Welcome to the March 2010 edition of The Director's Dilemma newsletter. I hope you find it interesting, informative and inspiring.

The first compilation of newsletters has now been published as a book: Dilemmas, Dilemmas; practical case studies for company directors. It has created a good deal of interest in the governance community - I have received more than 150 reviews, which has been slightly overwhelming! It is available for purchase on Amazon.com.

If you're new to The Director's Dilemma, I advise Boards and Directors on complex and challenging issues that can be resolved in a variety of ways. Every month this newsletter considers several responses to a real issue. Each way has different pros and cons for the individuals and companies concerned. Which response would you choose?

Lucinda is a director of a listed mining company. Early in 2009 the company issued some partly paid shares (also known as "contributing shares" or "instalment receipts"). The plan was to use the proceeds from the issue to fund the current exploration program and then, when that phase of exploration was complete, to call upon the outstanding unpaid capital to fund the next phase.

At the time of issue the ordinary shares were listed at 15c and the partly paid shares were issued with 5c paid and 10c outstanding. The GFC did not affect the exploration program which proceeded to plan. However the share price, like that of many companies, fell. It is now below the issue price of the partly paid shares. There was an unexpectedly high volume of trading in the partly paid shares in June, July and December 2009. Most are now held by people who did not subscribe through the prospectus.

Lucinda suspects that many new shareholders have no idea that the shares are partly paid. She raised the issue in a board meeting and suggested that the company make an announcement to alert shareholders that the call on capital is imminent. Her fellow directors disagreed. They said there had been no change to the timing or amount of the call on capital so there was no need to issue a statement. Shareholders who do not pay the additional instalment will forfeit their shares. Lucinda feels that the Board should warn the new shareholders of this fact. She is also concerned that auctioning the forfeited shares will not raise enough money to meet the needs of the program.

What should Lucinda do?

John’s Answer

The responsibility of the directors is to act as a fiduciary for the shareholders. In this instance, the principles of the duty of care demand transparency, especially when there may be a direct impact on shareholders.

Any time directors believe shareholders are informed but are not sure, there is a failure of communication and information transfer, notably between management and the directors. There should be no question, directors have an absolute obligation to assure that they are protecting the assets of the corporation on behalf of the shareholder. Failure to do so is an obvious breach.

Subsequent events to a share offering are often discussed in the presentation of risk factors. This may not be sufficient to provide due notice of developing circumstances. The disagreement among directors over the need to communicate is directly related to the details in the offering which may be subject to interpretation that can change over time. Since perception often belies reality, shareholders are best served when directors seek independent counsel to confirm the circumstances so as to demonstrate a serious effort to act as responsible fiduciaries. Anything less may be perceived as a breach of duty.

This is primarily a risk mitigation and compliance issue. As a director, Lucinda should contact the chair of the Audit Committee and if necessary, go directly to the independent auditor. In this manner, she will have exercised her duties of care and loyalty. If the auditor concludes there is no requirement for additional communication, Lucinda mitigates her personal risk as well as any organizational risk that the Board could assume by inaction.

John Shulansky is an experienced director and consultant. He is Principal of Shulansky Consulting in Hartford, Connecticut, USA.

Michael’s Answer

It is incumbent on the Board and its individual directors to assess whether the market has been properly informed and to comply with the continuous disclosure requirements. In view of the recent James Hardie decision, it is also important to recognise that in considering and approving ASX announcements and public statements directors have an obligation to exercise care and due diligence.

Lucinda has taken the correct step of ventilating her views at a Board level and bringing it to the attention of the other directors. Subject to considering the interests of the company as a whole she has no separate duty to inform a separate group of shareholders about their legal obligations attached to partly paid shares, particularly if there is publicly available information disclosing the same. She should keep accurate and contemporaneous minutes of directors' meetings at which strategic decisions are considered.

A director must assess the impact of any material circumstance by considering the interests of the company as a whole. On the one hand, there are shareholders who may suffer financial detriment as a result of a call and alternatively there is the danger that subsequent excessive selling by a group of shareholders, in order to avoid this liability, may have a significant impact on the company's financial stability and the value of the remaining shareholders' interests.

The correct approach is, to some degree, a matter of commercial judgement and should be based on balancing the interests of the whole shareholder group and the financial viability of the company rather than favouring one group of shareholders over the other. This is a commercial matter to be assessed by the Board in any event and not solely the responsibility of one individual director.

Michael Bracken is a Partner with Tresscox Lawyers, in Sydney, Australia. A more complete analysis (900 words) of this case is available by email from Julie Garland McLellan on request.

Julie’s Answer

Lucinda's company will get the shareholders it deserves. If the company is unreliable then the shareholders, in the long run, will also become unreliable.

Lucinda, and her board colleagues, must provide an adequate disclosure without breaching the guidelines concerning disclosures to be "news". Most stock exchanges do not allow companies to disclose the same information twice as it can be "overly emphatic" and lead to the investors having a distorted view of performance.

The Company Secretary or Head of Investor Relations (often the CEO or Chairman in small companies) should talk with their relationship manager at the exchange and explain the situation.

They will need evidence to support this unusual disclosure request. Analysis of the share register changes since the announcement date of the partly paid shares will be the key. If the company can prove that many current shareholders were not shareholders at the time of the last announcement on the topic of the partly paid shares, then the exchange may agree to the requested disclosure. The text of any posting on a share-traders' chat room or website that indicates ignorance is also good evidence.

Lucinda should investigate what planned disclosures occur before the date on which funds will be called. A small statement mentioning that there are partly paid shares on issue at the end of a regular announcement is more likely to be acceptable than a special, single purpose, announcement. This disclosure should help all shareholders by stating that progress is on track.

She must also manage the dynamics in the boardroom. This is a sensitive issue as shareholders may sell on learning about their obligations. Covenants, capital adequacy requirements, and other obligations must be checked so the Board can act swiftly if a breach occurs. Lucinda needs to take the leadership role and map out a course her colleagues can accept.

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

David’s Answer

Based upon the facts presented, namely no change in the amount or timing of the call, Lucinda's fellow directors appear to be correct in their view that there is no new information to disclose to the market or shareholders. This does prevent communication with shareholders, but such communication will depend upon the Board's assessment and strategy in dealing with investor and shareholder relations.

There is no single right or wrong answer; this is a question requiring consideration in the particular circumstances. As a board member, in such circumstances, it is important to abide by the Board's view and that the public approach by board members is consistent.

The question raises a pertinent issue in relation to regulatory and exchange listing requirements around partly paid shares, with some notable cases receiving broad media coverage in recent times. It is possible that new shareholders are unaware of the leveraged nature of their investment and that their financial exposure is greater than the original amount invested. However at some point the concept of individual responsibility needs to be recognised. If an investor does not undertake any basic research, nor seeks financial advice, that is their decision. It is not the case that the information is neither available nor public. The issue of entry levels or qualifications for investors is too broad to canvass here, but we need to be very careful in unduly restricting capital markets and their liquidity.

In terms of the risk to the company of defaults on calls, there is obviously an important risk for the Board to consider. One would need more details on the liquidity and solvency position of the company but each director should be satisfied adequate funding facilities are in place. If there is a concern in this respect then the issue should be raised with Chair of the Board and pursued until there is an adequate response. If that information is not forthcoming or is not satisfactory then Lucinda would need to consider her position on the Board.

David Slinn is CEO of Dem, a professional design practice based in Sydney, NSW

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

Two new courses – I have been busy over the past month developing two great new courses. Dealing with Director's Dilemmas is designed to improve your decision making in the boardroom. Using case studies and decision analysis tools it is guaranteed to give you a valuable edge. Secrets of Successful Boardroom Presentations is a one day course to enhance your skills at delivering information to your board.

Book reviews – This month I reviewed an entire program rather than a single book. Here is my review of Step Beyond Your Limitations by Suzanne Mercier. For the confirmed bibliophile here is Ralph Evans' review of Dilemmas, Dilemmas; practical case studies for company directors.

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 share my travel plans each month.