March 25, 2021
March 25, 2021
The dilemma: Cadenza is an entrepreneur. Like many other entrepreneurs, she needed additional income to live on while she grew her business. Among other work, Cadenza provided consulting services to another entrepreneur. When that individual also ran short of funds, Cadenza was paid in equity rather than cash and given a seat on the board. As Cadenza’s own business began to prosper, she paid little heed to the business of her former client. She stopped receiving board papers and attending board meetings. Now, a shareholder from the other company has asked Cadenza what is going on there. Cadenza called her former client (the CEO of that company) and asked for an update. The news was mixed. For a while, things went well—the company successfully raised capital and gained new shareholders. Then, progress stagnated and it appeared that some company assets were transferred to the CEO, or perhaps sold with the proceeds going to the CEO before a dilutionary capital raising and before some agreements were finalized, to “reward” him for intellectual property that once belonged to the company. The CEO also said that the shareholder who contacted Cadenza had been “causing trouble” for some time, asking for information and threatening to take legal action. He asked Cadenza to ignore the shareholder and take no further action. Cadenza is now worried. She knows that she has not fulfilled her duty as a director. She is still listed with regulators and on the company’s website as a board member. How can she protect her reputation and limit the repercussions from her lack of attention?
Julie Garland McLellan, nonexecutive director and board consultant: The best way to manage the risks of directorship is to do the job diligently. Cadenza’s lack of attention to her duties as a director could have serious repercussions. She has four options:
The fourth option, to me, is the only ethical one and the least risky. To succeed, Cadenza will need to reestablish a good working relationship with the CEO. Her duty is to the company. She must ensure that the CEO properly accounts, then either returns or pays the company for any assets appropriated and sold. She must also understand the positions of the major shareholders and the background of the capital raising.
Intellectual property is often contentious in small start-up and scale-up companies. CEOs may believe that it is their know-how; shareholders may view it as the company’s asset. Cadenza needs legal help identifying what belonged to whom and putting in place systems to control intellectual property and other assets.
Ron Heinrich, chair, Assetlink Group; director, Go Gentle Australia, FarmLink Research, Intersales Temora, Commonwealth Lawyers Association; partner, HBL Ebsworth Lawyers: Cadenza has clearly breached her duties as a director, namely her duty to exercise reasonable care and diligence, by failing to keep herself informed about the activities of the company. As a director, Cadenza had an obligation to act in the best interests of the company as a whole, rather than in the interests of a particular shareholder. She is potentially liable for damages for breach of director duties. She could also be liable to pay a steep financial penalty, as well as potentially be disqualified as a director.
Resigning as a director is not an option. In these circumstances, Cadenza should do all that is possible to mitigate the situation by taking various steps, including the following:
Albert Froom, managing partner, Leaders Trust; global practice leader, financial services, AltoPartners: Is there a good way out of this for Cadenza or for the CEO or for the shareholder? Cadenza has obviously failed to fulfill her duties as a nonexecutive director, and by her own admission took no notice of the board packs that were sent nor did she attend any meetings as her business activity increased.
In truth, the shareholder (the investor!) who speaks up and goes to Cadenza, the nonexecutive director, after trying to get information through the CEO has taken the right steps. But until now, the things that might be wrong only appeared to be wrong, with no proven facts known yet to Cadenza or the shareholder.
So what should Cadenza do? She can still act on the rumors! She is still on the board and can fulfill her role by conducting her own due diligence—reviewing past board papers, financial statements, supporting materials, and meeting minutes that were sent to her to establish whether the rumors are true and that business was conducted in the interest of the company and its shareholders.
If she does not have the most recent board papers, she should request them from the company secretary. To reduce her reputation damage, Cadenza should act immediately, informing the shareholder that she is on a fact-finding mission and that she will act accordingly. Based on her findings, she might inform the authorities, either confirming or negating the shareholder’s suspicions. If her findings show that the rumors are true, she can explain that she was just in time but acknowledge to the authorities that she should have been more attentive, learned a valuable lesson, and pledges to be more attentive as a director. She should also consult a lawyer about possible legal actions from the shareholder, the authorities, or even the CEO. A comprehensive media statement should also be prepared that is approved by the lawyer and the board at large in the event the situation is leaked to the press.
NACD: Tools and resources to help guide you in unpredictable times.