Corporate governance challenges of group companies

By ABDUL JABBAR BIN KARAM DIN

The Business Times, 8 December 2023

 

IN GROUP structures, the parent company often seeks to control and implement groupwide corporate governance policies. This may not always go well with the boards of group companies when there are conflicts of interests between the parent company and subsidiaries or associated companies.

Certain jurisdictions allow the directors of a group company to act in the interests of the group (subject to certain conditions). For example, if the board’s decisions and actions are balanced by future advantages arising from being part of the group.

Other jurisdictions, such as Singapore, require that the board of the group company has to act in the best interests of the group company, and not in the interests of the group as a whole or the parent company.

In Singapore, courts have held that persons acting as directors of a group company may consider the collective interests of the companies in the group but must still act in good faith in the interests of the company they are appointed directors of.

From a practical perspective, much also depends on the presence of minority shareholders in the group company, and greater care should be taken where such a group company is not wholly owned by the parent company.

Conflicts of interest

At a personal level, directors of a group company may face potential conflicts of interest. It is common practice for parent companies to nominate their directors, employees or other individuals to the board of their group companies to exercise control and influence.

However, a director nominated by the parent company to the group company’s board may at the same time owe obligations to the parent company by virtue of his directorship in, or employment relationship with, the parent company.

In situations where the interests of the parent and group company are not aligned, there is a possibility that such a director will have to act against the interests and instructions of one or the other, and risk breaching either his fiduciary duties to the group company or his contractual obligations to the parent company.

There are also differences in perception amongst the various boards in a group, which may give rise to conflicts. Parent company boards often view the group as a single organisation and do not differentiate decision-making based on each entity in the group.

Further, corporate governance-related policies are often developed at the parent company level and required to be implemented in all group entities without regard to the separate legal entity status.

In cases where the group companies are joint venture entities, the interests of joint venture partners will also have to be taken into consideration.

Where a group company is listed or regulated, the stock exchange or regulator will have more rules on the governance of the entity, which must be carefully considered and incorporated, especially when implementing group policies.

A group company that is an associated company may also have other controlling shareholders, and the ability of a parent company to implement its group policies may be limited, as it may merely have “influence” over rather than control of the group company.

Governance for group companies

Part of the best practices in group governance involves adopting a group governance framework. In adopting such a framework at group company level, regard must be had by the group company board to the general environment and unique legal, tax and business landscape in which group company operates.

For example, the group company may be regulated or listed on a stock exchange that may prescribe rules in relation to the governance and independence of the group entity.
The impact of such a framework on other minority shareholders (in the case of non-wholly owned subsidiaries) or other controlling shareholders (in the case of associated companies) that may be present in the group entity will have to be taken into consideration.

In the case of joint venture entities, a shareholders’ agreement may also prescribe certain governance requirements that may conflict or be inconsistent with the group governance framework.

There must thus be a delicate balance achieved between allowing the parent company to retain control and oversight and retaining flexibility for the group company.
To facilitate such a balance, the boards of group companies should engage the parent company in ongoing communications so there is a a clear understanding of the group’s and individual group company’s objectives, strategy and risks.

While considering the collective interests of the group structure as a whole, individual directors of group companies should ensure they continue to comply with their fiduciary duties to act in the best interests of their respective entities.

Best practices

As group structures continue to gain prominence in Singapore’s business landscape, it is essential to address potential corporate governance challenges effectively.

While the existing regulatory framework in Singapore on group governance may require updates, companies can benefit from adopting international best practices and principles.

This will enable them to maximise the benefits of group structures while minimising associated risks, ultimately contributing to long-term success and sustainability.

This is the second of a two-part series on the governance of group structures, associate companies, subsidiaries and joint ventures.

The writer is a member of the Professional Development Committee of the Singapore Institute of Directors.