Making The Board Accountable

16 May 2014 | News


It is important that delegates at tomorrow’s Co-operative Group Special General Meeting vote in favour of a resolution that will start a process of reform.  But it is important that that process of reform addresses a fundamental weakness in the proposals put forward in the Myners report.

The central proposal is to create a new board which, like the board of directors of a company, can exercise all the powers of the organisation.  But company law contains a statutory right for shareholders to remove directors, a right that cannot be varied in the articles or by any agreement.  Industrial and provident society (IPS) law contains no equivalent statutory right. The appointment of an all-powerful board must therefore be underpinned by appropriate checks and balances.

Member control

A corporation is a mechanism for delegation, by which the many (members or shareholders) delegate power to the few (directors).

Although company law allows these arrangements to be varied, in a company, the articles of association normally provide that the directors may exercise all the powers of the company.[1]  The shareholders or owners of the company expressly delegate all authority to do virtually everything in their name, and act as their agents in running the company. Their role is as investors, and the intention is for the directors to run the business on their behalf to derive the best return on their investment.

Shareholders of a company retain very limited powers themselves.  This is logical, as the more powers the shareholders retain, the less authority directors have, which in turn undermines their ability to do their best for the company and its members.  The basic powers which the shareholders retain are first the power to wind up the company; and second to make changes to the constitution (under which directors hold power).[2]

The other important power which the shareholders retain is to appoint and remove directors.  They appoint their agents to run the business for them, and company law requires those agents to make a report annually on the affairs of the company.  On the basis of that report, which must be audited by a qualified external third party to give comfort that it is accurate, the shareholders can hold directors to account – ultimately by removing them if they are dissatisfied with the performance of directors.

Company law contains an essential provision which underpins these arrangements, namely a statutory power for the shareholders to remove directors.[3]  This power cannot be excluded in the articles or in any agreement between the company and a director.  This is because it underpins the idea of entrusting so much power to individuals to do things as agents.  And because these agents have so much power, the law imposes very serious duties on those agents to act and behave in a way which is appropriate when have they responsibility – like trustees – for somebody else’s assets.  These duties are now codified in company law in the Companies Act 2006.[4]

In its basic architecture, a co-operative appears to have a number of similarities to a company.  The members delegate most of the power of a society to a board of directors to run the society on their behalf.  As in a company, the members retain the power to wind up the society, and to approve changes to its constitution (rules).[5]

But there is also an important difference.  Unlike in company law, there is no equivalent statutory power in IPS law for the members to remove directors.  What is the background to this?

In a co-operative, the role of members is very different from investors in a company.  The latter entrust their money to the company under the control of its directors, but after that, theirs is a remote and detached relationship.  This is not the basis of a co-operative, where the members or owners of the society are its customers or employees.  The ICA definition of a co-operative as “an autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise” describes something very different from a company, and a member/society relationship is very different from that between a shareholder and a company.[6]

Those elected to positions of responsibility in a co-operative are individuals chosen by their peers to oversee their collectively-owned enterprise.  IPS legislation has never (as far as I am aware) included a power for the members to remove board members.  No one person has such power in a co-operative society that it needs to be counterbalanced by the ability for such a person to be removed.

Whilst the directors of a relatively small society would commonly appoint a manager to manage the day-to-day business of the co-operative, the directors would still reserve to themselves significant functions.  So traditionally the rules gave the directors of a co-operative full power to manage the business (similar to table A), with a discretion to appoint a manager.  This is the historical model, which arguably became outmoded some time ago because the nature and scale of the business had reached the point where it needed individuals with specialist skills to run the business.

In the mid-1990s, the rules of societies started to be changed, by delegating within the rules day-to-day executive responsibility for running the business, retaining to the directors strategic responsibility for the society, including the power to hire and fire the chief executive.  This was a significant step, because it required the directors to appoint an appropriately qualified individual to run the business: they were no longer allowed by the rules to run it themselves.  But this approach as well – at least in the case of the Co-operative Group – had become outmoded.

Upholding members control in the Co-operative Group

So the model needs to be changed, and this means that something new is needed to provide a proper stewardship of the assets of a society as large as the Co-operative Group, whilst retaining member control.  What is wrong with the Myners proposals?

The board proposed by Myners is essentially a professional board of people who are qualified to serve as executive or non-executive directors.  But the problem comes with entrusting this board with all of the powers of the society – when the members have no statutory or other power to remove the directors if they are failing to discharge their responsibilities.  This is a truly dangerous approach and seems to me to be seriously flawed.  The ability to remove a director on the third anniversary of their appointment is clearly insufficient.

In my view, there are two ways in which the powers of such a professional board need to be tempered in a co-operative.  The first is to require that members’ representatives should have some role in contributing to and approving forward plans and strategy.  The directors should not have unfettered powers to decide what the co-operative does.  It belongs to its members, and member-control requires at least some element of member contribution to the planning of future services.

The second way of retaining some effective control for members is for their representatives to have the power to remove directors (or some of them) if they are not adequately discharging their duties, or are acting outside the agreed forward plans and strategy.  The shareholders of a company have such a power of removal, and it is an essential ingredient of achieving a proper balance of power in the overall architecture.  Even if such a power was given to the members in the rules, in an organisation with a very large number of individual members, it would be very difficult to exercise such a power making it ineffective.

Such a power should therefore be held by members’ elected representatives.  There is a further very good reason why such a power should be exercised by elected representatives of members, rather than individual members.  Elected representatives, as well as being informed about the needs of and issues facing the society, would owe some duties to exercise their powers in the best interests of the society and its members.  This seems to be more appropriate than providing that such a key decision should be taken by members, who would owe no legal duties in making any such decision.

One of the questions raised in the Myners’ report Q and A asks why a two-tier structure with a supervisory board is not being proposed.  The answer given is that a two-tier structure is not formally recognised under English law.  The proposal above is not for a supervisory board.  It is for a two-tier structure in which the board remains sovereign – though it does not have unfettered rights to exercise all of the powers of the society as to the directors of a company.  Their powers would be curtailed – to manage the business within the parameters agreed with the members’ representatives, and the accepted values and principles.

This governance design is already established in English law – for public benefit corporations, or NHS Foundation Trusts as they are more commonly known.  Whilst I would not advocate many of the features of that corporate structure in the present context, it nevertheless illustrates governance arrangements (established in statute) in which elected representatives have essentially the powers described above.

Such a restriction of powers would feel very uncomfortable to any person who has served on the board of a public company in the UK.  They would argue, amongst other things, that it does not give them the authority and freedom to do their job as they would in a company.  This would be true; but it would also reflect the essential difference that a co-operative is not a company, and a director of a co-operative is not the same as a director of a company.

These are very important issues which need to be carefully worked through if the Co-operative Group is not to move to a constitutional arrangement which will see the end of member control, and the creation of something which in time will seem to have very little difference from an investor-owned company.  IPS law is not the same as company law.  Whatever emerges – if it is to be a co-operative society and not a company – needs to have an ownership and governance design which works under the legislative framework under which it is registered and the purpose for which it was created.

Final observations

Inevitably in the current circumstances, much of the focus is on structure and governance, as it is this which is seen to have failed.  But we must be careful: structure is simply a means to an end.  It needs to provide a stable framework to hold a business and to enable it to prosper and succeed.  But to do this successfully it must in practice provide scaffolding to support a pre-existing set of human relationships, and a way of working and doing business which is underpinned by a particular culture – a culture of co-operation, of ambition for co-operative values, and a culture of mutual trust.

[1] See for example article 3 of table A for a public company: “Subject to the articles, the directors are responsible for the management of the company’s business, for which purpose they may exercise all the powers of the company.”

[2] Companies Act 2006 also gives certain other powers in a PLC such as approving certain executive contracts, self-dealing by directors etc.  Listing requirements also give shareholders additional powers and rights in relation to certain large transactions.

[3] Section 168 (1) Companies Act 2006 “A company may by ordinary resolution at a meeting remove a director before the expiration of his period of office, notwithstanding anything in any agreement between it and him.”

[4] Section 170 – 177 Companies Act 2006

[5] The latter depends on FCA insistence as it is not specifically required by IPS legislation.  As in many other areas, IPS law allow much greater freedom in corporate design, though it insists on democratic control in a co-operative.

[6] The variety of different types of co-operative e.g. consumer, worker, consortium etc. also permits a range of difference types of relationships