Welcome to the December 2011 edition of The Director's Dilemma.

This newsletter provides case studies that have been written to help you to develop your judgement as a company director. The case studies are based upon real life; they focus on complex and challenging boardroom issues which can be resolved in a variety of ways. There is often no one 'correct' answer; just an answer that is more likely to work given the circumstances and personalities of the case.

Although these are real cases, the names and some circumstances have been altered to ensure anonymity. Each potential solution to the case study has different pros and cons for the individuals and companies concerned. Every month this newsletter presents an issue and several responses.

Consider: Which response would you choose and why?

Graham worked as a management consultant assisting the national operations of a company that has grown over twenty years by acquiring 'non-family' shareholders who now account for 40% of the capital. The founder's son, who owns 10% of the shares, heads an overseas division and is a director. The founder retains the remaining 50% and is a 'passive' investor.

Graham's work helped the company grow market share, revenue and profits. He was offered, and accepted, a board seat. He was elected unopposed at the next AGM that followed this offer. Graham performed little due diligence as he knew the domestic operations well, which accounted for most of the activity.

Once on the board he discovered that the overseas division is very unprofitable and has been losing money for years. The salaries paid to staff in the division are well above market rates. Market demographics and local regulations suggest the division will make losses even if costs are cut. Graham raised this at a board meeting and was informed by the son of the founder that the long established strategy of 'loss leadership' for developing this market cannot be questioned or changed. The Chairman closed down the discussion asking for more information to allow informed discussion at the next meeting.

After the meeting the founder sent Graham an email stating that his son was exempt from board oversight and that he, as the major shareholder, was happy for the overseas division to operate at a loss. Discussions with senior staff alert Graham to the fact that the son does little other than attending occasional board meetings (allegedly for the opportunity to combine travel with a holiday and shopping) and is married to a senior executive in his division who is a native of the host country. The Chairman calls Graham and informs him that the major shareholder wants Graham to resign from the board immediately.

What should Graham do?

Donald's Answer

Resign.

I see no arguments supporting an attempt to remain a director.

Sixty percent of the company's shares are held by people who support the current policy. Further, they understand the current policy and are willing to bear the financial burden of that policy. Graham has presented his views, but the Chairman and his son continue to hold their positions. Graham won't be able to alter their views.

The holder of 50% of the shares is calling for Graham's resignation. That alone makes Graham's position untenable.

Graham may have a fiduciary responsibility to the remaining 40% of the shareholders. If so, based on his research and conclusions, he cannot best fulfill his responsibility by remaining on the board and agreeing to actions that he feels are not in the best interests of the remaining 40% of the shareholders.

Whether the board is passive or dysfunctional, whether the CEO should base decisions on the best financial interests of the company, or whether the board needs a strong minority shareholder are interesting considerations ... and equally meaningless. We might as well suggest that the overseas operations never should have been started. We (and Graham) need to deal with reality, not what should be or what might have been. The reality is that Graham has placed himself in an untenable position and one in which he's powerless and in which his continued presence might actually expose him to liability.

Graham needs to resign.

Donald Tepper is Business Owner at Solutions 3D LLC, a Realtor at Long & Foster, and the Editor of the American Physical Therapy Association's PT in Motion member magazine. He is based in Washington, USA.

Julie's Answer

Graham needs a good corporate lawyer. If the company does not pay for his legal advice he should consider it a wise investment. Boardroom dynamics are very different to management hierarchies and Graham has already misjudged this board. He may need to consider reporting the situation to the appropriate regulator.

Graham now has a fiduciary obligation to protect the interests of the minority shareholders and a statutory obligation to act in the best interests of the company. He is also in a position where a clear majority of the board can vote him off simply by calling an EGM and putting a motion to the shareholders.

A major question in all of this is the level of engagement that the minority shareholders have with the company. Do they know about, and permit, the seeming abuse of their funds? They may not know but, once the EGM is called, they will find out. If the company is tightly held it may be possible for Graham to meet with some shareholders to ascertain their preferred course of action.

Having uncovered an untenable situation Graham needs to be resolute in finding a solution that meets the needs of all stakeholders. The company is profitable and there is time to implement a course of action. However it cannot be allowed to continue for too long or Graham may be held (along with his colleagues) liable for damaging the interests of minority shareholders. Open, respectful and transparent dialogue is required. Some board and management education is clearly required as is some long term strategic and succession planning.

Graham needs to generate some attractive strategic alternatives such as changing the dividend policy so that the founder and his son have cash without resorting to sham employment. This might save the costs of running an overseas division. Succession is clearly an issue; who inherits the founder's 50%?

He should try to build a sustainable solution but be prepared to resign, and state reasons, if the others refuse to improve their governance.

Julie Garland McLellan is a specialist board consultant and practising non-executive director based in Sydney, Australia.

George's Answer

I would tackle this from a corporate governance perspective and assume that this is a publicly traded company.

1. To begin with the majority shareholder is a passive investor at 50%; he is not on the board nor involved in the operations of the business. Therefore he is a shareholder with voting rights when the board brings a vote to shareholders and not before.

2. The overall business must have a CEO; it is not the son or the major shareholder.

3. The board is within its rights to ask for the son's resignation for non-performance as a director ... not properly representing the rights of all other shareholders.

4. The board maybe passive and dysfunctional which is why they are likely paralyzed and don't know how to deal with the son given the ownership his father holds. The Chairman likely called the founder for direction.

5. This board is in need of a strong minority shareholder and board activist to challenge the board and the negligent manner in which the company is being managed.

6. The board will need to create performance guidelines for all directors to make it easier for the Chair to address issues like the founder's son.

7. In a situation like this it would be in the best interest of the shareholders if the directors could bring the founder into the meeting and have an on-camera discussion about the son. If this fails to resolve the situation the Chair should resign and publicly explain to minority shareholders that the company is being mismanaged. Usually a majority shareholder does not want the publicity or the exposure of such a situation to the markets where recognition of mismanagement can cause the share price to decline.

8. I am not sure where the CEO is in all of this, but it looks like he/she is also passive in which case a more credible CEO is required who can demonstrate the best interests of all.

I have seen cases like this before where the Founder is Chair, CEO and majority shareholder, and the board has been able to gain control with a minority holder who comes in and challenges the board to be tougher.

George Minakakis is Sr. VP and General Manager Canada (LensCrafters, Pearle Vision, Licensed Brands) at Luxottica Retail and a former President of the Vision Council of Canada.

Disclaimer

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.

What's New

Special holiday offer - This year is ending soon and many directors have not yet considered their holiday reading or what to give their board colleagues as gifts. Here is a suggestion and special readers' discount for you:

Visit https://www.createspace.com/3413182 and enter promotion code 5SZX4QH5 for $15.00 off the list price of Dilemmas, Dilemmas and/or,

Visit https://www.createspace.com/3445262 and enter promotion code Z3QMSQPM for 10% off the list price of Presenting to Boards.

Praise for 'All Above Board' - Feedback from readers has been very positive and the book was featured on Sky News' Perrett Report program on 14 November. . You can get a copy from
www.companydirectors.com.au/Director-Resource-Centre/Publications/Books/PUB40/

You can also read a review at http://www.psnews.com.au/Bookreviewpsn2911.html

Book reviews - One of my most rewarding directorships is a landfill and waste recycling company. This month I have reviewed a book that you may like to read with your children over the holiday season to develop some shared ideas about the role your family can play in building a sustainable future. The book is Where do Recyclable Materials Go? by Sabbithry Persad and it will generate some interesting conversations. Suitable for ages seven and up; enjoy!

Where's Julie? - A few readers manage to catch up with me on my travels and it is such a pleasure to meet them that I now share my travel plans each month.

Date Place Activity
1 December Sydney Australian Institute of Company Directors; Long Lunch (Christmas Celebration)
4 & 5 December Melbourne Private client course
6 & 7 December Melbourne Liquid Learning; Governance Masterclass
9 December McKay Bounty Mining Christmas Party
16 December Argentina Holiday and Latin American Governance fact-finding mission

Please call or email me if you would like to schedule a meeting or find out more about attending one of these events.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Farewell until the next issue (due 1 February 2012). Have a peaceful, prosperous and pleasant holiday season, best wishes for Christmas, Hanukkah, and Eid al-Adha.

Best regards
Julie

www.mclellan.com.au | PO Box 97 Killara NSW 2071
email julie@mclellan.com.au | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711