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MARK RUHINDI
The Ugandan Supreme Court recently ruled that Bank of Uganda did not act unconstitutionally when it closed National Bank of Commerce (NBC). The bank’s shareholders(Led by Businessman Humphrey Nzeyi) had challenged the Central Bank’s actions on grounds that they infringed on constitutional rights; Particularly the right to own property(among others), arguing that the regulatory intervention amounted to an unlawful deprivation of their interest in the bank.
In its decision, the Court reaffirmed the broad statutory and constitutional mandate of the Bank of Uganda (BoU) to preserve financial stability and to protect the public interest, especially the interests of depositors and the wider financial system.
The Regulatory Mandate of the Bank of Uganda
The central bank’s regulatory powers over licensed financial institutions include licensing, supervision, intervention, statutory management, and in extreme cases, revocation of a banking license.
The exercise of this regulatory mandate is meant, first and foremost, to protect the integrity of the financial system and to safeguard depositors’ funds. These two objectives consistently outweigh shareholder rights when a licensed financial institution is deemed unsafe or unsound.
Leverage, Fiduciary Duty, and the Nature of Banking Entities
Banks are, by the nature of their business, highly leveraged institutions. Depositors’ money is recorded as a liability on a bank’s balance sheet. As such, at law, depositors are creditors of the bank. This makes banks uniquely vulnerable to rapid insolvency when asset values drop or liquidity dries up, especially in the absence of adequate capital buffers.
A bank run(heavy sustained depositor withdrawals) that lasts up to 72 hours can easily take out a small bank.
This unique structure underpins the regulatory emphasis on capital adequacy, prudential ratios, and early intervention. It also explains why the central bank’s duty to depositors and to the financial system at large far outweighs shareholder entitlements when a crisis looms.
Directors, Shareholders, and the Company ‘as a Whole’
While shareholders own the company, they DO NOT own the assets of the company. The assets they own are the shares allotted to them. The company owns its assets. Conversely, the shareholders are not the managers of the company. They must first become directors in law for them to exercise managerial roles.
The directors(the Managers) owe a fiduciary duty to the company as ‘a whole’. This fiduciary duty requires directors to act in good faith and in the long-term interests of the entity, balancing the interests of both shareholders and creditors.
This is because the total assets of a company are composed of shareholder equity+liabilities (i.e. creditor interests). For the section of my readership without an accounting background, in law this is the starting point of the accounting equation. The company as a legal entity is therefore subject to these two competing legal(or equitable) claims.
The directors’ duty to act in the company’s best interests logically includes the obligation to weigh and balance these interests at all times.
The law recognizes that the weight given to creditor interests increases as a company approaches financial distress. This is particularly true for financial institutions, where insolvency can have systemic ripple effects.
This modern understanding of fiduciary duty is echoed in the views of leading Corporate governance titans such as Lawyer Martin Lipton, founding partner of the Wall Street Business Law Firm, Wachtell, Lipton, Rosen & Katz (WLRK), and one of the most influential personalities in Corporate law and Corporate governance in the last 50 years.
“The board’s duty is not solely to shareholders but to the corporate enterprise as a whole; including employees, creditors, customers, and the communities in which the company operates. This obligation becomes especially critical in times of financial stress or systemic risk.”
Mr. Lipton’s views reflects what many refer to as the “entity-centric” view of a corporate director’s fiduciary duty, where the board must preserve the going concern of the enterprise in the long term, even where that requires limiting or postponing shareholder returns.
In a highly leveraged institution such as a bank, this thinking has real teeth in the form of regulatory tools by the regulator to intervene and close a bank.
Is a BoU Takeover an “Insolvency Event”?
The argument that BoU’s takeover of a distressed financial institution can be equated to an insolvency event is technically valid in limited contexts, but best understood through three lenses:
1. Substance Over Form (Economic Insolvency vs. Legal Insolvency)
While statutory insolvency typically requires formal triggers (e.g., inability to pay debts as they fall due or liabilities exceeding assets, courts and regulators often rely on indicators of economic insolvency, factual signs of distress which threaten a company’s viability even in the absence of formal insolvency proceedings.
BoU’s intervention powers are often triggered by precisely such concerns: inadequate capital, governance failures, or threats to solvency. In this sense, a BoU intervention functionally resembles an insolvency scenario, even if it is not formally declared as such.
Bearing in mind that banks are by their nature highly leveraged, time is of essence for such regulatory action and there is no need to wait for a bank to actually fail to pay its debts for the regulator to act. This could prove fatal for depositors.
2. Fiduciary Duty During Insolvency
In jurisdictions like the UK, Delaware (U.S.), and Australia, courts have affirmed that directors must prioritise creditor interests as a company approaches insolvency. This “duty shift” does not require formal insolvency but only a recognition that the company is in the so-called “zone of insolvency.”
It follows therefore that, where a company is insolvent or bordering on insolvency, the directors’ fiduciary duty to the company includes a duty to pay more attention to the interests of creditors.
In this context, Bank of Uganda is under the constitutional and statutory mandate to intervene and demand remedial action, where there are apparent signs of capital inadequacy, financial distress, governance weaknesses among other triggers even before real risk that a bank might fail crystallizes.
3. Suspension of the Board and Shift in Control
Once BoU places a bank under statutory management, the board of directors is suspended and the regulator assumes all powers of management, including those of the board. This makes the continuing exercise of fiduciary duty by directors moot, as they no longer retain agency or control.
While the BoU is not a fiduciary in the traditional Corporate Law sense, its actions are guided by public interest objectives enshrined in the Constitution and legislation.
These actions are also justified by the traditional insolvency stand of shifting focus toward creditor protection in the lead-up to an insolvency event in the case of a non-banking company.
Therefore, while a BoU takeover does not legally constitute insolvency proceedings, it acts as a strong regulatory proxy for insolvency proceedings whenever a bank is closed over financial distress and capital inadequacy.
The Risk of Contagion
In 2008, as the global banking crisis unfolded, defunct institutions like Lehman Brothers were leveraged up to a 33:1 ratio. That meant for every $1 of shareholder equity, the bank had $33 in liabilities. Such high leverage amplifies small losses and can wipe out equity within days if not hours.
This is why Bank of Uganda enforces capital adequacy ratios and minimum paid-up capital requirements, to ensure that depositors do not become dangerously exposed to banks’ balance sheet vulnerabilities. If a bank operates below capital requirements, it is a ticking time bomb. And since banks are interdependent (they lend to one another), the collapse of one bank can trigger a systemic domino effect and collapse the entire financial system.
For this reason BoU will normally not permit a bank with inadequate capital and poor corporate governance in place to continue operating without immediate remedial action from its shareholders.
Where such action is not forthcoming, BoU is within its powers to revoke the license in order to preserve broader financial stability as was the case with NBC.
The Supreme Court’s Position
In the NBC case, the Supreme Court confirmed that shareholders were given time to rectify capital shortfalls and governance failures, but these issues were not addressed. Therefore, BoU’s intervention was lawful, rational, and constitutional.
As such, the Court rejected the argument that shareholder constitutional rights were violated, reiterating that constitutional property rights are not absolute, especially where public interest and regulatory prudence are concerned.
Conclusion
For entrepreneurs and business owners, particularly those running leveraged companies and especially in the highly regulated sectors like banking and microfinance, the principles enunciated above bear repeating.
When a company enters financial distress, the law demands that the board begin to prioritize the interests of creditors alongside those of shareholders and certain transactions are outright void at law in extreme circumstances where this principle is breached.
Entities that use large amounts of debt must always seek transaction legal guidance for this reason.
Good Corporate governance and Board composition matters.
A competent, diverse board is better equipped to navigate financial stress and generally, the intricate market and regulatory dynamics in which the company operates. Ensure you have a blend of directors with expertise in risk, tax, legal, and operations as opposed to just investors, friends or family members.
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