Royal Bank Column- Company law needs reviewing

By Alex Tawanda Magaisa

THE current crisis in the financial sector is a symptom of the general crisis affecting the Zimbabwean economy, which according to the recent International Monetary Fund (IMF) report

has shrunk by about 30%.


In recent months the authorities have focussed attention on alleged malpratices in the corporate sector. I have already argued in this series, that while the effort is commendable, the aggressive and heavy-handed tactics appear to border on illegalities and to that extent does not sit comfortably with the rule of law. Undoubtedly, at the centre of problems in some corporate bodies is poor corporate governance. In my view, effective solutions to the crisis will be achieved by adopting a more comprehensive review of the current laws regulating companies and business practices within the corporate sector.


There are conditions that nurture poor corporate governance practices that must be acknowledged and dealt with appropriately. In order to achieve this, a comprehensive enquiry must be undertaken either by the government or initiated by the corporate sector.


Firstly, it is necessary to understand the legal and economic nature of the Zimbabwean corporate organisation. The company is probably the most important vehicle for conducting major commercial business throughout the world.


There are three features that operate in tandem to give the company a distinctive character that makes it so attractive to business people. These features that form the bedrock of company law are incorporation, corporate personality and limited liability.


The process of incorporation gives birth to the company while corporate personality ensures that the company is a distinct legal person that is separate from its shareholders.


Additionally, the principle of limited liability ensures that the liability of shareholders in a company is limited only to the extent of their subscription in the company’s shares. The assets of a shareholder cannot be claimed to pay the debts of an insolvent company if the shareholder has met his shareholding commitments.


Collectively, these legal principles operate to shield the shareholders from liability that the company might incur which exceeds their shareholding. Directors may incur liability if they breach their statutory and common law duties.


However, because courts are usually reluctant to interfere with business judgements, in most cases it can be quite difficult to attach personal liability to directors.


Since at law a company is a separate person, it can also become a shareholder in another company. The result is that you can have an individual forming a holding company which in turn owns shares in another company and so on. That helps an individual to effectively cover him against liability that might be incurred by numerous subsidiary companies located down the chain.


As opposed to the traditional single company, corporate groups consisting of myriad of small companies with a dominant now dominate the scene. There is nothing inherently wrong about organising companies within a group to reduce exposure to liability. In fact it is the availability of such protection that enables entrepreneurial activity and risk taking.


Nonetheless, the potential for abuse of the corporate structure exists and to that extent, it is necessary to maintain a close eye on activities in the corporate sector particularly in unsophisticated and developing markets. It is quite possible that corporate groups can be structured in such a way that risky activities can be loaded onto an undercapitalised subsidiary.


The potential for elusive amoeba-like corporate structures with locations in different territories and regulated by different agencies is what made the proper regulation of the Bank of Credit and Commerce International (BCCI) a notoriously complex matter. In my view it is important to understand how companies are organised and structured in Zimbabwe in order to develop proper regulatory mechanisms and good corporate governance.


Preliminary research indicates that a major individual shareholder or a small group of shareholders normally dominates the typical Zimbabwean company. In practice, the Zimbabwean economy is dominated by corporategroups rather than the traditional single company.


At the head of the corporate group structure is a holding company whose main purpose is to hold shares in one or more subsidiaries that carry out several related or different activities. There are numerous and often complex cross-shareholdings and cross-directorships between the companies comprising the corporate group. Characteristically, there is a single dominant shareholder (or groups of shareholders) in all the companies within the group. Institutional shareholders are normally courted to provide the much-needed cash resources which individuals usually lack. Hence institutional investors such as Old Mutual, First Mutual, NSSA, and several pension funds are normally found on shareholders’ registers of most companies.


Effectively the dominant shareholder is in control of the corporate group. He is usually the chairman of the board of the holding company and also the managing director of the main subsidiary. He may also hold several positions on the boards of the various smaller subsidiaries. Alternatively, he is in control of the selection process of the directors most of who are beholden to him and therefore lack the independence that is necessary to promote good corporate governance.


Consequent upon holding several positions executive or non-executive, the dominant individual is legally entitled to earn fees and salaries from the various companies.


The problem is that the law has failed to keep pace with developments on the commercial marketplace. While the phenomenon of the corporate group has become the dominant feature in economic affairs, the law still largely focuses on the traditional perspective of the single company. The result is that legal responsibility is still apportioned to the single company, thus ignoring the reality of group activity and therefore the law has failed to develop principles of group responsibility.


In view of the reality of economic unity in corporate groups, the legal plurality permitted under the current legal set-up is artificial and produces distortions. The law endorses the separate personality of the individual companies in a group but fails to accept the reality of control by the parent/holding company or dominant shareholder. In my view, the law that was designed to regulate the single company is inadequate to deal with the corporate group situation. The rigid and formalistic approach adopted in the present company law uncritically applies corporate personality and limited liability principles in the context of corporate groups.


Consequently there is need to bridge the gap between these traditional corporate law principles and the realities of modern business organization structures so as to protect the interests of other stakeholders.


These legal problems have implications for the corporate governance regime in Zimbabwe. For purposes of corporate governance, it is necessary to acknowledge the economic realities of business structures and to avoid being hoodwinked by the formal legal structures. A closer look at the Zimbabwean business organisation is necessary in order to unravel its nature and operations.


Preliminary research indicates that the single biggest problem is the abuse of power by the dominant individual or small group of shareholders who manipulate the legal form to pursue their individual interests. It may be wrong but that does not mean that it is illegal since in most cases they are doing nothing that is beyond the law. It only means that our company law is slow and outdated and does not deal with these new problems. We must develop principles of corporate governance that deal with the problems of multi-and cross directorships within corporate groups. The business sector in Zimbabwe can be criticised for failing to take initiatives to control abuse within corporations.


A comprehensive review of the nature of corporate organisation and business practices in Zimbabwe and a thorough review of our company law is needed. It is surprising that the business organisations in Zimbabwe have not done much to address the problems but continue to rely too much on the King and Cadbury Commissions. There may be similarities between the business sectors in Zimbabwe, South Africa and the United Kingdom but I believe that there are peculiarities that need to be highlighted and dealt with in each individual market. In my view, this is the perfect opportunity to carry out that audit by setting up a commission to unravel the business structures, the problems and suggest ways of resolving them.

Simultaneously, the government can seriously consider updating our archaic company law to respond to the challenges of modern day economic activities.


* Alex Tawanda Magaisa is Baker & McKenzie Lecturer in Corporate & Commercial Law at The University of Nottingham. He can be contacted at alex.magaisa@nottingham.ac.uk or alex-magaisa@hotmail.com