On 27 August 2013 the Australian Securities and Investments Commission (ASIC) published Report 368 "Emerging market issuers" addressing the challenges faced by emerging market issuers and risks to retail investors, particularly in relation to corporate governance and disclosure.
In the Report, ASIC identified a number of key challenges faced by companies with assets and operations in emerging markets and recommends that emerging market issuers respond to these challenges by implementing effective internal controls and risk management systems.
The judgment of a Delaware, United States court earlier this year (which was brought to our attention by Stikeman Elliott in Canada) exposes a slightly extreme example of how things can go wrong, but it is nevertheless a timely reminder for directors of corporations with significant overseas assets and operations.
In re Puda Coal, Inc. Stockholders Litigation concerned "derivative" claims made by the shareholders of Delaware incorporated Puda Coal Inc. against the company's directors. The claims were based on alleged breaches of the directors' duty of loyalty and duty to monitor the corporation's affairs and officers.
In Delaware, the duty to monitor is an obligation to prevent harm to the corporation, that will be breached when harm occurs due to the inattention or inaction of a company's board. For present purposes it can be considered analogous to the duty placed on directors of Australian corporations to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise in the circumstances.
The plaintiffs' claims related to losses suffered by Puda Coal after its Chairman (yes, its Chairman!) Ming Zhao, a Chinese national, allegedly sold to himself the company's 90% stake in Shanxi Puda Coal Group Co. Ltd without shareholder or board approval and, it appears, without paying for it. China-based Shanxi was Puda Coal's main corporate asset and its only revenue-producing, operating subsidiary. The transfer left Puda Coal as a shell company with no ongoing business operations.
The independent directors of Puda Coal, apparently unaware that the company's assets had been misappropriated until some 18 months later, continued to authorise the public release of documents referring to Puda Coal's ownership of the assets. Puda Coal also continued to raise funds from US investors through public offers purportedly to raise capital to enable Shanxi to acquire coal mines, despite the fact that Puda Coal no longer had an ownership stake in Shanxi.
Following the details of the transfer becoming public, the independent directors immediately resigned, the company's share price plummeted and investors lost hundreds of millions of dollars.
In an interlocutory decision, Chancellor Strine of the Delaware Chancery Court denied the independent directors' motion to dismiss the shareholders' claims for breach of fiduciary duty, mainly on the basis that to dismiss the claim would (because the independent directors had resigned) leave the "decision whether to bring an action against those suspected wrongdoers" in the control of the person alleged by the independent directors to be the "principal wrongdoer" (ie. the Chairman).
In his ruling from the bench, Chancellor Strine articulated some general duties relevant to directors of Delaware corporations with overseas assets and operations and indicated that, in order to satisfy such duties, directors ought:
be physically present in the country where the assets are based "an awful lot";
maintain a "system of controls" to make sure the directors know that the company actually owns the assets;
have the language skills "to navigate the environment in which the company is operating"; and
retain "accountants and lawyers who are fit to the task of maintaining a system of controls over a public company".
Chancellor Strine suggested that directors must ensure they deal with the linguistic, cultural and other special challenges raised by the fact the company's assets are held overseas, and that a director will need to do far more than participate in a quarterly telephone conference call to discharge his or her fiduciary duties.
In dismissing the motion, Chancellor Strine noted the magnitude of the circumstances, the length of time the issue went undetected by the independent directors and the continued filing of statements stating that Puda Coal owned the assets, and held that it was "perfectly conceivable" that there had not been "a good faith effort to try to monitor" the company and its assets.
Lessons for directors of companies with overseas assets
The decision provides some guidance for directors of Australian companies with material assets or operations in foreign jurisdictions on what is expected from them in order to discharge their directors' duties.
With the Puda Coal decision and ASIC's Report 368 in mind, a director of a company with material assets or operations in foreign jurisdictions should:
- spend time in the jurisdiction in which the assets or operations are based;
- be aware of the applicable legal and regulatory requirements and practices in the relevant foreign jurisdiction;
- review disclosure policies, both the terms and the practice (with particular focus on systems that are in place to ensure that information that must be disclosed to the market is communicated promptly to the board and other persons authorised to disclose);
- involve jurisdictional experts and undertake adequate verification of assets and ownership to ensure that any disclosure document is not misleading and provides an accurate reflection of the business undertaken by the entity and the risks involved;
- with assistance from jurisdictional experts (legal and otherwise), develop effective strategies for dealing with the unique risks overseas operations pose, including implementation of systems of control to guard against misappropriation of assets;
- ensure transactions involving connected/key personnel are subject to a legal review under the related party transaction provisions and to robust consideration by the board - when in doubt, it is usually appropriate to put the matter to shareholders for approval; and
- be aware of the unique cultural and linguistic challenges of the jurisdiction, and have access to language skills relevant to the overseas jurisdiction.
 "Derivative claims" are known as such due to the cause of action resting with the company against the directors. Ordinarily (for obvious reasons) the directors are unwilling to cause the company to prosecute the action against themselves, and so shareholders are given the standing to prosecute the action on behalf of the company. Back to article
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