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Group I
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Borrowing Powers of Directors of
Public Limited Company
Introduction
Corporate governance is to ensure that a system is in place to protect the
individual as well as collective interests of all the stakeholders in a company.
In this respect the role of Board of Directors becomes very important
because by its very nature a company is an artificial juridical person in the
sense that it can sue and can be sued. But it works through its directors who
are its eyes, brain and muscle. Directors are the persons who run day to day
affairs of the company and possess the first hand information about every
aspect of its operations. Directors are also in the best of position to
determine its future course i-e set objectives, formulate strategy, devise
operational plans etc. Shareholders are the owners of the company who
provide capital to the company for its operations but do not run its affairs
and delegate this function to professional managers. These professional
managers may also be shareholders of the company. This separation of brain
and capital poses agency problem and dual role of directors, shareholders as
well as directors creates conflict of interest with other stakeholders such as
outside shareholders.
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As directors manage a corporation for and on behalf of the shareholders who
own it, it is critical that any regulatory and legal requirements placed on
directors do not seriously compromise their goal of maximizing shareholder
wealth. Directors’ behavior influences the efficient operation of corporations.
If directors are subject to undue transaction costs in protecting themselves
from personal liability, these costs will ultimately be passed onto, and borne
by, the corporation itself. On the other hand, if directors are permitted to
operate completely unfettered by regulation and a degree of shareholder
control, investor confidence in the corporate may potentially be undermined.
In this regard, it is clear from past experience, particularly in relation to the
corporate collapses as mentioned above, that the conduct of directors
through corporations can have a significant impact on public perceptions and
market confidence.
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significant problems with conflicts of interest and incentive compensation
practices. The analysis of their complex and contentious root causes
contributed to the passage of Sarbanes–Oxley Act in 2002. In a 2004
interview, Senator Paul Sarbanes stated:
Response
In line with the findings of the Senate Committee, Sarbanes–Oxley Act was
enacted in 2002. The Act requires from the management and the external
auditor to report on the adequacy of the company's internal control over
financial reporting (ICFR). Under Section 404 of the Act, management is
required to produce an “internal control report” as part of each annual
Exchange Act report. The report must affirm “the responsibility of
management for establishing and maintaining an adequate internal control
structure and procedures for financial reporting.” The report must also
“contain an assessment, as of the end of the most recent fiscal year of
the Company, of the effectiveness of the internal control structure and
procedures of the issuer for financial reporting.” To do this, managers are
generally adopting an internal control framework such as that described
in COSO (Committee of Sponsoring Organizations of the Treadway
Commission). The Public Company Accounting Oversight Board (PCAOB)
approved Auditing Standard No. 5 for public accounting firms on July 25,
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2007. This standard superseded Auditing Standard No. 2, the initial guidance
provided in 2004. The SEC also released its interpretive guidance on June 27,
2007. It is generally consistent with the PCAOB's guidance, but intended to
provide guidance for management. These two standards together require
management to:
“Sec. 196(2) The directors of a company shall exercise the following powers
on behalf of the company, and shall do so by means of a resolution passed at
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their meeting, namely. —
(a) to make calls on shareholders in respect of moneys unpaid on their
shares;
(b) to issue shares;
(c) to issue debentures or participation term certificate, any instrument in
the nature of redeemable capital;
(d) to borrow moneys otherwise than on debentures;
(e) to invest the funds of the company;
(f ) to make loans;
(g) to authorize a director or the firm of which he is a partner or any partner
of such firm or a private company of which he is a member or director to
enter into any contract with the company for making sale, purchase or
supply of goods or rendering services with the company;
(h) to approve annual or half-yearly or other periodical accounts as are
required to be circulated to the members;
(i) to approve bonus to employees;
(j) to incur capital expenditure on any single item or dispose of a fixed asset
in accordance with the limits as prescribed by the Commission from time to
time;
(vii) The directors of listed companies shall exercise their powers and carry
out their fiduciary
duties with a sense of objective judgment and independence in the best
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interests of the listed company.
(viii) Every listed company shall ensure that:
1. risk management;
4. marketing;
8. investments;
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A complete record of particulars of the significant policies, as may be
determined, along with the dates on which they were approved or amended
by the Board of Directors shall be maintained.
The Board of Directors shall define the level of materiality, keeping in view
the specific circumstances of the listed company and the recommendations
of any technical or executive sub-committee of the Board that may be set up
for the purpose;
(c) the Board of Directors establish a system of sound internal control, which
is effectively implemented at all levels within the listed company;
(d) the following powers are exercised by the Board of Directors on behalf of
the listed company and decisions on material transactions or significant
matters are documented by a resolution passed at a meeting of the Board:
Code of Corporate Governance also allows directors to exercise all powers on behalf
of the company and only binds them morally to do this “with a sense of objective
judgment and independence in the best interests of the listed company.”
Further, it asks to maintain “A complete record of particulars of the significant
policies, as may be determined, along with the dates on which they were
approved or amended by the Board of Directors.”
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Proposal 1
There should be a maximum limit on the borrowing powers of directors such as a
certain percentage of net equity. That limit should be prescribed in the Company
Law.
The obvious advantage of this limit on borrowing is that this limit will itself take care
of the excessive borrowing to hide the mismanagement by the directors. The
directors of a company shall not be able to borrow beyond this limit.
Proposal 2
There should be a provision in the Articles of Association of every listed company
that sets a maximum limit on the borrowing powers of directors such as a certain
percentage of net equity or total assets.
The advantage in this proposal is that it gives flexibility on case to case basis rather
than one solution fit all situations like law provision. Another advantage is that while
giving certificate of incorporation regulators can verify that the borrowing limit is in
line with the industry standard or not. This pre-checking will definitely protect the
interests of the stakeholders.
The disadvantage in this proposal is that sometimes directors genuinely and for the
benefit of the company and its stakeholders need to go beyond the limit prescribed
in the Articles but cannot do so. This would be a very serious impediment in the way
of maximizing shareholder value. Even if the shareholders in AGM allow them, they
have to go a lengthy procedure to avail the opportunity – amendment in Articles of
Association – and by the time they are through the opportunity may have gone.
Proposal 3
There should be a system of internal controls that plug the loop holes and
strengthen the decision making procedures thereby reducing the chance of
imprudent borrowing.
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It is highly recommended that following provisions in the Companies
Ordinance 1984 should be inserted to comply with mandatorily by all listed
companies.
Section 404 of the Sarbanes–Oxley Act may be adopted in true spirit that
requires management to produce an “internal control report” as part of each
annual report. The report must affirm “the responsibility of management for
establishing and maintaining an adequate internal control structure and
procedures for financial reporting.” The report must also “contain an
assessment, as of the end of the most recent fiscal year of the Company, of
the effectiveness of the internal control structure and procedures of the
issuer for financial reporting.”
Provision should be inserted for criminal penalties for violation of any of the
above provisions. Here, section 802 of the Sarbanes–Oxley Act may be
adopted.
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Recommendation to SECP
We recommend to SECP that Proposal 3 may be adopted. The recommendation is
based on following:
The Code is not a rigid set of rules. Rather, it is a guide to the components of
good board practice distilled from consultation and widespread experience
over many years. While it is expected that companies will comply wholly or
substantially with its provisions, it is recognized that noncompliance may be
justified in particular circumstances if good governance can be achieved by
other means. A condition of noncompliance is that the reasons for it should
be explained to shareholders, who may wish to discuss the position with the
company and whose voting intentions may be influenced as a result.
In relation to the requirement to state how it has applied the Code’s main
principles, where a company has done so by complying with the associated
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provisions it should be sufficient simply to report that this is the case;
copying out the principles in the annual report adds to its length without
adding to its value. But where a company has taken additional actions to
apply the principles or otherwise improve its governance, it would be helpful
to shareholders to describe these in the annual report.
If a company chooses not to comply with one or more provisions of the Code,
it must give shareholders a careful and clear explanation which shareholders
should evaluate on its merits. In providing an explanation, the company
should aim to illustrate how its actual practices are consistent with the
principle to which the particular provision relates and contribute to good
governance.
Two very important points emerge from the reading the above excerpt that
are relevant to our discussion:
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Laws cannot cover everything and every situation. These are broad
guidelines much like control charts having lower and upper limits within
which different behaviors are acceptable. It is the intention that is required
because laws can be circumvented when required. Therefore, both
guidelines as well as intention to implement the guidelines in true spirit are
required to avoid financial fraud.
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