The corporate governance principle of independence

Principle 5 of the Corporate Governance (CG) Code for Publicly Listed Companies (PLCs) provides that “The Board should endeavor to exercise objective and independent judgment on all corporate affairs.”

Recommendation 5.1 provides that “The Board should have at least three independent directors, or such number as to constitute at least one-third of the members of the Board, whichever is higher.”

The Explanation for Recommendation 5.1 takes the position that the presence of independent directors (IDs) in the Board ensures the exercise of independent judgment on corporate affairs and proper oversight of managerial performance, including prevention of conflicts of interest and balancing of competing demands of the corporation. In addition, it explains that experts have recognized that there are varying opinions on the optimal number of IDs in the board. However, the ideal number ranges from one-third of the board’s members to a substantial majority.

Recommendation 5.2 provides that “The Board should ensure that its IDs possess the necessary qualifications and none of the disqualifications for an IDs to hold the position.” The Explanation then proceeds to enumerate the “ideal IDs” by enumerating the requisite qualifications and disqualifications.

Section 22 of the Revised Corporation Code of the Philippines (RCCP) provides that corporations vested with public interest shall have “IDs constituting at least 20% of such board.” Although the RCCP does not adopt the recommended “three IDs or one-third of the entire board, whichever is higher,” the Securities and Exchange Commission (SEC) has been given explicit authority under Section 179(m) of the RCCP to “Prescribe the number of IDs and the minimum criteria in determining the independence of a director.” We should therefore anticipate the SEC to later on change the rule for IDs of PLCs to constitute at least one-third of the Board.

Section 22 of the RCCP defines an ID as “a person who, apart from shareholdings and fees received from the corporation, is independent of management and free from any business or other relationship which could, or could reasonably be perceived to materially interfere with the exercise of independent judgment in carrying out the responsibilities as a director.”

Although the RCCP does not express in statutory form the peculiar qualifications and disqualifications for IDs, nothing prevents the SEC from adopting by formal regulation any and all the criteria covered in the Explanation of Recommendation 5.2 pursuant to its quasi-legislative power under Section 179(m) of the Revised Corporation Code, as well as by the express power granted under the last paragraph of Section 22, thus: “IDs must be elected by the shareholders present or entitled to vote in absentia during the election of directors. IDs shall be subject to rules and regulations governing their qualifications, disqualifications, voting requirements, duration of term and term limit, maximum number of board memberships and other requirements that the Commission will prescribe to strengthen their independence and align with international best practices.”

CG PRINCIPLE OF ‘WORKING AND PROPERLY COMPENSATED BOARD’
Principle 1 of the CG Codes for Publicly-Listed Companies, Public Companies (PCs), and Registered Issuers (RIs) provides that “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.”

In turn, Principle 3 of the CG Codes provides that “Board committees should be set up to the extent possible to support the effective performance of the Board’s functions, particularly with respect to audit, risk management, compliance and other key CG concerns, such as nomination and remuneration. …”

Under the original CG Code, one of the CG principles promoted was that of properly compensating directors or trustees, as well as Senior Officers, thus: “Levels of remuneration shall be sufficient to attract and retain the directors, if any, and officers need to run the company successfully.” It also provided that to protect the funds of the corporation, the SEC “may regulate the payment by the corporation to directors and officers of compensation, allowance, fees and fringe benefits in very exceptional cases, e.g., when a corporation is under receivership or rehabilitation.”

The CG Code for PLCs pursues the principle of “competent and properly compensated working Board,” under Recommendation 2.5, thus: “The Board should align the remuneration of key officers and board members with the long-term interests of the company. In doing so, it should formulate and adopt a policy specifying the relationship between remuneration and performance. Further, no director should participate in discussions or deliberations involving his/her own remuneration.”

The CG Code for PLCs explains the rationale behind Recommendation 2.5 in the following manner: “Companies are able to attract and retain the services of qualified and competent individuals if the level of remuneration is sufficient, in line with the business and risk strategy, objectives, values and incorporate measures to prevent conflicts of interest. Remuneration policies promote a sound risk culture in which risk-taking behavior is appropriate. They also encourage employees to act in the long-term interest of the company as a whole, rather than for themselves or their business lines only. Moreover, it is good practice for the Board to formulate and adopt a policy specifying the relationship between remuneration and performance, which includes specific financial and non-financial metrics to measure performance and set specific provisions for employees with significant influence on the overall risk profile of the corporation.”

Unfortunately, the RCCP does not embrace the principle that a competent Board must be properly compensated for its members’ invaluable service to the company. In fact, Section 29 of the RCCP has retained the rule that “In the absence of any provision in the bylaws fixing their compensation, the directors or trustees shall not receive any compensation in their capacity as such, except reasonable per diems; Provided, however, That stockholders representing at least a majority of the outstanding capital stock or majority of the members may grant directors or trustees with compensation and approve the amount thereof at a regular or special meeting.”

On the other hand, Section 34 of the RCCP institutes the CG principles of a “working Board” by inserting a new paragraph that provides: “The board of directors may create special committees of temporary or permanent nature and determine the members’ term, composition, compensation, powers, and responsibilities.” Section 34 of the RCCP therefore provides an opening by which to compensate working Board members when they discharge their duties and responsibilities in the Board committees to which they are appointed to. This legal position seems to be consistent with the ruling of the Supreme Court in Western Institute of Technology v. Salas, where it held that — This proscription, however, against granting compensation to directors/trustees of a corporation is not a sweeping rule. Worthy of note is the clear phraseology of [what is now Section 29 of the RCCP which states: “… The directors shall not receive any compensation, as such directors, …” The phrase as such directors is not without significance for it delimits the scope of the prohibition to compensation given to them for services performed purely in their capacity as directors or trustees. The unambiguous implication is that members of the board may receive compensation, in addition to reasonable per diems, when they render services to the corporation in a capacity other than as directors/trustees. In the case at bench, resolution … granted monthly compensation to private respondents not in their capacity as members of the board, but rather as officers of the corporation, more particularly as Chairman, Vice-Chairman, Treasurer and Secretary of Western Institute of Technology.

When directors or trustees are properly entitled to receive compensation apart from reasonable per diems, the CG Code for PLCs explains that a key consideration in determining proper compensation should be that “no director should participate in deciding on his remuneration.” Section 29 of the RCCP now expressly provides that “Directors or trustees shall not participate in the determination of their own per diems or compensation.”

To corporate practitioners, the language of Section 29 seems incongruous on the following grounds:

Firstly, if directors cannot participate in the setting of their per diems, then no per diem can ever be set because all the directors would be disqualified to participate in the Board vote (the Board can only act as a body) in setting the per diem rates. What would happen would be to follow a proceeding whereby the per diem rate of the Board is set on a per member basis, without the interested member participating in the deliberation.

Secondly, it is unlawful for a director or trustee to participate in the determination of their compensation, because this is only upon an action by the shareholders or members. In other words, outside of the Western Institute of Technology doctrine and the compensation for committee positions under Section 34, there is no occasion by which directors or trustees may participate in the setting of their compensation, when the same is by a vote of the shareholders or members. Thus, in Central Cooperative Exchange v. Enciso, the Court held that since it is the shareholders who have the power to set Board compensation, therefore the resolution of the Board of Directors setting their compensation is void.

Finally, if the provision for compensation of directors or trustees is to be set-up through a bylaw provision, then it becomes indispensable that the Board must first adopt a resolution for the proper amendment of the bylaws, before the same is submitted to the shareholders or members for their ratification vote as required under Section 47 of the RCCP.

This 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.

Attorney Cesar L. Villanueva is Chair of the MAP Corporate Governance Committee, Trustee of Institute of Corporate Directors (ICD), was the first Chair of Governance Commission for GOCCs (2011 to 2016), was Dean of the Ateneo Law School (2004 to 2011), and is the author of The Law and Practice in Philippine Corporate Governance and the National Book Board Award winning Profession, and a Founding Partner of Villanueva Gabionza & Dy Law Offices.