Revisiting the fiduciary duties of the board of directors and management
Among the essential features of an effective corporate governance (CG) regime would be the proper designation of the agency in the corporate setting that is primarily responsible for promoting CG: Who is primarily responsible for promoting CG principles and best practice within the company setting?
This would include establishing the hierarchy of responsibilities and accountabilities among the various agencies operating within the corporate setting, and answers the critical question: With whom does the buck stop when it comes to the duties and responsibilities for CG?
It is equally important for an effective CG regime to properly delineate the constituencies to whom such primary fiduciary duties of CG are owed to: To whom do we owe the fiduciary duty to properly govern the corporate affairs?
Achieving such proper delineations provides answers to the critical questions that directors and senior corporate officers ask in relation to pursuing good CG practices for the company: What are my primary duty in running the affairs of the company? When are we in breach of such duty as to become personally liable therefore? It also compels the responsible corporate agency to provide a hierarchical delineation of the varying and sometimes conflicting rights of such constituencies.
This paper seeks to revisit the provisions Code of CG for Publicly Listed Companies ( PLCs) (SEC Memorandum Circular No. 19, s. 2016), which became effective on Jan. 1, on how it structures the primary responsibility of promoting CG with the corporate setting, and how it effectively addresses the issues of what constitutes the “legitimate interests” of stakeholders, other than the stockholders, of PLCs.
Part I Erroneous Dichotomy:
The Board Must Limit Itself to Policy- Setting, and Must Respect Management Autonomy to Run the Affairs of the Company
( a) Prior to the CG reform movement in our country, the mantra that one often hears in corporate boardrooms is that “The Board must limit itself to policy setting, and the main work of running the company is with Management, headed by the CEO.”
This anachronistic CG attitude can also be found sprinkled in Philippine jurisprudence, a sampling of which can be seen in Western Institute of Technology v. Salas, which held:
“There is no argument that directors or trustees, as the case may be, are not entitled to salary or other compensation when they perform nothing more than the usual and ordinary duties of their office. This rule is founded upon a presumption that directors/ trustees render service gratuitously, and that the return upon their shares adequately furnishes the motives for service, without compensation.” The Supreme Court ( SC) pointed to Section 30 of the Corporation Code (CC) which provides that in the absence of any provision in the bylaws or upon vote of stockholders representing at least a majority of the outstanding capital stock, “directors shall not receive any compensation, as such directors,” except for reasonable per diems for actual attendance at meetings.
Such judicial attitude derogates the “Board service” as not inherently compensable since it amounts to “nothing more than the usual and ordinary duties of their office.” In effect, the “work” that directors do in the corporate setting is essentially to attend meetings. Such judicial attitude treats directors as not performing a professional role that ought to be compensated, but merely as an adjunct role to their primary status as owners of the company. When carried into management practice, such attitude creates a warped value system among directors that it is their proprietary right to company earnings that remains their primordial concern, to which their fiduciary duties to the company and other stakeholders is only an adjunct role.
Such erroneous dichotomy of the roles of the Board and Management is also enshrined in the case- law doctrine of “Business Judgment Rule” which not only provides the general rule that resolutions, contracts and determinations of the Board are binding on the corporation even against the opposition of the stockholders, but that even when losses are incurred by the company, the directors shall not be held personally liable therefore as long as they had acted in good faith.
Reliance by directors on the representation of Management in arriving at corporate decisions, has traditionally been considered as “acting in good faith” as to shield them from personal liability for corporate acts and contracts that cause damage to the corporation.
The classic formulation of the rule was enunciated by the SC in Montelibano v. Bacolod-Murcia Milling Co., Inc., which held that when a resolution is “passed in good faith by the board of directors, it is valid and binding, and whether or not it will cause losses or decrease the profits of the [ corporation], the court has no authority to review them,” adding that “it is a well-known rule of law that questions of policy or management are left solely to the honest decision of officers and directors of a corporation, and the court is without authority to substitute its judgment [for that] of the board of directors; the board is the business manager of the corporation, and so long as it acts in good faith its orders are not reviewable by the courts.”
The “insulation-from-personal-liability” effect of the Business Judgment Rule eventually lead to a “general rule of non-liability of directors and officers” for losses sustained by corporations, except only in enumerated instances, Tramat Mercantile, Inc. v. Court of Appeals came up with a “formula” in determining the issue of personal liability for corporate officers, thus:
Personal liability of a corporate director, trustee or officer along (although not necessarily) with the corporation may so validly attach, as a rule, only when: (a) He assents: (i) to a patently unlawful act of the corporation;
(ii) for bad faith or gross negligence in directing its affairs; or
(iii) for conflict of interest, resulting in damages to the corporation, its stockholders or other persons (Section 31, CC);
( b) He consents to the issuance of watered stocks or who, having knowledge thereof, does not forthwith file with the corporate secretary his written objection thereto (Section 65, CC);
(c) He agrees to hold himself personally and solidarily liable with the corporation (De Asis & Co., Inc. v. Court of Appeals, 136 SCRA 599 [1985]);
( d) He is made, by a specific provision of law, to personally answer for his corporate action (Exemplified in Section 144, CC; also Section 13, P.D. No. 115, or the Trust Receipts Law).
By the use of the phrase “may so validly attach, as a rule, only when,” it is clear that the SC emphasizes that the general rule is that directors, trustees, and other corporate officers are not personally liable for corporate debts, and that the only time they do become personally liable is on the specifically enumerated four areas indicated in the formula. The enumerative manner by which jurisprudence has effectively limited the cases when a corporate officer may be held liable has been reiterated verbatim in subsequent decisions of the SC.
The CG reform commenced by the SEC in 2002 for PLCs was in great part in reaction to such “smugness” of directors and senior officers to their primary fiduciary duties of diligence or care they owed to their company, its stockholders, and other stakeholders.