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Across the Board: Non-executive Directors, Part 3

Oct 2019

This is the third article in a series of three looking at non-executive directors’ duties, how these duties interact with the role non-executive directors play, and how organisations can get the most out of a non-executive director.

In this Part 3 of our “Across the Board” series focussing on non-executive Directors, we consider the practical impact of ASIC v Rich on the non-executive role, and further explore how companies can get the most out of non-executive directors in light of the Banking Royal Commission.

For organisations requiring a non-executive presence, or with a complex or developing corporate governance function, non-executive directors can provide invaluable reassurance to stakeholders, support corporate independence and provide technical insight and experience to the board. However, the suitability and need for a non-executive director will depend on the nature and complexity of the business – a positive and independent contribution to one business can be a costly handbrake to another.

In the final report of the Banking and Financial Services Royal Commission, Commissioner Hayne noted three chief benefits of including non-executive directors on ASIC’s own board, being:

  • enhancing the internal oversight function of the board of directors;
  • broadening the skills and experience of the board; and
  • reinforcing ASIC’s independence from the government and those it seeks to regulate.

Commissioner Hayne further stated that these benefits were directly comparable to the benefits yielded from the presence of non-executive directors on the board of profit-making corporations1.

In this series, we have explored the concept of non-executive directors. In the first article, we examined the differences between non-executives and executive directors under the Corporations Act 2001 (Cth) (the Act) and in commercial practice. In the second article, we assessed the different standards of directors’ duties applied by the court in ASIC v Rich. In this third and final article, we will use Commissioner Hayne’s comments as a guide to determine how a private company can get the most value out of the non-executive director role.

When to appoint a non-executive director?

The role and composition of a company’s board of directors is often dictated by its size and stage in the business lifecycle- from small single-director, single-shareholder- perhaps even single employee- companies, to blue-chip public entities with decades of experience across a senior board, to every transitional phase in between.

For entities at either end of this spectrum, non-executives are not likely to be a serious consideration: narrowly-held entities with a specialised market focus are more likely to served better by the decisive, focussed narrative of a small or single-director board with an intimate knowledge of and direct involvement in the day-to-day operations of the business; larger businesses will already have a panel of experienced non-executive directors in a range of disciplines on whom to draw when required.

It is most often those entities in a transitional phase who may be considering the need to appoint a non-executive director, or indeed have a non-executive director forced on to the board by circumstance.

Why appoint a non-executive director?

Hayne’s maxims both inform the role of the non-executive director and neatly encapsulate the reasons for their appointment.

  • Internal oversight: Typically a non-executive might come on board at a key fundraising stage pursuant to the terms of a shareholders agreement- representing e.g. a group of minority interests, a substantial new private equity investor, a major creditor or even employee stakeholders. In each case, the role of the non-executive is to represent a group which would not typically be involved in the company in a managerial capacity, but which nevertheless has a significant stake in the performance of the business.
  • Specialist knowledge: Where a business expands rapidly into new and unfamiliar areas, or where a relatively inexperienced board faces challenges associated with growth, the presence of an experienced and specialised non-executive director on the board can help the company to navigate complex challenges with relative ease. The right non-executive director can bring specialist expertise, relationships and industry experience to the board, helping the company navigate common obstacles to growth and opening doors that might otherwise remain closed.
  • Independence in appearance and practice: Entities may voluntarily consider the appointment of one or more non-executive board members to provide the appearance and practice of independence for certain critical aspects of the board’s role. It is for this reason that where a board has delegated powers to an audit committee, that it is typically comprised of non-executives- in this way the users of audit reports are given comfort that the auditors are truly independent, and they can rely on those reports with greater confidence.

Clearly, in each of these cases, the more complex a business becomes, the more likely a non-executive role is to bring value to the board; the increasing complexity of the shareholder base, rapid expansion of key operational roles and the increased attention of regulators can all be mitigated by the appointment of appropriate non-executives.

Getting the most from a non-executive director

While the benefit of a non-executive director to the company may be determined in part by the reasons for their appointment and should be considered subjectively, some guidance may be taken from the ASX Corporate Governance Principles and Recommendations (4th Ed, 2019, the Principles and Recommendations).

While the Principles and Recommendations are written for the benefit of ASX listed entities, they are structured around 8 central principles which are broadly useful to all companies when considering the operation of their board, and are a useful benchmark for non-executive directors, namely that a board should:

  • lay solid foundations for management and oversight;
  • structure the board to be effective and add value;
  • instil a culture of acting lawfully, ethically and responsibly;
  • safeguard the integrity of corporate reports;
  • make timely and balanced disclosures;
  • respect the rights of security holders;
  • recognise and manage risk; and
  • remunerate fairly and responsibly.

These principles are reinforced by practical recommendations about the role of non-executive directors. In particular:

  • The number of non-executive directors appointed should be appropriate to the size of the company and the other composition of the board. This is vital in ensuring that the non-executive director(s) have the practical capacity to challenge management and perform their oversight functions appropriately. Independence may be further reinforced by, periodically or as appropriate, meeting independently of the “executive suite”.
  • The board should ensure the independence of non-executives is maintained by requiring regular and timely conflict declarations, and requiring notice of other possible appointments before they are accepted. Interestingly and counter-intuitively, it has been shown that where non-executive directors sit on multiple boards, there is more likely to be a relative increase in the objective standard of the corporate governance function across each company2.
  • It may be appropriate for non-executives to have oversight over the performance and remuneration of the chair and the executive suite of directors. While this is compulsory for listed entities, this can also be an extremely valuable assurance role for unlisted entities, especially where the board is substantial or where a majority shareholding removes or limits the independence of the executive board.
  • Non executives should have a clear understanding of when they may be entitled to seek independent advice from external professional advisors (e.g. accountants or lawyers) in relation to matters before the board, and should be aware that their directors’ duties of care to the company and its members may require that they do so in order to discharge their duty of care. The standard to which non-executives may be held is discussed in Part 2 of this series.
  • Non-executives should have a clear understanding of the duties they owe and the stakeholders they represent- while a director may be appointed by a specific shareholder or group, their primary duty is nevertheless to act for the benefit of the company as a whole.

For any of the roles of a non-executive director to be effective, it is essential that non-executive directors are capable of challenging management and the executive board and holding them to account. This means that it is vital that non-executive directors have a detailed understanding of the corporate governance framework, reporting mechanisms and responsibilities attaching to the board and the different individual directors which comprise the board. In this sense, a non-executive director operates to monitor and implement the broader corporate governance checks and balances which may come to bear on the board.

While the duties incumbent on non-executive directors may in some contexts differ from the burden on executive directors (as set out in Part 2 and our analysis of ASIC v Rich) it is nevertheless clear that in order to fulfil their functions effectively, there is a significant burden of procedural understanding which must attach to the role of non-executives, and further duties may be attendant on individuals as determined by their specific role on the board.

By setting clear corporate governance frameworks, and by setting out the role and expectations of the non-executive board within those frameworks, corporations can empower non-executive directors to deliver value to the board by ensuring independence and objectivity in decision making, enhancing specialist knowledge, and giving comfort to shareholders that the company is being managed properly and effectively within a system of checks and balances.

Material in this article is available for information purposes only and is a high level summary of the subject matter. It is not, and is not intended to be, legal advice. You should first obtain professional legal advice prior to taking any action on the basis of any information contained in this article. This article is copyright. For permission to reproduce this article please email Hazelbrook Legal: enquiry@hazelbrooklegal.com

References

  1. Banking Royal Comission, Final Report vol. 1
  2. Biserka Siladi ‘The role of non-executive directors in corporate governance: An evaluation’ (2006)
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