The rights, duties and responsibilities of boards of directors

Principle VI.A states that “Board members should act on a fully informed basis, in good faith, with due diligence and care and in the best interest of the company and its shareholders”. The Civil Code Act sets out the general duties of members of a directing body of a legal person. The members of a directing body of a legal person are required to perform their obligations arising from law or the articles of association with the diligence normally expected from a member of a directing body and need to be loyal to the legal person. In Estonian law, the relation between a company and a management body is regarded as a contractual-like relation (authorisation agreement) and consequently the provisions of the Law of Obligations Act apply. The Law of Obligations Act (LOA) states that “upon the performance of a mandate, the mandatory shall act in a loyal manner with respect to the mandator and exercise the necessary level of diligence commensurate with the nature of the mandate”. By implication a member of the management board is obligated to make such efforts as would normally be expected from a reasonable person in the same field of activity or profession under the same circumstances. It is assumed that there exists a relationship of trust in the authorisation agreement between the company and a member of the management board. Duty of loyalty means that by performing his/her duties, a member of the management board has to take into consideration the interests of a company and to protect them by any means possible. Furthermore, LOA incorporates within its definition of duty of loyalty the notion of confidentiality and avoidance of conflict of interests.

In addition to this, the Commercial Code (CC) contains more specific regulation concerning the duty of loyalty for members of the management board in private and public limited companies by prohibiting management board members from holding a significant post in competing companies, the preservation of business secrets and the prohibition of loans (in certain cases26).

The management board is also required to perform its duties with due diligence. In several court cases the National Court has pointed out that an obligation to act in the most economically purposeful manner signifies also that a member of the management board has to be diligent, sufficiently informed to pass resolutions and should not take unreasonable risks in relation to a company.

As pointed out repeatedly by market participants, Estonia is a very small country, thus increasing the potential for conflicts of interest, as “everyone knows everyone”. This may work in many ways: on the one hand related party transactions and conflicts of interest may be more common, but on the other hand it was suggested that the size of the country makes reputation an important deterrent, as any wrongdoing detected by the community can easily and rapidly ruin someone’s reputation.

Principle VI.C states that “the board should apply high ethical standards. It should take into account the interests of stakeholders.”

Estonian companies are not required to produce a code of conduct. Furthermore, boards are not legally required to perform self-evaluations either. The law does require members of the management board to adhere to the lawful orders of the supervisory board and also to act in the most economically purposeful manner.

The CG code contains provisions regarding boards. In particular it looks at the duties, composition and responsibilities, and conflicts of interest. Generally, the analysis conducted by the FSA of the recommendations points to inadequate explanations provided by issuers.

Principle VI.E.2 states that “the board should be able to exercise objective independent judgement on corporate affairs”, and for that should consider “assigning a sufficient number of non-executive board members capable of exercising independent judgement to tasks where there is a potential for conflict of interest. Examples of such key responsibilities are ensuring the integrity of financial and non-financial reporting, the review of related party transactions, nomination of board members and key executives, and board remuneration.”

This Principle has become even more relevant with the recent adoption in Estonia of the mandatory establishment of audit committees in all Public Interest Entities (all listed companies and SOEs would fall under this category27). The Auditing Act establishes the following parameters for audit committees: 1) all members to be appointed and removed by the supervisory board, 2) the committee will need to include at least two people both of whom will be a finance, legal or accounting professional; 3) a member of the audit committee cannot be an internal auditor, member of the management board28 or the auditor; and 4) the chair of the audit committee cannot be the chair of the supervisory board. The explanatory note to the Law states that the last two requirements were introduced in order to ensure the committee’s “independence from the company/public institution’s management but also from the supervisory board”. The Audit Committee will be charged with providing advice to the supervisory board in the following areas: accounting, auditing, risk management, internal control and auditing, budgeting and legal compliance. The Audit Committee would not be required to approve certain other sensitive transactions where the potential for conflicts exist, such as remuneration policy and related party transactions.

The Auditing Act does not define the “independence” per se of the audit committee members. While Estonian supervisory board members are by definition non-executive, Estonian companies are not required to nominate members with independence from the controller, raising some questions as to whether all conditions will be in place to allow for the “independent judgement” the committee should exercise. One market participant went as far as describing this audit committee (in its current form) as a “Potemkin village”, meaning that it would look nice from the outside but would change nothing in substance. However, while independence of the Audit Committee is an important concern, other requirements such as that at least two members have financial or accounting backgrounds could prove to be useful. The FSA has recently proposed to the Ministry of Finance to consider the issue of independent supervisory board members of listed companies to be regulated and enforced by law. As the Estonian authorities have not provided information on any specific elements of what such a proposal would entail, it remains an issue for further consideration.

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