Archive for May, 2013

Is resignation in a troubled company a good decision for a director?

Spanish law establishes the Directors` Duty of Loyalty, as the obligation to act in favor of the firm`s interest, and to abide by law and by the company`s bylaws. The Duty of Care is also established as the obligation to act in a diligent manner, and to gather all the necessary information for that purpose.


The duty of care is internationally well-developed by law, and normally courts do not interfere in business decisions, according to the business judgement rule. That means business decisions, if informed, if adopted with all the necessary insights and risk analysis, cannot be blamed if results are bad, or different than thought, so directors are not liable for those results or the damages caused to the firm or the shareholders` wealth. The duty of loyalty is well-developed in Anglo-American systems, not so much in continental Europe.


The case in this post is in some occasions a director may find it difficult to determine how he best serves those duties. One of those situations is insolvency, bankruptcy or uncovered fraud situations. What should a director do? He might be considered responsible for the situation the firm has arrived to, so he could think of resigning; on the other hand, resigning lets the firm`s and shareholders` interest unattended. What serves those interest best then?


We will in this post consider some particular cases, or situations, extracted from the Delaware courts, (where many of US public companies are incorporated), and some other sources.


Recently in Spain, some non-executive directors offered their resignation, in a bankruptcy situation in Pescanova, an industrial fishing firm; once the judge decided to force all directors out of their jobs, appointing Deloitte as a temporary administrator, the Executive Chairman forced the company to appeal that decision, arguing the interest of the firm`s business and assets required incumbents to stay; but independents, and some other directors representing certain shareholders, (other than the Chairman), decided to resign, accepting the situation in which the firm already was would be best served by Deloitte than by the Chairman, whose bad governance practices in the past had been clearly damaging for the company, and themselves. Is this always the case?


Cattles, a financial services firm where a big financial hole was discovered, saw its Non Executive Directors stay and fight for the recovery of the firm, which forced them to dedicate much extra time and efforts. Of course, with no extraordinary payment for that.


From a personal point of view, once this kind of situation arrives, liabilities for the past activities of directors cannot be avoided it there was a breach of the duties, (loyalty, care and so on). So, if resigning does not help in that sense, it can instead damage a director`s reputation and future career prospects. On the other hand, staying in a damaged company will not harm directors` prospects, particularly if the company finally goes out of trouble successfully.


But other than that, can resignation itself be considered a breach of a director`s duties?


Some 2013 decisions by Delaware courts help navigate through this dilemma; in a fraud case, (Puda Coal), after Neds were stonewalled in their intentions to lead an inquiry and sue officials, they resigned; but it was considered those directors left the company`s assets on the hands of those officials they knew had been damaging the company, which was said to constitute itself a breach of the directors fiduciary duties. In Fuqi International, a similar case, resignation was considered an abdication of director`s fiduciary duties. A failure to act, in the face of a known duty, (even in cases where those actions are banned by officials, by a fractured board or any other cause), is a breach of the duty of loyalty.


As a conclusion, in a case of wrongdoing or corporate malfeasance, what should directors do? Some of the following actions can be recommended:


–         Taking all reasonable steps to stop any wrongdoing.

–         Engaging the board with appropriate advisors to effectively uncover the trouble, and determine the best actions to be adopted.

–         Of course, directors need to have all these engagement, inquiries, and actions recorded in the board`s minutes, so that it is clearly perceived directors fulfilled their obligations.

–         If these efforts by Neds are blocked, perhaps a resignation can be recommended. A noisy resignation can unveil the problems, but can also generate a reputation damage that could be attributed to the resigning director.

–         Moreover, in certain circumstances, resigning can undermine the probability that the company`s boards tackles the problems, (as a strong voice would be lost in favor of investigating and remedying the issue). In that case a director should stay, as stated in the cases above.

–         A director can then sue the company, which is costly and not always the most effective option. He can also support other legal actions initiated by shareholders, other third parties, or regulators.

–         And above all, a director needs to do an appropriate due diligence before accepting a nomination for a board, and of course be an active director, complying with his duties, so as to avoid participating in a path to the kind of situation we described in this post.




–         Insolvent? Don`t do a runner, by Carly Chinoweth, 28 April 2013 The Sunday Times.

–         Can you resign from the Board of a troubled company?, by David A. Katz and Laura A. McIntosh, 23 May 2013, Columbia Law School`s blog on Corporation and the Capital Markets.



Introducing Growth and Value Creation in a Corporate Governance model

Although early investors and founders in Facebook are necessarily happy with their investment, it is not the case of those investors having joined the company at the occasion of the IPO.

Corporate Governance advocates had somehow predicted the result, as they had argued its governance structure (multiple voting shares allocated to founders and a few others so that they controlled much more than their investment stipulated) did not guarantee shareholder value creation would be a priority. The Corporate Governance model they advocate for focuses in managerial control mechanisms, as the agency problem between investors and stakeholders, versus founders and early investors, needs to be tackled.

Nevertheless, others justify this governance structure: the autocratic system helps founders of high potential growth companies to focus on long-term sustainable growth, while rejecting short-term pressure by equity markets.

Regulation after the late 2000s crisis tried to fight short-termism, introducing shareholder engagement, (thus the two dimension model, managerial control and long-term commitment). But engagement is somehow still limited to voting the shares, and the rational behavior is following proxy advisors, that are not enough to help long-term behavior. Trading differentiated taxes, voting right allocation rules in favor of long-term investors and so on, are nowadays in the political agenda.

But, how can those opposite strengths –short and long-term perspectives- be more efficiently reconciled?

A new Corporate Governance model with a focus on growth and value creation, (the third dimension), is proposed by McCahery, Vermeulen, and Hisatake, in their article “The Present and Future of Corporate Governance: Re-Examining the Role of the Board of Directors and Investor Relations in Listed Companies”.

How does the model work in practice, what is the dynamics?

The point is: shareholder value and stakeholder satisfaction comes from growth and innovation potential, (instead of coming from oversight or long-term investor commitment).

Board dynamics and composition. There are several steps followed by successful companies:

–         First funds come from family, friends, and fools, that do not generally have access to the board.

–         Secondly, angel investors and venture capital funds appear, and they typically have access to the board. They are usually beneficial for growth, for their industry experience, and their strategic involvement, and understanding of value drivers.

–         Third, after an IPO, the model accepts the dual-class share governance structure, as something connected to innovation and value creation in that kind of company, and thinks of the board as not only responsible for oversight functions, but more relevantly for experienced advice for strategy, value creation and growth. That leaves room for boards full of industry experts, familiar to the Ceo or not, but deeply involved in the company`s growth strategy. On the other hand, this model is not confronted to independence, diversity, Chairman-Ceo separation, and other standard composition rules.

The relevance of Investor relations.

The authors advocate for a strong communication and investor relations strategy, so that investors and other stakeholders clearly understand the competitive advantage their corporate governance structure provides, and why it separates from certain general “one-fits-all” recommendations. Investors need to understand how this structure promotes revenue generation and stakeholder satisfaction.

Above all, these companies need to be transparent and engage in information sharing regarding their innovation and growth prospects.