Strong corporate governance is no longer a luxury, it’s a necessity. A well-functioning board of directors plays a critical role in guiding a company towards success. Directors set the strategic direction, oversee management, and ensure the company operates ethically and responsibly. But what happens when the wrong person sits at the board table? Appointing a disqualified director can have serious consequences, exposing your company to legal and financial risks, and potentially damaging your reputation.
Who Can’t Be a Director? Understanding Disqualification Rules
Ensuring your company has qualified and responsible leadership is crucial for good governance and long-term success. The Companies Act in South Africa plays a vital role in this by outlining who is prohibited from serving as a director. Appointing a disqualified director can lead to a host of legal and financial headaches, so understanding these restrictions is essential.
Grounds for Disqualification: Protecting Your Company’s Interests
The Companies Act establishes clear categories of individuals who cannot be directors. These restrictions aim to safeguard companies from those who might pose a risk due to:
Lack of Capacity
- Minors: Individuals under 18 or those deemed legally incapable lack the necessary experience and judgment to discharge the duties of a director.
Financial Issues
- Unrehabilitated Insolvents: Someone who has not been released from sequestration shows a poor track record of managing their finances, and one of the most important roles of a director is to safeguard the company’s finances.
Breach of Trust
- Removed from Positions of Trust: If a person has been summarily removed from a position of trust on account of dishonesty, it is indicative of that person not having the character and reputation for absolute integrity and trustworthiness that the person holding the position of director must have.
- Serious Criminal Convictions: People convicted of certain offenses – for the most part, involving fraud, theft, or other forms of dishonesty – pose quite a big threat to a company’s financial health and reputation. The fact that imprisonment or heavy fines may be imposed will also be relevant. This applies both within South Africa and outside.
Beyond Criminal Offenses: Other Disqualifications
The Act extends beyond simple criminal convictions to other situations in which a person may be considered unfit to be a director:
- Court Orders: There are a number of ways in which the court can declare a person to be disqualified from acting as a director – this would include a situation where the person is declared a “delinquent director” under the Companies Act.
- Company Regulations: The company’s MOI may specify additional criteria for directors to meet in holding office—for example, the requirement of a particular level of experience or belonging to a particular professional body and holding specific certifications. Failure to meet these qualifications would disqualify a person.
- Juristic Persons: This isn’t exactly a disqualification, but rather a statement that no business or other form of legal entity can be considered a director—only human beings.
Exceptions: When Can a Disqualified Person Act as a Director?
While the Companies Act provides clear disqualification conditions, it also contains provisions for granting relief to certain disqualified people in specific circumstances. Here’s a closer look at these statutory exception arches that may allow disqualified persons to act as directors:
Court Relief: Section 71
This presents the most prominent exception to disqualification grounds. A disqualified person may approach the court for an order to be allowed to act as a director again. Still, here the claimant is required to show—as a very high threshold:
- Rehabilitation: They’ve taken concrete steps to address the underlying reasons for disqualification, proving they’re unlikely to repeat past mistakes.
- Exceptional Circumstances: The court might consider the specific circumstances around the disqualification and weigh it against the potential benefits the individual could bring to the company. For instance, a minor offense committed several years ago might hold less weight than a recent serious offense.
- Time Elapsed: The longer the period since the disqualification, the stronger the case for rehabilitation.
Limited Liability: Section 69
The disqualification might be specific to a particular company due to an offense committed against that company. This could allow the individual to hold directorships in other companies, provided they meet the eligibility criteria. However, it’s crucial to carefully examine the disqualification order to determine its scope.
Materiality and Relevance (Case Law)
Courts consider the nature and severity of the disqualification reason. Here’s how it might influence exceptions:
- Minor Offense vs. Serious Offense: A minor offense in the distant past might be viewed more leniently compared to a recent serious crime involving dishonesty.
- Relevance to Directorship: If the disqualification reason isn’t directly relevant to the responsibilities of a director (e.g., traffic violation), it might hold less weight when seeking court relief.
Important Considerations:
Exceptions are complex and highly dependent on the specific circumstances of each case. Consulting with a qualified business lawyer is crucial to assess the viability of exceptions and navigate the legal process.
Even if an exception applies, the court retains discretion to deny permission. A strong case demonstrating rehabilitation and the potential benefits to the company are essential.
Why Does This Matter? Consequences of Appointing a Disqualified Director
Appointing a disqualified director can be a costly mistake for a company, leading to a domino effect of legal and financial headaches. Here’s a closer look at the potential consequences:
Invalid Appointment and Legal Challenges
The very foundation of the director’s role in the company can be shaky. If the appointment is declared invalid due to disqualification, all decisions made by the director and the board might be challenged in court. This can lead to delays, disruptions in operations, and significant legal costs in defending the company’s position.
Company Liability for Losses and Damages
It’s like this – a disqualified director makes a decision in this case that brings about a financial loss to the said company. If the company knew or should have known about the disqualification, then they could be held liable for those losses. The company could face lawsuits from shareholders, creditors, and even aggrieved third parties that would have dealt with the company because of the director’s actions in his capacity.
Regulatory Fines and Penalties
The Companies Act expects companies to be compliant. The appointment of a disqualified director is a clear violation of this, and regulatory bodies can impose fines or other applicable penalties for non-compliance. This can spell even more damage in terms of the reputation and even the financial status of the company.
Damage to Reputation and Loss of Investor Confidence
Bad news travels fast, and this can be said to be especially true in the world of business. Having a disqualified director will severely damage a company’s reputation. An investor may lose confidence in the company’s governance and decision-making, reflected in the declining share price and difficulty in attracting future investment.
Contractual Issues
All of the contracts that a disqualified director of a company had entered the company into become exposed to litigation, with the other contracting party contending in court that the contract is not binding on them since the director had no authority. This can lead to disputes, delays in projects, and potential financial losses.
Bear in mind
Even when the company wasn’t aware of the disqualification at the time of the appointment, they might get blamed for some of the consequences, especially if they failed to conduct proper due diligence on the director before recruiting them.
How to Protect Your Company: Ways to Eliminate Disqualification Issues
Appointing a qualified and responsible board is crucial for good corporate governance and the protection of your company’s interests. Here are some practical steps you can take to avoid the pitfalls of appointing a disqualified director:
Establish a Strong Process for Nominating Directors
- Formal Nomination Forms: Have a standardised nomination form that requires potential directors to disclose any history of bankruptcy, criminal convictions, or other disqualifying factors.
- Reference Checks and Due Diligence: You must conduct thorough reference checks with past employers and business associates and verify qualifications and experience.
- Disqualification Checks: Use the Companies and Intellectual Property Commission’s (CIPC) Disqualified Director Register to cross-reference the potential eligibility of directors.
- Independent Verification: Have a third-party verification service to undertake an independent verification check.
Legal Advice
Do not rely on self-disclosure. Obtain assistance from a business lawyer to vet potential directors and any disqualification risks. They will also be able to guide you on the specific requirements under the company’s MOI.
Ongoing Monitoring
Put in place a system to review the status of your directors from time to time. This may be repeated disqualification checks at, say, each year-end, birthday, major life event (e.g., criminal charges, etc.)
Attach importance to directors disclosing any change to their circumstances that could affect their qualifications.
Training of Directors
However experienced the directors are, there should be training in the legal duties that they owe and about what disqualifies a director.
Other Considerations
- Document the process for appointing directors, including the due diligence steps you’ve undertaken and the rationale for the appointment.
- Draft a director disqualification policy that sets out your company’s process for managing potential, or actual, disqualification situations.
- Create a culture within the company that prioritizes and promotes ethical behavior and compliance with the law.
With these proactive measures, you will minimize your exposure to the risk of appointing a disqualified director and thereby protect your company against legal and reputational consequences and at the same time cultivate a well-reasoned board to create long-term value for your company.
Conclusion
Understanding the rules for director disqualification is a very important part of achieving good corporate governance. A qualified and respected board ensures that your company remains in good financial standing, legally sound, and free of reputational damage. A well-composed board builds trust with investors, enhances the quality of your decisions, and creates a path for your business to succeed in the long term.
For more questions or guidance regarding director disqualification or best practices for governance, it is recommended to consult with a qualified business lawyer who can help. An attorney will provide you with appropriate advice based on your company’s situation and will guide you around these regulations together with the confidence you need.
Take a proactive step and ensure that you put your company on good governance, which will steer it away from any legal traps and also empower your board in making informed decisions for sustainable development.
