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Fri 30 Apr 2010 04:00 AM

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The law is your friend

Law firm Freshfields has put together a practical guide to soothe worried company directors.

The law is your friend
The law is your friend
Omar Momany, of law firm Freshfields Bruckhaus Deringer.
The law is your friend
Clare O’Hare, of law firm Freshfields Bruckhaus Deringer.

Wrongdoing at several firms has resulted in jittery boardrooms all over the Gulf. Freshfields has put together a practical guide to soothe worried directors.

The roll-call of household names that have fallen foul of the recession in the GCC has been pretty disheartening to hear. Face is vital in this part of the world, and it has been uncomfortable to watch once-proud firms descend into a welter of recrimination and litigation.

One only needs to look at the travails of jewellery giant Damas, where a series of unauthorised transactions laid the Abdulla Brothers managing partnership of the firm low last year. Not knowing the rules is clearly no longer an excuse that will wash with the local authorities. Elsewhere in the region, Kuwait’s Investment Dar and Global Investment House have faced debt restructuring and concerns about the activities of their directors. In Saudi Arabia, the Saad Group and Algosaibi and Brothers Company saga rumbles on.

But while restructuring is by-and-large taking place successfully, local jurisdictions are starting to put in place measures that are aimed at preventing such incidents from recurring. So what’s new? The day-to-day activities of company directors may not have changed — yet — but the recession has brought the issue of corporate governance under the microscope of stakeholder opinion. Shareholders and creditors might once have paid little heed to what went on in the executive boardroom earlier, but leaner times have resulted in more questions from the other two corners of the stakeholder triumvirate. “These issues will keep on coming,” says Omar Momany, a senior associate with law firm Freshfields Bruckhaus Deringer. “It’s going to take a while to clear through the mess, but the positive point is that both sides are starting to go through the learning process.”

In every respect, Gulf directors have the same duties as their counterparts elsewhere but there are some differences in the local set-up — the lack of transparency in the legal system being one. Another issue is the presence of around 5,000 family-owned conglomerates in the region, which are estimated to control around half a trillion dollars. Add the fact that corporate governance codes in the GCC were only being introduced recently, and it’s easy to see how some executives have become confused about their roles in the past.

To that end, Freshfields has been working on a guide to advise directors of the pitfalls they face, particularly in the face of adverse financial conditions. “We ended up doing quite a lot of work for a number of clients both in the UAE and elsewhere about directors’ duties in general, especially where those companies are facing financial difficulties,” continues Momany. “So this work is not only a summary of the existing legal provisions but also a practical guide accrued from the advice and assistance we’ve offered to our clients over the last year or so.”

The firm asserts that its guide is not a reaction to the circumstances afflicting any one company. And until late 2008, Momany says, directors had not generally faced too many questions about their duties. But a pattern of heightened activity in the courts and in the press recently has been matched by the implementation of a new governance code for public companies, which will be enforced by the Emirates Securities and Commodities Authority (ESCA) from the beginning of May. Particularly on the back of a few local cases, questions are being asked of firms, especially those that have grown from being tiny family-owned outfits into multinational conglomerates. “Public companies have had three months to comply with the new corporate governance code,” says Momany. “For private companies, right now a draft is being worked on, but no-one has seen it yet. We’re expecting it to be a summary of the public code.”

“For private firms, the law is really light on what directors need to observe,” says Clare O’Hare, Freshfields associate and co-author of the report with Momany. “It needs analysis and research, particularly as while there is a degree of caselaw, there is no system of precedent as there is in other jurisdictions.”
So where, precisely, are directors going wrong? Specific pitfalls are listed in the report, and there are a few obvious danger areas. Unrealistic speculation on financial markets, expenses exaggeration, diverting corporate opportunities to directors or paying exorbitantly high bonuses while the company is facing losses all crop up. If you are busily engaged in any of the above activities, you won’t need a lawyer to tell you that you’re heading in the wrong direction.

Of more relevance to local directors will be the less obvious traps, or those where they might subconsciously be breaching guidance. One area is the need to comply with the level of authority to which they have been appointed. Some directors might hold office for a number of years, and can start to feel that they have effectively unlimited power to represent that firm. This perspective is exacerbated by the fact that some directors might be expatriates under the assumption that the various pages of attorney in their contract leaves them as the ultimate decision maker. “That mentality has persuaded a lot of directors that they ‘are’ the company, almost,” O’Hare indicates. “But people acting with the best intentions can often be acting outside the scope of their authority. You might need a specific authority to enter into a loan agreement, for example, or an arbitration or litigation agreement.”

Another area involves directors dealing with companies in a personal capacity. O’Hare uses the example of a director who uses the services of another firm — say, as a supplier — of which he is also a director. It makes no difference if the deal is the best option available to both firms, either. “If he doesn’t declare that interest when he’s signing the documents, he’s acting outside the scope of his authority, because that information hasn’t been passed onto the shareholders,” she explains. “That leaves him open to challenge from shareholders or creditors — who might then question what else has not made clear to them.”

Given the diversification practised by many of the family giants in the GCC, conflict of interest has become a watchword for foreign investors who are looking to make acquisitions in the region. If you have a group that has arms in trading, hospitality and construction, say, alongside some close but undisclosed links to the government, directors clearly need to tread carefully. But Momany thinks that these are cases where traditional Western company law can be unfair to GCC firms which might have a minimum number of shareholders. “You shouldn’t be penalised for leveraging the goodwill of another company just because you are not in the position to make a decision due to a lack of majority via conflict of interest, for example,” he argues. “This is one of the difficulties of applying public company provisions to private companies.”

Part of the problem, Momany argues, is to do with the mentality of some executives, who have painstakingly built up their companies over a period of years, and find it difficult to switch into a mindset where details of that firm’s performance need to be shared with others. “It’s understandable, but it takes time for some owners to realise that they can’t act in the way that they are used,” the associate remarks. “People find that time-consuming but that’s part and parcel of growing small businesses and integrating them into the wider business community.”

Given the various trapdoors that directors might consciously or subconsciously have fallen through, it’s entirely conceivable that some might have been effectively breaking the law for a period of years. What sort of advice do the lawyers have for them? “Speak to your shareholders immediately,” says O’Hare. “By their nature, people tend to look at someone to blame and I think that’s one of the reasons that directors need to be sure they have recorded everything.”
By simply recording a black-and-white decision, directors are leaving themselves open to challenge as the reasoning behind that decision can theoretically be called into question later. Details of input provided by more than one party will also extend the accountability of that decision beyond the single director. Momany cautions against the lack of information in the company minutes. “It’s vital that you outline the deliberations made prior to a decision,” he says. “You don’t need to record every single word, but try and reflect the views of each party. You’re also then clear that everyone is aware about in which direction the company is going.”

Another problem with some directors is that they allow matters to reach a point where the firm they represent has reached crisis point, before they acknowledge that action needs to be taken. O’Hare says that a lot of executives are fundamentally optimists, which might explain that behaviour. “But if you wait too long, you can be staring into the abyss,” she adds. “The best solution is to sit down with the shareholders and look to see if there’s a way out. If you wait too long, everyone loses out and what value there was has gone.”

If directors opt to stick their metaphorical heads in the sand, they’ve effectively failed to protect the interests of the shareholders and creditors, the lawyers caution. “If you try and you fail, you’ve at least done what you’ve supposed to do, and theoretically complied with your duties from a liability perspective; if you don’t , there are potential criminal negligence or fraud charges on the horizon,” warns Momany. “If you don’t have any records setting out what you did and why you did it, you’re in a difficult position to defend the actions that you’ve taken. At least when you take a proactive approach, history shows that people are much prepared to listen to you.”

It’s the director’s role to try and make the best call in every type of financial condition. With corporate governance finally making it to the top of some regulators’ agendas, the hope is that this crisis will prove a learning curve for directors anxious to stay on the right side of the law and ensure that less will be caught in the net next time round. Like the restructuring being undergone by Dubai World, it sometimes takes a large entity to provide precedent to allow smaller outfits a chance to see how the ground lies.

“We are certainly not here to tell people to stop doing something; we are here to tell them to document it in the right form,” cautions Momany. “The law is not there to tell people to stop doing business, it’s there to regulate and make matters more transparent, for you, your creditors and your shareholders.

CAVEAT COUNSEL: What company directors need to do

• Directors must stay away from unrealistic speculation on financial markets, expenses exaggeration, diverting corporate opportunities to directors or paying exorbitantly high bonuses while the company is facing losses all crop up.

• They need to comply with the level of authority to which they have been appointed — say, while entering into a loan agreement, or an arbitration or litigation agreement.

• Directors must be extra careful while dealing with companies in a personal capacity — they must declare to shareholders any personal interest (financial or official) in the transactions involved before signing any documents.

• Directors need to inform their shareholders immediately if they spot any irregularities in the firm’s practices, compliances or performance.

• They must ensure that detailed information has been compiled in the company minutes about the deliberations made prior to any financial or business decision.

• Be alert to protect the interests of the shareholders and creditors at all times.

Amer Hassan 9 years ago

The last 2 years were full of lessons not only to directors but to all stakeholders. I agree Omar that director's pitfalls were the hardest rod in the wheel of their national & even global economy. Being their companies' navigators, small pitfalls in directing their businesses will simply reflect on increasing deviations from the track of shareholders' interests. Directors in this part of the world have a sort of blurred vision when it comes to their versus their business' entities. This may only lead to disinterest in precise documentation as well as unconcious perception of their own interests as legitimate even when they obviously conflict with their company's. I enjoyed the article. Thanks Omar & Clare

Mounir 9 years ago

Is there a specific reason why government-owned entities like Dubai World (Nakheel) were left out of mention in this article?