ABOVE BOARD SUMMER EDITION

Directors Liability

In late 2006 the Corporations and Markets Advisory Committee (CAMAC) released their latest report entitled ”Personal Liability For Corporate Fault“. This considers the ways that Directors and Officers can incur liability as a consequence of corporate misconduct. The report considered whether the imposition of personal liability can be justified on the basis simply of a person's relationship to a company. It also looked at the opportunity to harmonise their legislative approach to this issue across the various jurisdictions. You will be pleased to know that CAMAC is of the view that individuals should not normally be made criminally liable for misconduct by a company except where it can be shown that they have been accessories. They pointed out that where Officers are liable for corporate conduct, and they can make out a defence, it is objectionable in principle and unfairly discriminates against corporate Officers. They are recommending that the law be changed to incur liability if the following situation exists:

• An individual must have taken part in the management of the company.
• An individual was able to influence the criminal conduct of the company.
• An individual was aware of, or allowed the conduct to occur.
• It should be a defence that the individual took all reasonable steps to prevent the conduct.

The CAMAC report has provided a solid body of advice to government with respect to Corporate Governance responsibilities and potential changes to the Corporations Act. While they are yet to become Law, they appear logical and well reasoned and company Officers may anticipate the adoption of many of recommendations in due course. Meanwhile, the report emphasises the need for all Directors and Officers to remain aware of, and strictly adhere to their statutory and common law responsibilities, particularly in light of the potential personal liability for acts of the company until such changes are made.

Takeover Time

As you are no doubt aware, the last six month has seen a big increase in takeover and merger activity in corporate Australia. It appears that the ASX and ASIC are increasingly concerned about market rumours of such takeovers and mergers involving private equity players and the sudden spikes in share activity that seem to follow. This just confirms the amount of funds that are available for private equity players looking to take a position in successful companies throughout the nation. At the same time, recent reports indicate that public floats have increased to the extent that there will be far more in 2006 than in the previous year. Despite the larger number of IPOs, it seems that the total capital raised in 2006 was smaller in dollar value than in the previous year also. This indicates a larger number of small floats than in previous times. It's a good time to remind you to beware of lazy Balance Sheets if you are a Director. It seems that companies should be warned they must be more proactive in managing their capital to avoid unwanted attention from takeover merchants.

Loans to Companies

If you are a shareholder in your own company and have loaned it money, you might like to answer the following question. When is a loan from a shareholder to a company not a loan? Answer? When the Tax Office deems it equity. The ATO now says that any such shareholder loan agreements must encompass repayments of principal, and sometimes interest, by the company back to that shareholder – even though they own the company. It's not uncommon for owners or shareholders in small private companies to provide working capital by way of loans which are often interest free and only repayable if and when the company has funds. The ATO will deem non performing shareholder credit loans as capital of the company and will restrict shareholder access to these funds without tax implications. In other words, your loan may be converted to equity in the company if the Tax Office decides so. You may want to talk to your accountant about this matter if you are in this position.

Multiple Directorships

It seems Australia has a very low incidence of multiple directorships according to a recent study. In considering ASX listed companies, Directors hold an average of 1.3 directorships. 82% held only 1, while 13% held 2, and 4% held 3. Only a small number of Directors held 5 or more directorships across all ASX listed companies. While it should be pointed out however that these numbers don't apply to the same extent for small or large Pty Ltd companies, it's not uncommon for Directors to hold half a dozen Board positions at the same time. It would appear that this is because the workload is less and the compliance and disclosure requirements reduced in the case of such SME companies. The survey also found that the company's performance is not affected by the size of the Board or the total number of directorships held on that Board by the Directors. However, in our view, the number of directorships a person takes up should be limited only by the person's capacity to fulfil their obligations to the shareholders of each company. The best way to gauge an individual Director's performance is through an evaluation process. The shareholders will soon judge whether a Director is performing, whether they serve on just one Board or a multiple of Boards at the same time.

Corporate Social Responsibility

Corporations Law expert Bob Baxt believes Corporations Law should not be amended to encompass corporate social responsibility. Instead, he thinks that corporate Australia should evolve towards a cultural compliance rather than through legislation. Corporate social responsibility encompasses the Board's focus on a wider range of issues than simply producing profits for shareholders. It ensures the company's obligation to its employees and customers as well as to the wider general community. On that note, I wanted to share my own experience recently on two of the Boards I Chair. We've held robust discussions on deciding if each company should be a corporate donor and what criteria we are looking for from a charity or cause the company would like to support. In each case, we've been keen to find opportunities where the staff can be involved, either in payroll deductions or direct donations, or more particularly through volunteering their time to assist the particular cause that the company supports. At the same time it has to be a win/win so that the company receives appropriate recognition as a good corporate citizen from a charity or cause that has the systems and people in place to provide that support back to the donor company. This is a topic that your Board may want to discuss at some time in the future and establish a policy for it.

Cashflow Management

In providing advice to a number of companies recently, I've noticed that the Board has not focused on cashflow management as much as it should. We all know that cash is king and is the lifeblood of the company. It is interesting for example to note that some businesses have sales made on a cash basis, including Eftpos or by credit card. While cashflow should be strong in such collections, any variations to cashflow should be investigated immediately. Some indicators of poor cashflow include:

• The business overdraft is at its limit and the bank is reluctant or unwilling to extend.
• The business may be finding it difficult to pay major overheads such wages and rent.
• Suppliers are constantly contacting the business asking for payment.
• The time taken to pay suppliers is increasing.

Some causes of the problem may include:

• The value of stock being carried is too high.
• The business is undercapitalized.
• Cash projection and budgets have been incorrect or do not exist.

In my experience the businesses that are more profitable and will have a stronger cashflow have the following features:

• Have better management and reporting systems.
• Have overheads under control.
• Have better stock management.

I think that Boards should have reports from management in relation to tracking gross profit margins, and insist on cashflow forecasts out to 12 months, as well as cashflow statements for the previous month. I can't think of a better way for a Director to fulfil their duties to the company and its shareholders than by keeping a close eye on cashflow at all times.

Board Culture

Over the years as I've worked with many Boards, I've come to realize that the culture of the Board is a vital ingredient in its success in meeting its obligation to the company and shareholders. A healthy Board culture will acknowledge that each Director will bring relative strengths and relative weaknesses to the Board and these should be included accordingly. Another thing to look for is the way the Board interacts with management. Is this relationship adversarial or more in the nature of a partnership? Does the CEO anticipate the Board's needs, or do they have to be spelt out for him? Does the Board think for itself or simply react to the CEO's initiatives? In my view, trust must exist between the Board and CEO at all times. Once that's gone, so too is the CEO. There is no doubt that the Chairman's contribution to the Board's culture is vitally important.

As the leader of the Board they should be continually monitoring the culture and dynamics of the people around the Board table and take steps for corrective action where necessary. A part of every Board evaluation or performance review that we conduct for clients, involves a look at the culture or dynamics of the people themselves. This is to establish whether it is adding to any dysfunctional outcomes or contributing to a positive and functional Board meeting all of its objectives and role. It might be a topic your Board would like to discuss at some time.

Book Review

I thought I would mention more than one publication for your possible interest in this Newsletter.

1. ”Essential Director“ by Bob Tricker. This is a real A to Z with several hundred entries that explain the essentials of Corporate Governance and the function and responsibility of Directors. It's 240 pages long and retails for $29.95.
2. The latest edition of Bob Baxt's book ”Duties and Responsibilities of Directors and Officers“ is now in its 18th edition. Including Australian common law cases, it provides a useful guide to Directors on their legal duties and responsibilities. 209 pages in soft cover and retails for $32.50. It's also available now in CD Rom format for $15.00 for those that don't have time to read.
3. Finally, for those Directors looking to improve the performance of their business and add a dash of innovation to their companies, you can't go past a new book by Simon Tupman, ”Why Entrepreneurs Should Eat Bananas – 101 Inspirational Ideas for Growing Your Business and Yourself“. This is a fun book that is deceptively simple but has a lot of truly profound home truths. It gets you thinking about what you're doing with your career and your life and your business. It's probably a great read for executive Directors. 167 pages in soft cover and it retails for $25.00.

Finally, a thought from billionaire businessman Warren Buffett ”In the business world, the rear view mirror is always clearer than the windshield“.

Until next time.
Warren Tapp

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