Limiting directors’ authority by reserving matters for shareholders’ decision

Limiting directors’ authority by reserving matters for shareholders’ decision

The concept of control in terms of the Companies Act

As a board member you may often be uncertain as to which decisions can be taken by the board without shareholder involvement and which matters can only be dealt with by shareholders. This is especially important if some shareholders in a company are not serving on the board.

Section 66(1) of the Companies Act 71 of 2008 (as amended) (“the Act“) provides that the business and affairs of a company must be managed by or under the direction of its board, which has the authority to exercise all of the powers and perform any of the functions of the company, except to the extent that the Act or the Memorandum of Incorporation of the company (“MOI“) provides otherwise.

This section places a positive obligation on the board of directors, collectively, to manage and control the company’s affairs. However, such authority is not without limit as the Act limits, restricts, and qualifies the authority of the board in various sections. In addition, the Act also provides that the MOI can further limit the authority of the board to perform acts on behalf of a company.

How to restrict directors’ authority

The Act does not provide guidelines in terms of the MOI can limit the authority of the board. Usually, our recommendation is to avoid wide and over-reaching restrictions on the authority of the board to perform acts on behalf of a company. Over-reaching restrictions may interfere with the boards’ primary mandate in terms of section 66 (1) of the Act, that is to manage and control the company’s affairs, if the approval framework is not alive to the need to sometimes make decisions regarding the operations of the company on an urgent basis.

One example in which the shareholders may agree to limit the authority of the board, is against concluding any transaction on behalf of the company above a monetary threshold. Before the board can conclude and implement any transaction above such monetary threshold, shareholders will be entitled to first deliberate and approve such matter at shareholder level.

The effects of reserved matters

Reserving matters for shareholder approval delays the decision-making process, which is sensible when it comes to major transactions that will materially impact the shareholders’ long-term interest in the company, but it can also mean that the board is frustrated in its purpose if the reserved matters are over-reaching.

It is important to remember that a shareholder can always vote thinking only of its own best interest, whereas the board of directors always need to apply their discretion in the best interest of the company. It is important, therefore, to use this as a guiding principle when determining which matters are to be decided on board or shareholder level.

Directors’ go-ahead with shareholder ratification  

This brings us a crucial question of what happens if the board needs to decide quickly if there is a time‑sensitive commercial activity? Also, what happens if the board is of the opinion that a pipeline transaction, being a reserved matter, is likely to increase the company’s revenue but the shareholders are at loggerheads? Can the board authorise that transaction without the shareholders’ approval?

Section 20 (2) of the Act provides that if a MOI limits the authority of the board to perform an act on behalf of the company, the shareholders, by special resolution, may ratify any action by the company or board that is inconsistent with any such limitation, subject to such ratification not being in contravention with the Act. Therefore, the board can go ahead with the reserved matter transaction without shareholders’ approval and only when the latter deems the transaction favourable, at a later stage, can they ratify by special resolution the transaction authorised improperly by the board.

Directors’ go-ahead without shareholder ratification 

However, remember that the ratification by shareholders is not a certainty, so the board should be very careful not to bind the company unconditionally to transactions that require shareholder approval. What happens if the shareholders resolve not to ratify a reserved matter transaction after it has already been concluded and currently under implementation? Will such transaction concluded by the board outside of the ambit of their authority be valid, voidable or void and unenforceable?

The answer to this question depends on the third party’s knowledge about the existing restrictions against the board to conclude a reserved matter transaction without shareholders’ approval. Under section 20 (7) of the Act, the common law Turquand rule has been codified. This rule provides that a person dealing with a company in good faith, other than a director, prescribed officer or shareholder of such company, is entitled to presume that a company, in making any decision in the exercise of its powers, has complied with all of the formal and procedural requirements. These requirements are in light of the Act, its MOI and any rules of the company unless, in the circumstances, the person knew or reasonably ought to have known of any failure by the company (represented by the board) to comply with any such requirement. The application of this provision must always be read in line with the common law position.

A significant factor in terms of this section is the fact that the third party must be dealing with the company in good faith. This means that any person who would have reasonably known that the board did not have authority to act on behalf of a company in a reserved matter transaction, such as the company’s director, prescribed officer or shareholder (also acting in a third party capacity), amongst others, would not succeed if attempting to enforce or uphold such reserved matter against the company.

Shareholders’ recourse against directors

If the court, upon an application by an interested person, upholds a restricted transaction against the company without the shareholders’ ratification, shareholders will remain entitled to recourse against the board. Section 20 (6) of the Act provides shareholders with a claim for damages against any person who intentionally, fraudulently or due to gross negligence causes the company to do anything inconsistent with the Act or with a limitation imposed by the MOI.

Conclusion

It is therefore important not to impose restrictions on the board’s authority in a manner that may hamper operational decision-making. If this is done without careful consideration the company may be restricted from moving to make key commercial decisions quickly and the board may expose itself if it takes the gamble to conclude transactions outside the scope of its authority.

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