NZSA Best Practice

Directors’ Retirement Allowances.

The listing rules of the New Zealand Stock Exchange provide compulsory constitutional provisions for any company seeking listing. One of those is a provision limiting payments to directors on their retirement. There are two alternatives. The first alternative is a limit to an amount that " does not exceed the total remuneration of the director in his or her capacity as a director in any three years chosen by the Issuer". The second alternative is for any amount, provided " the payment is authorised by an ordinary resolution of the Issuer".

This provision is embodied in listing rule 3.5.2. The rule is made compulsory consequent on the provisions of listing rules 1.9.1, 3.1.1 (a) and appendix 6 of the listing rules.

The first alternative power that arises under rule 3.5.2 in effect permits the Board of Directors to allocate a sum equivalent to the best three years’ earnings of a director, to that director as a retirement benefit.

The second alternative power under rule 3.5.2 is the standard provision for any other payments to directors: namely, that shareholders approve all and any payment of remuneration to directors. This standard provision appears in the listing rules at 3.5.1.

Accordingly, the first alternative power under rule 3.5.2 is an exception to the established standard provision for listed public companies in New Zealand.

The New Zealand Shareholders’ Association Incorporated objects to the existence of this exception to the standard provision.

The standard provision balances the interests of those affected by the operation of the company, as regards the remuneration payable by the company to the directors. It allows for payments to directors to be approved by someone other than the directors themselves. The appropriate alternative source of such oversight is the shareholders, as the company must have an annual general meeting every year. An opportunity is thereby given to set the remuneration of the directors, and monitor their performance generally. This is a much more straightforward means of controlling a director’s salary than any of the alternatives: approval by employees of the company, creditors of the company, or the State itself.

One of the principles of the concept of natural justice is that a person should not be a judge in their own cause. Allowing directors to set the retirement benefit for their fellow directors is a breach of this concept. No-one could realistically believe that directors voting on such a decision would not have in their own mind that their own turn will arrive in due course. Accordingly, no independent oversight of the decision occurs.

Another way of expressing this same concern is that there is an inherent conflict of interest where directors vote in relation to benefits received by directors.

The rule means that the usual checks and balances built in to the usual forms of internal controls (requiring some form of unbiased independent inquiry) are avoided.

There is also a perception that, generally, fees for directors of listed companies are adequate in relation to other professional fees. These already include sufficient provision in respect of retirement benefits. In effect, directors are paid in a range of about $150 to $250 per hour for their involvement in the operation of the company. Most people would regard this level of remuneration as sufficient for directors to provide for their own retirement.

In the case of non-executive directors, it should be noted that these directors are usually selected due to their experience, either as former advisors (lawyers and accountants) or as former management. The very fact of existing experience indicates that they are either close to, or in some cases have already reached, retirement. One would expect that they have already made adequate provision for their retirement. Accordingly, the entire rational for making any payment under this power seems suspect.

There is an important additional point to be raised relevant to this issue. When directors are seeking an increase in directors’ remuneration, surveys of directors fees in other jurisdictions are often relied upon. It should be noted that New Zealand seems to stand alone in allowing a rule such as 3.5.2. In other words, surveys of directors fees in other jurisdictions must over-state directors’ salary when compared to the New Zealand situation. Directors in overseas jurisdictions do not have the prospect of their fellow directors paying them three times their best years’ earnings when they retire. They must provide for their retirement from the amount awarded them for their annual remuneration. Accordingly, the issue of retirement benefits is already built into their annual remuneration. In New Zealand, directors have the added benefit of rule 3.5.2, which is not reflected in any of the overseas survey information.

The existence of this exception is something that must be born in mind if New Zealand is ever to harmonise its listing requirements (with Australia, for instance). The exception is also something that should be borne in mind by overseas entities seeking to take significant shareholdings in New Zealand listed companies. The existence of this provision will be foreign to them.

The opposition to this exception to the general rule has been acknowledged by the New Zealand Stock Exchange. When Restaurant Brands Limited changed its constitutional provision in this regard (as a result of a shareholder resolution), the Stock Exchange granted an exception from its listing rules in relation to that change. Clearly the Exchange accepts that there is no compelling reason to maintain this exception.

The Association has entered into correspondence with the Exchange on this issue. In addition to matters referred to above, the Exchange notes that the Board has a number of powers that impact on shareholder interests, that do not require shareholder approval. The Exchange referred to listing rule 7.3.5 (which allows directors to issue up to 10% of the total number of equity securities in a class, without shareholder approval) and also listing rule 7.3.4 (a) (which allows a pro rata issue to existing shareholders, again without shareholder approval).

The Exchange suggested that these rules indicate that good governance does not always require shareholder approval.

However, that is not the point the Association is making. The point the Association objects to is that directors are voting on matters that affect their own interests. Indeed, the examples given by the Exchange above would not be suitable for the shareholders to determine, because then the shareholders would be voting on their own interests.

The view of the Association is that these examples in fact support the Association's contention. Where such conflicts of interest arise, it is important to then find a way of avoiding them. The general rule regarding directors’ remuneration does avoid them. This particular exception (Rule 3.5.2) does not.

The Exchange also refers to listing 9.2.2 (d) as providing a limitation on the payment of directors’ retirement benefits. This rule provides limits where the Board is considering any transaction exceeding 0.5% of the lesser of shareholders’ funds, or the average market capitalisation of the Issuer. Once that threshold is exceeded, shareholder approval must be sought. The Exchange regards this as an important limitation on the remuneration payable to a departing director.

The Association regards 0. 5% of these thresholds in most public listed company as a very large sum of money. As such, the limitation is largely illusory. Further, if 4 directors were retiring in any one year, that would mean up to 2% of the shareholders funds or average market capitalisation of the Issuer could be applied to directors retirement allowances, without any opportunity for objection by the shareholders.

If one were to be cynical, there is also a question of how many times a director may "retire" under this rule.

The Exchange advises that this listing rule has been required of issuer constitutions for at least the last 15 years. It also notes that the Companies Act does not provide any limitation on directors’ remuneration at all. To that extent, rule 3.5.2 represents a limitation. It also acknowledges that, for instance, the Australian Stock Exchange requires shareholder approval for any such payments to directors.

To the extent that the New Zealand listing rule provides a limit of three years remuneration, the Exchange suggests that this is more strict than the Australian rules. The rationale for this suggestion is that if the directors recommend to shareholders at an annual general meeting, that payment of five years salary be paid as a retirement benefit, shareholders in Australia can approve that. The listing rule 3.5.2 (as far as the first alternative power is concerned) is limited to 3 years.

However, the Exchange appears to overlook the alternative basis for retirement payments under rule 3.5.2, which is that a proposal for five years payment can still be put to shareholders for approval (under the second alternative power in the rule).

The Exchange observes that its listing rules are subject to periodic review, and has noted the comments of the Association.

The Association promotes a model constitutional provision, which deals with these issues. The wording for such a proposal is as follows:

"That clause {relevant clause number from company constitution} of the Constitution relating to payments to directors upon cessation of office be deleted and replaced with the following clause:

Payments to Directors upon cessation of office

The Company may make a payment to a director or former director, or his or her dependants, by way of a lump sum or pension, upon or in connection with retirement from office of that director, only if:

102.1 The total payment (or the base for the pension) does not exceed ten percent of the total remuneration paid to that director in his or her normal capacity as a director of the Company, and

102.2 the payment is authorised by an ordinary resolution of shareholders of the Company.

Nothing in this clause affects (and is excluded from the calculation envisaged by this clause) any amount paid to an executive director upon or in connection with the termination of his or her employment with the Company, or the payment of any amount attributable to the contribution (or any related normal subsidy) made by a director to the Company's superannuation scheme".

The Association accepts that a company may wish to provide for the payment of retirement allowances to directors in appropriate circumstances. However, the model requires shareholder approval, and imposes an absolute limit. That limit would only approach the current level after a director had been continuously with the company for 30 years (10% of 30 years remuneration is approximately 3 years remuneration).

The suggested wording also prevents the abuse of the power by a majority shareholder.

The Association believes that this model clause provides the necessary independent oversight, allows payment of such benefits in appropriate cases, but also limits them in any event. This protects all interested parties - the directors have the prospect of a payment, the majority shareholder(s) can support it, the minority can not be abused, and creditors, employees and the State are unlikely to be prejudiced.

The Association has promoted this or similar amendments in a number of annual general meetings of public listed companies. It would hope that individual shareholders of public listed companies can now take up this issue and propose constitutional amendments in line with the model clause, without the need for further input from the Association.

It is also hoped that the listing rule itself will soon be amended to address the concerns outlined in this paper.

R M Dillon

Director/Advocacy, New Zealand Shareholders Association Inc.