The New Ethiopian Commercial Code: Uncovering the Major Changes in Composition, Role, and Accountability of the Board of Directors

Jan 24 2022

 

 

 

 

Abstract

Ethiopia introduced a new Commercial Code in March 2021, replacing the Commercial Code of the Empire of Ethiopia Proclamation No. 166/1960 (the repealed Commercial Code) that governed business operation since 1960. There were many factors that necessitated the revision of the repealed Commercial Code including the demand for responsible corporate management. In Ethiopia, the emergence of publicly held share companies and the rise in the number of shareholders demand to give due emphasis to corporate management. The 1960 Ethiopian Commercial Code failed to provide an adequate legislative response to complex governance issues of the day. Consequently, the Federal government of Ethiopia introduced wide-ranging legal reforms as part of the economic liberalization and modernization. However, the lack of up-to-date legal research and expert commentaries has remained a major challenge to adapt for practice and for the judicial sector. This paper aims to uncover changes under the new Commercial Code of the Federal Democratic Republic of Ethiopia Proclamation No. 1243/2021 (the FDRE Commercial Code) concerning the composition, role, and accountability of the board of directors.

 

 

 1. Introduction

The 1930 Commercial Code of Ethiopia, the Fetha Nagast - The Law of the Kings, and customary laws remained the basis of corporate governance in the Ethiopian legal system until the introduction of the Commercial Code of the Empire of Ethiopia in 1960. It is indisputable that the Commercial Code of the Empire of Ethiopia brought a major change in regulating the constitution and activities of all business organizations. It bestowed the shareholders’ meeting, board of directors, and the general manager to carry on the management of the company. As Fikadu Petros noted, among these management bodies, the board of directors was a new concept in a company’s governance tier with considerably exaggerated power.

 

However, as time went on, experts and companies realized that the Ethiopian company law lacked adequate legislative provisions on governance issues related to the separation of supervision and management responsibilities, as well as on the composition, independence, and remuneration of the board of directors. This and other modernization issues forced the Ethiopian parliament to amend the six-decade-old commercial code.  Accordingly, the Federal Democratic Republic of Ethiopia (FDRE) Commercial Code (Proclamation No. 1243/2021) has come into force in the year 2021 and it introduced several positive changes, including two tier board of directors’ structure of a Share Company.  In this paper, an attempt is made to uncover and assess the power, duties, and liabilities of the board of directors of companies, the most powerful managerial body in the ladder of corporate governance under the FDRE Commercial Code.

 

The recently enacted FDRE Commercial Code authorized the board of directors to take over top management of share companies. The board of directors is a body of elected or appointed members who jointly oversee the activities of a company.  Persons by whom a business of the company is carried out are termed as directors, while a group of directors as an institution is termed as a board of directors. Among the newly introduced rules into the new commercial code of Ethiopia, the following major changes are adopted concerning a board of directors.

 

A. Board of Directors in Private Limited Company

Unlike the repealed 1960 Ethiopian Commercial Code that obliged only share companies to assign directors, the new FDRE Ethiopian Commercial Code allows both a share company and a private limited company to be governed by a board of directors.  Although it is not mandatory, a private limited company may have a board of three to seven members at its discretion.

 

B. Non-Shareholder Board Members

The repealed Commercial Code stipulated those directors must be shareholders of the company. This requirement has been eliminated by the new Code, allowing companies to appoint non-shareholders as directors. In doing so, the new law has adopted both the ‘stockholders’ approach, in which case only shareholders of a company can be a member of the board of directors, and the ‘Stakeholder’ approach, where a non-shareholder stakeholder can be a member of the board of directors. This change enables independent directors to sit on the board, bringing an outside perspective and a more objective viewpoint to the company.

 

C. Introduction of a Supervisory Board

Another new development in this new Code is the supervisory board. Companies have been given an option to establish a supervisory board, in addition to a board of directors. Accordingly, a company may have a supervisory board consisting of three to five shareholders. Only shareholders of the company who are not already members of the board of directors can be appointed as members of the supervisory board. The purpose of this board is to supervise the board of directors and the management, to ensure that directors and managers are discharging their responsibilities properly. The supervisory board is mandated to submit its observation and recommendation to the subscriber's meeting when they find acts that jeopardize the interest of the company. Tsegamlak, in his commentary, noted that this change introduces a tiered board system to the Ethiopian company law to undertake the role of a board of directors in the absence of directors in terms of calling general meetings of shareholders.

 

2.1 Composition of Board of Directors

The composition of the board of directors refers to the number and type of directors that participate in the work of the board. Although Article 296 of the new Commercial Code failed to define who is a director, it briefs the composition of the board of directors. As per this provision, the board of directors shall be established by a general assembly from the shareholders and from non-shareholders. However, the number of non-shareholder directors may not exceed one-third of the total membership of the board of directors. Companies are at liberty to determine the number of directors, but it must not be under three and not more than thirteen. Regarding the composition of the board of directors, the other major departure from the 1960 Commercial Code is that two-thirds of the members of the board of directors may not have an executive role in the day-to-day management of the company.

 

3. Powers, Duties, and Liabilities of the Board of Directors

3.1 Powers of Board of Directors

In companies with dispersed ownership, shareholders are usually unable to closely monitor their management, its strategies, and its performance. Thus, the board of directors is responsible for filling the gap between the uninformed shareholders, as principals, and the fully informed executive managers, as agents, by monitoring the agents more closely. Board of directors has the authority to represent, control and direct the company on behalf of shareholders. According to Article 315 of the new commercial code, directors shall be responsible for exercising duties imposed on them by law, memorandum of association, and resolutions of general meetings of shareholders. The same provision illustrates that the board of directors shall:

  1. Manage the company’s finances with a view that ensures the company has adequate capital and liquidity to meet its liabilities in a timely manner.
  2. Ensure the company´s governance arrangements allow the proper monitoring of the company’s financial statements and positions.
  3. Ascertain those sufficient procedures for risk management and internal control are established.
  4. Provide to the supervisory board, if any, all information needed for the performance of the duties of the supervisory board in a timely manner.
  5. Prevent damage to the company, or where prevention is not possible, mitigate the adverse impact of acts that are prejudicial to the company.

 

The above list is not exhaustive. As it is inferred from sub-article 6 of Article 315, there are other responsibilities conferred to the board of directors such as keeping regular records of meetings and submitting an annual report of the company’s operations. A close look to the provisions of the new FDRE Commercial Code allows us to conclude that the board of directors is the ultimate ‘managing’ body of a company. It enjoys extensive powers as provided in the Code and under the memorandum of association. In general, it is the board's main responsibility to make the company effective and efficient by using appropriate strategic leadership.

 

3.2 Duties of Board of Directors

Parallel to the powers, they are granted, board members have a duty of loyalty, and they are required to act in good faith. Article 316 of the FDRE Commercial Code stipulates that boards must consider the long-term interests of the company, the interests of the workers, the interests of the financiers, and the impact on the community and the environment. This provision details several obligations and shows the seriousness of the responsibilities of the board of directors. Unless otherwise restrictions are stipulated in the memorandum of association or by agreement with the company, members of the board of directors must make an independent and impartial decision to execute their responsibilities.  However, independence of the director does not entail that the director’s activity in violation of the memorandum of association, the decisions of the General Assembly or the law would not bring liability.

 

The other duty which board members owe is the duty to act due diligently and with due care. Article 318 of the same Code specifies that member of the board of directors is required to perform their responsibility diligently. Though the standard of diligence is subjective and arguable, the responsibility of the director shall be measured in terms of care and skill that a director of a company must exercise as well as the diligence that may reasonably be expected of a person carrying out the functions of a director of the company.

 

Duty to avoid conflict of interest is also another obligation in which directors are prohibited from using the company's assets, information, or business opportunities for personal gain or for the benefit of others. To avoid conflict of interests between the company and directors, the new Commercial Code provides two types of provisions: prohibited and regulated transactions. In one hand, directors are not allowed to loan agreements with a company nor to be partners with joint and several liabilities in competitor companies or contend against the company directly or indirectly; on the other hand, a director may make transactions with a company with the prior approval from the General Assembly.

 

3.3 Responsibility and Accountability of the Board of Directors

Members of the board of directors, whether they are members of a corporation or not, are responsible and liable for any misconduct in their administrative duties, including civil and criminal liability.

 

  • Civil Liabilities of the Board of Directors

Directors are agents and trustees of the company, as such, they owe certain duties to the company, either imposed on them by law or the statutes and resolutions of the meetings.  Violation of these duties or failure to carry out these duties makes directors jointly and severally liable to the company, third-party creditors, and its shareholders.

 

3.3.1 Liability towards the Company

Directors’ liability towards the company is distinctly stipulated under Article 325 of the new commercial code. Accordingly, directors shall be jointly and severally liable to the company for damages caused by failure to carry out their duties.  Consequently, the company can claim any or all of them, and collect the total damages from any or all of them. In this regard, the law does not have any objective liability standard. However, sub-article 2 of Article 325 dictates that directors shall bear the burden of proof for showing that they have exercised with due care and diligence. The only way to overcome liability is by proving that their action was in due care and due diligence. This possible defense for directors is further elaborated under Article 327 of the same code. A director, who made a business decision in good faith, who has dissented and has notified to the external auditor as soon as possible may not be liable.

 

A. Liability to shareholders

The members of the board of directors shall be liable to shareholders of the company for damages they caused to one or more shareholders.  Under Article 333 of the Ethiopian Commercial Code, the right of shareholders to institute proceedings against board members is granted. Here, the law does not set out whether shareholders can bring legal action based on joint and several liabilities of directors. However, as it can be inferred from the text of Article 325(1) that makes directors jointly and severally liable to the company, the intention of the legislature is expected to be similar for directors’ liability towards shareholders.

 

B. Liability to Creditors

Creditors are those who have legitimate claims from the company. Since one of the duties of the directors is to preserve the asset of the company, they shall be liable to the company's creditors to the extent of the reduction in the company’s assets they caused where the company’s assets are not sufficient to pay creditors.  In fact, third parties have the right to satisfy their claims from the property of the company. If the assets of the company are not sufficient to cover the company's debts when the directors are at fault, the claimant has the right to sue the directors privately. In this case, the mere fact that the company decides to drop its lawsuit against the directors will not relinquish creditors' right to sue the directors.

 

C. Criminal Liability of Members of the Board of Directors

In addition to their civil liability, company directors are criminally liable for their failure to adhere to responsibility or for acting in a way that harms the interests of the corporation. According to Article 702(1) of the Ethiopian Criminal Code, a person who is legally or contractually bound to watch over or to manage the property rights of another and intentionally causes prejudice to such property interest by misusing their powers or by failing in their duties is punishable with simple imprisonment or fine.  Where the criminal committed negligently, the punishment shall be a fine, or simple imprisonment not exceeding six months. Where the criminal has committed the crime with intent to obtain for themself or to procure for another a benefit in property, the punishment shall be simple imprisonment for not less than one year, and a fine not exceeding 30,000 Birr. The penalty may be higher depending on the circumstances.

 

4. Concluding Remarks

The new FDRE Commercial Code shows that the role and responsibilities of the board of directors have been considerably amended. The departures in tasks and responsibilities, composition, and qualification of the board of directors in the new Commercial Code from the old Commercial Code requires cautious assessment. The FDRE Commercial Code introduced both permissive and obligatory rules in relation to the board of directors. Only companies that want to organize their boards into two tiers can have the newly introduced supervisory board. The Board of directors for private limited companies is also permissible.

 

Most importantly, the new code clearly stipulates the roles, responsibilities, liabilities, and remuneration of the board of directors to address governance problems. The new Code has an illustrative list of powers, save to the powers and the responsibilities of directors, conferred by the shareholder's general meeting and memorandum of association. The new Commercial Code sets out strict rules to protect companies, shareholders, and creditors from faults of directors and extends the liability of board members to their private property. Unless proven otherwise, any damage to the company due to directors will have the effect of civil and criminal liability. In this regard, even if the company is either tolerant or reluctant to proceed against its board members, shareholders are granted the right to request an audit and to sue the board members individually.

 

In closing, the corporate climate in Ethiopia is changing with the emergence of newer companies with several thousand shareholders who have no control over the company. In such cases, control over the company is left in the hands of the board of directors and a few managers. Thus, directors who are appointed based on the previous law and persons who are assigned after the promulgation of the new law should be cognizant of the roles and responsibilities of being a director. At the same time, companies that previously formed a board of directors are required to review the powers and responsibilities of directors in accordance with the provisions of the new FDRE Commercial Code.

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Read 3435 times Last modified on Jan 24 2022
Misganaw Belete

The blogger (LL B, MBA), is a Lawyer and Consultant, formerly District legal officer, Dashen Bank S.C, Bahir Dar, Ethiopia.