Articles

The true impact of King III

Synopsis:

The main impact of the latest report on corporate governance will be on the broader community of business people who serve as directors of closely-held private companies, who now have to bring their actions and their deeds in line with a code of ‘best practice’ that is likely to be upheld by our courts.

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The King III Report

 

The third report of the King Committee (King III) was published in September, 2009, and became effective on 1st March, 2010.

 

The introduction to the report concludes with the following statement:

”In contrast to the King I and II codes, King III applies to all entities regardless of the manner and form of incorporation or establishment and whether in the public, private or non-profit sectors. We have drafted the principles so that every entity can apply them and, in doing so, achieve good performance. All entities should apply the principles in the Code and consider the best practice recommendations in the Report.”

The question that may be raised is how a series of statements of principle drawn up by a voluntary association of individuals (which is what the King Committee is – appointed as it is by the Institute of Directors, itself a Section 21 company) can be said to apply to other independent organizations and limited liability companies.

 

The answer is that, whilst the King Code is not a law, it may become effective as such by virtue of its role in the interpretation of the law. For, where a court is asked to consider whether a director has applied the required degree of skill and competency or discharged his fiduciary duties, the code may indeed serve as evidence of accepted and acceptable standards in these areas. This may be the case by virtue of the way in which the code has been developed – with contributions and input from institutions in all sectors of activity in the country and with regard to standards being observed in other capitalist countries. And if, for example, the Supreme Court accepts King III as a source of reference in relation to a dispute over the discharge of fiduciary duties, then this establishes a precedent for all other courts to do so as well. This is how our law evolves.

 

Applicability

 

Standard employment contracts that establish a normal employee/employer relationship are not affected. Agreed terms and conditions will continue to apply. It is only where a fiduciary duty exists in relation to the appointment - to act responsibly and to account -that reference will be made to the code. It will therefore normally apply to the directors of corporate entities (whether it be a public company or private company, whether it is for profit or not-for-profit, and whether it is in the public or private sector). Think of the directors of a closely-held private company which has admitted one or more minority shareholders (perhaps a BEE investor); the code in terms of King II would not have applied to them. King III however does.

 

It follows that in future where one party appoints another into a position of trust and the parties wish to contract with each other for specific reduced or additional performances on the part of the appointee, they will no doubt be advised by their legal advisers to stipulate in the contract that the relevant coded principle does not apply – for clarity.

 

Affected practices

 

What practices are affected by the code? There are close to 600 principles. They are contained in eight chapters, and cover employment contracts, remuneration policy, codes of conduct, incentive schemes, and the management of risk and stakeholder relationships.

 

Who will be affected?

 

The extension of the application of the code to all organizations will primarily affect closely-held private companies. Their boards of directors will be expected to appoint non-executive directors, establish a remuneration committee, disclose remuneration policy, and so on. If they do not, their minority shareholders may call on them to do so – obviously here providing minority shareholders with better protection from abuse.

 

Whilst that may be beneficial, will the code on this basis not render private companies less attractive as investment vehicles? Possibly, yes – but conceivably it will render them more attractive, which is the stated objective of the code – to facilitate and promote the functioning of capitalism in the interests of the whole economy. Trust and transparency are key pre-requisites for the separation of the management of funds from the ownership of funds – which is the cornerstone of capitalism.

One of the additional requirements of disclosure is that the details of the remuneration of the three most highly paid employees should be disclosed. How, it may be asked, can the company disclose this to shareholders when it may be implicit in the contract (or in the policy of the company) that remuneration details are to be treated on a confidential basis? The answer is that the code will not over-ride existing contractual arrangements; but, the company will be expected in future to contract with employees on the basis that such details can in future be disclosed in compliance with the code. Companies will be expected to take steps so that they can apply the principles of the code in future.

 

Apply or explain

Most adverse effects arising from the adoption of the code can be avoided by taking advantage of the “apply or explain” rule. In terms of this rule, it is explained in the code that where a principle clearly applies, it should then either be applied or the reason why it is not to be applied clearly explained to the stakeholders affected. In some cases the principles will not be applied on the grounds that they are not considered necessary or applicable in the circumstances, and it is acknowledged in the report that all surrounding circumstances can and should be taken into account in this way.

 

This may be a practical solution in many situations. Nevertheless one feels that the process itself – of systematically reviewing all corporate governance rules – will be highly beneficial to our capitalist system, and should be welcomed by all.

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Library updates:

Updates made to this library in the last month are as follows:-

• The JSE Quarterly Abstract results in Section 6 has been updated to June 2009. We anticipate that the update for September 2009 will be completed by the end of April 2010.

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