Recommendations on qualification, disqualifications, and competence of directors under the CG Code for PLCs

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Cesar L. Villanueva

MAP Insights

The CG Code for Publicly-Listed Companies (PLCs) through its “adopt or explain approach,” is able to avoid all the legal obstacles that may be found in the Board-enabling clauses of the original and Revised CG Codes, by adopting a formal Principle 1 for “Establishing a Competent Board,” thus:

Principle 1:

The company should be headed by a competent, working Board to foster the long-term success of the corporation, and to sustain its competitiveness and profitability in a manner consistent with its corporate objectives and the long-term best interests of its shareholders and other stakeholders.

and then provides for a set of recommended structures that seek to ensure Board competence and independence, thus:

Recommendation 1.1

The Board should be composed of directors with a collective working knowledge, experience or expertise that is relevant to the company’s industry/sector. The Board should always ensure that it has an appropriate mix of competence and expertise and that its members remain qualified for their positions individually and collectively, to enable it to fulfill its roles and responsibilities and respond to the needs of the organization based on the evolving business environment and strategic direction.

Recommendation 1.2

The Board should be composed of a majority of non-executive directors who possess the necessary qualifications to effectively participate and help secure objective, independent judgment on corporate affairs and to substantiate proper checks and balances.

Recommendation 1.3

The Company should provide in its Board Charter and Manual on Corporate Governance (CG) a policy on the training of directors, including an orientation program for first-time directors and relevant annual continuing training for all directors.

Recommendation 1.4

The Board should have a policy on board diversity.

The afore-quoted Recommendations do not empower the Boards of PLCs, by the sheer exercise of business judgment, to adopt qualifications and disqualifications that become binding in the election process for the members of the Board of Directors (BOD), or on the continued tenure of the directors who have been duly elected into the Board. The CG Code for PLCs leaves it to the Board to determine which processes it may adopt by which the recommendations can be put into effect, whether by introduction of the proper by-law provisions, or by adopting Board policies and guidelines in the executive search that become integral in the manner of nominating candidates into the Board.

What needs to be discussed in this section are the important practical and legal differences between locating the set of qualifications and disqualifications through clear by-law provisions, or merely pursuing them through a policy of guidelines or by actual practice in the nomination and election processes.

We will illustrate such differences in legal consequences by looking at Recommendation 1.4 that “The Board should have a policy on board diversity.” If the Board’s policy on diversity provides for, say, at least 40% in the members of the Board being of the feminine gender, and that provision is in the by-laws of the company, then the nomination and election process that ensures that at least 40% of those elected into the Board are females would be legally effective. The Nominating Committee can then pursue a nomination process for the annual election of the members of the Board that would allow the determination of those who receive a plurality of votes between assuring that the winning nominees would be split between nominees of the male gender who would constitute 60% of the membership of the Board, and the nominees of the female gender who would constitute 40% of the Board membership. This is the same procedure that is followed in the annual stockholders’ meeting to arbitrarily set the nomination and election of the members of the Board between the regular members and the independent directors.

On the other hand, if the policy of diversity is not provided for in the by-law provisions, and can be found only in guidelines of the Board or through a Board policy, then although the nomination process can be tailored to seek the declared policy, nothing can prevent the majority and/or the minority stockholders from insisting on nominating and casting their votes to a number of candidates who may end up winning all the seats which do not meet the diversity desired. The main reason for this is that unlike in the case of independent directors as a statutorily required component of all PHCs as provided for in the Securities Regulation Code, and the nomination and election processes can be tailor-fit to achieve the required regular-to-independent director’s ratio, the diversity ratio that does not find itself expressed as a by-law provision, thereby does not a have legal and binding effect on the stockholders who have a right to nominate and cast their votes in favor of candidates who are not otherwise disqualified under the by-laws of the company. In other words, when a policy of diversity is not expressed clearly in the by-laws of the corporation, the Board may campaign among the stockholders for a set of candidates that meet such diversity policy, but they cannot oppose the candidacy, much less disqualify other candidates who do not fall within the diversity policy set by the Board.

The foregoing discussions highlight the downside of the “comply or explain approach” of the CG Code for PLCs in that it would pursue fruition of the CG reforms in the PLC sector by relying on either the political will of the BOD who either pursue permanent company reforms through formal amendments of their articles of incorporation and/or by-laws, or use their position of corporate influence to convince the majority or controlling stockholders to dilute their majority representation in the Board itself.

Remuneration Rules under the Revised CG Code

The Revised CG Code contains specific provisions that empower the Boards of PHCs to develop attractive and competitive remuneration structures for both directors and corporate officers, thus:

J) Remuneration of Directors and Officers

The levels of remuneration of the corporation should be sufficient to be able to attract and retain the services of qualified and competent directors and officers. A portion of the remuneration of executive directors may be structured or be based on corporate and individual performance.

Corporations may establish formal and transparent procedures for the development of a policy on executive remuneration or determination of remuneration levels for individual directors and officers depending on the particular needs of the corporation. No director should participate in deciding on his remuneration.

The corporation’s annual reports and information and proxy statements shall include a clear, concise and understandable disclosure of all fixed and variable compensation that may be paid, directly or indirectly, to its directors and top four (4) management officers during the preceding fiscal year.

To protect the funds of a corporation, the Commission may, in exceptional cases, e.g., when a corporation is under receivership or rehabilitation, regulate the payment of the compensation, allowances, fees and fringe benefits to its directors and officers.

There are clear implications under the Revised CG Code seeking to establish director’s compensation as a cornerstone in good CG practice. Indeed, a system of “professional directorship” for covered corporations must include a necessarily formal compensation system that would “attract and retain the quality of directors to run the company successfully.” Nonetheless, because of the limitation under the Corporation Code against the grant of any form of remuneration or compensation to directors as such, outside of formal stockholders’ grant and/or provisions in the by-laws, it would be difficult, and perhaps also highly suspicious, to develop a system of director’s compensation would fall within the business judgment control of the BOD.

By necessary implication from the decision in Western Institute of Technology, the BOD of any corporation retains the power to provide for compensation for members of the board who occupy at the same time “officer” position, such as Chairman, Corporate Secretary, Corporate Treasurer, etc. In such case, their compensation really pertains to their position as officers, not as directors as such. This situation is amply covered by provisions of the Revised CG Code that refers to compensation for executive directors: “A proportion of executive directors’ remuneration may be structured so as to link rewards to corporate and individual performance.”

Consequently, the provisions of the Revised CG Code on compensations for non-executive directors become problematic to implement, for their compensation is precisely for their role as directors only. Thus, the provision that ties the non-executive directors’ compensation to individual qualifications and performance:

• Levels of remuneration of non-executive directors shall reflect their experiences, responsibilities and performances.

• Levels of remuneration for non-executive directors shall reflect the time commitment and responsibilities of the office or position.

would be extremely difficult to implement based on the following legal considerations.

Firstly, it is clear from the language of Section 38 of the Corporation Code that the granting and setting of compensation or remuneration for directors as such is outside of the legal competence and power of the BOD of any corporation. Therefore, the adoption by the Board of a system of compensation for directors outside of by-law provisions cannot be implemented by mere board resolution, and would require stockholders’ approval representing at least two-thirds (2/3) of the outstanding capital stock. This would be an extremely difficult system to enforce because the stockholders’ meeting is held once a year, and the setting of a special meeting of the stockholders and obtaining thereat a two-thirds (2/3) ratificatory vote would be extremely expensive, and may not engender obtaining the best and brightest of candidates who are elected into the board for a term of only one year.

Secondly, any system that allows the BOD to provide individually for a measure of compensation for individual directors would amount to a measure of “disciplining” in the hands of the Board, and therefore would have a difficult time overcoming the “good governance” principle under the Corporation Code that prohibits any form of “punishment and reward” in the hands of the BOD with respect to any of their members.

Thirdly, matters on directors’ compensation are inherently conflict-of-interests situations for the Board, and therefore are treated with much reservation under Philippine Corporate Law, as matters that inherently cannot be dealt within the Board’s exercise of business judgment. Under any scenario one can think of, when it is the BOD, or through its Remuneration Committee, that sets the compensation package of any director as such, even when the Revised SEC Code provides that the affected director cannot participate in the proceedings wherein his compensation is set, nonetheless, it would be a case where the members of the Board would be tempted to be involved in a system of “I scratch your back, and you scratch my back.” That is the reason why, under Section 38 of the Corporation Code, no such occasion is granted to the BOD of any corporation to be in a tempting position to grant, through the exercise of business judgment, compensation to any of the directors as such.

The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the MAP


Cesar L. Villanueva is Chair of the MAP Corporate Governance Committee, the Founding Partner of the Villanueva Gabionza & Dy Law Offices, and the former Chair of the Governance Commission for GOCCs (GCG).