Corporate Governance

Orla Keane’s talk on corporate governance to a Hayes solicitors breakfast seminar held on 27 January 2004.
Tom Shipsey (Chartered Director and CEO of Stonehouse), Andrew O'Rorke (Hayes solicitors Managing Partner) and Orla Keane (Associate Solicitor, Hayes solicitors)
Pictured above are Tom Shipsey (Chartered Director and CEO of Stonehouse), Andrew O'Rorke (Hayes solicitors Managing Partner) and Orla Keane (Associate Solicitor, Hayes solicitors)

INTRODUCTION
Recent corporate and boardroom scandals such as Enron and Parmalat have refocused attention on the manner in which companies are directed and controlled. In Ireland, the Dirt Inquiry led to the investigation of a number of companies, which gave rise to the Report on Auditing Standards which ultimately led to the introduction of the Companies (Auditing and Accounting) Act, 2003 and further legislation in the area of corporate governance and compliance. Each new piece of legislation reinforces the message that a zero tolerance policy now exists regarding companies’ compliance with their legal and regulatory obligations.

SCOPE
The scope of corporate governance is extremely broad. The following is an extensive, but not exhaustive, list of the type of issues with which company directors have to be concerned.

  • Constitution of the Board of Directors
  • Relations with Shareholders
  • Appointment of Non-Executive Directors
  • Furnishing up to date and accurate information
  • Director’s Remuneration
  • Disclosure of interest in Shares / Contracts
  • Length of Appointment for Directors
  • Minutes of EGM/AGMs
  • Minutes of Board Meetings
  • Accountability and Auditors
  • Register of Directors
  • Laying reports before the Board/Shareholders
  • Keeping proper books of accounts
  • Storing of Electronic information
  • Register of Members
  • Share Transfers and Certificates
  • Website disclosures

 
  • Filings in the CRO

 

It is the ultimate responsibility of directors to ensure that they are fully aware of and comply with all facets of company legislation and regulation. Serious consideration should be given to becoming a director or non-executive director of a company as major responsibilities attach to the office.

The scope of corporate governance is so broad it is extremely important to ensure that the correct structures and processes are put in place to ensure that directors can effectively and objectively manage the performance of the company and at the same time ensure compliance with all legal and regulatory obligations. The responsibility lies with all of the directors - not just the director responsible for the particular area where a breach has been identified.

LEGISLATION/CODES OF CONDUCT
  • Companies Acts, 1963 – 1999
  • Combined Code 1998 – 2003
  • Criminal Justice (Theft & Fraud Offences) Act, 2001
  • Company Law Enforcement Act, 2001
  • Company Law Review Group Report 2001
  • ODCE Annual Reports
  • European Influence - Winter Report etc
  • Companies (Auditing and Accounting) Act, 2003
  • Proposed New Companies Consolidated Bill, 2004

THREE KEY AREAS:
  1. Company Law Enforcement Act, 2001
  2. Companies (Auditing and Accounting) Act, 2003
  3. The Office of the Director of Corporate Enforcement

COMPANY LAW ENFORCEMENT ACT, 2001
This Act has given “teeth” to all of the provisions in the previous Companies Acts 1963 to 1999.  It has also brought about a number of significant developments, some of which are addressed below.  The Act introduces fundamental changes in directors’ duties and responsibilities. 

The Act places the burden of proof on each director where there has been a breach of the Companies Acts.  Once a breach has been shown to have occurred, each director of the company (as well as the company secretary) will be presumed to have permitted the default unless he can establish that he took all reasonable steps to prevent it or that he was unable to do so by reason of circumstances beyond his control.  This represents a fundamental change in the duties and responsibilities of directors and company secretaries.  Prior to the introduction of this Act, a director or company secretary would not necessarily be guilty of a breach of duty or breach of statutory duty through a failure to act.  Liability in such circumstances would have depended on the knowledge and skill of the particular director.  Therefore, it is important that companies conduct a review of their corporate compliance procedures so that their directors can meet the burden of proof that now applies under the Act.

  1. Establishment of the Office of the Director of Corporate Enforcement (ODCE)

The key functions of which are: 

  • Encouraging compliance with company law;
  • Investigating and enforcing suspected breaches of legislation;
  • Prosecuting breaches of the Companies Acts;
  • Sanctioning improper conduct relating to insolvent companies; and
  • Ensuring circulation of information and advice where requested. 

Prior to the 2001 Act, the responsibility for investigating and prosecuting companies remained with the Minister.  Due to the level of other commitments it meant that provisions to deal with breaches were not used. 

  1. Establishment of the Company Law Review Group
This is a statutory advisory expert body charged with advising the Minister for Enterprise Trade & Employment.  Its first report was published on 31 December 2001.  Chapter 4 of the report relates to the Simplication of Corporate Governance.  The key areas it addresses are:
  • Registered office, name and company seal.
  • Register of member and other registers.
  • Website disclosure.
  • Register of directors and secretary.
  • Notices, meetings and resolutions.
  • European Communities Single Member Private Limited Company Regulations 1994.

At the end of the chapter there is a summary of all of the recommendations which include;

  • Written resolutions of directors ought to be possible by way of separate pieces of paper signed separately.
  • For companies other than PLCs, it should be possible in law for such company’s members to dispense with the need to hold an AGM (instead a unanimous written resolution can be used). 
  • Where records are retained by a company on a generally accessible website the Registrar of Companies should be notified on the existing statutory Form B3 of the relevant website address.

All of the above highlights the fact that it is widely accepted that the current raft of legislation is extremely complex and difficult to deal with and that the legislation needs to be refined and simplified.

A point of interest can be found at Chapter 11 - Directors and Other Officers.  Directors’ duties are divided into those arising under common law and statute.  Directors have a fiduciary duty to the company under common law and the CLRG has proposed that these duties should become statutory duties and form part of the Companies Acts.

The Second Report, due to be published in early 2004, will be the combination of the CLRG’s work in 2002/2003.  The objective is that the recommendations from both reports will be considered by the Government and form the basis of the new Companies Consolidated Bill.  It is hoped that the Bill will be published in 2004.

The main idea is to replace the public company (plc), (which forms the basis of the 1963 Act) with the private company limited by shares. This will accord with the actual reality that 85-90% of all companies are private companies limited by shares.  In particular, this will facilitate small and medium size businesses, giving them clarity and relative simplicity in their regulatory and compliance regime.  Part 4 will deal with corporate governance and specifically directors, meetings of directors and committees of directors, register of members, inspection of registers, the consequences of default, AGMs, EGMs, business at EGMs, minutes of meetings, remedies in cases of oppression and so forth.  

  1. Transactions involving Directors

The Act aims to tighten Part III of the 1990 Act, which deals with transactions involving directors. For example, Section 77 amends Section 33 of the 1990 Act by requiring that loans to directors must be kept below the threshold of 10% of a company’s relevant assets. Where parties fail to remedy a situation within a prescribed period then, for example, the loan shall be violable at the instance of the company. This is important, as this is one of the areas in which the ODCE has investigated and prosecuted people.

  1. Increased Investigative Powers

These powers have always existed but were not used.  They have been added to by the 2001 Act and are now being used.

  • The ODCE may call upon a company to produce its books for inspection and provide the ODCE with facilities for inspecting and taking copies of the contents of those company books.  If an officer or agent of the company fails to produce books, attend with the inspectors in reviewing the books or answer any questions that the inspector may have in relation to books, then the inspector may certify the refusal or failure to the court and the court may thereupon enquire into the matter, may obtain any statements in relation to their investigation and make any order or direction it thinks fit.
  • The ODCE is entitled to obtain documents from a bank, which holds books for a company whether or not the company under examination is a customer of the bank.
  • The Director’s powers to investigate the affairs of related companies have been extended to include any company with which the company under investigation has a commercial relationship.
  • An officer of the ODCE may operate any computer at a place which is being searched or require any persons at the place which is being searched to give them full access to the computer facility which includes all passwords and coded documents.

  1. Provisions to ensure compliance with filing obligations

New rules were introduced in relation to a whole range of forms and, in particular, the annual return. Section 107 provides that no document will be deemed to be filed where a corrected document is not returned within 14 days.  The effect is that you cannot avoid default fines by filing an incorrect document.

  1. Fines and Penalties
  • Court Imposed Penalties

In general the maximum penalty on conviction (a) of a summary offence under the Companies Act is €1,900 and/or 12 months in prison, and (b) an indictable office under the Companies Acts is €12,700 and/or 5 years imprisonment.

The Companies Acts do, however, provide for higher sanctions in respect of certain offences such as fraudulent trading, where fines of €63,000 and/or 7 years imprisonment on conviction of indictment can be imposed and insider trading where fines of €254,000 and/or 10 years imprisonment on conviction on indictment can be imposed. 

  • Administrative Fines

These are imposed where the ODCE believes that there is no need to bring a summary prosecution.

  • Civil Penalties

(a) Disqualification – the Director of Corporate Enforcement can apply to the courts seeking the disqualification of any person (i) guilty of two or more offences of failing to maintain proper books of accounts, or (ii) guilty of three or more defaults under the Companies Acts. 

(b) Restriction for a period of up to five years. 

(c) Strike Off – If a company is struck off, ownership of a company’s assets automatically transfers to the State.  An application to reinstate the company would have to be made to the High Court. 

COMPANIES (AUDITING AND ACCOUNTING) ACT, 2003

The functions of the Irish Auditing and Accounting Supervisory Authority (IAASA are set out in Section 9(2) and details with regard to investigation of breaches of standards prescribed by accountancy bodies are set out in Section 24.

Audit Committees – Section 42 of the 2003 Act

Subsection 2 deals with audit committees for public limited companies.  (It lists 16 responsibilities with which the committees should comply). 

Subsection 3 deals with audit committees for large private companies.  A large private company is defined as a company where the balance sheet exceeds €25m for the most recent financial year and the immediately preceding financial year or the amount of turnover exceeds €50m for the most recent financial year and the immediately preceding financial year. 

In relation to large private companies the Board of Directors shall either

(a)establish an audit committee, or

(b)decide not to establish an audit committee.

The Board of Directors shall state in their annual report whether the company has established an audit committee or decided not to do so.  If it has established an audit committee it must set out the responsibilities of the committee and whether it has followed the responsibilities specified in Section 42(2).  If it has not established an audit committee the reasons for that decision must be set out. 

It is not clear from the explanatory documentation issued with the Bill(s)/Act, and indeed from the Department itself, what reasons can be put forward for not having established the audit committee.  We are told, however, that ODCE will monitor those companies above the threshold which have not established an audit committee and the reasons why they have not.

Two points should be noted. First, the threshold for requiring an audit committee is very high.  Secondly, there is no absolute obligation on a company to establish an audit committee.  

Auditors Independence – Section 44 of the 2003 Act

This provision requires disclosure by undertakings in the notes to the annual accounts of work carried out in the financial year by the auditor of the relevant undertaking (a copy) or as a separate requirement by a new firm or new individual affiliated with the auditor.  An identical requirement is also imposed in respect of the preceding year. 

The term "all work" is defined as audit, audit-related or non-audit work.  Where there was remuneration for non-audit work in the case of either financial year, the nature of the work in question must be specified.  These disclosure requirements apply only if, in the financial year in question (i.e. present or preceding), the remuneration for each of the three categories of work as referred to above when added together amounts to more than €1,000. 

In cases where the disclosure requirement applies and where remuneration in the financial year for non-audit work is greater than that for audit and audit related work added together the directors (or the audit committee if one exists) are required to state in their report that they have satisfied themselves that the carrying out of this non-audit work has not interfered with the auditor’s independence in respect of the relevant undertaking. 

Directors Compliance Statement – Section 45 of the 2003 Act

This Section applies to both public and private companies.

In relation to private companies the relevant exemption is set out in sub-section 9.  If the balance sheet for the year does not exceed €7,618.428 or if the amount of its turnover for the year does not exceed €15,236,856 then the provision does not apply. 

The director’s compliance statement must:

  1. be in writing
  2. submitted for approval by the board of directors,
  3. be revised by the directors every three years, and
  4. be included in the director’s report pursuant to Section 158 of the 1963 Act.

Directors of the companies will be required to include a compliance statement in its annual accounts which will include the following information:

  1. its policies respecting compliance with its relevant obligations.
  2. its internal, financial and other procedures for securing compliance with its relevant obligations; and
  3. its arrangements for implementing and reviewing the effectiveness of the policies and procedures referred to in (a) and (b).

The report will also have to include:

  1. A statement acknowledging that they are responsible for securing the company’s compliance with its relevant obligations (as defined below).
  2. Confirming that the company has internal financial and other procedures in place which are designed to secure compliance with its relevant obligations and if not specifying the reasons.
  3. Confirming the directors have reviewed the effectiveness of the procedures referred to in (b) during the financial year to which the report relates and if this is not the case specifying the reasons. 

Relevant obligations are:

  1. Obligations under the Companies Acts
  2. Obligations under the Tax Code
  3. Obligations under all other enactments, which provide a legal framework from within which the company operates and which materially affect its financial statements.

The auditors will be required to undertake an annual review of these statements to determine whether the statement is fair and reasonable and the auditors report must include a report on such review and the conclusions of the auditors in that regard.  If the auditors form the opinion that these obligations have not been complied with then they must report the matter to the ODCE.

ANNUAL REPORTS OF ODCE

Some interesting points arise out of the interim report of the ODCE for the year 2003 as published on 10 January 2004.  The results saw:

  • Convictions or other Court Orders made on application by the Director in 33 cases (up from 8 in 2002).  
  • The restriction by the High Court of about 200 directors on the application of liquidators following their examination of the Liquidators Report.
  • The issue of several hundred warnings letter to company directors and others drawing attention to certain defaults and indicating that enforcement action will be taken in the absence of future compliance.  
  • The referral of over 1,000 filing-related cases to the Companies Registration Office for attention.  This would include annual returns.
  • The number of auditor’s reports to the ODCE exceeded 1,500 (up from 399 in 2002) while the number of public complaints and other reports more than doubled to 448.  It was notable that 50% of the public complaints received did not result in any action being taken.  

The following matters dominated auditor’s reports:

  • The failure to provide timely, financial and other information to the CRO.
  • The provision of loans from company assets to directors in excess of the permitted level (about 200 reports of non-compliance were received).
  • The failure of companies and the directors to hold EGMs in circumstances where company’s net assets have fallen to less than 50% of the companies share capital.  Arising from same hundreds of warning letters were issued urging directors to formally address the weak financial position in the interest of the company’s stakeholders with a view to assessing the need for prudent action; and
  • The failure to keep proper books of account.

An example of the powers exercised in 2003:

  • Search warrants executed (10)
  • Orders served for the production of banking documentation (13)
  • Arrests (10)
  • Detention (5)

All of the above highlights the fact that corporate governance is an issue which directors (of whatever nature) have to take seriously.  Failure to comply is being highlighted and where the failure is remedied both companies and directors are being prosecuted, in some cases, with very serious consequences. 

Orla Keane
January 2004

(This is an edited version of a talk given by Orla Keane (Associate Solicitor) to a Hayes solicitors seminar on Corporate Governance held on 27 January 2004)