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Revisiting the fiduciary duties of the board of directors and management

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Cesar L. Villanueva

M. A. P. Insights

Revisiting the fiduciary duties of the board of directors and management

Among the essential features of an effective corporate governance (CG) regime would be the proper designation of the agency in the corporate setting that is primarily responsible for promoting CG: Who is primarily responsible for promoting CG principles and best practice within the company setting?

This would include establishing the hierarchy of responsibilities and accountabilities among the various agencies operating within the corporate setting, and answers the critical question: With whom does the buck stop when it comes to the duties and responsibilities for CG?

It is equally important for an effective CG regime to properly delineate the constituencies to whom such primary fiduciary duties of CG are owed to: To whom do we owe the fiduciary duty to properly govern the corporate affairs?

Achieving such proper delineations provides answers to the critical questions that directors and senior corporate officers ask in relation to pursuing good CG practices for the company: What are my primary duty in running the affairs of the company? When are we in breach of such duty as to become personally liable therefore? It also compels the responsible corporate agency to provide a hierarchical delineation of the varying and sometimes conflicting rights of such constituencies.

This paper seeks to revisit the provisions Code of CG for Publicly-Listed Companies (PLCs) (SEC Memorandum Circular No. 19, s. 2016), which became effective on 01 January 2017, on how it structures the primary responsibility of promoting CG with the corporate setting, and how it effectively addresses the issues of what constitutes the “legitimate interests” of stakeholders, other than the stockholders, of PLCs.

Part I Erroneous Dichotomy: The Board Must Limit Itself to Policy-Setting, and Must Respect Management Autonomy to Run the Affairs of the Company

(a) Prior to the CG reform movement in our country, the mantra that one often hears in corporate boardrooms is that “The Board must limit itself to policy setting, and the main work of running the company is with Management, headed by the CEO.”

This anachronistic CG attitude can also be found sprinkled in Philippine jurisprudence, a sampling of which can be seen in Western Institute of Technology v. Salas, which held:

“There is no argument that directors or trustees, as the case may be, are not entitled to salary or other compensation when they perform nothing more than the usual and ordinary duties of their office. This rule is founded upon a presumption that directors/trustees render service gratuitously, and that the return upon their shares adequately furnishes the motives for service, without compensation”. The Supreme Court (SC) pointed to Section 30 of the Corporation Code (CC) which provides that in the absence of any provision in the by-laws or upon vote of stockholders representing at least a majority of the outstanding capital stock, “directors shall not receive any compensation, as such directors,” except for reasonable per diems for actual attendance at meetings.

Such judicial attitude derogates the “Board service” as not inherently compensable since it amounts to “nothing more than the usual and ordinary duties of their office.” In effect, the “work” that directors do in the corporate setting is essentially to attend meetings. Such judicial attitude treats directors as not performing a professional role that ought to be compensated, but merely as an adjunct role to their primary status as owners of the company. When carried into management practice, such attitude creates a warped value system among directors that it is their proprietary right to company earnings that remains their primordial concern, to which their fiduciary duties to the company and other stakeholders is only an adjunct role.

Such erroneous dichotomy of the roles of the Board and Management is also enshrined in the case-law doctrine of “Business Judgment Rule” which not only provides the general rule that resolutions, contracts and determinations of the Board are binding on the corporation even against the opposition of the stockholders, but that even when losses are incurred by the company, the directors shall not be held personally liable therefore as long as they had acted in good faith.

Reliance by directors on the representation of Management in arriving at corporate decisions, has traditionally been considered as “acting in good faith” as to shield them from personal liability for corporate acts and contracts that cause damage to the corporation.

The classic formulation of the rule was enunciated by the SC in Montelibano v. Bacolod-Murcia Milling Co., Inc., which held that when a resolution is “passed in good faith by the board of directors, it is valid and binding, and whether or not it will cause losses or decrease the profits of the [corporation], the court has no authority to review them,” adding that “It is a well-known rule of law that questions of policy or management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its judgment [for that] of the board of directors; the board is the business manager of the corporation, and so long as it acts in good faith its orders are not reviewable by the courts.”

The “insulation-from-personal-liability” effect of the Business Judgment Rule eventually lead to a “general rule of non-liability of directors and officers” for losses sustained by corporations, except only in enumerated instances, Tramat Mercantile, Inc. v. Court of Appeals came up with a “formula” in determining the issue of personal liability for corporate officers, thus:

Personal liability of a corporate director, trustee or officer along (although not necessarily) with the corporation may so validly attach, as a rule, only when:

(a) He assents:

(i) to a patently unlawful act of the corporation;

(ii) for bad faith or gross negligence in directing its affairs; or

(iii) for conflict of interest, resulting in damages to the corporation, its stockholders or other persons (Section 31, CC);

(b) He consents to the issuance of watered stocks or who, having knowledge thereof, does not forthwith file with the corporate secretary his written objection thereto (Section 65, CC);

(c) He agrees to hold himself personally and solidarily liable with the corporation (De Asis & Co., Inc. v. Court of Appeals, 136 SCRA 599 [1985]);

(d) He is made, by a specific provision of law, to personally answer for his corporate action (Exemplified in Section 144, CC; also Section 13, P.D. No. 115, or the Trust Receipts Law).

By the use of the phrase “may so validly attach, as a rule, only when,” it is clear that the SC emphasizes that the general rule is that directors, trustees, and other corporate officers are not personally liable for corporate debts, and that the only time they do become personally liable is on the specifically enumerated four areas indicated in the formula. The enumerative manner by which jurisprudence has effectively limited the cases when a corporate officer may be held liable has been reiterated verbatim in subsequent decisions of the SC.

The CG reform commenced by the SEC in 2002 for PLCs was in great part in reaction to such “smugness” of directors and senior officers to their primary fiduciary duties of diligence or care they owed to their company, its stockholders, and other stakeholders.

(b) A good number of Board members in PLCs tend to behave as though their service is an act of “voluntarism” or equivalent to quasi-public service, for which the highest form must take the norm of giving sage advice to Management, the consequences for which they cannot be held personally liable, since it was Management that made the final decision to pursue and implement the same. Yet, the substantive law provisions under Philippine Corporate Law do not support such a dichotomy of CG.

Section 23 of the CC embodies the doctrine of “Centralized Management” which clearly and directly vests “all corporate powers, all corporate properties, and all corporate business” of the corporation with its Board of Directors, which has the following legal and substantive consequences:

(a) That the Board possessing all corporate powers is the direct agent of the corporation considered by law to be the “principal” and to whom the Board owes fiduciary duties of diligence and loyalty;

(b) That the Board possessing legal title to all the assets and business enterprise of the company does not act as an agent, but rather as a trustee, of the stockholders and its corporate decisions, as a general proposition, cannot be overturned by the stockholders; and

(c) Management (i.e., President and the Senior Officers) are appointed by the Board in the exercise of its plenary corporate powers, and thereby Management is considered to be the Board’s sub-agent vis-à-vis the corporation as the principal in the corporate setting.

The rule under Agency Law, as embodied in the Civil Code of the Philippines, as it ought to operate in Corporate Law, is that the primary agent (the Board) remains primarily liable to the principal (the corporation) even when such agent appoints a sub-agent to carry on the principal’s affairs; and that primary agent (the Board) remains personally liable to the principal for the acts of its sub-agent (Management).

Under such substantive corporate and civil law structures, the Board is vested directly with the primary duty to manage the assets and affairs of the company, and that the appointment of Management does not take away such primary responsibility of the Board; that in fact the Board ought to be personally liable to the principal (the company, as a separate juridical person) and the stockholders (when the corporation is seen only as a medium of doing business) for the defaults of Management, whose members constitute the Board’s sub-agents.

In actual corporate practice, of course, the Board of Directors is not expected to run the day-to-day affairs of the company, but that it is expected to employ its plenary corporate powers to appoint Management, headed by the CEO, as its direct sub-agent to run the affairs of the company pursuant to the purpose of the enterprise as set out in the company charters. Through the decades, the concept of “strong CEO”, who often was the Chairman of the Board at the same time, created a culture of “Board reticency” which relied upon Management to carry the ball in running the affairs, postered by the fact that members of the Board who act in good faith relying upon the representation and assurances of Management and general counsel, to be insulated from personal liability for the wrong suffered by the company under the business judgment rule.

Even the CC, which does not provide for the office of the Chairman of the Board, still contains provisions that are supportive of the “strong CEO” culture in the corporate setting, thus:

  • the President must be a member of the Board (Sec. 25);
  • the stockholders’ meeting to be held to remove a member of the Board must be called by the secretary on order of the President (Sec. 28);
  • special meetings of the Board may be held at any time upon the call of the President (Sec. 53);
  • The President presides at all meetings of the Board, as well as of the stockholders’ meetings, unless the by-laws provide otherwise (Sec. 54);

A conscious return to the proper dichotomy of the roles and hierarchical responsibilities of the Board and Management was one of the primary aims for the CG reforms undertaken by the SEC when it promulgated in 2002 the original Code of CG (SEC Memo Circular No. 2, s. 2002) that specifically applied to PLCs, where it provided under the heading “The Board Governance” that –

The Board of Directors (Board) is primarily responsible for the governance of the corporation. It needs to be structured so that it provides an independent check on Management…

It is the Board’s responsibility to foster the long-term success of the corporation and secure its sustained competitiveness in a manner consistent with its fiduciary responsibility, which it should exercise in the best interests of the corporation and its shareholders. …

The original SEC Code of CG also provided under the heading “Accountability and Audit” the proper designation of the fiduciary duty of governance to be with the Board, thus:

…The Board is primarily accountable to the shareholders and Management is primarily accountable to the Board. The Board should provide the shareholders with a balanced and understandable assessment of the corporation’s performance, position and prospects on a quarterly basis. The Management should provide all members of the Board with a balanced and understandable account of the corporation’s performance, position and prospects on a monthly basis…

The objective of the original Code of CG was to drill into hearts and minds of Board members the legal truism that on their shoulders is legally imposed the primary duty of pursuing the affairs of the company, and they cannot hide behind the theory of “Management prerogative” to withdraw into the background of CG.

(c) Philippine CG reforms for PLCs formally began with the promulgation by the SEC in 2002 of the original Code of CG (SEC Memo Circular No. 2, s. 2002), which among others provided in clear language the central theme of good CG: The Board, headed by the Chairman, is primarily responsible and accountable to the stockholders and other stakeholders, for CG; whereas, Management, headed by the CEO, is primarily accountable to the Board.

It is our position that essentially, the Code of CG for PLCs (SEC Memo Circular No. 19, s. 2016) has maintained the CG dichotomy that “The Board is primarily responsible for good CG to the stockholders and other stakeholders; whereas, Management is primarily responsible to the Board.” We base our position on the following key provisions of the CG Code for PLCs, thus:

First, CG Code for PLCs has retained substantially the definitions of the Board and Management as in the original Code of CG, that indicates such dichotomy, thus:

Board of Directors – the governing body elected by the stockholders that exercises the corporate powers of a corporation, conducts all its business and controls its properties.

Management – a group of executives given the authority by the Board of Directors to implement the policies it has laid down in the conduct of the business of the corporation.

The Code also recommends that the Board should be headed by a competent and qualified Chairperson and provides for his roles and responsibilities; and provides that the position of Chairman and CEO shall be held by separate individuals, with each having clearly defined responsibilities.

Secondly, Principles 1 and 4 embody the primary role of the Board to be a “competent and working Board” in fostering the long-term success of the company, thus:

Principal 1:

The company should be headed by a competent, working board to foster the long-term success of the corporation, and to sustain its competitiveness and profitability in a manner consistent with its corporate objectives and the long-term best interests of its shareholders and other stakeholders.

Principle 4:

To show full commitment to the company, the directors should devote the time and attention necessary to properly and effectively perform their duties and responsibilities, including sufficient time to be familiar with the corporation’s business.

In other words, the “work of the Board” goes beyond just attendance at meetings, but constitute full professional service to oversee the company’s operations.

The CG Code for PLCs clearly considers the “work of the Board” as essentially compensable work and recommends that the Boards of PLCs “should align the remuneration of key officers and board members with the long-term interests of the company [and] formulate and adopt a policy specifying the relationship between remuneration and performance.”

In fact, Principle 6 requires a periodic measurement of the performance of such “working Board”, thus: “The best measure of the Board’s effectiveness is through an assessment process. The Board should regularly carry out evaluations to appraise its performance as a body, and assess whether it possesses the right mix of backgrounds and competencies.”

Thirdly, the recommended CG practices under Principle 2 (Establishing Clear Roles and Responsibilities of the Board), ensure that the Board exercises dynamic recruitment and supervision over Management and thereby be responsible for the competence and performance of Management.

  • Recommendation 2.4 provides that the “Board should be responsible for ensuring and adopting an effective succession planning program for directors, key officers and Management to ensure growth and a continued increase in the shareholders’ value.”
  • Recommendation 2.8 provides that the “Board should be primarily responsible for approving the selection and assessing the performance of the Management led by the Chief Executive Officer (CEO), and control functions led by their respective heads (Chief Risk Officer, Chief Compliance Officer, and Chief Audit Executive).”
  • Recommendation 2.9 provides that the “Board should establish an effective performance management framework that will ensure that the Management, including the Chief Executive Officer, and personnel’s performance is at par with the standards set by the Board and Senior Management.”

Finally, the recommended CG practice under Principle 2, places squarely on the Board’s shoulders the establishment of the company’s risk management systems, thus:

  • Recommendation 2.10 provides that the Board should oversee that an appropriate internal control system is in place, including setting up a mechanism for monitoring and managing potential conflicts of interest of Management, board members, and shareholders. The Board should also approve the Internal Audit Charter.
  • Recommendation 2.11 provides that the “Board should oversee that a sound enterprise risk management (ERM) framework is in place to effectively identify, monitor, assess and manage key business risks. The risk management framework should guide the Board in identifying units/business lines and enterprise-level risk exposures, as well as the effectiveness of risk management strategies.”

It would have been more useful, of course, if the CG Code for PLCs had formally and expressly adopted within its Principles the very cornerstone of good CG: The Board of Directors is primarily responsible to the stockholders and other stakeholders; whereas, Management is primarily responsible to the Board.

(The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the M.A.P.)

 

Cesar L. Villanueva is a member of the Management Association of the Philippines (M.A.P.) CG Committee, the former Chair of the Governance Commission for GOCCs and the Founding Partner of the Villanueva Gabionza & Dy Law Offices.

cvillanueva@vgslaw.com

map@map.org.ph

http://map.org.ph