Ways to Avoid Governance Mistakes

February 12, 2020

March 22, 2019

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Governance

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The role of a director is not simply to rely on the auditors’ figures without questions or separate assessment

The Case:

The High Court recently released a much-anticipated decision on directors’ liability concerning the failure of construction firm Mainzeal.

Mainzeal Property and Construction Limited was one of the top players in the New Zealand construction industry prior to its collapse in early 2013.

In a decisive victory for the Mainzeal liquidators, Justice Francis Cooke ordered the directors of the failed construction business to pay $36 million to creditors.

While many think an appeal is likely, Institute of Directors’ CEO Kirsten Patterson says there’s food for thought aplenty for directors in Justice Cooke’s argued judgment, particularly concerning good corporate governance within organisations.

“The decision highlights the importance of directors focusing on the complex risks they may be facing and making sure they are spending adequate time in the boardroom mitigating that risk,” Patterson says.

“It also highlights the complexity of some of these operational environments and the responsibility that comes with some of these governance roles.”

So, what does this mean for SMEs and not-for-profits?

The recent High Court decision is an important reminder of board directors’ legal duties in New Zealand.

A high legal bar is set to establish liability for reckless trading. Board Directors must carefully consider the circumstances and the source of the information on which they are relying to make commercial decisions. They best avoid risk by ensuring they approach their legal duties properly. With hindsight, decisions may be judged harshly.

For a small-to-medium-sized organisations, particularly at an early stage in its life cycle, most effort is spent on those projects and activities that will deliver revenue to the business. Similarly, many not-for-profit organisations (NFPs) are fighting to deliver much-needed services to the community while managing limited budgets and keeping administration overheads to an absolute minimum

Ways to Avoid Governance Mistakes

Organisations must not rely on non-legally binding assurances of financial support where that support is critical to the organisation.

It's common for many businesses to make handshake deals or emails outlining various arrangements when it comes to obtaining financial support. The level of oversight depends on whether you are a business owner obtaining funds from people such as friends or family, or founders/executives receiving funding from shareholders, external investors or financial institutions.

Arrangements and agreements should be written down. At the very least, the process should include an email outlining the deal (loan, bridge- funding or cash for equity) that should be tabled and agreed by all parties. If this is done in an email, it should ideally be accompanied by a memorandum of understanding, letter of intent or term sheet that clearly outlines the main terms of the arrangement. A better operations strategy would be to get a more formal ‘letter of comfort’ or guarantee from the funding provider. In either case, the commitment should be unconditional or, if that is not possible, subject to conditions that the Board can control.

A useful free resource library of legal tools, including documents and templates can be found at https://simmondsstewart.com/templates.

Work relationships between directors and CEOs can be very close. Tabling a letter of intent or term sheet may seem like an imposition that challenges the business relationship and sense of trust between the parties. However, it is perilous to ignore the advice to formalise business arrangements.

“A loan is a loan – and it needs to be repaid at some stage! Don’t EVER think you don’t need to document the terms, just because it comes from ‘friendly’ parties, or is for a very short time.

It’s reasonably common for start-ups to raise bridging finance through a convertible note or loan – but you need to be very clear in the documented terms”- Debra Hall, Independent Director, Mentor, and Advisor

What triggers repaying the loan, and what triggers conversion to equity and at what price.

If there is an inter-company loan in place, be very clear that in the role of director, you are responsible for the balance sheet of your organisation, and not the one to whom you may have loaned the money. Related party or not, you must have absolute clarity about your financial position.

Your term sheet or letter of intent should clearly name all parties to the arrangement. There should be a space for acceptance signatures of both parties, the date at which the document is effective/signed, and any plan or arrangements for equity-swap for investment or loan repayment conditions.

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