The Role of the Non-Executive Director An Overview

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Introduction

Set out below is some practical guidance to assist non-executive directors of UK private companies and ensure they are involved in corporate policy and material decision making. As a first point we would note that the great majority of private limited companies in the UK have not in the past appointed non-executive directors to their boards. In the main this was only relevant for publicly quoted companies and much larger private companies where, perhaps, there were very good reasons to make such appointments. This may have been to represent a finance house or a powerful minority shareholder. However, over the last few years we have seen an increasing trend for medium size and larger private companies to appoint non-executive directors for some of the reasons set out below. Much of what we discuss below is, therefore, taken from guidance which has been produced for publicly quoted companies but can, if suitably adjusted, be applied to private companies. 2. The Role

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Essentially the role of a non-executive director is to provide what could be called a creative contribution to the board of directors by giving objective criticism and advice. Today it is widely accepted that non-executive directors have an important contribution to make to the effective running of many companies. As The Cadbury Report, produced in 1992, stated they should bring an independent judgment to bear on issues of strategy, performance and resources including key appointments and standards of conduct. There is no legal distinction between executive and non-executive directors. As a result, in the UK unitary board structure, non-executive directors essentially have the same legal duties, responsibilities and potential liabilities as their executive colleagues. Although it is understood non-executive directors cannot and do not give the same continuous attention to the business of the company, it is important that they show the same commitment to its success as the executive directors.

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All directors should be capable of seeing company and business issues in a broad perspective. However non-executive directors are generally chosen because they have a breadth of experience, are of an appropriate calibre and have particular personal qualities. Additionally they may have specialist knowledge that will help provide the board with useful insights or, perhaps, key contacts in related industries or in the City. Of genuine importance is their independence from the management of the company and any of its interested parties. This means they can bring a degree of objectivity to the boards deliberations and play a valuable role in monitoring management decisions. This cannot be the case where the non-executives represent, for example, the majority shareholder or the controlling shareholder. This in itself produces various legal difficulties under the new Companies Act 2006 when discussing how those directors should act, or not act, in contributing to the success of the company. Non-executive directors may have an inherent conflict if it is the intention of the majority or sole shareholder that they represent their or its interests. In such a case they may be unable to carry out one of their primary functions to promote the success of the subsidiary company. If this in any way conflicts with their duties to their own parent company then they would have to consider their position. This is often going to be a practical problem, particularly because of the new requirements of the Companies Act 2006. For quoted companies, the various reports that have been produced over the years stress that the board should include enough independent non-executive directors for their views to carry significant weight in the deliberations of the board. We note here that independent directors, which is of course not the same as non-executive directors, are essentially persons who apart from directors fees and shareholdings are independent of the management and free from any business or other relationships which could interfere materially with the exercise of their independent judgment. In the UK, the management function is delegated to the executive directors. Certain, limited matters, would generally require board approval. These differ for each company. 3. The functions of non-executive directors

Non-executive directors are expected to focus on board matters and not stray into executive directions. In so doing they should provide an independent view of the company, distinct from its day-to-day operations. Non-executive directors therefore are appointed to bring to the board: (a) (b) (c) (d) (e) independence impartiality wide experience specialist knowledge personal qualities.

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Key responsibilities of non-executive directors

Non-executive directors should be used to provide general guidance and a different perspective on matters of concern. The board (or the chairman) will often seek their guidance on particular issues before they are raised at formal board meetings. Indeed in listed companies some of the main specialist roles of non-executive directors will be carried out in board sub-committees, in particular, audit or remuneration committees. 5. Strategic direction

As an outsider, the non-executive director may have a more objective view of external factors affecting the company in its business environment than the executives. The normal role of the non-executive director in strategy formation is therefore to provide a creative and informed contribution and to act as a constructive critic in looking at the objectives and plans devised by the management team. 6. Monitoring

Non-executive directors should take responsibility for monitoring the performance of executive management especially with regard to the progress being made towards achieving agreed company strategy and objectives. They may also act as a sounding board for management. Rather like their audit function (see below) it is up to the non-executives to probe continually and ask questions of management, especially where they have particular concerns. They must continually act as a sounding board for management, and as we have said, probe and ask questions where they have any doubts or concerns. To fulfill this function effectively they must be fully briefed by executives and have adequate sight of any information or documents which they request. It is not appropriate for management to use delaying or other tactics such that the non-executives only receive, for example, board papers at the last minute giving them no time to consider these in detail. This may of course lead to conflict between executives and non-executives but this is something which has to be dealt with in any company structure. Board and other briefing papers should be full and complete if they are not, the non-executives should query the point accordingly. 7. Audit

It is the duty of the board as a whole to ensure that the company accounts properly to its shareholders by presenting a true and fair reflection of its actions and financial performance and that the necessary internal controls and systems are put into place and monitored regularly and rigorously. A non-executive director has an important part to place in fulfilling this responsibility, whether or not a formal audit committee has been constituted. As previously mentioned, it is essential the non-executive directors ask appropriate questions when they have any doubts or concerns as to actions or financial positions or structures being taken or organised by the management. They must satisfy themselves that the financial information produced is

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accurate and that financial controls and systems of risk management are both robust and defensible. 8. Conclusion In summary the best practical advice we can give to the non-executive directors is to challenge constructively and continuously ask questions of the executives. They should ensure that all information requested is delivered in a proper and timely manner. They must also feel comfortable in general and specific terms with their executive board colleagues and their management team. They should ensure that they have suitable access to the companys auditors and bankers, and should be able to seek independent legal advice if they believe this to be necessary. For further information on this subject please contact: Nick Gould - nick.gould@incelaw.com June 2008

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