Large private companies and King IV – proportionality is the answer February 2018

By JUSTINE KRIGE AND GASANT ORRIE, Published in Company Law

On 1 November 2016, the Fourth King Report on Corporate Governance (King IV) was published. It became effective on 1 April 2017.

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As with previous iterations, King IV is a codification of voluntary principles and best international practices in corporate governance. It is not binding legislation. That said, many of the principles have found their way into binding legislation such as the Companies Act, and other insurance and public security exchange laws.

In principle, King IV can be applied to all entities. It employs the generic reference "governing body" when referring to the primary governance structure within an organisation (in the case of a company, its board). The principles of King IV are framed and expressed in general and high-level terms, and are capable of being implemented by any organisation, regardless of its nature and size.

However, one of the most significant criticisms of prior iterations of King IV has been the lack of guidance as regards the practical implementation of these general principles. King IV aims to remedy this through the introduction of sector-specific supplements, which are intended to provide practical guidance to its implementation with reference to specific organisations. The sector-specific supplements cover state-owned entities, non-profit organisations, municipalities, small-to-medium enterprises, and retirement funds.

The application of King IV to public companies is relatively clear, as is its application to those sectors for which specific sector supplements have been prepared. However, virtually no guidance is given on the implementation of King IV in large private companies – that is, organisations which fall outside the classification of small-to-medium sized enterprises set out in King IV. This is unfortunate for at least two reasons: first, there are a considerable number of large private companies in South Africa which would benefit from practical guidance; and second, the adoption of King IV (and its success) would be aided through its proper implementation by large private companies.

Sector supplement on SMEs

The sector-specific supplement on small-to-medium enterprises describes these as organisations in the initial stages of development that are, in the main, entrepreneurial in nature. It defines them as private for profit companies with a public interest score of at least 350 in terms of the Companies Act.

Large private companies typically have developed and established corporate structures. Notwithstanding this, these companies would also be well-advised to take heed of the general principles set out in the sector-specific supplement on SMEs. But, to what extent can (and should) large private companies implement King IV?

The principle of proportionality and the importance of compliance
King IV acknowledges that even within the same sector, organisations vary in size, resources and extent and complexity of activities. It is for this reason that it expressly recognises that a "one size fits all" approach to corporate governance is unworkable. For example, a full-scale implementation of King IV may be inappropriate for many larger private companies, due to the size of the company, nature of the business or the manner in which the company operates. It may simply be too onerous, or ineffectual to implement certain measures.

The solution proposed by King IV is reflected in its underlying principle of proportionality, which provides that the principles in King IV must be applied to organisations in accordance with their size and turnover of workforce, resources, and extent and complexity of the activities of the enterprise.

In this regard, it states, "[t]he practices as recommended in the Code are, however, positioned at the level of leading practices and may therefore not be suitable and appropriate for all organisations. Mindless compliance and a quantitative approach is not the aim". It goes on to state that: "[e]ven where not expressly stated in the Code, practices are meant to be scaled in accordance with the following proportionality considerations particular to the organisation: size of turnover and workforce, resources, extent and complexity of activities".

It is arguable that, in accordance with the proportionality principle, the larger the company, the greater the number of shareholders, and employees, and the larger the turnover and profit, the greater the imperative for compliance with King IV.

But, what about larger private companies with a large workforce but only one or two shareholders? This is where the water becomes even more muddied.

In practice, these companies will need to assess the extent to which the various principles are appropriate for their specific needs, and can be practically implemented. Success will likely be found through trial-and-error, with adaptation evolving organically. Some principles will be retained, while others will be discarded. This is the wisdom of King IV: there is no single recipe.

Even in respect of the sector-specific supplements, the suggested practical implementation of the principles is not intended to be applied strictly to the letter. King IV is concerned about outcomes, and its core principles must be adapted and customised as appropriate in each instance.

Although King IV is acknowledged as being non-binding, it comes with a clear warning. There is an expectation (although not fully crystallised in law as yet) that all directors, especially those of large companies, acquaint themselves with King IV. There is a definite trend in South African case-law to refer to King IV as yardstick against which the standards of conduct of directors is measured. In assessing whether or not directors have discharged their obligations properly, courts may take into account whether they have complied with the principles underpinning King IV. There is significant risk that failure to comply may attract liability. It is, therefore, imperative that larger private companies get to grips with King IV – it is simply no longer possible to turn a blind eye.

As King IV gains more widespread application, it will become increasingly ingrained and companies will be hard pressed to ignore its application.

The application of King IV to larger private companies will hopefully become clearer. Until then, private companies, particularly those larger companies that fall outside the ambit of SMEs, will need to consider carefully the extent to which the principles in King IV are relevant, and can be applied to the company on a case-by-case basis.

Krige is a Director, Corporate and Commercial, and Orrie is Cape Managing Partner and a Director in the Corporate and Commercial practice, Cliffe Dekker Hofmeyr.

Cliffe Dekker Hofmeyr