Monday 19 January 2015

Reconstructing company law

By Willie Cheng, Published The Straits Times, 17 Jan 2015

FOR businesses, the Companies Act is like a hallowed building in which they are housed and from which they operate. After all, the Act defines and regulates the company as the primary legal vehicle to organise and run business.

By and large, it has worked well. Today, companies employ more people and generate more wealth than any other form of organisation.

And like buildings, laws, especially those related to a rapidly changing environment, need to be renewed from time to time. Since it was first enacted in 1967, the Companies Act has undergone some 17 rounds of amendments.

This last round was the most massive ever. The Companies (Amendment) Bill incorporating some 200 sets of amendments was passed by Parliament last October.

These changes were seven years in the making. They were, and are, an ambitious effort to finesse the Act in a way that would ensure an efficient and transparent regulatory framework within which Singapore can grow as an international hub for businesses and investors. The process was extensive: an overarching steering committee, five working groups, 17 focus groups and nine public consultations, not to mention the countless meetings that must have taken place.

There are, however, in my view, two major structural changes which this last reform should have incorporated but did not: the types of directors and the new model of capitalism.

Expectations of directors

THE board of directors is at the heart of the corporate governance of a company. The Companies Act places a heavy emphasis and load on directors to serve the interests of the company.

There are, however, different types of directors. The Act does not seek to distinguish much between them. Specifically, the Act and the amendments do not distinguish between executive directors (EDs) and non-executive directors (NEDs), even though their respective roles and responsibilities are so starkly different.

EDs are part of the management of the company. They work full time for the company and are remunerated for it. They are in day-to-day control of the company. NEDs, on the other hand, can only provide oversight and rely heavily on representations made to them by the EDs. Most NEDs of listed companies are also independent directors, meaning they have no relationship with controlling shareholders, management, and so on, that would likely impair their objectivity.

Despite these differences, the Act holds all directors equally responsible and accountable for all decisions and actions. And the penalties for breach of duty can be severe; they include imprisonment and fines.

In the recent, widely publicised Airocean Group case, non-executive chairman and independent director Ong Chow Hong was fined and disqualified from acting as director because he was found guilty of failing to exercise reasonable diligence in his duty as a director; he had approved the release of a public announcement by the company without reviewing its contents.

Mr Peter Madhavan, another independent director of Airocean, was initially convicted and received a sentence of a fine as well as four months' imprisonment. He was charged with not notifying the Singapore Exchange on the Corrupt Practices Investigation Bureau's investigation of the company's chief executive, and for releasing a false public announcement to stabilise market prices. His conviction was overturned on appeal by the Chief Justice who found insufficient evidence to show that the non-disclosure would have materially affected the share price of Airocean and that the public announcement was "not materially misleading".

Even though it was subsequently overturned, the imprisonment sentence handed out to an independent director sent shock waves through the director community in Singapore. It demonstrated the onerous burden of a director's fiduciary duty (under Section 157 of the Act) and its consequences. At least, in Britain (from which Singapore inherited its company law), criminal liability has been removed and the consequences of a breach in a director's fiduciary duty is not criminal but civil in nature only.

In fact, decriminalising a breach of duty under Section 157 was proposed to the steering committee. However, it was rejected, "so as not to send the wrong signal". The concern was "that decriminalisation may encourage misconduct". Instead, the signal that has been sent is the disproportionate liability that directors face, which, in turn, will discourage good competent candidates from taking up non-executive directorships.

Changing model of capitalism

FOR the past five decades, the prevailing model of modern capitalism has been based on the mantra of maximum shareholder value. The Companies Act reinforces that mindset by providing shareholders with a comprehensive set of governance rights. It is the shareholders who ultimately appoint the board of directors, and it is they who propose and approve all resolutions on key matters of the company.

There is little, if any, mention in the Act of the other stakeholders of the company: employees, customers, suppliers, and the community. That should not be surprising. Legal scholar Joe Bakan points out that companies are really legal entities created to "valorise self-interest and invalidate moral concern". He concludes that corporations are thus naturally and "pathologically selfish" in their pursuit of profits.

But, increasingly, this model of "brute capitalism" is finding less favour with world leaders, consumers, employees, the public at large, and even investors. Growing income inequality, demonstrations by the Occupy movement and the global financial crisis, among others, are leading to calls for a new form of capitalism.

This new form of capitalism is evolving and goes by different names. However, it has two key concepts: a focus on multiple stakeholders (not just shareholders) in a company, and a focus on not just economic value, but also community and shared values.

Enlightened companies, including many here in Singapore, have begun to embrace these concepts in extended corporate social responsibility programmes. Almost perversely, these elements of social or environmental responsibility are not mentioned in the Companies Act or the amendments.

That said, we can say with confidence that a new informal corporate form is, in fact, emerging.

Known as a social enterprise, this hybrid organisation is a business with a social mission. It conducts ordinary business, such as selling food, providing finance, and washing cars, and at the same time, seeks to make a significant social impact through employing beneficiaries and channelling profits back to the community.

Under the Companies Act today, there is no formal legal construct for such a hybrid entity.

This is why most social enterprises are registered as regular commercial companies (usually exempt private or private limited companies). But this also means that they can operate as most other regular commercial companies and do not need to channel their profits back to the community.

In fact, there are several companies that call themselves social enterprises when they are really not. This situation arises because there are many benefits to being branded a social enterprise, from easy funding and free publicity to support from volunteers, customers and suppliers.

Other jurisdictions have sought to legitimise or encourage the development of true social enterprises through new legal constructs.

For example, in 2005, the British Companies Act introduced a new legal entity called the community interest company (CIC). In a CIC, there are limits to the dividends (maximum 35 per cent of profits) and interest payments that can be made to shareholders and financiers.

In the US, three different types of legal entities have been created in recent years to facilitate the growth of social enterprises: the low-profit limited liability company (L3C), benefit corporation and flexible purpose corporation,

The L3C has been introduced in about 10 states. An L3C focuses on achieving a socially beneficial objective. Profit is secondary and some of its shareholders are limited to a lower than market return.

The benefit corporation governing documents has to identify its socially beneficial purpose and it is the duty of the directors to ensure that the corporation seeks to accomplish that purpose. Further, the benefit corporation must annually measure the company's fulfilment of its socially beneficial purpose against a third party standard such as that of B Lab, a non-profit organisation which certifies sustainable businesses.

California has introduced the flexible purpose corporation, which is similar to the benefit corporation except that it does not require third-party certification, only a self-review of its efforts to be socially beneficial.

The steering committee noted that a separate committee led by the Ministry of Social and Family Development is looking into a vehicle similar to the CIC. For that reason, the committee decided not to include this sub-genre of organisations, at least not "until a workable alternative or regime is formed".

Playing catch-up

THE law is typically known to lag behind real time commercial developments. In part, this reflects its inherently conservative nature.

However, the reality is that the different types of directors, the new model of capitalism and social enterprises have been around for some time now. What's more, other jurisdictions have dealt directly with aspects of these developments.

Hopefully, over the next few years, we will see some of these changes incorporated into the Companies Act while waiting for the next major redevelopment down the road.

Willie Cheng is chairman of the Singapore Institute of Directors. He is the author of The World That Changes The World.

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