Kazakh Legislation Regulating Liability of Board Members

Kazakh Legislation Regulating Liability of Board Members

    One of the most important and most commonly discussed problems, though not carefully studied problem of corporate governance in Kazakhstan, is the necessity to step up and specify the liability of members of boards of directors. This is due to their desire to prevent their participation in actions, which can cause internal corporate scandals, lawsuits, fall in profitability or even the bankruptcy of a company. European countries pay more attention to the problem of corporate governance and liability of persons in charge of administration. In our country, this topic is quite undeveloped. For example, back in the late nineties a British commission on legislation prepared a report on boards of directors — “Company directors: settlement of conflict of interests and definition of duties”(1). It is believed that in order to increase the standards of management at the level of the board of directors, the company should have a minimum list of requirements regarding the activities of board members, which they should adhere to all the time. The higher the minimum standards, the higher the general level of corporate governance in a company. Thus, the higher the general level of corporate governance, the better the situation for all. Thus, Western countries envisage a lot of formal duties that are designated to improve the contribution of board members in the general management of companies.
    Joint stock companies, as a rule, and since they are large companies, make a huge contribution in the economic well-being of a country. They possess huge economic, social, and even political force(2). Taking into account the importance of various joint stock companies and their significant role in the national economy’s development, legislators undertake serious steps to improve legislation so as to protect the rights and interests of shareholders and joint stock com¬panies as independent entities in the market.
    Clause 6, Article 1 of the On Joint Stock Companies Act of the Republic of Kazakhstan qualifies members of board of directors as officials of a joint stock company. The board of directors carries out general management of a joint stock company, defines the strategies of a company, and carries out one of the main functions of corporate governance of a joint stock company. The main function of board members in the course of their activity is diligent performance of assigned duties using ways that best reflect the interests of a company and its shareholders.
    It is believed that board members should protect the interests of not just a specific shareholder (group of shareholders), but all shareholders of a company and, hence, should bear responsibility for the success of the entire company. But one should not forget about large shareholders who elect “their” representatives to the board and who pursue their own interests. It is logical that the issue exists of protection of rights and interests of minority shareholders who are similar to other shareholders represented by an independent director(3). In fact, the independent director is the most qualified manager (as a rule, engaged from Western countries), who has authority in society and protects the interests of business itself. Legislators believe that an independent director can make a significant contribution to the appropriate management of a company. Such a director should openly and freely express his or her point of view, which may be disliked by those who protect and lobby the corporate interests of separate groups of shareholders.
    Unfortunately, the On Joint Stock Companies Act does not contain a single article regulating the liability of board members. According to Article 63 of the On Joint Stock Companies Act, board members bear civil liability before society and shareholders for the harm caused by their actions (failure to act) in accordance with the legislation of the Republic of Kazakhstan, including for losses, resulting from:
    1) providing misleading information or deliberately false information;
    2) violating the order of provision of information as established by the mentioned Act.
    A joint stock company has the right, upon a decision of a general meeting of shareholders, to file a court claim against a member of the board of directors, to compensate for harm or losses caused to the company. Board members of a joint stock company are relieved of liability if they can prove in court, that:
    1) they voted against the decision of the company that resulted in losses for the company or its shareholders;
    2) they did not participate in voting at all.
    As mentioned above, board members of a company should diligently carry out their duties and use ways that in the best way reflect the interests of a company and shareholders. In the course of their management, board members should demonstrate liability and professional level. Actually, it is usually difficult to tell what actions of a director (hereinafter — a member of the board of directors) can be considered to be neglectful or unfair execution of their duties if, of course, such actions are expressly of a criminal nature.
    Risks in the course of economic activities are an integral attribute of any company. A company may suffer losses in the future, but that is not proof that directors neglect their duties or act unfairly. It should also be remembered that management of a company is quite a difficult process accompanied by risk that decisions adopted by boards of directors in a reasonable and diligent manner can prove to be wrong and entail negative consequences for both company and shareholders.
    Thinking about future relief of the possibility of being held liable for a decision, a board member governed by provisions of Article 63 of the On Joint Stock Companies Act can assume the stance of “since I did not vote for this decision I am not guilty”. However, in this case there is a risk of a director’s liability for damages caused by failure to act. Directors are not elected to be passive participants of meetings. Instead, they should prevent wrong decisions.
    At the same time, if directors voted for a certain decision which ultimately turned to be a failure for their company or the company suffered losses because of it, it is necessary to establish that a director is guilty. The liability of such a director depends on whether he acted honesty and reasonably. That is, whether he acted with care and discretion that are expected from a good leader, and whether he took measures to perform his duties in an appropriate way. A board member is believed to act honestly if he personally is not interested in approval of a specific decision and if he carefully learned all the information necessary to make a decision. Establishment of the fault of independent directors seems practically impossible in such cases because they are not dependent and do not lobby the interests of certain shareholders (groups of shareholders) and make decisions which, in their opinion, are exclusively diligent.
Along with liability of board members for damages and losses caused by their actions, the need also exists for their protection. In this regard, foreign legislation is much more advanced. Many European countries have types of insurance like “Directors and Officers liability insurance” (D&O). D&O policy covers the financial risks carried by the board members of a company and members of an executive body related to possible errors in the management of a company, except for intended infringement of legislation, fraud and other criminal offences.
Liability of board members
    When legislators introduced into On Joint Stock Companies Act the possibility of board members being liable for actions (failure to act) causing damage to a company, they intended to differentiate between the liability of a company itself, an executive body, and that of board members. However, liability of board members is limited since its possible grounds are their non-performance or inadequate performance of a small number of their duties. The majority of types of liability established by the legislation for officials of companies apply mainly to the executive body (President, Board, etc.).
    Civil law liability is based on a violation by a party of certain obligations (either contractual or non-contractual). To become a board member it is not necessary to conclude an agreement with a would be member. All the duties of a director are established directly by the Companies Act and a company’s Charter. We believe that obligations assigned to board members are non-contractual by their nature. Unfortunately, we are not aware of any cases where board members would be brought to civil law accountability in the Republic of Kazakhstan. The reasons may include certain obstacles arising for minority shareholders. For example, according to Article 63 of the Act On Companies Act, a company has the right to file a court claim against board members seeking compensation of harm or losses the company suffered because of a decision adopted by the general shareholders meeting. This provision can fail to protect the interests of minority shareholders whose votes may be not enough to make a decision on filing a claim.
    We believe that the mechanism of bringing board members to civil law liability for infringement of rights and interests of shareholders and a company can start working if at least 2 (two) options are introduced:
    – there should be an official interpretation of certain norms of the Act, specifying cases when the guilt of board members directly follows decisions adopted by them;
    – or it is necessary to establish strict liability for those board members who voted for certain decisions that caused losses (damage) for a company.
    Bringing officials to administrative accountability is complicated by the fact that MPs failed to differentiate in the Administrative Offences Code of the Republic of Kazakhstan cases of administrative liability concerning a legal entity itself or an official, thereby making it difficult to apply norms of administrative law. We believe that the optimal option is to introduce ap¬propriate changes to the Code establishing when responsibility applies to heads of companies (with a breakdown of responsibility for executive bodies in charge of current management and board members), and when a company itself is liable.
    When talking about the criminal liability of a board member, it should be admitted first and foremost to admit that Kazakh legislation does not provide for such a special subject of crime as that of “a member of the board”. The criminal legislation of Kazakhstan does not have legally defined crimes related to specific offences by board members. Thus, a board member can be subject to criminal liability only on common grounds (age, mental or other properties) and, hence, cannot be a subject of crime of «an official». For example, Article 228 of the Criminal Code of Kazakhstan states that abuse of official powers by a person with managerial functions in a commercial organization contrary to the legitimate interests of the organization in order to receive benefits and advantages for oneself or other persons and organizations, or if the abuse caused harm to other persons or organizations resulting in financial losses to the rights and legitimate interests of citizens or organizations or protected interests of society or the state, is an offence entailing quite serious punishment. A person with managerial functions in a commercial organization is one who permanently, temporarily or upon special assignment performs organizational, administrative, or managerial duties in such an organization. The maximum possible punishment for such a crime is imprisonment for 2 years which, in our opinion, does not fairly reflect the interests of joint stock companies, since the damage caused by criminal acts of board members can have much more serious consequences that can turn out to be incomparable with such punishment. This especially concerns joint stock companies that are major economic entities in the scope of a separate region, and certainly, of the state as a whole.
We need to wait and see how courts in the Republic of Kazakhstan apply Article 63 of the On Joint Stock Companies Act in practice.

(1) Commission on legislation, No 261, 1999 (Law Commission, Company Directors: Regulating Conflicts of interest and Formulating a Statement of Duties).
(2) Report by Dr. Wartington at the Fourth round table meeting on corporate governance. Moscow, 2001.
(3) According to G. Kopbasarova, Coordinator of Good Governance. Program of the US Department of Commerce in Kazakhstan and Central Asia countries.

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