The corporate icing on the cake

Written by: Alexander Garrett Posted: 14/01/2019

BL60_Directors dutiesPatisserie Valerie is just one of several recent high-profile corporate governance failures – and that’s putting board directors under increasing pressure to go beyond their statutory duties towards the companies they oversee

It was the latest case of a boardroom malfunctioning. The parent company of upmarket cake emporium Patisserie Valerie announced that it had found a ‘material shortfall’ – otherwise known as a black hole in the accounts – and needed an immediate injection of cash to stay afloat.

In the days that followed, Patisserie Holdings’ finance director was arrested, its auditors came under investigation and it also emerged that part of the business had been served a winding-up order by Her Majesty’s Revenue and Customs – about which most of the directors knew nothing. 

How could such a disastrous set of events have occurred in a listed company, supposedly open to public scrutiny? The finger was immediately pointed at corporate governance, the mechanism by which companies are directed and controlled, and which is the culprit for so many high-profile failures. 

Think of high street department store BHS, which collapsed after its owner, Sir Philip Green, sold it for £1 in 2005, thereby conveniently alleviating his responsibility for the company’s pension fund. Then there was Carillion, the construction giant that went into liquidation with £1.5bn of debts, leaving many public contracts in the lurch. 

In these and many other cases, it’s the failure of boards to follow best practice, and of individual directors to live up to their responsibilities, that causes corporate collapse, with widespread reverberations. In the specific example of Patisserie Valerie, the finance director was also the company secretary. 

Simon Osborne, Chief Executive of ICSA: The Governance Institute, says: “If you confer that much power in a single individual, they can control everything from the front desk to the post room to the board room and then there’s huge opportunity to abuse that influence.”

Recent company failures, coming in the wake of the financial crisis, have highlighted to the public why it’s important that listed company boards have the right structures in place and that the directors are fully accountable for their actions. 

The two are related but distinct, says David O’Hanlon, a Partner at Guernsey law firm Collas Crill. “Directors’ duties are the legal obligations and standards by which the directors will be individually judged,” says O’Hanlon, “whereas corporate governance is the mechanism and processes by which a company is controlled.” Since December 2018, the Wates Principles have provided a similar framework for larger private companies.

In the UK, the Financial Reporting Council (FRC) publishes a Corporate Governance Code, which was significantly revised in 2018. It’s not compulsory, but all listed companies have to report how they have applied the code – or explain why they have not. 

Directors’ duties, by contrast, are legally imposed on directors of all limited companies via the Companies Act 2006 in England and Wales. They range from promoting the success of the company to exercising ‘reasonable care, skill and diligence’ to declaring interests and avoiding conflicts of interest. 

Local laws

In the Channel Islands, Jersey and Guernsey each have their own company law, which follows English law to differing degrees. In Jersey, the Companies Law (1991) states that directors shall ‘act honestly and in good faith with a view to the best interests of the company; and exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances’. Many director duties are drawn from customary law.

Jeremy Garrood, a Partner in the litigation department at Carey Olsen in Jersey, who has been involved in the liquidations of BHS and Carillion, says: “Jersey’s companies have one of the highest degrees of regulation. Directors all have to be vetted and non-executive directors all have to be certified, for example.” 

There’s also a high level of transparency, he points out. “For £4 you can see the ownership of any Jersey company.”

In Guernsey, O’Hanlon says: “In terms of corporate governance and directors’ duties, for historic reasons Guernsey follows closely best practice in England, and Guernsey courts will look at cases that arise there.” Because of the dominance of highly regulated investment companies and other financial vehicles, directors need to be particularly aware of what’s expected of them, he adds. 

So, what are the ingredients for best practice in corporate governance? Malin Nilsson, Managing Director of global advisory firm Duff & Phelps in the Channel Islands, says: “There needs to be real independence, which means the directors are strong enough to challenge each other. You need to change the board periodically, you need diversity – both gender and generational, you need a good range of qualifications represented such as legal and accounting and you need to evaluate effectiveness at regular intervals.”

Above all, she says, “everything comes back to the board. It’s the tone from the top that really matters”.

Human failure

But while corporate governance is designed as a framework to ensure a company runs well, it is still prey to human failings. “The biggest danger is having a dominant leader,” says Garrood. “You can have all the structures you need, but if you have one powerful individual who sweeps everything before him or her, it doesn’t work.”

Conflict of interest is another reason why corporate governance often goes awry, says Nilsson. “That may be the conflict between different priorities, such as risk versus performance, or it may be having board members who go back 30 years or have become too close to your auditors.”

The ICSA’s Osborne says board members are too often out of touch with their company’s culture – a factor that the FRC has sought to address in the latest edition of the Corporate Governance Code. “Are they aware of practices for paying the supply chain? Does the company conduct exit interviews? How do they handle complaints from customers?” Any of these could be an early warning sign to the board of problems that are brewing. 

You cannot generally depend on external bodies to detect when things are going wrong, says Sara Johns, a Partner in Ogier Jersey’s corporate and commercial team. “Regulators and auditors, of course, play their part in providing external checks on companies, but in reality they can only ever be a last line of defence. No company should be relying on its regulator or auditor to realise and remedy the failings of its board – to ‘catch out’ any wrongdoing.”

And while few believe that improving the governance code or tightening sanctions will stop companies failing altogether, steps could be taken to make corporate governance more effective. 

According to Osborne, the FRC has repeatedly asked government for greater powers, but has been denied. “If a board director is a qualified accountant, the FRC has the power to discipline them, but many directors are not,” he says. “We also need to have more robust disqualification proceedings.”

At the behest of government, the ICSA is creating a new code to beef up boardroom effectiveness evaluations, too often seen as a box-ticking exercise that lacks transparency.

Nilsson agrees that there need to be stronger incentives for directors to avoid failure, pointing out that levying fines on a company only hurts the shareholders. 

With this in mind, since October 2018 the Jersey Financial Services Commission has been able to fine ‘principal persons’ up to £400,000 for breaches of its code of practice. Nilsson adds: “I think millennials will drive a lot of change [by putting public pressure on boards to do the right thing]. They have a different set of values.”

Wider interests

There are signs that corporate governance is evolving in another way: towards increasing recognition of wider stakeholder interests, and not just those of shareholders. 

Johns believes well-run companies will be considering this anyway. “It would be strange to imagine an effective board, doing its job properly, would not be considering the perspectives of its customers,” she says. “That said, for corporate governance to be truly effective, there arguably needs to be a cultural shift by companies towards a greater collective social responsibility.  Perhaps this means reforming rules around corporate governance, but what we’re really talking about is the need for an appreciation of the company’s footprint and the impact of that in a wider sense.”

Jonathan Bates, who recently set up a financial protection and advice service in conjunction with the Guernsey Investment Fund Association through his company Thorndon, says: “I was involved with industrial resource-based companies, which have to be long term in their thinking. The ethical aspect is driven by the long-term nature of business. Every board has to think about the ethical constraints they should adopt to be successful in the long run. 

“In my experience, they should set and adopt ethical principles – for example, treating everyone internally and externally with ordinary decency and distributive justice, which is about whether the distribution of assets and rewards is fair and equitable.” 

In the case of Sir Philip Green and his treatment of BHS pensioners, Bates says, that was clearly not deemed to be the case. 

According to this line of thinking, directors increasingly will have to think not just about accountability to their shareholders, to regulators, and to company watchdogs, but also about their impact on society at a time when people’s faith in capitalism has been shaken. 

As the rewards for business success scale new heights, the scrutiny is only going to get more intense. 

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