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Royal Bank Column – Directors’ liability for corporate actions

By Alex Tawanda Magaisa

THE area of corporate criminal liability lies within the province of corporate governance. However, it is not a sufficiently developed area of corporate law and along with the law on

directors’ duties, it is a notoriously complex matter.

In recent months, the Zimbabwean authorities have been using criminal sanctions against some companies and business executives alleged to have been involved in illegal foreign currency dealings. Tough legislation has been passed and used to pursue individuals suspected of having been involved in, inter alia, externalisation of foreign currency. A judge of the Supreme Court recently described the new laws as “patently unconstitutional”.

One of the most prominent direct victims of these laws is James Makamba, a director of Telecel Zimbabwe, one of the mobile telephone companies. Telecel itself was recently fined for contravening the Exchange Control laws. A number of corporate executives, including the executive directors of NMB Bank Ltd, have left Zimbabwe, probably to protect the erosion of their rights under the draconian laws in view of the fate of Makamba who remains in custody despite the potential unconstitutional nature of the laws under which he is being pursued.

Suing – company or directors?

The use of criminal sanctions against directors of companies raises potentially complex issues with regards to the allocation of liability between companies and directors for activities carried out by or on behalf of the company. From a corporate governance perspective, it also raises issues in respect of the conduct expected of directors as far as their duties to the company are concerned during periods of general economic distress.

We argue firstly, that under the present law the proper course is to pursue the company rather than individual directors, secondly, that company directors should be protected where their conduct is shown to be in pursuance of their duties to uphold the best interests of the company. In addition, principles of distributive justice require that all persons in similar circumstances must be treated in the same way and the selective targeting of a few selected individuals and companies is unfair and unjust. Legality and fairness must always underpin the promotion of good corporate governance.

Corporate personality

The principle of corporate personality is a fundamental tenet of company law. It states that a company is a legal entity that is distinct from its shareholders or directors. It has the power to hold its own assets and incur liabilities in its own name. The principle of limited liability means that shareholders are only responsible for the value of amount of shares to which they have subscribed in the company.

The company is responsible for its excess liabilities and third parties cannot be held to account if the company cannot satisfy them unless the limited exceptions apply. The protection offered by these principles explain why most business is conducted through the company in the mainstream economy. The fact that directors and shareholders are insulated from direct liability enables them to be more entrepreneurial, taking risks that they would otherwise shy away from if they were to attract personal liability. It is bad enough when it is civil liability, which reduces their net worth. It is much worse when it is criminal liability, which might attract custodial sentences.

When directors or other officers act for and on behalf of the company, the initial culprit in case of any wrongdoing is the company and unless the strict exceptions apply, the individual freedom of officers should be protected.

Directors’ duties

The law recognises that directors who have the task of managing corporate affairs owe certain responsibilities towards the company. There are duties that are imposed by legislation and other duties that exist at common law. These include fiduciary duties, which include honesty, good faith and trust and duties to exercise care and skill when conducting the affairs of the company.

For example, a director may not use the company’s property for personal gain and he must avoid conflicts of interest. The breach of duties by the directors is a wrong against the company and only the company is entitled to seek redress against the directors. Other than in exceptional circumstances shareholders and employees cannot take action against the directors for wrongs committed against the company. Likewise, liability is owed by the company, not by directors or shareholders. However, directors may incur personal liability where directors act in their own interests and not those of the company, where they abuse their power or breach the terms of their contracts or statutory duties. Arguably, the law takes the approach that the company is responsible for its affairs as conducted through the directors and therefore the principal target in case of any wrongdoing is the company. It is not the policy of the law to make directors or officers the principal targets, moreso, where personal liberty is at stake. Most businesspersons would be deterred from using the corporate form if it no longer offers similar protection.

Company’s interests

It is clear that directors must act in the best interests of the company. Consequently, where directors have taken measures to promote the business of the company such as ensuring its basic survival during times of difficult economic conditions it would be wrong to impose criminal liability against them. Arguably, good corporate governance is severely challenged during times of economic distress, since companies have to use unorthodox channels to ensure survival of the business.

In that case, it is not the directors that should be blamed but the external operating environment and those that are responsible for it. During the preceding four years, Zimbabwe has experienced serious economic difficulties characterised by, inter alia, severe shortages of foreign currency leading to the unavailability of fuel and other basic commodities. The result was the proliferation of parallel markets for most products, including foreign currency.

Most public and private companies engaged in the parallel market to trade in scarce foreign currency. This was induced by necessity, although it is true that greed may have motivated some to go to excess. Most individual and corporate persons who participated in the parallel market were aware that they were contravening the exchange control laws. It has been stated that this also included the government and state companies such as Noczim, GMB and Zesa. In some cases banks were engaged by these companies to source foreign currency. To that extent, though illegal, parallel trading was an accepted fact.

The directors acted on behalf of their companies in order to survive under difficult conditions and to that extent it may be argued that they were upholding their duties to promote the best interests of the company. If anyone is guilty of any offence, it should be the companies themselves and not individual directors who were doing their best to ensure their survival.

Unless the state can show that directors participated in the parallel market not as agents of the companies but in their personal capacity to promote individual interests, there is little justification for picking them out among the other millions. The law is clear about the separation between the company and its directors and in these cases even the exceptions can hardly be justified. The factors that created the dire conditions are the principal reasons for the decline in the standards of corporate governance for it is very difficult to promote good practice in a virtually unregulated parallel market.

Distributive justice

The principle of distributive justice is one of the major planks upon which our legal and justice system rests. Distributive justice is concerned with the distribution of burdens and losses within and across the community. It requires that like cases must be treated alike for it is unfair to punish one group of people and spare another even though they did the same thing. In my view, the persecution of selected corporate directors for engaging in the parallel market while thousands others did the same thing is grossly unfair and unjust. The difference, if any, is in the degree of participation or the returns that individuals may have gained in the process. But the size of the returns does not diminish the guilt of any individual. I argue not with any bias towards the businesspersons but only on the basis of principle.

Any decent and mature society, no matter the degree of wealth abhors the selective application of the law. It may be against a select group of directors today; tomorrow the same approach may be used in a different set of circumstances. It is wrong to pursue some companies or individuals while others in the same situation are treated differently. It is negative because it further reduces confidence in our justice system and on the economic front.

As indicated, by engaging through its entities, the state seems to have given implied permission for the parallel market. To now turn back and attempt to prosecute those from whose hands it fed smacks of gross hypocrisy. The RBZ, through its governor, Gideon Gono who, during the critical period, was at the helm of a major bank that did much to source foreign currency from the parallel market to assist critical industries appears to have recognised the futility and hypocrisy of punishing financial institutions. The RBZ has given them general amnesty. It is difficult, under such conditions, to understand the rationale behind pursuing companies or individuals alleged to have engaged in the market. The economy requires uniformity of messages, not contradictions that only cause confusion.

I believe that the message that the state and the RBZ intended to send has been heard. It is time to open a fresh leaf and move on, otherwise the market will continue to totter under the heavy burden of confusion and uncertainty. I insist that rather than be vindictive, a comprehensive enquiry is required, so that we can learn of the mistakes that we have made, in order that we do not make new ones in future. And when all is said and done, we must never forget the primary reason for the existence of the parallel market.

The scarcity of foreign currency may have been artificial at times, but principally, it is because we were not generating enough of it. This problem continues to exist. The generation of foreign currency, and not vindictive measures, is what we must focus on without further ado. Good corporate governance can only be secured when the economic conditions allow it to flourish.

-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

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