Welcome to the July 2009 edition of The Director’s Dilemma newsletter. I hope you find it interesting, informative and inspiring.

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three responses to a real issue. Which response would you choose?

Lydia is an executive working for a multinational company; she is also director of a joint venture (JV) company owned by her employer (30%) and two other shareholders (each with 35%). The board is comprised of Lydia and a representative of each of the other shareholders.  Lydia is chairman. The others defer to her because she has governance training and works for a large corporation; they are both from small businesses.

Lydia’s employer supplies equipment to the JV. The JV sells that equipment in its domestic market.  A shareholders agreement governs the way in which the board acts. It states, very clearly, that decisions must be made in the best interests of the JV and not in the interests of any one of the shareholders. All decisions must be unanimous.

Lydia’s boss has asked her to persuade the board to sign a contract that would be very advantageous to her employer. She knows that this contract is uncommercial and that the JV could get far better terms from an unrelated party. It is, in effect, a transfer of profits from the joint venture to the multinational company. She is aware of her duty to the JV and unwilling to put the resolution for fear of breaching her duties.

Lydia’s boss has made it clear that her job depends on getting the contract signed. He has no board experience or training and believes that the chairman should be able to instruct the others to do her bidding.

How would you advise Lydia?

Susan’s Answer

Lydia needs to educate her boss about directors’ responsibilities and liabilities. The hook for him would be to avoid potential negative publicity resulting from violation of the JV’s shareholders agreement that “decisions must be made in the best interests of the JV and not in the interests of any one of the shareholders.”    

Lydia also needs to educate her fellow directors about governance processes and what questions to ask. The other two companies together own 70% of the JV, versus the 30% ownership of Lydia’s employer. The agreement also stipulates that “all decisions…be unanimous.” A key question is how much market information is available to the other two directors. Acting for itself, Lydia’s company isn’t required to put the deal in context of potential “far better terms from an unrelated party.” That’s for the JV Board to do.

I assume the Board has informal as well as formal communication channels. Now’s the time to activate them, and Lydia should take the lead, not only because she’s effectively the senior director but also because she’s the one whose job is at risk. Rejecting the deal is not only necessary, given the shareholders agreement. It’s also the way to mitigate Lydia’s conflict with her boss, while avoiding potential legal liability for all parties.   

What’s so striking yet sadly familiar is the other two directors’ failure to act. Their deference to Lydia recalls the findings of University of Michigan Professor James Westphal cited by James Surowiecki in a recent New Yorker article (The Financial Page, “Board Stiff,” June 1, 2009). Lacking Lydia’s governance training, they’re like the “independent directors of boards [who are] sometimes inexperienced, which makes it harder for them to take on management….”  

Susan K Becker is principal at Becker Consulting Services, a B2B marketing communications firm in New York, USA.

Julie’s answer

Lydia must declare this conflict immediately to her board colleagues. Their support is essential. She will be in a worse situation if she loses their trust. Given her conflict Lydia cannot discuss the contract or vote to accept or reject it.

The constitution and shareholders agreement should provide actions to take in the event of disputes, abstention from voting, or deadlock.

Lydia’s co-directors should decide what to do about the contract. They could delegate the task of assessing the contract to an independent third party. A commercial review may ascertain commerciality. Qualified opinion should be sought on tax or legal implications of a transfer of profits offshore via an uncommercial contract. The subtleties may be beyond her boss’ comprehension.

Does the contract confer a longer term advantage that outweighs the short term disadvantage? If Lydia’s colleagues decide the long term best interests of the JV are served by signing the contract she has no immediate problem. This issue may reoccur and not be so easily solved next time. She must be better prepared.

An independent chairman is required. Lydia’s problem is how to get this fact appreciated at head office without losing her boss’ support. Lydia must document the implications of a compromised governance structure. Many line managers do not understand the duty of board members and see their role on JV boards as ‘representing’ their employer’s interests.

Her boss may be unscrupulous or ignorant but should be capable of understanding the legal and reputation risks of his initial proposed course if Lydia communicates well.

This situation could become untenable. In the short term her employer may benefit from this contract; in the long term it could destroy a valuable partnership, exclude the company from a market, and damage its reputation.

Dean’s Answer

Whatever Lydia decides, she would be aware that she represents the minority shareholding in the company. Poor performance of the JV will hurt the majority shareholders and should act as a wake-up call, especially if they see the minority shareholder profiting at their expense. If she gets the board to sign the contract, Lydia opens herself up to being accused of breaching most of her duties by promoting a related party transaction to the detriment of the JV. Lydia could quite easily find herself the recipient of a civil lawsuit and under scrutiny of the regulator for possible criminal action.

Fortunately, Lydia has a very simple way out. She needs to explain to her boss, possibly backed by a legal opinion, that putting the contract to the board has quite serious ramifications and that her boss would also be liable as they would be considered to be a person involved in a contravention under Section 79 of the Corporations Act (Under section 79 of the Corporations Act liability can be attributed to a person where their actions have aided and abetted a contravention of the Act, including breaches of director’s duties under sections 181, 182 or 183).

Furthermore, Lydia should point out that by acting on her boss' instructions, her boss would effectively be considered a director of the company under the definition of director in Section 9 of the Corporations Act . As a result Lydia's boss could be personally held liable in any civil or criminal proceedings.

Dean Cording is Principal at Succurro Corporate Services, a member of the Management Committee at Parentline ACT Inc, and Company Secretary at ME/CFS Australia Ltd.

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 have been changed to ensure anonymity.

What’s New

Book review – Directors do a lot of reading. I keep a note of my thoughts on each book I read. Here is my review of Billionaire in Training by Brad Sugars. It is a useful starting point for executives who decide that the shortest way to meaningful board seats is via a successful entrepreneurial activity.

Video Tips – I have filmed a series of video tips with IIR Executive Development. These video tips have proven so popular that I have sought and obtained permission to reproduce them on my website. They will be available for viewing during July.

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 divulge my non-confidential travel plans each month. Where events are open to the public I list the organiser and title. Where events are private I can only meet before or after the function and cannot divulge details.

Please call or email me if you would like to schedule a meeting.

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. It is (still) free.

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

Be an expert – I will post the next dilemma on LinkedIn. If you would like to feature next month just log on to my Q&A and type in your advice. I will pick the best answers to be published in the next newsletter. 

Farewell until next issue (due 1 August 2009). Enjoy governing your corporations; we are privileged to do what we do!

Best wishes
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

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