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Distinction between Executive Directors vs Non - Executive Directors

The board of a company generally consist of executive and nonexecutive directors.

Executive directors (“EDs”) act in dual capacity – they are a member of the board and at the same time full time employees of the company. They manage the everyday operations of the company and deal with the implementation of the business and strategic plans of the company. The EDs may be elected by shareholders and employees or they might also be the company’s employee, officer or stakeholder. The EDs are subordinate of the chief executive officer or managing director of the company.

Non-executive directors (“NEDs”) on the other hands are qua directors – they are board members who are not employees of the company and without responsibilities for daily management of the company.

NEDs are normally cherry-picked by the company for their specialised skills, personal qualities and relevant experience. They are expected to address the ‘elephant in the room’ in a well-deliberated and independent manner in a way which can surpass any organisational obstacle. NEDs should be able to do this with consummate diplomacy and a helicopter overview of all the circumstances involved.[1]

NEDs primarily focus on board matters and attend meetings of the board and committee(s) of the board to which they are appointed. As they are not involved in the daily management of the company, they are generally expected to lend objective criticism on board matters and independent perspective of the business to the board by constructively challenging the EDs as well as facilitating strategic decisions by the EDs.

The NEDs may further be categorised into independent and nonindependent NEDs.

Roles, Duties and Liabilities

Before we go into the differences between EDs and NEDs, from the eyes of the law, both EDs and NEDS have similar legal duties, responsibilities and liabilities. They both hold highly- responsible roles in a company, have a fiduciary duty to the company and must act in the best interests of the company.

The duties and responsibilities of a director is aptly illustrated in Ravichanthiran a/l Ganesan v Percetakan Wawasan Maju Sdn Bhd & Ors [2008] 8 MLJ 450.

The High Court in that case referred to a Singapore Court of Appeal case of Planassure Pac formerly known as Patrick Lee Pac v Gaelic Inns Pte Ltd [2007] SGCA 41 which held that “every director of a company, regardless of whether he has an executive or non-executive designation, has fiduciary duties and legal responsibilities to his company.”

The High Court further observed that even if the plaintiff was a NED, his roles and duties were still governed by the Companies Act 1965 (the predecessor of the current Companies Act 2016 (“CA 2016”)).

In the recent case of Kian Joo Can Factory Berhad & Ors v See Teow Koon [2017] MLJU 972, the Court of Appeal observed that the CA 2016 does not differentiate between EDs and NEDs and the distinctions between them lie in the roles, functions and capacity of employment.

A ‘director’ is defined under the CA 2016 to include any person occupying the position of director of a corporation by whatever name called and includes a person in accordance with whose directions or instructions the majority of directors of a corporation are accustomed to act and an alternate or substitute director.[2] Statutorily speaking, senior management will also need to be aware as the term ‘director’ may include chief executive officer, chief financial officer, chief operating officer or other individuals primarily responsible for the management.[3]

All directors therefore primarily have the following duties under the CA 2016: they owe fiduciary duties to the company; they shall exercise reasonable care, skill and diligence; and they shall exercise their power for proper purpose and in good faith in the best interest of the company. As highlighted in the above case that the CA 2016 does not distinguish between types of directors, theoretically both EDs and NEDs may be liable to similar penalties under the CA 2016. For example, the contravention of duties and responsibilities of directors under Section 213 of the CA 2016 may attract a penalty of imprisonment for a term not exceeding 5 years or fine not exceeding RM3million or to both.[4]

On the other hand, references to EDs and NEDs are made in various paragraphs of the Main Market Listing Requirements (“MMLR”) although said terms are not defined in the MMLR. Under the MMLR, at least 2 directors or 1/3 of the board of a listed company shall consist of independent directors (i.e. independent NED)[5].

An independent director is defined as a director who is independent of management and free from any business or other relationship which could interfere with the exercise of independent judgement or the ability to act in the best interests of the listed company.[6] The MMLR also require NEDs to be part of the audit committee[7] and nominating committee[8] and the majority of such committees’ members to be independent NEDs. Notwithstanding the express reference to EDs and NEDs in the MMLR, the provisions of the MMLR do not provide for different liabilities on EDs and NEDs.

Similar to the CA 2016, the provisions of the Capital Markets and Services Act 2007 do not distinguish EDs and NEDs and the meaning of ‘director’ in this statute refers to the definition of ‘director’ under the CA 2016.

Challenges Faced by NEDs: Different roles but same liability

While the provisions of the express laws do not distinguish the liabilities of EDs and NEDs and as a result, all directors may be made equally accountable, one important consideration must not be overlooked – the challenges faced by the NEDs in exercising their roles, duties and responsibilities required of them under the applicable laws, in the company’s constitution or any other documents of the company. Some of the challenges comprise the following:

• Time and attention

Although all directors are required to commit sufficient time commitment and expertise, the NEDs by their very nature cannot contribute similar time or attention to the company’s business as compared to their executive counterparts and even then, they are as accountable as the EDs if anything were to go wrong.

• Information access

It is also likely that they may not be furnished with all relevant and adequate information in a timely manner than their executive counterparts. For listed companies, there is a general requirement that a listed company must ensure that every director has the right to the resources, whenever necessary and reasonable for the performance of his duties, including full and unrestricted access to any information pertaining to the listed company and the advice and services of the company secretary and obtain independent professional or other advice.[9] In similar vein, the Malaysian Code on Corporate Governance (“MCCG”) provides that directors should receive complete and accurate meeting materials within a reasonable period prior to the meeting[10] to facilitate robust board discussions. Further, the MCCG recommends that the meeting materials are to be circulated at least 5 business days prior to the board meeting.[11] However, similar requirements are not expressly provided for non-listed companies, which may enable situations such as non-provision of complete documents/meeting materials or non-provision of documents/meeting materials to certain directors. In addition, the information received by the NEDs is developed by the executive team and it may be possible that the executives may portray the information in the best possible picture to the board.

• Remuneration

While the EDs are usually paid competitive salaries and attractive benefits, the total amount of which may constitute sizeable amount of the company’s distributable funds, the NEDs are remunerated with fees and benefits for their services which are comparatively lower than the EDs.

The 2017 KPMG research shows an increase in the yearly remuneration of the NEDs to an average of RM162,000 in the top 300 largest companies on Bursa Malaysia Securities Berhad (“Bursa Malaysia”) by market capitalisation.[12]

Although the foregoing increase is applauded, the existing steep pay-gap between EDs and NEDs may still need to be relooked at in tandem with the greater time commitments and contribution perceived from the NEDs and higher exposure of liabilities on the NEDs.

• Frequency of Board meetings

In addition, for the NEDs to exercise meaningful oversight or control over management, the board must be convened regularly. There is no express requirement under the CA 2016, MMLR or MCCG as to the minimum number of board meetings to be convened by the company.

This decision is often left to the discretion of the company depending on the necessity of each company and there may be instances that the meeting is not convened at a regular interval disrupting NEDs meaningful oversight or control over the management of the company.

Perhaps an article published by the Financial Times summarizes the challenges faced by NEDs best. It says “Above all, a good non-exec needs diplomatic skills. They need “emotional intelligence” — the ability to evaluate people’s characteristics and their agendas quickly and thoroughly. They should never appear to be domineering, especially when dealing with directors who are unused to being challenged. Equally, they should never forget that it is their job to hold the board to account.”[13]

Approach Taken by Courts and Regulators

In the recent case laws, as highlighted above, the courts do not distinguish the directors with the label attached to such directors and may hold directors liable if they fail to exercise their statutory or fiduciary duties.

Apart from the decided case laws, the recent decisions taken by the regulators similarly indicate that both NEDs and EDs may be held accountable in cases of breach of duties by them or the company and severe penalty was imposed on the directors primarily responsible for such breach, regardless of their executive and non-executive position.

Take the recent Bursa Malaysia’s public reprimand of Lay Hong Berhad and its directors for example.[14] Lay Hong Berhad and its directors (i.e. 4 EDs and 4 NEDs) were publicly reprimanded for breaching regulations in relation to the company’s response to unusual market activity queries on November 2015 and January 2016. In addition, its 4 EDs and 4 NEDs were also fined RM750,000 in total. A higher fine were imposed on the EDs due to the fact that they were involved in the proposals and were primarily responsible for the approval and issuance of announcements to Bursa Malaysia as compared to the NEDs. The administrative action by SC may be seen with regard to TRIVE Property Group Bhd (“TRIVE”) and its directors[15] and Lotte Chemical Titan Holding Berhad (“Lotte”).[16]

SC publically reprimanded TRIVE and its directors as well as imposed penalty on all the directors for failure to perform an impairment assessment on TRIVE’s development expenditure amounting to RM21.1million as at 31 July 2014 in accordance with the approved accounting standard in the audited financial statements for the financial year ended 2014.

The 5-Board members at the relevant time of breach comprised 3 independent NEDs (who were also audit committee members) and 2 EDs. Each NEDs were imposed a penalty amounting to RM539,000, which were higher than the EDs who were imposed with a penalty of RM465,500 each. It is presumed that the reason higher penalties on the NEDs may be due to the fact that the NEDs were also the members of the audit committee, which is responsible to review the financial statements of the company.

In another recent SC administrative action, all 6 directors of Lotte were reprimanded for the company’s failure to inform the SC of its material developments prior to its listing on the Main Market of Bursa Malaysia. Lotte’s board of directors comprised 4 independent NEDs and 2 EDs. The SC has also imposed fine penalties on both the EDs although it has not expressed any reason for such imposition.

Conclusion

The EDs and NEDs undeniably play an important role in the governance of a company, the former as a ‘director and full-time employee’ and the latter solely exercise their directorship duties. Nevertheless, they are deemed to be equally liable and accountable for any breaches of the company under the eyes of law.

The recent Federal Court case of Tengku Dato’ Ibrahim Petra bin Tengku Indra Petra v Petra Perdana Bhd and another appeal [2018] 2 MLJ 177 highlighted the specific question of “whether a distinction should be drawn between executive and non-executive directors in circumstances where non-executive directors have limited management functions and played a limited role in executing the impugned decisions made collectively by the board of directors.”

While the decision of the apex court may have provided further clarity and reinforced judicial approach on the issue at hand, unfortunately the apex court has left the resolution of said question to a case where it must be necessarily determined. Until the above issue is addressed, it is submitted that a NED, although being a director of the company may not have similar opportunities as that of the ED and the challenges faced by the NED must be taken into account in considering his liability and relevant punishment.

Norhisham Abd Bahrin*
*Norhisham is a Partner of Mergers and Acquisitions and Corporate Practice Group at Azmi & Associates. He coaches board members and senior management of various companies in Malaysia and regularly conducts talks or appear as a panellist in relation to Companies Act 2016, -governance and compliance matters.

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1 What is a Non-Executive Director and how do you get there? Retrieved from www.freshminds.co.uk/whats-fresh/post/2017/07/21/what-is-a-nonexecutive-director-and-how-do-you-get-there
2 Section 2 of the CA 2016.
3 Section 210 of the CA 2016.
4 Note that generally all penalties particularly fines imposed under the CA 2016 have been enhanced from its predecessor, the Companies Act 1965.
5 Paragraph 15.02 (1) of the MMLR.
6 Paragraph 1.01 of the MMLR.
7 Paragraph 15.09 (1) of the MMLR.
8 Paragraph 15.08A (1) of the MMLR.
9 Paragraph 15.04 of the MMLR.
10 Practice 1.5 of the MCCG.
11 Guidance 1.5 of the MCCG.
12 KPMG Report on Non-Executive Directors’ Remuneration 2017, pg 9. Retrieved from https://home.kpmg.com/content/dam/kpmg/my/pdf/KPMG_NEDReport2017_FINAL.pdf
13 Cook, L. (March 1, 2018). Have you got what it takes to be a non-executive director? Retrieved from https://www.ft.com/content/87bed6b0-14bb-11e8-9e9c-25c814761640
14 Bursa Malaysia’s media release dated 20 June 2017. Retrieved from http://www.bursamalaysia.com/corporate/media-centre/media-releases/5165
15 SC’s administrative actions in 2017. Retrieved from https://www.sc.com.my/post_archive/administrative-action-in-2017/
16 SC’s administrative actions in 2018. Retrieved from https://www.sc.com.my/post_archive/administrative-action-in-2018/

Prepared By:

Norhisham Abd Bahrin (Partner) norhisham@azmilaw.com

Nur Sajati Asan Mohamed (Senior Associate) nursajati@azmilaw.com