Due diligence and directorships: making the right moves

In the wake of the recent decision of the High Court to uphold claims of reckless trading against four directors of Mainzeal, it is now more important than ever to undertake proper due diligence before accepting roles in company governance. Effective due diligence carried out by a would-be director can play a crucial part in recognising whether an invitation to join a board of directors should be prudently accepted, or politely declined.

Knowing your obligations

Taking on a position at the helm of a company naturally carries with it a number of important obligations. When considering a directorship, you should familiarise yourself with your duties under the Companies Act 1993 to ensure that the role is right for you.

You should be aware that after accepting a board position, you will be legally obliged to act in the best interests of the company, avoid or properly disclose self-interest in transactions, exercise due care, act for a proper purpose and implement good faith in your decisions at all times.

If you are unsure of whether you have the time, determination, and independence required to meet your legal obligations and sustain a successful directorship, you may wish to think twice about committing to the governance role.

Getting the right fit

As a potential director, deciding whether the company provides for a good personal fit can be just as important as a firm understanding of its operational elements. In carrying out proper due diligence, you should reflect on your motivations for joining the board and consider whether this complements the culture and direction of the company.

Do you have the experience, time availability and skills to be an effective leader? Is the core focus and goals of the company something you can passionately take hold of? Do you have any conflicting interests which could limit your ability to act independently?

While a role on the board of a company can be prestigious and well remunerated, you should not lose sight of these practical considerations.

Accounts, reports and financials

During due diligence, some of the most important information about a company can be sourced from its financial records and annual report. As a prudent prospective director, you should request copies of these records and reports over the last few years, and use them to build a picture of how the company is operating, and which direction it is headed.

You should take particular note of any financial or transactional irregularities, and satisfy yourself as to their impact upon the company. Trends in financial performance revealed by an extended assessment of a company’s trading history can also help you to assess the future prospects of success.

Thoroughly examining all company documentation available to you before accepting a governance role can help you determine if your skills can be used to leverage the strengths of the company, while addressing any weaknesses. It can also assist you in pinpointing critical red flags in the company’s operations, such as if the solvency of the company is in question, or if major litigation claim or other liability may be on the horizon.

Strategy and status

While much can be garnered from the raw figures of financial records and the information presented in annual reports, another important aspect of due diligence are the strategies implemented by the existing board, and how these strategies translate into commercial action.

Before accepting a governance position, you may wish to take steps to get to know the fellow directors and key employees you would be working alongside, and ensure that their approach and vision for the company aligns, or is at least compatible with, your own.

It is also a good idea to determine how successful the company is in adhering to its strategic direction. Points to check here include how regularly the existing board meets to strategize and transact business, and how often the company is successful in meeting its own strategic goals.

A solid understanding of the status of the company should be another key aspect of your due diligence assessment. Does the company have a positive reputation and standing in New Zealand? Are banking and overdraft facilities in place and used sensibly? Is the company in a stable position, and are you equipped to deal with any foreseeable problems which might change this?  You should also review any recent media coverage relating to the company, as in some instances a simple Google search can reveal important information pertaining to the company’s public profile.

Director liability insurance

Regardless of how thoroughly a potential director carries out due diligence, governance roles can be risky. When things go wrong, director and officer liability insurance (often referred to as D&O insurance) can provide a safety net against personal liability.

Section 162 of the Companies Act generally prohibits the ability of a company to indemnify and insure its directors against personal liability unless expressly permitted by the company’s constitution.  A properly drafted constitution can enable a company to indemnify its directors (in their governing capacities) against certain circumstances including civil liability for acts or omissions, and costs incurred by the director in defending proceedings. As a potential director, determining whether a company has effective indemnities in place, and favourable insurance policies for its directors (including run-off insurance after they vacate office), are essential parts of the due diligence process.

Concluding comments

By taking the time to really understand the ins and outs of a company, you can recognise when accepting a position on a board is a commercially sound decision, and when it is just not the right place for you.

The Business Law team at Lane Neave has considerable experience in corporate advisory and governance matters, and can assist you in deciding if joining a board of directors is right for you and also along the way on your governance journey.

Business Law team

If you need any assistance, do not hesitate to get in touch with the Business Law team at Lane Neave.

Gerard DaleClaire EvansGraeme CrombieEvelyn JonesAnna RyanJoelle Grace,  Peter OrpinEllen SewellMatt TolanCarlo WanKristina SutherlandJacob NuttWhitney MooreAlex StoneBen Cooper, Lisa Catto

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