Fiduciary Duty of Loyalty: Conflict-of-interest situations for directors, trustees, or officers

DAMIR KOPEZHANOV-UNSPLASH

Principle 2 of the Corporate Governance (CG) Code for Publicly Listed Companies (PLCs) provides that: “The fiduciary roles, responsibilities and accountabilities of the Board as provided under the law, the company’s articles and by-laws, and other legal pronouncements and guidelines should be clearly made known to all directors as well as to shareholders and other stakeholders.”

In turn, Recommendation 2.1 provides that “The Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interests of the company and all shareholders.” The Explanation recognizes that there are two key elements of the fiduciary duty of members of the Board: the duty of care and the duty of loyalty; and that the “duty of loyalty is of central importance in that the board member should act in the interest of the company and all its shareholders, and not those of the controlling company of the group or any other stakeholder.”

The language of the Explanation to Recommendation 2.1 is quite peculiar since by limiting the application of the duty of loyalty to “shareholders” and by stating that board members should act in the interests of the company and all its shareholders and not those of “any other stakeholder,” it seems to conclude that no fiduciary duty is owed at all to the identified stakeholders of the company. The focus on the concept of duty of loyalty should limit itself to the fact that in conflict-of-interests situations, directors or trustees should chose to pursue the best interests of the company and the stakeholders to whom they owe fiduciary duty, and not their personal interests.

In realm of good CG, matters pertaining to the duty of loyalty cover primarily “related party transactions,” covered under Recommendation 2.7, thus: “The Board should have the overall responsibility in ensuring that there is a group-wide policy and system governing related party transactions (RPTs) and other unusual or infrequently occurring transactions, particularly those which pass certain thresholds of materiality. The policy should include the appropriate review and approval of material or significant RPTs, which guarantee fairness and transparency of the transactions. The policy should encompass all entities within the group, taking into account their size, structure, risk profile and complexity of operations.”

The Explanation to Recommendation 2.7 recognizes that ensuring the integrity of RPT is an important fiduciary duty of the director. It mandates the Board to formally adopt and implement an RPT Policy and provides for the contents thereof.

Section 31 of the RCCP now embodies the concept of “self-dealings” and “related party transactions,” which can be summarized as follows:

GENERAL RULE: Every contract of a corporation with any of its directors, trustees, or officers, or their spouses and relatives within the fourth civil degree of consanguinity or affinity, shall be voidable at the option of the corporation (i.e., acting through its Board of Directors);

EXCEPTION: Such contract shall be valid and binding on the corporation (i.e., corporation, acting through its Board of Directors, shall have no option to seek the annulment of such contract), when the following conditions are present:

(a) The presence of the interested director or trustee in the Board meeting in which the contract was approved was not necessary to constitute a quorum for such meeting;

(b) The vote of the interested director or trustee in such Board meeting was not necessary for the approval of the contract; and,

(c) The contract is fair and reasonable under the circumstances;

(d) In the Case of a Corporation Vested with Public Interest: Material RPT shall be approved by:

(i) At least two-thirds of the entire membership of the Board;

(ii) With at least a majority of the Independent Directors voting to approve the Material RPT;

(e) In the Case of an Officer: The contract has been previously authorized by the Board.

IF ANY OF THE CONDITIONS (1), (2) OR (4) ARE NOT PRESENT: In the case of a contract with a director or trustee, such contract may be ratified by a vote of shareholders representing at least two-thirds of the outstanding capital stock or of at least two-thirds of the members in a meeting called for the purpose; PROVIDED THAT:

(1) Full disclosure of the adverse interest of the directors or trustees involved is made at such meeting; and,

(2) The contract is fair and reasonable under the circumstances.

While the language of Section 31 of the RCCP clearly implies that the interested director or trustee may actually participate in the meeting involving a self-dealing transaction and actually vote thereat, Section 52 thereof expressly provides that “A director or trustee who has a potential interest in any related party transaction must recuse from voting on the approval of the related party transaction without prejudice to compliance with the requirements of Section 31 of this Code.”

Since Section 52 does not provide for any penalties when an interested director or trustee fails to recuse himself from participating in RPTs, the question must be: If an interested director or trustees does not recuse himself in participating in the meeting and voting on a self-dealing or related party transaction, does that make him criminally liable under Section 170 of the RCCP? Our position, as discussed below, is that violation of the prohibition under Section 52 does not make the offending director or trustee criminally liable under Section 170 of the RCCP. Nevertheless, the same may be the subject of administrative sanctions of the Securities and Exchange Commission (SEC) pursuant to Section 158 thereof.

In April 2019, the SEC issued Memorandum Circular No. 10-2019 (Rules on Material RPTs for PLCs), which has the following salient features:

• Recognized that RPTs are not inherently reprehensible, and that in fact “transactions between and among related parties may create financial, commercial and economic benefits to individual institution and to the entire group where said institutions belong.”

• Defines covered “Material RPTs” as those amounting to 10% or higher of a PLC’s Total Assets based on its latest audited financial statements, over a 12-month period with the same related party; and that if the reporting PLC is a parent company, the Total Assets shall pertain to its total consolidated assets.

• Obliges the PLC’s Board of Directors to adopt and submit to the SEC a Material RPT Policy, signed by the Board Chairman and the Compliance Officer.

• Obliges the filing with the SEC an Advisement Report on Material RPTs (signed by the Corporate Secretary or authorized representative) within three calendar days after the execution date of the transactions.

• Mandates disclosing in the Integrated Annual CG Report filed with the SEC (submitted annually every May 30) a summary of Material RPTs entered into during the reporting year.

Memorandum Circular No. 10-2019 indicates clearly that SEC is not gun-shy at all in activating its administrative sanction powers under Section 158 of the RCCP as it imposed specified basic and daily/monthly penalties for (a) Non-filing or late filing of or incomplete/incorrect signature in the Material RPT Policy; and, (b) Non-filing or late filing of or incomplete/incorrect Material RPT Advisement Report. In addition, the memorandum circular provides:

Continued non-payment of the assessed fine and/or failure to comply with the requirement within a period of 15 days after notice and hearing, shall be a sufficient ground for the Commission to take other appropriate action or remedies available under Section 158 of the RCCP.

Further, the commission of a fourth offense for the same violation is a ground for the suspension/revocation of the erring company’s registration or secondary license, which shall be made after notice and hearing, in accordance with the abovementioned procedures.

This is without prejudice to administrative penalties that may be imposed by the Commission pursuant to the provisions of the RCCP, the Securities Regulation Code, and other related laws.

With the imposition of basic penalty and daily/monthly penalties for the defined offenses, we do not understand the saving clause in the afore-quoted last paragraph that holds “This is without prejudice to administrative penalties that may be imposed by the Commission pursuant to the provisions of the Revised Corporation Code.”

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 MAP Corporate Governance Committee, trustee of the Institute of Corporate Directors, former Chair of Governance Commission for GOCCs (August 2011 to June 2016), Dean of the Ateneo Law School (April 2004 to September 2011), author of the book The Law and Practice in Philippine Corporate Governance and the National Book Board Award-winning Profession, and founding partner of the Villanueva Gabionza & Dy Law Offices.