Susan Watson: Grey boards need a touch of flair

Former Feltex Carpets chairman Tim Saunders outside the Auckland District Court. Photo / Dean Purcell

Directors of our failed companies may well feel beleaguered as the spotlight of public reprobation turns in their direction.

Following their acquittal on criminal charges, apologists for the Feltex directors criticised the Registrar of Companies for bringing proceedings against honest men who did their honest best. But can we expect more from the directors of our companies than honesty?

The law certainly does. The requirements for directors set out clearly in the Companies Act 1993 centre around honesty and competence.

Honesty requires a director to do his best for his company and, when conflicts between his own interests and the interests of the company arise, as they inevitably will, to put the interests of the company first.

Directors of a number of the finance companies - with their tangle of related party transactions that may not have been at "arm's-length" fair value or in the best interests of the company at all - may ultimately fall at the first hurdle on honesty. But many directors of our failed companies were honest, with no taint of self-interest.

Where they may have tripped up is at the second hurdle: Competence.

When a company fails, the duties around competence found in the Companies Act 1993 come into sharp focus. Directors must not enter into transactions that the company will not be able to perform. All directors also have an obligation to ensure that the company doesn't engage in reckless trading.

This second obligation extends to all directors on the board, not just the executive directors or those actively involved in making the decision to carry on trading.

As the Court of Appeal said recently, the days of the sleeping director are over. Looking at a number of the recent corporate failures, it might be time for all directors on all boards to wake up to this obligation.

Directors must also be careful. This means using the care, diligence and skill that a reasonable director would use in the same circumstances. This is, therefore, an objective standard: the skill set and knowledge that the director brings to the table does not affect the level of competence expected from him.

The commercial lawyer banned as a company director who argued his defence as a lack of knowledge of financial matters found this out to his cost in the High Court recently.

The only qualifiers on the standard of care required are those that allow courts and directors to put the role of the particular director in context, by taking into account the nature of the company, decision to be made, and the responsibilities undertaken by the director.

Directors do not operate in isolation but as part of a board. The role of a board is to monitor, supervise and manage the running of the enterprise ... that is, the company on behalf of its stakeholders; most particularly its shareholders, creditors and employees. The stakeholders trust the directors to do this honestly and well.

The word "manage" has a special legal meaning. Directors do not have to manage companies in the sense that they need to involve themselves in its day-to-day operation. This they can leave others to do.

Nor do directors need to make themselves familiar with every aspect of the business - as the Feltex directors found to their benefit recently, directors can reasonably rely on information and advice from others.

What directors must do, collectively and individually, is provide the good sense and leadership that those who repose trust in them justifiably expect. Just as directors can rely on others for advice and information, stakeholders rely on directors to achieve a balance between safeguarding and furthering the interests of the enterprise.

Meeting this standard extends beyond honesty to competence and diligence. Put simply, directors must do a good job.

Some decry the recent litigation as risking acting as a deterrent to "pillars of the community" taking on directorships. Those who have lost their shirts in failed companies may not necessarily regard this as undesirable. A changing of the guard at the boardroom table may be no very bad thing.

Setting aside the corporate failures, our sharemarket remains sluggish with the performance of a number of our companies being uninspiring. Rather than this being a time for conservatism in board selection (as the Institute of Directors suggests), we may in fact need men and women who can bring to the boardroom a broader range of skills and life experiences.

Conservative selection of grey-haired accountants has not led to accountability when companies fail. Instead accountants escape liability by relying on the advice of other accountants.

For our companies to prosper, integrity and honesty may need to be leavened with competence and creativity.

* Professor Susan Watson heads the department of commercial law at the University of Auckland Business School.