directorships. It may also cause stronger friction in multiple directorships or more severe or common breaches of the duty of care with directors spreading themselves too thin.

However, fiduciary law is flexible and based on fundamental principles of loyalty and care by the agent to the principal. As long as the director adheres to these principles owed to the company there should not be a pressing issue, more so for executive members of the board at least.

It seems safe to say the EC needs to think long and hard about the implications of involving shareholders and non-executives more in the company. Under the current structure non-executives should not become more involved without some sort of increased monitoring of them, which is a cost shareholders are unlikely willing to bare. But if directors and the company can be seen as the principal then it may go a long way to improving corporate governance as directors are more attached to the company, capable of understanding the company's needs, and objectives.

Conference on "European Company Law: the way forward" and employee participation in an SE

The European Commission announced that there will be a conference in Brussels 16-17th May.

This two day conference will cover areas including:
1) Corporate mobility and European company law
2) A European Model Company Act
3) Workers' participation
4) Tax and company law
5) Groups of companies
6) Services and company law

All areas are of particular interest within the field of regulatory competition.

Workers' participation is something of particular interest in the European Union with countries like Germany and co-determination or the UK with no employee participation

When companies in the European Union decide to form a "European Company" otherwise known as a Societas Europaea or "SE" they can do so in four ways: 1) Merger of 2 plcs from different Member States; 2) Transformation by turning your own company in to an SE as long as you have a subsidiary in another Member State for more than 2 years; 3-4) Joint holding or joint subsidiary meaning the founding companies will still exist as well. The latter may be appropriate when two companies wish to pursue a specific venture but not combine all their business.

When an SE does form however, there are employee participation rights under the SE Regulation 2157/2001, and Employee Participation Directive 2001/86

Article 12(2) of the Regulation states no SE shall be registered unless
1) There has been an agreement on employee participation
2) The employees have waived their rights to participate
3) The Standard Rules have been triggered

The first two are fairly self-explanatory. However, Standard Rules under the SE require a little more elaboration.

The Standard Rules make clear that where two companies where the Member States require no participation, then under the Standard Rules there will be no employee participation.

If both Member States of the founding companies require participation then the "highest standard" applies. This does not require some subjective analysis. It is merely an arithmetical one. If one Member State requires 20% employee participation on the board and the other 21% then the latter is the higher standard.

However, it may become more confusing when employees have different rights that are not synonymous with one another. i.e. one Member State may allow employees to vote one third of the members on to the board whereas another may be able to recommend half the member's of the board.

There will also be the situation where one Member State requires participation but the other does not.

Here we can apply the no-escape and no-export principles. The no-escape principle works with "highest standard". The fact that one Member State requires participation will mean that under the Standard Rules that is the highest standard. The company cannot "escape" employee participation by merging with a company that does not require employee participation.

On the other hand there is the no-export principle which attempts to counter-balance the no-escape principle. The Directive provides that when the total of the workforce - that is the employees of all companies merging - covered by employee participation is less than 25% then the Standard Rules will not automatically apply.

However, in such a situation the employees may unilaterally decide to apply the Standard Rules, which they presumably would do if they cannot negotiate anything better.

One other exception does allow for the parties to decide that the Standard Rules will not apply but if such a decision is reached there must be an agreement on participation or the employees waive their rights to participate.

This in theory is likely to leave two positions under the Standard Rules. Either the SE will not have employee participation because neither company requires it; or at least one company does require it and so there will be employee participation to the highest standard.

It will be interesting to see how the discussions on employee participation in Europe goes and what suggestions are put forward. - Unfortunately for me I am likely to have to keep my eyes posted rather than attend due to prior commitments.

Social Science Research Network Download

For those who don't have a subscription to legal databases or the journal itself an early version of my published articles are now available here for download.

There are minor asymmetries with this and the final version.

Are we there yet?

No David, we are not!

I am nearing the date of my transfer from Mphil to PhD and perhaps this is a good time to reflect on what has been done and look forward to what needs to be done.

It takes no Mathematician to figure out 20,000 words of potentially 100,000 is no where near half way to completion of the thesis despite being 16 and half months in to it. I expect once in my transfer and after I will be made aware of how much needs to be done in a short period of time.

But it is not all such a gloomy outlook; one could easily draw on a clichéd comparison with the recession to describe mine or possibly anybody’s thesis at this stage. So, what have I achieved so far and what is there in the pipes?

My articles on derivative claims now both available on Westlaw, see here for blog on part 1. They really offered some positives in my first year which was demanding and a relief from lots of reading and seminar preparation with teaching. The articles were in total around 10,000 words in length and will form some part of my thesis. They will however be adapted to make it applicable to the central topics of directors' duty of loyalty and multiple directorships. The articles themselves provide more of an analysis of some of the objectives of the derivative claim.

I have just completed a chapter analysing conflicts of interest for directors as well. This chapter focused on how we understand a conflict rather than a detailed analysis of what an "interest" is. This will form some part of the following chapter to this one.

The chapter looked at some of the key functions of the duty of loyalty from Conaglen's protective function of non-fiduciary duties to Fischel and Easterbrook's theory on the purpose of avoiding high contractual costs.

These theories, amongst others, were applied an analysed against some of the key elements of the duty of loyalty: The no-profit and no-conflict rules; scope of business test; ex-directors; and corporate opportunities. In the context of directors it appeared to be that Conaglen's protective function served best as a last resort rather than any driver behind directors aligning their interests with those of the company.

However, they were still true and applying them to ex-directors it was discovered that there has been various erroneous decisions relating to ex-directors where the courts have attempted to apply a somewhat varied corporate opportunities doctrine. This part of the chapter, as well as applying some of the key theories, looked at Sealy and Worthington's and Lowry and Edmund's views on corporate opportunities of ex-directors and suggests that these approaches are too wide and overlook the purpose of the duty of loyalty.

So what is in the pipe line?

The next port of call is the theory chapter itself. What are the key theories to look at. I do not intend to list them here but the focus will be on those relating to agency theory and how they apply to the duty of loyalty. On a deeper level there will also be focus on methods and theories applying to how parties to the fiduciary relationship interests are aligned. Analysis seems to be available across different schools from Law; business; economics; psychology etc.

Board structures also need to be analysed to coincide with the discussion multiple directorships and there is plenty of information out there although perhaps not as much on non-executive directors who I believe will form a significant amount of the discussion. See blog here for why.

I have also collected some sample data on multiple directorships and board remuneration. I aim to wait until the next financial year to collect all the data as firms are more likely to meet higher transparency requirements in line with recommendations from the market (source lost at time of writing).

I have also begun collecting sample data on case levels of directors' duties. There were numerous claims pre and post 2006 about duties and their transparency, clarity, effectiveness. This data can aid on two fronts throughout the thesis, first on the duty of loyalty: I hypothesise that this is the most frequent breach of duty which may suggest increased pay is not helping to align interests. This may be especially so if the data in fact shows an increase in duty breaches. One would have to consider the issues of enforcement as well. Duties are not frequently enforced but a correlation can possibly be drawn between remuneration levels and level of breaches of duty.

So to reiterate the title's answer, no I am not at the completion of my thesis, nor am I close. But there is plenty to look forward to with possibly a little less reading and most likely a lot more writing to come in the next 19 months.   

Queen's Bench Considers Companies Act 2006 s 175 - Duty to Avoid a Conflict of Interest

The Queen's Bench Division recently passed judgment in Cambridge v Makin [2011] EWHC 12 (QB) available here. The case made reference to but did not decide upon a director's conflict of interest including a conflict of duties.

An overview of the complaint by the company (NRPSI) in relation to s175 was:

"Two NRPSI Board Directors, … and Janet Cambridge had interests in CINTRA Ltd, an agency which obtained our data … Janet Cambridge worked as a trainer for CINTRA at the time our data were sold. There is evidence in the Coventry Partnership Project, the Lincolnshire Business Case Study, the East Midlands Delivery Plan and CINTRA's Training Manual from 2005 that CINTRA used its connections with the CIOL [Chartered Institute of Linguistics] and NRPSI, through the two directors, to obtain a contract with five East Midlands constabularies and Norfolk."

A Ms Glegg owed duties as an executive to NRPSI and non-executive of CINTRA and the court observed there was little comparable facts to previous case law. The judge - citing Company Directors Law and Liability (Sinclair, Vogel and Snowden Sweet & Maxwell, 2005 ed, updated April 2008) at para 3.86 - stated:

“Although it is clear that an executive director (ie a director who carries out a management function on behalf of a company, often employed pursuant to a service contract) is prohibited from competing with a company of which he is a director…, it does not appear that non-executive directors are prohibited from competing with the company or from taking directorships of competing companies. This stems from the difference in function between an executive and non-executive director. A non-executive director's role is usually limited to a supervisory one, effectively a policing function. By contrast executive directors actively manage its business”.

Since Ms Glegg was not a party to the action and the court stated it was not equipped to make rulings on conflicts of interest. The court mentioned though that Ms Glegg's relationship with CINTRA was well known by NRSPI. The law on conflicts of interest under s175 is well settled though, at least on the following point. Nothing short of full authorisation will avail Ms Glegg of this type of conflict. The claimant's knowledge of the conflict under s175 is not an adequate defence for a defendant. The case would be different under a s177 conflict where the director has an interest in a proposed transaction or arrangement with the company. In such a scenario, disclosure or knowledge of the conflict will allow the company to proceed with all the knowledge and facts to make an informed decision.

It is unfortunate that no ruling was able to be given in relation to Ms Glegg. The difference in conflict of interests between executive and non-executive directorships (as opposed to executive-executive directorships) highlighted by the Tugendhat J seems to suggest that a conflict may not arise where the companies are competing, at least not automatically. Tugendhat J stated that this case "illustrates how non-executive directors, who are chosen because of their experience, may find themselves in a position where they are at least open to criticism (whether well founded or not) for acting in pursuit of an interest when that may be said to in conflict with a duty".

The acclaimed conflict of interest against Cambridge however was unfounded since it was evidenced that Cambridge had no personal interest in CINTRA at the time leading up to and awarding of the licence to them. The court did provide some opinion on whether a conflict may arise in a situation where a person is a director of one company and employed by another. Citing again Company Directors Law and Liability (Sinclair, Vogel and Snowden Sweet & Maxwell, 2005 ed, updated April 2008) at para 3.54:

“It is not clear what is required in order for a director to be considered as having an interest in a contract. … A direct financial interest will clearly be sufficient… Similarly, a director will be considered as being interested in a contract in which he has an indirect financial interest, such as a contract entered into by a company in which he holds shares (whether beneficially or as trustee) or a partnership of which he [is] a partner … In certain circumstances, a director would be considered as being interested in a contract between the company of which he is a director and a second company by which he is employed. This will largely depend upon the role that the director has within the company by which he is employed and the extent to which he benefits as a result of the relevant contract”.

It is unclear exactly how such a scenario may give rise to a conflict. For example, in Bhullar v Bhullar the directors came across an opportunity in their free time and pursued it personally and where liable for a secret profit to the company for a conflict of interest.

However, in this scenario the employee is not the one pursuing the contract. If they come across the information there is no separate fiduciary duty of disclosure. In their capacity as director they may be liable under s172 for failing to promote the best interests of the company. This would be because the information is clearly something the company would be interested in knowing. This test is subjective though and it would have to be demonstrated that he did not honestly believe, or no reasonable man could believe, that the information was not going to be of interest to the company. See for example the case of Fassihi.

There is no breach of s175 by simply failing to disclose. The company which the director works for would have to show that the director omitted or actively did something to divert the opportunity away from the company to the company which employs him. This may result in a claim for equitable compensation. They could also attempt to show that they did in fact have some interest in the opportunity, i.e. increased opportunities for offering interpretation services to the public sector by being able to charge lower rates and may be able to claim secret profits.  

Article Publication Released

The Company Lawyer have published part one of my article on the 'Statutory Derivative Claim' and is available online from the normal legal databases.

Citation is (2011) 32(2) Company Lawyer 41

Part 2 is in the pipeline for next month as I am just going through the final proofs.

Since I have returned to work after the festive break I have focused my attentions on completing my first chapter and looking at the arguments for an individual no-profit rule for directors. Watch this space for a blog update on the topic!