Page1

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

S.172 of the Companies Act 2006 fails people and planet?

Stephen F. Copp. Comp. Law. 2010, 31(12), 406-408 [Company Lawyer] Publication Date: 2010 Subject: Company law. Other related subjects: Banking and finance Keywords: Banks; Corporate social responsibility; Directors' powers and duties; Ownership Abstract: Reviews the corporate social responsibility aspects of directors' duties to promote the success of the company under the Companies Act 2006 s.172, and examines the Administrative Court ruling in R. (on the application of People & Planet) v HM Treasury, challenging the State's ownership and control of the Royal Bank of Scotland on the grounds that the policy was not adopted after proper consideration and the Treasury misdirected itself as to the effect of s.172. Discusses the flaws of s.172 revealed by the case, and whether it has raised expectations it cannot fulfil and should be replaced. Legislation Cited: Companies Act 2006 s.172 Cases cited: R. (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD (Admin))

Page2

Company Lawyer
2010

S.172 of the Companies Act 2006 fails people and planet?

Stephen F. Copp Subject: Company law. Other related subjects: Banking and finance Keywords: Banks; Corporate social responsibility; Directors' powers and duties; Ownership Legislation: Companies Act 2006 s.172 Case: R. (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin) (QBD (Admin))

*Comp. Law. 406 Introduction

Social and environmental concerns were a major focus of parliamentary debates over the proposal to replace a director's traditional duty of loyalty with a duty to promote the success of the company.1 There was also considerable feeling outside Parliament over the issue, with amendments to tighten up the draft tabled following discussions with the Trade Justice Movement and the CORE coalition, representing a consortium of NGOs with more than 100 organisations and 9 million members.2 The records of individual companies were brought into question, with Lord Avebury, for example, praising Shell but seemingly criticising other equally well-known companies.3 The case was passionately put by him against a company's success being dependent on its ability to continue damaging the environment, and within a fairly distant time horizon, making large parts of the globe uninhabitable.4 Lord Goldsmith defended the Government's proposals, arguing that the alternative would be a move towards a pluralist approach,5 in other words, where directors would have to serve goals other than shareholder value in their own right. Rather oddly, he added that while issues such as the environment were enormously important, We do not think, however, that they should be addressed through company law reform6 --precisely what the measure appeared to be doing. The resulting compromise was s.172 of the Companies Act 2006, which introduced a duty on a director to act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to a specified list of factors, including (d) the impact of the company's operations on the community and the environment and (e) the desirability of the company maintaining a reputation for high standards of business conduct. This duty was brought into force on October 1, 2007, just as the credit crunch was gaining momentum, the United Kingdom having experienced in September 2007 the first run on a bank within living memory.7 There could scarcely have been a less auspicious time to have introduced radical reform to directors' duties. Amid the chaos that followed on the financial markets, problems emerged at the Royal Bank of Scotland (RBS), which in April 2008 revealed a fivefold increase in its leveraged loans to 1.25 billion in just six weeks8 and its first loss in 40 years--some 692 million--after writing down 5.9 billion of investments.9 Following an announcement in October 2008,10 the Government subsequently took a 58 per cent stake in RBS, increasing this to 70.3 per cent of its ordinary shares in April 2009.11 At the time of writing, the Government's stake had risen to an astonishing economic interest of 84 per cent.12 The vehicle for the Government's ownership of RBS was a limited company, UK Financial Investments Ltd (UKFI), founded on October 10, 2008.13 Given such a sizeable government stake, it is unsurprising that the arrangements for its ownership

Page3

and control would come under close scrutiny, not least as RBS appears to have marketed itself as one of the top lenders to the energy industry.14R. (on the application of People & Planet) v HM Treasury15 is therefore a fascinating case because it involves a challenge by activists16 to the Government's approach to its ownership of RBS given the Government's own stated policy on issues such as climate change.

*Comp. Law. 407 The grounds

The litigation arose not by way of a shareholder derivative claim, the potential route for activist concerns that had so occupied Parliament, but by way of judicial review. People & Planet objected to HM Treasury's policy as to the UKFI's management of RBS, claiming that its policy was unlawful on three grounds. First, it had a legitimate expectation that when government exercised its powers, it would do so with a view to preventing public money being spent on projects with the most obviously detrimental impact on climate change. Secondly, the policy was not adopted after proper consideration by HM Treasury in accordance with the Green Book. This was the most substantial ground, including three sub-grounds, namely that HM Treasury had failed properly to evaluate the arguments for a more interventionist policy, that it had regard to an irrelevant consideration, specifically the desirability of industry-wide regulation as opposed to a policy focused on just two banks, and that there was a misdirection of law by HM Treasury as to the effect of Companies Act 2006 s.172. Thirdly, the policy was alleged to be unlawful on human rights grounds. This article will focus on the s.172 issue. It appears from the judgment that HM Treasury put together its policy in three stages. On March 3, 2009 it adopted a Framework Document; on July 20, 2009, HM Treasury officials completed a Green Book assessment with a view to creating a more detailed policy document. On August 5, 2009, Ministers approved the Green Book assessment of the Framework Document and a final draft of an Investment Mandate. The Framework Document provided, inter alia, that UKFI would manage the Investments on a commercial basis and will not intervene in day-to-day management decisions. Mr Justice Sales noted that the Green Book opened by providing that all new policies, programmes and projects should be subject to a comprehensive but proportionate assessment wherever practicable so as to promote the public interest; the Green Book presented the techniques and issues to be covered. Such an assessment does not appear to have been conducted in advance of the acquisition of the Government's stake in RBS and, in the circumstances, it is hard to see how it could have been. Sales J. noted that the Green Book was not intended to be highly prescriptive since it was addressed to the formulation of all government policy and did not lay down clear indications of mandatory relevant or irrelevant considerations. The extracts from the Green Book cited in the judgment illustrate the breadth of ground it covered, including the need for proposals to be underpinned by sound economic analysis, which should be provided in a cost benefit analysis; as well as--potentially inconsistent--issues such as environmental impacts. The Green Book assessment confirmed that a commercial approach would be the best way for UKFI to achieve its objectives and rejected the idea that UKFI should exercise a more policy-driven approach to issues such as the environment and human rights, on the basis that it could only make a limited contribution to such aims. It concluded that UKFI would only be expected to use its influence over such issues to protect the value of its holding if that could be negatively affected because RBS's policies were worse than other banks. If UKFI were to go beyond the commercial approach in the Framework Document, the Green Book assessment considered that it would, among other considerations, cut across the fundamental legal duty of boards to manage their companies in the interests of all their shareholders.17

Judgement on the section 172 argument

Mr Justice Sales rejected the application for permission to bring judicial review proceedings. The Green Book assessment showed that HM Treasury had had regard to environmental and human rights considerations. Further, the assessment was correct as

Page4

to how such considerations could be taken into account by RBS's directors in the context of their duties under s.172. Management decisions were, in his view, matters for the RBS directors' judgment and to have decided otherwise would have given rise to a real risk of minority shareholder litigation if share value had been detrimentally affected. While UKFI could properly seek to influence the RBS board to have regard to environmental and human rights considerations in accordance with their s.172 duty, it would have been wrong for HM Treasury: to seek to impose its own policy in relation to combating climate change and promoting human rights on the board of RBS, contrary to the judgment of the Board. Echoing some of the language of the Green Book assessment,18 he concluded that to go beyond this would have cut across the duties of the RBS board as set out in s.172, although he would not go so far as to say that there was an absolute legal bar to the introduction of a different policy.

Analysis
The judgment of Sales J. goes some way to resolving the inherent conflict built in to the new concept that directors should promote the success of the company. This conflict was visible in the parliamentary debates where Lord Goldsmith on the one hand argued that success was for members to define but on the other hand that it was for the directors to form a good faith judgment about what should be regarded as success for the members as a whole.19 Sales J. has emphasised the traditional position that decisions about the management of a company were matters for its directors and that insofar as a shareholder *Comp. Law. 408 might seek to influence this, a shareholder could only influence directors to act within the constraints imposed upon them by their legal duties, in this case s.172.20 Section 172(1)(f) not only requires directors to have regard, say, to the impact on the environment, but also to the need to act fairly as between members of the company. If the board of RBS were to be required to follow a policy whereby its commercial lending did not support ventures or businesses which might be said to be harmful to the environment by reason of their carbon emissions or insufficiently respectful of human rights, then this might presumably have involved sacrificing profits. It is hard to see how this would have been fair to other shareholders who had not invested in the company on this basis. As Sales J. points out, there is no absolute bar on RBS adopting a different policy. But it would risk minority shareholder litigation, presumably under Companies Act 2006 s.994 on the basis that the adoption of what would, in effect, be a non-commercial policy unfairly prejudiced minority shareholders. The likely remedy, if such an action were successful, would be for UKFI or RBS to buy out the remaining shareholders, something that would open up a serious can of worms. This conclusion demonstrates further flaws in s.172, namely the list of factors which directors are to have regard in s.172 is expressly made non-exhaustive (i.e. a director must have regard to a list of specified factors amongst other matters), and the absence of guidance as to how these should be weighted. This was implicitly acknowledged by Sales J. in his recognition that UKFI could properly seek to influence the RBS board to have regard both to environmental and human rights considerations. While the environment is explicitly recognised in s.172(1)(d), human rights are not, though such obligations might be read into the requirement to have regard to the impact of the company's operations on the community, also mentioned in s.172(1)(d), or the desirability of the company maintaining a reputation for high standards of business conduct within s.172(1)(e). But by placing the two obligations on a par with each other it demonstrates the lack of any real significance to inclusion on the list in s.172. The weighting of these factors appears assumed to have been a subjective matter for the directors, given the reference to management decisions being a matter for the directors' judgment, and therefore would be difficult to challenge. This would be consistent with at least one (but not unqualified) recent decision,21 though it has been suggested that the courts might introduce objective considerations.22 However, if anything, the risk must be that directors could be pressured into paying excessive weight to factors that entail

Page5

profit-sacrificing and a subjective test would equally make this difficult to challenge.

Conclusion
The judgment in People & Planet v HM Treasury is undoubtedly correct. Company law is not the appropriate vehicle for the achievement of environmental or human rights objectives beyond what the law requires generally. To use it as such would impose costs on non-consenting shareholders and, in the case of RBS the taxpayer. It is not the business of government to run banks and, if government were to attempt to do so, one suspects it would do so badly. Overall, the case demonstrates that s.172 has raised expectations that it cannot deliver and would be better replaced with a traditional statement of a director's fiduciary duty of loyalty. The law is stated as at March 1, 2010. Comp. Law. 2010, 31(12), 406-408 1. See Company Law Reform Bill cll.156(1) and (3) (HL Bill 34, November 1, 2005). 2. Hansard, HL, Vol.678, col.GC 265 (February 6, 2006). For example, Amendment 162A would have replaced the community and the environment with affected communities and the environment, including the desirability of minimising any significant adverse impacts on the same. 3. Hansard, HL, Vol.678, cols GC265-267 (February 6, 2006). 4. Hansard, HL, Vol.678, cols GC265-267 (February 6, 2006). 5. Hansard, HL, Vol.678, col.GC273 (February 6, 2006). 6. Hansard, HL, Vol.678, col.GC273 (February 6, 2006). 7. See H. Nugent, S. Coates and C. Seib, Northern Rock is bailed out by Bank of England; and J. Bolger and M. Leroux, Northern Rock savers rush to empty accounts, The Times, September 14, 2007. 8. P. Hosking, Royal Bank of Scotland admits loan losses hit 1.25bn in weeks, The Times, April 23, 2008. 9. C. Seib, Sir Tom McKillop says sorry over 692m losses at Royal Bank of Scotland, The Times, August 8, 2008. 10. P. Webster, Royal Bank of Scotland under state control, The Times, October 13, 2008. 11. http://www.investors.rbs.com/our_performance/equity.cfm [Accessed September 15, 2010]. 12. S. Goff, Pressure on Lloyds and RBS before results, Financial Times, February 19, 2010. 13. UKFI Annual Report 2008/9, p.46. 14.

Page6

See M. Murphy, Green groups to sue Treasury on RBS investments, Financial Times, June 30, 2009. 15. R. (on the application of People & Planet) v HM Treasury [2009] EWHC 3020 (Admin). 16. See http://peopleandplanet.org/ [Accessed September 15, 2010] for information on People & Planet, where it is described as the largest, student network in Britain campaigning to end world poverty, defend human rights and protect the environment . Documents relevant to the case can be found at http://peopleandplanet.org/ditchdirtydevelopment/legalchallenge/legaldocuments [Accessed September 15, 2010]. For the early background to the campaign, including other groups involved, see M. Murphy, RBS hearing to test Treasury's policy on ethical investment, Financial Times, August 21, 2009. 17. HM Treasury, Green Book (2009), para.13(e). 18. HM Treasury, Green Book, 2009, para.13(e). 19. Hansard, HL, Vol.678, cols GC255 and 256 (February 6, 2006); for further discussion on this point, see S.F. Copp, Corporate social responsibility and the Companies Act 2006 (2009) 29(4) Economic Affairs 16, 18. 20. The ordinary shareholding of UKFI has never reached 75% and, therefore, the question as to whether the articles of association might have contained the common provision entitling shareholders to instruct directors by special resolution did not arise here. 21. See Southern Counties Fresh Foods Ltd, Re [2008] EWHC 2810 (Ch) at [53], where Warren J. compared the old and new formulations of the duty, saying They come to the same thing, adding that the test both under the general law and under CA 2006, is a subjective one. However, he later added that a breach will have occurred if it is established that the relevant exercise of the power is one which could not be considered by any reasonable director to be in the interests of the company. In Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch); [2010] B.C.C. 420, Lewison J., in the context of an application under the Companies Act 2006 s.261, observed (at [85]-[86]) how there were many cases where some directors acting in accordance with s.172 would think it worthwhile to continue a claim but others would not and that the weighing of all the relevant considerations was essentially a commercial decision which the court is illequipped to take, except in a clear case (emphasis added). 22. A. Keay, Section 172(1) of the Companies Act 2006: An Interpretation and Assessment (2007) 29 Company Lawyer 106, 109.
2011 Sweet & Maxwell and its Contributors

Page7

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

Is section 172 of the Companies Act 2006 the guidance for CSR?
John Kong Shan Ho. Comp. Law. 2010, 31(7), 207-213 [Company Lawyer] Publication Date: 2010 Subject: Company law Keywords: Corporate social responsibility; Directors' powers and duties Abstract: Considers the development of the concept of corporate social responsibility (CSR) from the 1950s onwards. Addresses criticisms of the concept made on the basis that it does not increase real director accountability and that the definition of what constitutes CSR is unclear. Reviews the thinking of the Company Law Review Steering Group on the subject from 1997 onwards and the evolution of the Companies Act 2006 s.172. Suggests that s.172 could be referred to in order to resolve many of the uncertainties regarding CSR. Legislation Cited: Companies Act 2006 s.172

Page8

Company Lawyer
2010

Is section 172 of the Companies Act 2006 the guidance for CSR?
John Kong Shan Ho Subject: Company law Keywords: Corporate social responsibility; Directors' powers and duties Legislation: Companies Act 2006 s.172 *Comp. Law. 207 Section 172 of the UK Companies Act 2006 incorporates the concept of enlightened shareholder value together with a list of non-exhaustive factors that directors ought to take into account in promoting the success of the company. This article argues that the provision simply reflects existing law and modern business practices, and provides the guidance for CSR.

Introduction
The term corporate social responsibility (CSR) has existed for half a century but it was not widely used until about the mid-1970s when corporations began to understand more about such a concept. By the beginning of the 1990s, views on stakeholder and corporate governance started to gain recognition. Today, they have become hot topics worldwide and are popular terms in our business community. Also, at the turn of the millennium, a number of international bodies were established to actively promote CSR. However, despite its relative importance, there are not many people who genuinely understand what CSR is and why we need it, as there still exist some misconceptions and misunderstandings. Many corporations wishing to implement CSR also find it difficult to integrate it with their long-term development strategies and principal policies in order to support their overall goals. So, does company law provide a solution here? The UK Companies Act 2006, which became fully operative in October 2009 after a decade of consultation, addresses many corporate governance issues. Directors' duties have long been a critical element of corporate governance and one important part of the 2006 Act, s.172, addresses the conduct of directors. The provision sets out what directors should aim for in promoting the success of the company and what matters they should take into account. According to some commentators, the importance of s.172 is that it introduces a new approach to the issue, that is, for whose benefit are directors to manage companies?1 Its approach purports to end the debate over the meaning of the company and in the interests of the company.2 The section also explicitly favours a long-term, rather than short-term, outlook in corporate decision-making.3 This article will be divided into three main sections. The first section will review the concept and theory of CSR and examine some of its myths and limitations. The second section will review the process of company law reform in the United Kingdom and the eventual adoption of the enlightened shareholder value approach, leading to the enactment of s.172 of the Companies Act 2006. Finally, the third section will provide analysis and discussion as to the practical implications of s.172. Ultimately, this article will argue that s.172 of the Companies Act 2006 simply represents the practical reality of modern commercial practice and provides the guidance for CSR.

Corporate social responsibility: concepts, practice and myths

In most modern societies, corporations are major economic entities. The enterprises that we encounter on a daily basis, whether as suppliers of food, utilities and consumer goods or services, are likely to have adopted the corporate form as the basis of their economic association. Developed societies are fundamentally dependent on business activity and very often the great goal of economic growth relentlessly pursued by virtually all governments means no more than an increase in the level of business activity in the form of making, buying and selling goods and services. Given that the institution of business is society's principal mechanism for many of these economic

Page9

activities, the question has therefore arisen as to the role of the company in relation to social responsibility. Over the last few decades, much literature has focused on the nature of and motivations for corporate social responsibility (CSR). One of the first scholars who started the discussion on the issue was Bowen4 in the 1950s, who claimed that businesses have the obligation to pursue those policies, to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society.5 This inspired a number of scholars to develop the topic. Today, the practice of CSR, labelled variously as stakeholder management or corporate citizenship, is viewed as a legitimate and critical endeavour.6 The practice of CSR has become accepted as a legitimate and important function of many business entities. Therefore companies invest considerable effort and resources in selecting and implementing CSR practices. *Comp. Law. 208 However, ideal as it may sound, the practical question for many business practitioners is, does CSR or stakeholder management really benefit a company or is it just a convenient label? The biggest challenge to CSR is that, to date, there is still not a standard or universally accepted definition and so it lacks an officially endorsed assessment standard. This has served as the main hindrance to the development of CSR or stakeholder management. The European Union defines CSR as a concept whereby companies integrate social and environmental concerns in their business operations and in their interaction with their stakeholders on a voluntary basis.7 One of the major proponents of stakeholder management, Freeman, advanced the argument that systematic attention to stakeholder interests is critical to firms' success. In his view, management must pursue actions that are optimal for a broad class of stakeholders rather than those that serve only to maximise shareholder interests.8 However, the question is, who and what counts as stakeholders? More recent work has been directed at further development of the stakeholder management model. Authors have considered and evaluated the descriptive accuracy of competing stakeholder theories, investigated the impact of firm characteristics on corporate social performance and identified the stakeholder groups that corporations view as most significant.9 Yet such insistence on multiple accountability makes business objectives difficult to sustain. Traditional economists generally believe that the goal of a corporation is profit maximisation,10 while management academics believe that if corporations have to sustain growth, value must be created for their customers. However in the modern world, there are many corporate managers who cry out for social responsibility. Are there any clashes between company profit and social responsibility/value? At present there are still a large number of people who believe that company profit and social responsibility cannot coexist. The question lies in the term of accountability, and when one uses this term, one needs to be clear as to its meaning and as to whom corporate managers are accountable and in what manner. Critics of CSR and stakeholder management point out that a business that operates in accordance with the stakeholder approach differs from an ordinary business in many ways.11 Whereas an ordinary business is accountable to its owners, a stakeholder business is supposed to be accountable to all its stakeholders. Yet the managers, employees and other agents are themselves stakeholders of the business. In other words, the doctrine would therefore seem to render them accountable inter alia to themselves, without offering any explanation as to how such multiple self-accountability is meant to work. The other key criticisms of stakeholder management are that it is incompatible with corporate governance and it undermines private property, agency and wealth.12 The key concept in corporate governance is accountability, i.e. the accountability of directors to shareholders and the accountability of corporate employees and other corporate agents to the corporation. Yet the theory is inimical to both. According to stakeholder critics, the essential principle of stakeholder theory that corporations should be equally accountable to all their stakeholders is not wholly unjustified, but is unworkable. This is because an organisation that is accountable to everyone is actually accountable to no one.13

Page10

Therefore, according to stakeholder critics, stakeholder management is merely popular and a convenient label.14 Thus the doctrine is ideal to serve authoritarian and collectivist political ends because its apparent generosity encourages people to accept it uncritically so that almost any kind of state intervention, no matter how intrusive or restrictive, can be enforced in terms of stakeholder theory.15 Furthermore, the concept of CSR or stakeholder management is still misunderstood by some people. For example, some companies think that they have assumed a level of CSR if they have resolved employment problems, paid their staff on time or paid their tax in accordance with the law. They have in fact only assumed a small part of the economic responsibility that is required by rules and regulations. In recent years, many have expected large and successful corporations to make regular donations to society, and some believe that to make a big charitable donation is to assume social responsibility; they regard the donation amount as an index for measuring CSR. Certain corporations have used a large sum of money to play the philanthropist on one hand, while bullying minority shareholders and employees.16 CSR activities exceed general charitable donations. Under all circumstances, a company's irresponsible acts can never be paid for with charitable donations. Likewise, is CSR rhetoric or reality? Do companies that acknowledge social and environmental responsibility sufficiently change their operations and daily practices or are they merely using it as *Comp. Law. 209 window-dressing while simultaneously engaging in harmful business practices?17 Shell, the energy giant, has a much publicised CSR policy and was a pioneer in triple bottom line reporting. But this did not prevent the 2004 scandal concerning the misreporting of its oil reserves, which seriously damaged its reputation and led to charges of hypocrisy. On a practical level, we need to acknowledge that most corporations are originally set up by private individuals or entrepreneurs in order to pursue some personal goals and achievements. Private enterprises are not welfare states; they need to have a sound financial well-being in order to survive and their success has been the bedrock of the Western capitalist system for over 150 years, and it is clear that they cannot operate purely on the basis of social responsibility.18 Therefore a long-term view must be taken when assessing whether an activity is advantageous to any particular corporation. What shareholders desire is maximum returns, and this depends on sustainable growth of the corporation, which may be the exact advantage brought about by CSR. If corporate activities can balance the needs of the society and environment, steady profit can be expected, subsequently pushing share prices upwards. Yet this does not mean that the more CSR activities the better. Corporations need to strike a balance based on their own needs, and prioritise them when making decisions. Based on the above analogy, we can see that although the spirit of CSR can be encouraged, it is not possible to rely solely on corporate conscience. In addition, it can be difficult for corporations to define what activities are actually disadvantageous to the society or unethical, other than those that are explicitly prohibited by law. Hence legislation is the ideal way to clearly define acceptable corporate practices in order to prevent/reduce social damages. Therefore this smoothly leads us into the next section where the author will examine the process of company law reform in the United Kingdom and how it seeks to provide a balance between different competing interests who deal with corporations.

UK company law reform post 1997

During the election campaign of 1997, one of the pledges New Labour made under Tony Blair was to further strengthen the competitiveness of the UK economy by launching a series of financial regulatory and corporate governance reform. The Blair government was keen on the idea of what it called enlightened shareholder value or stakeholder capitalism, arguing that the value of shareholders can only be maximised if the interests of other stakeholders are also catered for. After just one year in power, the Blair government set up the Company Law Review Steering Group (CLRSG) in 1998. The main objective of the CLRSG was to devise a framework of

Page11

company law which facilitates enterprise and promotes transparency and fair dealing.19 In its consultation document published in early 1999, it acknowledged that then current UK system of company law operated largely to benefit shareholders. In its first consultation paper, it set out its objectives as being to provide straightforward, cost effective and fair regulation which balances the interests of business with those of shareholders, creditors and others.20 During its preliminary stage, the CLRSG proposed two possible areas of reform, which it termed the enlightened shareholder value model and the pluralist model. The enlightened shareholder value model argues that the shareholder's interests should prevail. In contrast, the pluralist model argues that the directors should balance these potentially conflicting interests, without giving automatic priority to the shareholders.21 The enlightened shareholder value model soon became known as the inclusive approach and is based on the idea that long-term profit maximisation can only occur through the fostering of co-operative relationships with the various non-shareholder constituents. It believes that long-term financial well-being can only be achieved if the parties trust each other.22 A common criticism of British business people is that their approach is too short-term, preferring immediate profits to long-term growth, and that is bad for the British economy.23 This can be attributed partly to the failure to foster longterm relationships between various parties such as employers and employees. Such relationships of trust between the company and its employees have become imperative in the modern economy owing to factors such as technological innovations and unionism. Employees may be reluctant to gain firm-specific skills if they do not trust the management. Employees that trust their employers will be more willing to acquire those skills and this will eventually have positive effects on profits.24 However, critics of the inclusive approach argue that the reform does not go far enough because in cases of conflicts of interest between shareholders and nonshareholder groups, preference is still given to shareholder interests. The alternative recommendation which was made within the CLRSG was the pluralist approach. This approach argues that preference should not automatically be given to shareholders, but management should seek to balance potential conflicting interests between different stakeholders. Those in support of this model believe that giving shareholders automatic priority is not always most efficient because unlike other *Comp. Law. 210 stakeholders such as employees, directors or shareholders may be reluctant to make the necessary firm-specific investments which may benefit the company in the long term. After a more thorough consultation, the CLRSG eventually adopted the enlightened shareholder value or inclusive approach in its company law review. One important reason for rejecting the pluralist approach by the CLRSG was that they could see no practical way of enforcing it because if it was adopted, then the directors would have to balance the views of numerous groups within the corporate nexus and such a duty would be highly subjective. It argued that provided the law makes it clear that the inclusive approach should maximise the community of interests between shareholders and wider constituents, then a pluralist approach is largely unnecessary.25 In drafting its statement, the CLRSG proposed that a company's directors ought to have an inclusive approach in mind. As a result, it intended that the new company law should clarify the law on directors' duties. A study conducted by the Institute of Directors in 1999 found that many directors believed that the law required them to maximise shortterm shareholder benefit at the expense of long-term profit.26 A major step towards reforming this problem was taken in 1999 when the Law Commission formally recommended that directors' duties be made statutory and offered a proposed statement.27 Eventually, the statement of directors' duties was accepted by the Government in its White Paper on modernising company law and this is now provided under ss.170-177 of the Companies Act 2006. In line with the concept behind the enlightened shareholder value approach, s.172 of the Act requires a director to act in the way which he/she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Directors must uphold the

Page12

current legal view that the shareholders' interests override all other parties within the corporate nexus. However, s.172(1) of the 2006 Act goes on to list other relevant factors that directors ought to take into account such as the need to foster business relationships with employees, business partners and customers. They also need to take into consideration the effect of their operations on the communities and the environment.28 It seems that one objective of the proposed company law reform is to bring together shareholder and other stakeholder interests. However, during the law reform process, legal practitioners argued that s.172 might alter the outcome of directors' decisions because of the requirement that directors must promote the success of the company for the benefit of its members as a whole. Lawyers argue that requirements for boards to consider the effects of their decisions on employees, customers, the environment and local communities are impractical and will make decision-making more cumbersome and fraught. Companies could be left exposed to opportunistic legal challenges from activist shareholders, such as employee or environmental groups, to bring tactical litigation alleging that directors have negligently failed to consider one of the factors in s.172, or placed undue weight on others.29 Yet others believe there is no substantive problem with such a duty. On controversial issues, or matters which may be open to challenge, lawyers have suggested that directors would be best to seek advice from independent consultants and lawyers.30 Providing directors take these steps, the courts are unlikely to set aside or query their decisions. Moreover, more detailed board minutes could reduce the risk of legal action commencing, so long as they demonstrate to the shareholders that the statutory factors have been duly considered.31 Supporters of the codification of directors' duties argue that s.172 would make directors think harder about the statutory factors and they would be more likely to seek additional information to support their decisions. This could orientate them to more inclusive and integrated decisions, leading to more open and transparent communications with both shareholders and stakeholders which, in turn, could lead to better-informed assessments of the long-term consequences of their decisions.32 Arguably s.172 does not in reality change directors' practice substantively. Indeed, the CLRSG during the consultation process thought that it simply reflected existing law and best practice. According to Mayson, French and Ryan,33 s.172 of the Companies Act 2006 is based on the equitable fiduciary duty which was formulated, in combination with the duty to act within powers, by Lord Greene M.R. in Smith & Fawcett Ltd, Re.34 This principle was confirmed more recently by *Comp. Law. 211 Arden L.J. in Item Software (UK) Ltd v Fassihi.35 Therefore the purpose of codification was to reinstate the law on directors' duties to clarify and make it more accessible, with the aim of bringing about a change in directors' behaviour by educating directors and providing them with greater certainty regarding what the law requires.36 At the time of writing, the UK Companies Act 2006 and s.172 have only been in force for a short time. Its impact on the behaviour of corporate actors is still yet to be seen. However, it raises some potential benefits for the future of corporate governance in the United Kingdom. Directors may begin to take the view that it is necessary to take account of the factors listed in s.172 to comply with their general duty and avoid litigation. The possible outcome of this provision may introduce (albeit through the backdoor) stakeholder management, despite the fact that it was originally rejected by the CLRSG. It would strengthen, rather than weaken, the board's position insofar as it has been argued that it could make it more difficult for a shareholder to mount a successful challenge to management decisions so long as directors have made good-faith business judgments with reasonable care, skill and diligence.37

Analysis and discussion

In the first section the author examined the concept of CSR, some of its underlying limitations and the challenges which many businesses face in attempting to implement a coherent CSR strategy that suits their long-term goals. The second section briefly reviewed the company law reform in the United Kingdom that paved the way for the

Page13

enactment of s.172 of the Companies Act 2006, which seeks to balance competing interests who deal with companies. In this section the author will argue that s.172 simply reinstates the practical reality and makes the law more accessible, with the aim of providing greater certainty regarding what the law is required from directors. It ultimately argues that the provision provides an off-the-shelf guidance for businesses attempting to engage in CSR/stakeholder management activity. Regardless of which system of corporate governance one prefers, we all agree that corporations cannot exist without the support of certain groups be they shareholders, customers or employees. Our society is constantly changing, and practices that were regarded to be acceptable and ethical in the past may not withstand the current social standards. For example, it was appropriate for children as young as the age of five to work in coal mines during the industrial revolution. Today such practice is not just unlawful but it would also be seen as against contemporary moral standards. Therefore, as a successful business, it is important to make relevant changes depending on the change in mood of the society and the people whom the organisation is seeking to serve. Many marketing lessons which have occurred across the world illustrate that those businesses which neglect their key stakeholder, such as customers, are deemed to pay the price. In the UK retail industry, for example, Tesco Plc is currently the largest retail chain but this was not the case in the early 1990s. According to Sir Terry Leahy, its chief executive officer, the retail giant's dramatic change in fortune was achieved through a return to customer focus. Speaking at a lecture at Cass Business School, City University of London, Sir Terry said Tesco had reinvented itself a number of times in recent memory, all of which were borne out of crisis or impending crisis.38 In the early 1990s, the United Kingdom was hit by recession and Tesco found itself to be a struggling middle player between Sainsbury's and a number of new market entrants from Europe. This led the management team to consult 250,000 customers. According to Sir Terry, the findings were a shock because customers told the retailer they were not giving them value. From that day on, Tesco determined to follow the customers and not the competition. Today, Tesco is worth more than Marks & Spencer (M&S) and Sainsbury's combined. This is despite the fact that, in the early 1990s, M&S was the most profitable retailer in the world and Sainsbury's was the most profitable food retailer. Tesco's commitment to making its business more relevant to the customers has driven much of its successful innovation, such as launching value lines, the introduction of a loyalty card, introducing 24-hour shopping and developing online services. The success story of Tesco illustrates the importance of focusing on the needs of customers. If value is placed on the principles of free market and competition, then it also needs to understand that consumers freely change allegiance. Every rational customer seeks reliable products at the most competitive prices and suppliers who provide consumers with the most satisfaction are likely to succeed. Apart from satisfying customers, a successful business would also see its share price go up, which eventually benefits the shareholders. For example, those who bought Tesco shares in the mid1990s would no doubt have made a significant return on their investment. Yet, in contrast, shareholders of either Marks & Spencer or Sainsbury's would not have been satisfied with the directors of their board. What this article attempts to suggest is that instead of saying that a company is responsible to various stakeholder groups from shareholders to customers, employees or even the community at large, it should be more accurately put that companies ought to be accountable to those stakeholder or stakeholder groups *Comp. Law. 212 whose behaviour or activities would have the most stake in the well-being of the company. The question is how should companies define those stakes? The answer is that it should be a question of fact depending upon circumstances such as the nature of the business, the overall economic condition and, more importantly, the objective of the business at the particular time.39 A business model that may be successful for one company does not necessarily suit another because every company is unique. Likewise, a business approach which yielded

Page14

good performance in the past may not be ideal for modern times. Different businesses require different business models at particular times. This practical approach is precisely what the CLRSG in the United Kingdom had in mind when it decided to adopt the enlightened shareholder value approach which eventually paved the way for the enactment of s.172. A careful reading of s.172(1) of the 2006 Act illustrates that it is for the director him/herself to consider, in good faith, what action would most likely promote the success of the company for the benefit of its members as a whole, having regard to a list of non-exhaustive factors. Thus the company law reform approach in the United Kingdom acknowledges that it is important for businesses and directors to take a more practical approach in the decision-making process. Instead of proposing either a shareholder-centric or stakeholder-centric model, it seems to suggest that businesses face different challenges at different stages of their operation, and that it should be left to directors themselves to determine which interests ought to deserve more consideration depending upon the circumstances of the case,40 In reality, this is indeed what directors of many companies do on a day-to-day level. Therefore s.172 of the UK Companies Act is simply a reinstatement of modern commercial practices. This view has also found support from scholars such as Margaret Blair and Lynn Stout, who have claimed that the board of a large public corporation should more accurately be referred to as a mediating hierarchy where the conflict of interests between different constituencies (shareholders and non-shareholders) is resolved.41 Blair and Stout argue that the team production theory represents a more appropriate basis for understanding the practical economic and legal functions of the modern public corporation, and their analysis focuses on the observation that shareholders are not the only group that provides inputs into corporate production. The role of the board, according to Blair and Stout, is to strike a balance between these conflicting constituencies, and they also say that the mediating hierarchy approach is neither shareholder-centric nor stakeholdercentric.42 In justifying their argument, Blair and Stout point out that modern public corporations are made up of team members with different interests who have made firm-specific investments. For example, the interests of shareholders may often differ from, say, employees or creditors. Therefore the underlying rationale of assigning control to a mediating hierarchy (i.e. the board) creates a win-win situation, preventing team members from being exploited by each other.43 Thus, in establishing a public corporation, a mediating hierarchy is created. The board of directors is conferred with the authority to make decisions for the corporation and it is composed of team members and outsiders. The board is vested with the ultimate authority to make decisions regarding the corporation, such as the utilisation of corporate assets and resolving disputes between different team members. This means that no single constituency or team member can be regarded as a principal who enjoys a right of control and priority over another. Directors are therefore not agents who merely pursue the interests of shareholders at the expense of employees, creditors and other non-shareholders. Instead they are directors for the company, whose duty is to balance the competing interests between these constituencies in order to maintain harmony within the corporation. Therefore the phrase interests of company ought to be interpreted more broadly than merely the interest and wealth maximisation of shareholders and should include the joint welfare and interests of all individuals that have committed their investments to the corporation. They include employees and other parties that have contracted to provide goods and services to the company such as creditors, suppliers and even the local community.44 By implementing a statutory duty on directors to promote the success of the company for the benefit of its members as a whole would actually give greater flexibility and discretion to boards in balancing competing interests, with statutory backing. Providing that directors can show they have made a good faith judgment, taken into consideration of relevant factors in coming to that decision and illustrate how it can potentially benefit

Page15

the interest of the company in the long term, then the decision is unlikely to be challenged by third parties. Therefore s.172 can be viewed as a guidance for those corporations engaging in CSR/stakeholder management strategy. As mentioned earlier, in trying to implement CSR, corporations need to strike a balance according to their own goals and strategies, and prioritise them when making a decision. This is precisely what s.172 is trying to accomplish. That is, we should leave it to directors (or managers) themselves to determine what is the most appropriate manner to promote the success of the company in the long term by taking into consideration *Comp. Law. 213 of different constituent groups and other factors such as the state of the business or socio-economic condition at that particular moment.

Conclusion
This article has examined the concept of CSR, its myths and limitations. It also looked at the enactment of s.172 of the UK Companies Act 2006, enshrining the concept of the enlightened shareholder value approach and some of the potential implications which s.172 may have on corporate governance. Our starting point was whether company law can provide a solution to companies that want to integrate CSR into their long-term development strategies. The biggest problem with CSR is that it seems to be an altruistic utopia which is distant from the practical business world. Yet a provision like s.172 at least provides some guidance for businesses faced with the task of balancing different competing interests. So long as management can justify why they have come to a particular decision based on those statutory criteria, then there is no reason why they cannot claim they have integrated social and environmental concerns in their operations. Comp. Law. 2010, 31(7), 207-213 1. J. Loughrey, A. Keay and L. Cerioni, Legal Practitioners, Enlightened Shareholder Value and the Shaping of Corporate Governance (2008) 8(1) Journal of Corporate Law Studies 79. 2. L. Sealy and S. Worthington, Cases and Materials in Company Law, 8th edn (Oxford University Press, 2008), p.293. 3. See Companies Act 2006 s.172(1)(a). 4. H.R. Bowen, Social Responsibilities of the Businessman (New York: Harper & Row, 1953). 5. Bowen, Social Responsibilities of the Businessman, 1953, p.6. 6. D.S. Gelb and J.A. Strawser, Corporate Social Responsibility and Financial Disclosures: An Alternative Explanation for Increased Disclosure (2001) 33 Journal of Business Ethics 1. 7. See the European Commission's website on CSR http://ec.europa.eu/enterprise/policies/sustainable-business/corporate-socialresponsibility/index_en.htm [Accessed April 20, 2010]. 8. R.E. Freeman, Strategic Management: A Strategic Approach (Boston, MA: Pitman, 1984). 9. at

Page16

See, for example, Agle et al., Who Matters to CEOs? An Investigation of Stakeholder Attributes and Salience, Corporate Performance, and CEO Values (1999) 42(5) Academy of Management Journal 507. 10. M. Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962). 11. E. Sternberg, Corporate Governance: Accountability in the Marketplace, 2nd edn (Institute of Economic Affairs, 2004). 12. Sternberg, Corporate Governance, 2004, p.133. 13. Sternberg, Corporate Governance, 2004, p.135. 14. Sternberg, Corporate Governance, 2004, p.148-151. 15. Sternberg, Corporate Governance, 2004, p.151-152. 16. For example, PCCW of Hong Kong donate and sponsor a number of charitable events yet they were heavily criticised by the media and Hong Kong Court of Appeal for irregularities of their privatisation scheme. 17. R. Barth and F. Wolff, Corporate Social Responsibility in Europe: Rhetoric and Realities (Edward Elgar Publishing Inc, 2009). 18. J.K.S. Ho, Economic Theories of the Firm versus Stakeholder Theory: Is there a governance dilemma? (2008) 38(2) Hong Kong Law Journal 399, 424. 19. Company Law Review Steering Group, Modern Company Law for a Competitive Economy (London: DTI, March 1998). 20. CLR, Modern Company Law for a Competitive Economy: Developing the Framework (URN 00/656), para.3.51. 21. L. Roach, The Legal Model of the Company and the Company Law Review (2005) 26 Company Lawyer 98. 22. Ho, Economic Theories of the Firm versus Stakeholder Theory (2008) 38(2) Hong Kong Law Journal 399, 421-422. 23. Commission on Public Policy and British Business, Promoting Prosperity: A Business Agenda for Britain (London: Vintage, 1997). 24. Roach, The Legal Model of the Company and the Company Law Review (2005) 26 Company Lawyer 98, 100. 25. Company Law Review Steering Group, Developing the Framework, 2000, para.3.24. 26. Institute of Directors, Good Boardroom Practice (London: IOD, 1999).

Page17

27. Law Commission Report No.261, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties (1999). 28. For full details of s.172 of the UK Companies Act 2006, see the UK Government website: http://www.opsi.gov.uk/acts/acts2006/ukpga_20060046_en_13#pt10-ch2-pb2-l1g172 [Accessed April 20, 2010]. 29. Companies law reform threat to directors; see comments made by Peter Kennerley, company secretary at Scottish & Newcastle, and James Palmer, chairman of a company law committee at the City of London Law Society, Financial Times, May 8, 2006. 30. Companies law reform threat to directors, Financial Times, May 8, 2006. 31. Loughrey, Keay and Cerioni, Legal Practitioners, Enlightened Shareholder Value and the Shaping of Corporate Governance (2008) 8(1) Journal of Corporate Law Studies 79, 102. 32. Loughrey, Keay and Cerioni, Legal Practitioners, Enlightened Shareholder Value And the Shaping of Corporate Governance (2008) 8(1) Journal of Corporate Law Studies 79, 103 33. D. French, S. Mayson and C. Ryan, Mayson, French & Ryan on Company Law, 24th edn (Oxford University Press, 2007-08), pp.447 et seq. 34. Smith & Fawcett Ltd, Re [1942] Ch. 304 CA. 35. Item Software (UK) Ltd v Fassihi [2005] 2 B.C.L.C. 91 CA (Civ Div). 36. Loughrey, Keay and Cerioni, Legal Practitioners, Enlightened Shareholder Value And the Shaping of Corporate Governance (2008) 8(1) Journal of Corporate Law Studies 79, 90. 37. See Hansard, HL 681, cols 845-846 (May 9, 2006). 38. http://www.cass.city.ac.uk/media/stories/story_70_45816_34054.html [Accessed April 20, 2010]. 39. Ho, Economic Theories of the Firm versus Stakeholder Theory (2008) 38(2) Hong Kong Law Journal 399, 419. 40. Sealy and Worthington, Cases and Materials in Company Law, 2008, pp.293-294. 41. M. Blair and L. Stout, A Team Production Theory of Corporate Law (1999) 85 Virginia Law Review 247. 42. Blair and Stout, A Team Production Theory of Corporate Law (1999) 85 Virginia Law Review 247, 253-254. 43. Blair and Stout, A Team Production Theory of Corporate Law (1999) 85 Virginia Law

Page18

Review 247, 273-274. 44. Blair and Stout, A Team Production Theory of Corporate Law (1999) 85 Virginia Law Review 247, 288.
2011 Sweet & Maxwell and its Contributors

Page19

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

Considering the enlightened shareholder value principle.

Ji Lian Yap. Comp. Law. 2010, 31(2), 35-38 [Company Lawyer] Publication Date: 2010 Subject: Company law Keywords: Corporate governance; Corporate social responsibility; Directors' powers and duties; Shareholders Abstract: Discusses the enlightened shareholder value principle as enshrined in the Companies Act 2006 s.172. Highlights some criticisms of s.172, and considers alternative ways in which the principle of corporate social responsibility could be enacted by other jurisdictions. Legislation Cited: Companies Act 2006 s.172

Page20

Company Lawyer
2010

Considering the enlightened shareholder value principle

Ji Lian Yap Subject: Company law Keywords: Corporate governance; Corporate social responsibility; Directors' powers and duties; Shareholders Legislation: Companies Act 2006 s.172

*Comp. Law. 35 Introduction

The enlightened shareholder value principle has now been encapsulated in statute in the United Kingdom, in the form of s.172 of the Companies Act 2006. Should other countries follow by incorporating the enlightened shareholder value principle into a statutory formulation of directors' duties? This article seeks to consider this question in the light of Hong Kong; however, the discussion would be of interest to those from other common law jurisdictions who are looking with interest at the recent UK law reform efforts and considering whether to adopt them locally. This article also considers the broader question of what lessons may be learned from the experience in the United Kingdom in respect of the concept of corporate social responsibility that lies behind the enlightened shareholder value principle. It is trite law that a director should act in the interests of the company. The vexed question is: whose interests are to be considered the interests of the company? This article will first discuss the shareholder primacy principle that is well established in common law. It will then briefly describe the recent changes made in the United Kingdom in relation to the enlightened shareholder value principle, and consider the problems inherent in the recent s.172 of the Companies Act 2006. It will be argued that these difficulties are sound reasons why jurisdictions outside the United Kingdom may well be slow to adopt their own version of this section. Nonetheless it is suggested that the focus on corporate social responsibility implicit in s.172 of the Companies Act 2006 is an important one. In this regard, for jurisdictions that are wary of adopting their own local version of s.172 of the Companies Act 2006, alternative ways of promoting and emphasising corporate social responsibility will be suggested.

Whose interests are to be considered the interests of the company?

One of the principal facets of a director's fiduciary duty is that he must act in the good faith in the best interest of the company.1 However, it has been observed that a company is not a monolith consisting of bland interchangeable digits.2 Instead, there are many stakeholders who have an interest in the company. The question then is: whose interests are to be considered the interests of the company? The prevailing common law approach3 is that the collective interests of the members of the company may be equated with the interests of the company.4 This is known as the shareholder primacy principle, or the shareholder value principle. Directors in running the company must do so in such a way as to maximise the interests of members as a whole, as a priority above the interests of the other stakeholders in the company. The principal exception to the shareholder primacy principle is that, where a company is insolvent or near insolvent, the directors are then required to consider the interests of the creditors. Thus, where a company is solvent, first and foremost come the shareholders, but when the company is insolvent, or even doubtfully solvent, the interests of the company are in reality the interests of the existing creditors.5 The question of whose interests are to be considered the interests of the company may be approached in various ways. First, there is the shareholder primacy approach, which is essentially the prevailing common law approach as just discussed, pursuant to which

Page21

the collective interests of the members of the company are to be equated with the interests of the company. In contrast, the pluralist approach emphasises the interests of stakeholders, who are all those who can affect or be affected by a company's activities.6 These include employees, suppliers and creditors. The pluralist approach (otherwise known as the stakeholder approach) requires that directors manage the company for benefit of all the stakeholders, and thus requires that directors balance the interests of a multitude of stakeholders (including the shareholders) who can affect or be affected by the actions of a company.7 Section 172 of the Companies Act 2006 seeks to introduce another alternative approach known as the enlightened shareholder value approach, which seems to serve as a middle ground between the poles as constituted by the shareholder primacy approach and the pluralist approach.

The rationale behind section 172 of the Companies Act 2006

As we have seen, the general common law position then is that directorsmust act in the interests of the company, and, in turn, the interests of the company are viewed as those of the members collectively. While not directly addressing the *Comp. Law. 36 interests of the other stakeholders in the company, such a formulation has the advantage of elegant simplicity. There is generally no common law duty imposed on members to act and to vote sensibly, wisely or selflessly. Members of a company are entitled to vote in their own self-interest, without regard to the interests of other stakeholders. As the duty of directors to act in the interests of the company is conceived as acting in the interests of the members collectively, directors would under the general common law position be entitled to take a narrow view as to what is in the interests of the members, even if this is not in the interests of other stakeholders. Of course, the common law position does not preclude a director from considering the interests of stakeholders in determining what is best for the members collectively; it is simply that there is no obligation to consider the interests of stakeholders apart from members. Section 172 of the UK Companies Act 2006 introduced what seems at first to be a dramatic shift from the common law position as described above. Section 172 starts off in an uncontroversial manner, by stating that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. This seems like a re-statement of the existing common law position as described above. However, s.172 then goes on to state that a director must, in carrying out his duty to act to promote the success of the company, have regard (among other matters) to a long list of factors, including the long-term consequences of the decision, the interests of the company's employees, relationships with suppliers and customers, the impact on the community and the environment and the company's reputation. It is important to note here the mandatory nature of s.172, in the sense that the director must consider the factors listed therein. This statutory formulation seeks to embody the enlightened shareholder value principle, which seems to be a compromise position between the extremes of the shareholder primacy approach and the pluralist approach. The enlightened shareholder value principle involves the idea that, while the directors must promote the success of the company for the benefit of members, this can only be achieved by having regard to broader considerations, such as the environment, employees and customers. The enlightened shareholder value principle is thus a step beyond the common law shareholder primacy idea which focuses solely on the collective interests of shareholders. However, s.172 differs from the pluralist approach in that s.172, while requiring various stakeholder interests to be considered, still treats the interests of the members as paramount.

Criticisms of section 172 of the Companies Act 2006

There have been numerous criticisms levelled at s.172 of the Companies Act. The first relates to the question of what action the stakeholders listed in s.172 may take if the directors fail to take into account their interests in the decision-making process. After all,

Page22

a right without a remedy is worthless.8 While members may bring a statutory derivative action against directors on behalf of the company,9 it has been noted that the other stakeholders listed in s.172 will not be able take any action against the directors.10 This thus renders the stakeholders listed in s.172 (apart from members) toothless against the directors. The charge of tokenism could thus be levelled against s.172, in that while it appears to give more leverage to the stakeholders listed therein, the reality is that most such partieswould have no legal recourse in the event of a breach of that section. It is also important to note that under s.172, the interests of the members of the company are still paramount, insofar as the directors are to act in a way that would promote the success of the company for the benefit of its members as a whole. The factors listed in s.172 are only items to be considered in determining this overall question. In this way, s.172 strikes a balance between the traditional shareholder value approach and the pluralist approach. However, s.172 may be criticised as not going far enough to protect the other stakeholders, as the interests of members is still clearly paramount. Another criticism directed at s.172 is that the standard imposed upon directors appears to be too low. Pursuant to the literal words of s.172, a director would not be in breach as long as he shows that he considered his action in good faith. It has thus been noted that s.172 imposes mainly a subjective test.11 This is in contrast to the common law duty of a director to act in good faith for the benefit of the company which has an element of objectivity. For example, in Charterbridge Corp Ltd v Lloyds Bank Ltd,12 it was noted that the duty to act in good faith in the interest of the company could be impugned where what the directors did was something which no intelligent and reasonable man could have reasonably considered to be in the company's interest. While s.170(4) of the Companies Act 2006 does provide that regard shall be had to the corresponding common law rules in applying the new statutory duties, the explicit words of s.172 suggest only a subjective standard,13 which leads to a position of ambiguity. Indeed, it is this tension between the enactment of a new statutory set of duties and the pre-existing common law background that appears to be at the heart of the awkwardness in some aspects of s.172. A reading of s.172 gives an impression of a provision that seeks to embrace the new, without being willing to give up the old. This can be seen from the fact while the duties are set out in s.172, one would still have to look to case law for the remedies that would be consequent upon a breach of those duties.14 Creditors, who may surely often one of the most important stakeholders in a company, are not included in the list of interests in s.172(1). Instead, s.172(3) provides that the duty imposed by s.172 has effect subject to any rule of *Comp. Law. 37 law requiring directors to consider or act in the interests of creditors. This thus throws us back to the common law rules (as discussed above) requiring directors to consider the interests of creditors when a company is or is near insolvent. From a wider perspective, one of the key purposes of a statutory formulation of directors' duties is to make such duties clearer and more accessible to the layman. The ideal is that directors should be able to ascertain their duties and penalties for breach thereof from a plain reading of the relevant statutory provisions, without having to wade through volumes of case law. The various throwbacks in s.172 to the position as contained in case law appears to some degree to defeat this objective. Another unanswered question in relation to s.172 is: how are directors to prioritise the list of interests therein, if there are competing interests? For example, if a decision benefits employees but is detrimental to the environment, which factor should weigh more heavily on the director's mind? The reference to others in s.172(1)(c) is also wide and ambiguous, though the meaning of the word could be limited by the ejusdem generis rule. While the idea of enlightened shareholder value is attractive, the devil is in the detail, as is the case in many instances of law reform. The upshot of this list of criticisms of s.172 of the Companies Act 2006 is that jurisdictions seeking a model for the reform of their

Page23

own company law framework might be cautious in adopting wholesale their own version of this section. In time, s.172 of the Companies Act 2006 will no doubt receive the benefit of much judicial interpretation, academic commentary and perhaps further legislative amendment. It is perhaps for this reason that s.172 should not be too quickly dismissed from the field of interest of other jurisdictions. Instead, close attention should be devoted to considering how s.172 and the enlightened shareholder value principle is developed and applied with the United Kingdom. This appears to be the approach in Hong Kong. The Companies Ordinance15 in Hong Kong is in the midst of a radical overhaul of many of its provisions. However, the proposed statutory amendments in relation to the duties of directors are relatively muted. Specifically, the Consultation Conclusions16 published in December 2008 indicated that the notion of enlightened shareholder value that was recently introduced in the United Kingdom by way of s.172 of the Companies Act 2006 had received only limited support, which suggests that the principle might not be adopted in Hong Kong. It was observed that the requirement for directors to take into account various new factors in complying with the duty to promote the success of the company may pose new challenges to directors.17 The relatively recent enactment of the statutory formulation in the Companies Act 2006 was also noted in the recent consultation exercise. It was said that until there is case law in relation to the new duties, directors are left with uncertainty as to how the courts will interpret the new statutory statement.18 In the Consultation Conclusions19 issued subsequent to the Consultation Paper, it was stated that in relation to the issue regarding the proposal to incorporate the enlightened shareholder value concept into the duties of directors, only limited support was received. As such, the principle of enlightened shareholder value was not explored further.

The promotion of corporate social responsibility

We have seen that the difficulties with s.172 of the Companies Act may constitute sound reasons for other jurisdictions not adopting their own version of that section at this stage. However, there are still important lessons that can be drawn from the experience in the United Kingdom. Most importantly, s.172 of the Companies Act signals the importance of corporate social responsibility in underlining the fact that companies do not exist in a vacuum and that corporate decisions impact a wide variety of stakeholders. An emphasis on corporate social responsibility might add to the overall credibility of a jurisdiction, as it would show that its leaders are ready to enforce the responsibilities that companies owe to society, while at the same time reaping the benefits of economic development. For jurisdictions that are presently hesitant in adopting their own version of s.172 of the Companies Act 2006, the following are some alternative options by which corporate social responsibility might be further developed.

Sector-specific legislation
Section 172 of the Companies Act 2006 seems to be a broad-brush attempt to introduce the concept of corporate social responsibility into the general company law framework. This approach has given rise to criticisms as discussed above. It is thus argued that sector-specific legislation imposing duties directly on company directors would be a more finely tuned means of ensuring that directors take wider societal implications into account in their corporate decision-making. Examples of sectors that might attract such rules include food safety, consumer safety and workplace regulations. After all, in the long run, a failure to enshrine the principle of enlightened shareholder value within the legal framework sends a tacit signal that corporate social responsibility is not important enough to merit legislation. Sector-specific legislation targeting directors themselves would thus give statutory importance to the ideal of corporate social responsibility. Another advantage of such sector-specific legislation is that directors will be effectively given statutory licence to act responsibly (in accordance with the specific legislation) in coming to their decision. In the case of a director acting under shareholders' pressure to take a decision that is contrary to the interests of other

Page24

stakeholders (for example, in making a decision that will have negative environmental consequences), such statutes would provide grounds to a director for justifying his more enlightened view to steer the company on a more socially responsible course. *Comp. Law. 38 Criminal and civil sanctions could be introduced, specifically penalising directors for non-compliance with these sector-specific rules. It could also be provided that certain partieswould have a statute-based right to make a civil claim against the directors personally if directors breached their duties under such sectorspecific legislation. This would be in contrast to the position under s.172 of the Companies Act 2006, where stakeholders other than members do not have any enforcement rights, which is a key criticism of s.172 (as discussed above). An example of sector-specific legislation imposing criminal penalties on directors may be found in the Air Pollution Control Ordinance20 in Hong Kong. Section 47A of the Air Pollution Control Ordinance provides that where a company has been convicted of an offence under the Ordinance, and it is proved that the offence was committed with the consent or connivance of, or was attributable to any neglect or omission on the part of, a director, then that director also commits the offence. Legislation is a means by which enlightened norms may be impressed upon society. It is argued that sector-specific obligations and penalties may be more widely imposed specifically on directors, and the existing obligations made harsher where appropriate. This would hold directors responsible for their decisions in a nuanced and specific way, in contrast to the broad-brush approach in s.172 of the Companies Act 2006. Such sectorspecific legislation would send a message that directors are accountable for the decisions that they make on behalf of the company.

Voluntary self-regulation
Some might ask whether corporate social responsibility requires legislation, and whether further development of corporate social responsibility may be left to voluntary selfregulation. Nonetheless, a crucial criticism of voluntary self-regulation is that it often does not work, as the deterrent of legal sanctions for non-compliance is lacking. Indeed, self-regulation has been described as pragmatic tool to pay lip-service in respect of matters that are not regarded as vital enough to merit state regulation.21 Legislation (such as sector-specific legislation as suggested above) may thus be regarded as a signalling tool of what is important. Another criticism of a self-regulatory model is the perceived lack of transparency, reliability and credibility. An apparent difference between self-regulation and prescriptive legislation is that the former involves voluntary compliance while the latter involves enforced compliance. Yet it has been pointed out that, in reality, there can in fact be a strong flavour of compulsion in self-regulation. This is because there are times when the motive for selfregulation is really to avoid the imposition of future legislative control. This has been characterised as self-regulation in the shadow of the law,22 and this insight is equally applicable in the context of corporate social responsibility. As a preliminary step, directors in various industries may thus perhaps first be left to regulate their activities by way of voluntary codes. They might be motivated to do this more effectively if informed that failure to do so may result in legislative standards being enacted.

Public education
Ultimately, progress in corporate social responsibility requires public education. One place to start is by educating shareholders as to how their interests are tied in with the long-term sustainability of the company and its relationship with customers and suppliers. University programmes in relation to corporate social responsibility could be developed to educate young people and future shareholders. After all, one response to the idea of incorporating the enlightened shareholder value principlewithin the company law framework is that the reality is that such a shareholder simply does not exist in most companies. It is thus important that public education be initiated to cultivate genuinely enlightened shareholders. Indeed, it has been said that the overall effect of s.172 of the Companies Act 2006 is more likely to be educational rather than in any sense

Page25

restrictive.23 Public educational efforts (perhaps undertaken by Registries of Companies or corporate social responsibility agencies) would thus promote a similar goal.

Conclusion
In the light of the difficulties in s.172 of the Companies Act 2006, jurisdictions abroad may be reluctant to adopt their own version of that section at this stage. Nonetheless, inspiration should still be drawn from these recent law reform efforts in the United Kingdom that seek to push the ideal of corporate social responsibility forward. For jurisdictions that are reluctant to adopt their own version of s.172 of the Companies Act, sector-specific legislation imposing duties and penalties on directors could be pursued more widely and with greater rigour, together with increased public education efforts. These would be alternative ways by which the principle of corporate social responsibility (which is implicit in s.172 of the Companies Act) may be made to flourish. Ji Lian Yap Teaching Consultant, Faculty of Law, University of Hong Kong Comp. Law. 2010, 31(2), 35-38 1. Smith & Fawcett Ltd, Re [1942] Ch. 304 CA. 2. Walter Woon on Company Law, 3rd edn (Sweet & Maxwell Asia, 2005), Ch.8. 3. As seen in Greenhalgh v Arderne Cinemas [1951] Ch. 286 CA. 4. In Hong Kong, this is reflected in Principle 1 of the Non-Statutory Guidelines on Directors' Duties, which explains the duty to act in the best interests of the company as meaning that a director owes a duty to act in the interests of all its shareholders, present and future. 5. Brady v Brady (1987) 3 B.C.C. 535 CA (Civ Div); [1988] B.C.L.C. 20. 6. James Wallace, Value maximisation and stakeholder theory: Compatible or not? (2003) 15(3) Journal of Applied Corporate Finance 120. 7. Andrew Keay, Section 172(1) of the Companies Act 2006: An Interpretation and Assessment (2007) 28 Company Lawyer 106. 8. M. McDaniel, Bondholders and Stockholders (1988) 13 Journal of Corporation Law 205. 9. Pursuant to s.260 of the Companies Act 2006. 10. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106. 11. Gower and Davis' Principles of Modern Company Law, 8th edn (Sweet & Maxwell, 2008). 12. Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch. 62 Ch D. 13. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106. 14. Companies Act 2006 s.178 provides that the consequences of breach of ss.171-177 are

Page26

the same as would apply if the corresponding common law rule or equitable principle applied, and that the duties in those sections are enforceable in the same way as any other fiduciary duty owed to a company by its directors. 15. Companies Ordinance Cap.32. 16. Consultation Conclusions on the Rewrite of the Companies Ordinance (relating to Company Names, Directors' Duties, Corporate Directorships and Registration of Charges), dated December 10, 2008. 17. Second Public Consultation on Companies Ordinance Rewrite, dated April 2, 2008. 18. Second Public Consultation on Companies Ordinance Rewrite, dated April 2, 2008. 19. Consultation Conclusions on the Rewrite of the Companies Ordinance (relating to Company Names, Directors' Duties, Corporate Directorships and Registration of Charges, dated December 10, 2008. 20. Air Pollution Control Ordinance Cap.311. 21. J.A. Cannataci and J.P.M. Bonnici, Can self-regulation satisfy the transnational requisite of successful Internet regulation? (2002), available at http://www.bileta.ac.uk [Accessed November 18, 2009]. 22. D. Sinclair, Self-regulation versus command and control? Beyond False Dichotomies (1997) 19(4) Law & Policy 529. 23. Boyle & Birds' Company Law, 6th edn (Jordans, 2007).
2011 Sweet & Maxwell and its Contributors

Page27

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

The duty of loyalty of company directors: bridging the accountability gap through efficient disclosure.
John Lowry. C.L.J. 2009, 68(3), 607-622 [Cambridge Law Journal] Publication Date: 2009 Subject: Company law Keywords: Directors' powers and duties; Directors' reports; Fidelity Abstract: Examines the background to the formulation of the directors' duty of loyalty under the Companies Act 2006 s.172, and analyses the scope and nature of this duty. Discusses how the obligation of directors to produce a business review under s.417 of the Act can be seen as an integral part of the duty of loyalty, particularly since one objective of the business review is to inform company members about, and enable them to assess, how the directors have performed this duty. Legislation Cited: Companies Act 2006 s.170, s.172, s.417 Cases cited: Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244; [2004] B.C.C. 994 (CA (Civ Div))

Page28

Cambridge Law Journal

2009

The duty of loyalty of company directors: bridging the accountability gap through efficient disclosure
John Lowry Subject: Company law Keywords: Directors' powers and duties; Directors' reports; Fidelity Legislation: Companies Act 2006 s.170 , s.172 , s.417 Case: Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244; [2004] B.C.C. 994 (CA (Civ Div))

*C.L.J. 607 INTRODUCTION

THE core fiduciary duty of loyalty to which company directors are subject forms part of the general duties of directors which now appear in Chapter 2 of Part 10 of the Companies Act 2006.1 The statutory restatement is set at a fairly high level of generality and in part seeks to reform the common law upon which it is based.2 As a means of assessing the scope of the reformulated duty of loyalty found in s.172 of the Act, it is instructive to view the provision against the policy considerations underlying the Government's decision to place the general duties of directors on a statutory footing and, more generally, the wider objectives underpinning the company law reform project which, after eight years of consultations,3 culminated in the 2006 Act.

*C.L.J. 608 The mechanics and policy objectives of the company law review
The Act had a particularly long gestation period, being conceived in March 1998 when the Labour Government announced what proved to be the most far-reaching review of company law since Gladstone's Joint Stock Companies Act 1844 and the introduction of limited liability in 1855.4 In her Foreword to the first consultation document which formally launched the review process,5 Margaret Beckett, then Secretary of State at the Department of Trade and Industry, (since renamed the Department for Business, Innovation and Skills) described the UK company law regime then in force as a complex regulatory amalgam founded upon mid-19th century legislation as amended over the intervening century and a half by numerous additions6 (including EC Directives) and consolidations which no longer served the needs of the Government's strategy for national competitiveness. The principal objective of the review was stated as being to devise: a framework of company law, which is up-to-date, competitive and designed for the [new] century, a framework that facilitates enterprise and promotes transparency and fair dealing.7 The political objective, as stated by Gordon Brown, then Chancellor of the Exchequer, in a speech delivered in June 2001 launching new measures to tackle the productivity gap with Britain's major competitors, was to create in Britain a true enterprise culture where the chance to start and succeed in business is genuinely open to all.8 As part of this goal, the Government sought to make the UK the choice of location for doing business. Although the CLR recognised that fiscal, operational and macro-economic considerations rather than company law regimes are the critical factors taken into account when deciding whether or not to locate a business in a particular state, it nevertheless took the view that company law reform had a place in the Government's drive for regulatory reform.9 *C.L.J. 609 The mechanism which the Government put in place for undertaking the reform exercise was devised to maximise openness and independence together with

Page29

ensuring wide consultation.10 The review was administratively independent from the then Department of Trade and Industry. The Company Law Review Steering Group (hereafter the CLR), which stood at centre stage in the reform process, was charged with ensuring that the review's outcome was clear in concept, internally coherent, well articulated and expressed, and workable.11 The CLR's consultation exercise was wide ranging,12 and its Final Report was presented to the Secretary of State for Trade and Industry on 26 July 2001.13 The first White Paper, Modernising Company Law, which contained a draft Companies Bill, was published in July 2002.14 After a period of consultation, the second White Paper was published in March 2005,15 and the Company Law Reform Bill, subsequently renamed the Companies Bill,16 was introduced into the House of Lords on 1 November 2005. It received Royal Assent in November 2006 and was implemented in stages spanning a three year period, which ended October 1st 2009. From the outset the CLR stated that company law should be enabling and facilitative so that the new regime should allow enterprise to flourish freely in a climate of discipline and accountability.17 Achieving this objective, in its view, involved several core policy considerations that served to inform its specific recommendations. Underpinning the CLR's approach towards the scope and nature of the review was the axiom think small first. The point was stressed that the vast majority of UK companies are small, private and generally owner managed,18 so that from the economic perspective the role of such companies is critical in laying the foundations for future growth. Accordingly, the law governing small private companies should provide an optimal framework for the establishment, efficient operation and development and growth of these companies.19 The new companies' regime should, therefore, be constructed on the basis that it corresponds with the reasonable expectations of business people so that *C.L.J. 610 regulatory traps for the unwary are avoided while, in times of crisis, the response of the law is both predictable and constructive.20 The guiding principle was expressed as being simplification and accessibility so that the objective was to remove unnecessary detail together with excessive regulation.21 The CLR noted that many of the provisions of the Companies Act 1985, as was the case with its predecessors, do not apply to small private companies while those that do are not tailored to meet their specific needs. The 1985 Act thus proceeds on the false assumption that the paradigm company is a large publicly quoted business. It is peppered with detailed adaptations and derogations introduced on a piecemeal basis.22 The CLR thus concluded that the cumulative effect of this process had been to leave the present law in a state which is obtuse, overly complex and inaccessible for small business users.23

Restating directors' duties

With respect to director duties, the Government stated in the March 2005 White Paper that it believes that companies work best where the respective roles and responsibilities of directors and shareholders are clearly understood.24 It was stressed that directors may not appreciate what their duties were under the law and, similarly, that such obligations may be misunderstood by shareholders, in whose interests the directors should be acting. As a means of making the relevant law consistent, certain, accessible and comprehensible - key policy factors underpinning the wider company law reform process - the Government opted for a statutory restatement of directors' duties. Whether or not the duties of directors should be restated in the statute had generated considerable debate. It was a central issue that was explored in the work of the English and Scottish Law Commissions in 1999. They found that the case against restatement was founded upon loss of flexibility, while in its favour there were obvious advantages in terms of certainty and accessibility.25 Ultimately, the *C.L.J. 611 Commissions' conclusion was that the case for legislative restatement was made out,26 and the recommendation was taken up by the CLR for three principal reasons.27 First, directors should know what is expected of them and therefore such a statement will further the CLR's objectives of reforming the law so as to achieve clarity and accessibility. Indeed, these objectives underpin a core principle of the CLR's vision that company law should

Page30

provide an accessible framework for wealth generation.28 Second, the process of formulating such a statement would enable defects in the present law to be corrected in important areas where it no longer corresponds to accepted norms of modern business practice29 Third, such a statement would underpin the question of scope of the proposed company law regime: scope being defined as relating to the question of in whose interests should companies be run. Both the 2002 and 2005 White Papers30 accepted that directors' general duties should be codified,31 and the Government sought to settle the matter of whether the restatement should be exhaustive by noting that it will so drafted as to enable the law to respond to changing business circumstances and needs.32 It is stressed that the restatement will leave scope for the courts to interpret and develop its provisions in a way that reflects the nature and effect of the principles they reflect.33 The focus of this article is on the restatement of the core duty of loyalty together with the obligation on directors to produce a business review which, amongst other things, is designed to inform members of the company and help them assess how the directors have performed their duty under the Companies Act 2006, s.172.34 It assesses the contours of s.172(1) with a view to determining whether the duty of loyalty it seeks to encapsulate merely replicates the common law *C.L.J. 612 position or whether it holds the potential, as some have argued, to go beyond the pre-existing law by exposing directors to the risk of increased liability.35 Certainly the duties in Part 10 of the Act are not self-contained,36 and breach of s.172 will very likely give rise to the additional claim that the directors are in breach of their duty of care and skill under s.174.37 But the concern here is not with the range of claims which a breach of the duty of loyalty may trigger, but rather to consider the policy underlying the disclosure obligation imposed by s.417. A further anxiety lies with whether the drafting of s.172 results in a duty likely to be better understood by directors than its common law counterpart so that compliance and, more particularly, the self-assessment undertaken by directors in the business review goes beyond mere box ticking.

1. THE SCOPE AND NATURE OF THE GENERAL DUTIES

Section 170 provides the starting point for considering the ambit of the duty of loyalty in s.172 and, indeed, for any of the duties restated in Part 10 of the Act. Section 170 which, it will recalled, was viewed by the CLR as the key scoping provision, lays down what has long been the orthodoxy,38 namely that the general duties restated in sections 171-177 are owed by a director of a company to the company.39 It therefore follows that a breach of duty is a wrong to the company and the proper claimant is the company itself.40 Before leaving s.170, it is noteworthy that the provision also seeks to settle the criticisms, raised principally by the professional bodies *C.L.J. 613 during the CLR's consultations on the restatement, to the effect that setting the duties at a high level of generality would do nothing but cause confusion over the relationship between the statutory restatement and the existing jurisprudence surrounding directors' duties. The provision addresses these concerns in two ways. First, subsection 3 makes its clear that while the general duties are based on certain common law rules and equitable principles, the statutory restatement has effect in place of those rules and principles. Future claims for breach of duty by a director will need to be aligned with one or more of the duties set out in the Act unless the duty in question has not been restated, as is the case with, for example, the duty owed to creditors where the company's fortunes are declining into insolvency.41 Secondly, subsection 4 directs the courts to interpret and apply the general duties having regard to the pre-existing case law. Much of this case law, of course, developed by analogy with the duties of trustees and other fiduciaries and so it seems that the intention here is to maintain the relationship of the law on directors' duties with its wider equitable foundations. However, if s.170(3) and s.170(4) are read together, considerable doubt remains over the extent to which the restated duties actually do replace the pre-existing duties. One reason why such uncertainty arises is because the draftsmen use different terminology from that found in the judicial

Page31

formulations of the duties contained in the case law. The problem is compounded by the omission to set out precisely where the restatement diverges from settled common law and equitable principles. Notwithstanding the clear terms of subsection 4, the courts are given no legislative assistance for determining when or to what extent the pre-existing jurisprudence can be harnessed as an aid to interpreting the statutory restatement.42 This represents a major lacuna which runs counter to the declared objectives of the Company Law Review's recommendations to provide greater clarity on what is expected of directors.43

II. THE DUTY OF LOYALTY

As commented above, perhaps more than any other of the duties contained in Part 10, the framing of the fundamental duty of loyalty generated considerable debate both during the CLR's consultations *C.L.J. 614 and when the Companies Bill was going through Parliament. The statutory formulation has two elements. First, s.172(1) begins by stating that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole The provision thus aligns the interests of the company with its members as a whole. While the Explanatory Notes which accompany the Act see this as codifying the common law position, there is, in fact, a point of departure from the classic formulation of the duty by Lord Greene M.R. in Re Smith & Fawcett Ltd.44 He noted that directors must exercise their discretion bona fide in what they consider - not what a court may consider45 - is in the interests of the company.46 The CLR rejected the notion that success should be defined solely be reference to the interests of the company, on the basis that this would leave it to the good faith discretion of the directors to determine what the interests of the company are. It was felt that this would allow directors the discretion to set any interest above that of shareholders whenever their view of what is needed to promote the company's success require it.47 While at first sight the objective of this first element of s.172(1) appears to be aimed at limiting the discretion of directors, it does no more than reflect the common law position that a decision of the board to promote, for example, sectional interests within the company would be incompatible with the duty to promote the interests of the company.48 Nevertheless, within these strict confines it has long been settled that it is for the directors to decide, in good faith, on how best to promote the success of the company. The orthodoxy is that the court will not substitute its own view about which *C.L.J. 615 course of action the directors should have taken in place of the board's own judgment,49 although this is subject to the overriding jurisdiction of the courts to assess objectively the conduct in question. As explained by Arden L.J. in Item Software (UK) Ltd v. Fassihi,50 if a director embarks on a course of action without considering the interests of the company and there is no basis on which he or she could reasonably have come to the conclusion that it was in the interests of the company, the director will be in breach. The second element of the duty is that in promoting the success of the company a director should have regard (amongst other matters) to the non-exhaustive factors listed in subsection (1): (a) the likely consequences of any decision in the long term, (b) the interests of the company's employees,51 (c) the need to foster the company's business relationships with suppliers, customers and others, (d) the impact of the company's operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.52 To gain some insight into the meaning of this provision it is instructive to consider the CLR's deliberations on how best the duty of loyalty should be formulated. A major anxiety was whether to maintain the settled notion of shareholder primacy or whether

Page32

this should be substituted with a pluralist approach towards corporate governance. It was felt that this particular duty held the key for the proper determination of the true scope of company law.53 More particularly, this is linked to the question of what is meant by the somewhat obtuse phrase *C.L.J. 616 the interests of the company (terminology which, as we have seen, is omitted from the statutory formulation) which represents the reference point contained in the case law for determining to whom directors owe their duties.54 This, of course, is bound up with the critical issue of whether or not the UK should adopt what the CLR referred to as the stakeholder model,55 or adopt the wider pluralist model whereby directors are to take account of all relevant constituencies but give primacy to none.56 Although the CLR recognised the merits of a stakeholder approach it did not recommend its adoption as such but opted for a modified model whereby the core duty of directors would be founded upon the need to promote enlightened shareholder value.57 Under this approach, directors, whilst ultimately required to promote shareholder interests, must take account of the factors affecting the company's relationships and performance. The CLR took the view that the duty should be formulated in such a way as to remind directors that shareholder value depends on successful management of the company's relationships with other stakeholders. The statutory re-conceptualisation of the duty does not mean that non-shareholder constituencies rank equal to shareholders or have some independent priority in directors' decision-making, but rather consideration of their interests should only extend to the point where this promotes the success of the company for the benefit of its members. To this extent the CLR's approach towards the scope of the duty resonates with the reasoning of the Supreme Court of Canada in People's Department Stores v. Wise,58 in which Major and Deschamps JJ. explained: We accept as an accurate statement of law that in determining whether they are acting with a view to the best interests of the corporation it may be legitimate, given all the circumstances of a given case, for the board of directors to consider, inter alia, the interests of the shareholders, employees, suppliers, creditors, consumers, governments and the environment At all times, *C.L.J. 617 directors and officers owe their fiduciary duties to the corporation. The interests of the corporation are not to be confused.59 As s.172(1) makes clear, the interests of members continues to be the primary concern of directors in promoting the success of the company. This does not mean the individual interests of members but their interests as members of an association with the purposes and mutual arrangements enshrined in the constitution.60 While the Government's enlightened shareholder approach towards the duty of loyalty goes beyond the strict confines of the common law, its scope is arguably more modest than was feared by the respondents to the CLR's consultations and those in Parliament who were concerned that it might open the floodgates of liability for directors. The decisions in Hutton v. West Cork Rly Co61 and Parke v. Daily News Ltd,62 holding that generosity to employees had no place in the boardroom unless it furthered the interests of the shareholders, have long been viewed as belonging to a different age.63 Indeed, the modern approach towards directors taking account of factors going beyond the narrow objective of profit maximisation was explained by Berger J. in Teck Corporation v. Millar :64 If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders.65 Nevertheless, the anxiety over increasing directors' liabilities was such that Margaret Hodge, the Minister of State, was moved to allay the fear that directors would be exposed to increased litigation by publishing a compilation of ministerial statements on

Page33

the meaning of enlightened shareholder value. This publication, in itself, suggests *C.L.J. 618 that the law is far from clear notwithstanding that certainty, accessibility and simplification were key CLR objectives. In the Minister of State's introduction to the document, Duties of Company Directors,66 she places particular emphasis on s.172 explaining that it captures a cultural change in the way in which companies conduct their business. She states that there was a time when business success in the interests of shareholders was thought to be in conflict with society's aspirations for people who work in the company or supply chain companies, for the long-term well-being of the community and the environment: pursuing the interests of shareholders and embracing wider responsibilities are complementary purposes, not contradictory ones. The position taken is that businesses perform better when they have regard to a wider group of issues in pursuing success and it concludes by noting that it makes good business sense to have regard to the various factors listed in the provision and thereby embrace wider social responsibilities. While s.172 can be seen as doing no more than merely encapsulating the way in which the law and commercial practice has developed since Hutton and Parke, a key issue which remains is how is the notion of enlightened shareholder value to be enforced? Certainly the derivative action in Part 11 of the 2006 Act does not extend locus standi to employees or to any of the other constituencies listed in the provision.67 Enforcement of the duty is limited to the board of directors, a majority of members, a minority of members via a derivative claim under Part 11 of the Act, and liquidators acting on behalf of an insolvent company. Accordingly the concern that the provision would open the floodgates of liability is, indeed, ill-founded though,68 admittedly, employees and environmental groups do hold shares in companies and may possibly be so moved as to risk launching a claim.69 Rather, the CLR took the view that the duty will acquire its force not through the threat of litigation, but through increased disclosure obligations. In this respect there is an obvious synergy between the CLR's emphasis on disclosure as an enforcement device and the reasoning of the Court of Appeal in Item Software (UK) Ltd v. Fassihi.70 Arden L.J., delivering the leading judgment, explained that a director who is in breach of the duty of loyalty may be under a further *C.L.J. 619 (or super-added) duty to disclose the breach to the company on the basis that a duty of disclosure is an incident of the core duty of loyalty.71 On the facts, the Court was confronted with a claim for compensation for loss sustained by the company as a result of the defendant's breach of the duty to disclose rather than the more typical claim commonly encountered in corporate opportunity cases to recover profits. Of particular interest are the policy reasons harnessed by Arden L.J. to support her conclusion. These certainly appear to have had some influence on the framing of the statutory obligations on directors to disclose and explain in the business review, at least from an operational standpoint, how they have discharged their s.172 duty. Arden L.J. explained that the duty to disclose misconduct in no way discourages legitimate entrepreneurial activity.72 She stressed that to hold that a director was under no such duty would be inefficient in economic terms.73 It would result in the company expending resources in investigating the director's conduct and that the enforcement of a liability to compensate the company for misconduct depends on the happenchance of the company finding out about the impropriety.74 Recognising that the consciously misbehaving director is unlikely to comply with the duty, her response is that this is not a logically sustainable reason for not imposing it if it is otherwise appropriate.75 Arden L.J. is firmly of the view that the consequence of non-disclosure may be that the company makes erroneous business decisions because it lacked material information. A legal rule which condones this would condone inefficient outcomes.76 From a pragmatic standpoint, the reasoning is compelling, and viewed against this background the requirement to produce a business review becomes more readily comprehensible.

The Business Review

Setting the CLR's proposals and Item Software apart, the move towards increased

Page34

disclosure obligations on directors also gained *C.L.J. 620 considerable momentum as a result of the EU Accounts Modernisation Directive.77 The Directive, in part, explains that a business review requires a balanced and comprehensive analysis of the development and performance of the company during the financial year and the position of the company at the end of the year; a description of the principal risks and uncertainties facing the company; and analysis using appropriate financial and non-financial key performance indicators (including those specifically relating to environmental and employee issues). This will include information on environmental matters and employees, on the company's policies in these areas and the implementation of those policies. Moreover, key performance indicators must be used where appropriate (including those specifically relating to environmental and employee issues). The general objectives of the Directive are embraced by s.417(3), (4), (5) and (6). Put simply, the business review, forming part of the annual directors' report, is a narrative report of the company's business activities designed to flesh out the figures contained in the accounts. The intent behind the provision seems to be more of a declaration rather than an obligation on directors. It certainly explains how the requirements in s.417(5) and (6), which refer, amongst other things, to certain matters being included in the review such as the main trends and factors likely to affect the future development, performance and position of the company's business (including information about environmental matters, the company's employees, social and community issues and the company's relationship with its suppliers) are directed towards giving members an understanding of such trends and factors. Companies subject to the small companies' regime are exempted from the business review requirement.78 In this regard it is noteworthy that the CLR took the policy decision that the wider reporting obligations it envisaged for directors should be directed towards the boards of public and listed companies and other very large companies with real economic power.79 It was felt that the emphasis had to be on the need to provide adequate transparency of qualitative and forward looking information which is of vital importance in assessing performance and potential for shareholders, investors, creditors and others.80 The focus here is therefore not on the think small first axiom which underpinned the company law review but is directed *C.L.J. 621 instead on constructing a disclosure mechanism which serves to reinforce the duty of loyalty for directors of companies whose activities impact not just on shareholders' interests but on wider stakeholder interests. In a sense, the business review is designed to encapsulate the essence of corporate social responsibility. As has been noted, the statutory objective of the business review is declared in s.417(2) which provides that: The purpose of the business review is to inform members of the company and help them assess how the directors have performed their duty under section 172. It is therefore made clear that the review is an integral part of the duty of loyalty, at least in so far as the duty applies to directors of listed companies. In informing the members about the directors' performance of this duty, s.417(4) states that the review must give a balanced and comprehensive analysis and to achieve this subsection (6) requires the use of key performance indicators (KPIs) relating to financial matters and to environmental and employee matters. Although the particular KPIs used are left to the discretion of the directors, they must be effective in measuring the development, performance or position of the business. Since directors are required to have regard to the non-exhaustive list of factors specified in s.172(1),81 the effect of the reporting requirements in s.417 will, at the minimum, focus the minds of directors on stakeholder interests. One effect of the requirement to have regard to constituencies outside the narrow realm of members' interests in promoting the success of the company is it that it will allow directors to defend almost any bona fide decision aimed at promoting the success of the company.

Page35

For example, where directors in good faith favour the interests of employees over, for example, the making of short term profit, that decision will be immune from attack. This is not a radical departure from the common law. For example, in Re Welfab Engineers Ltd,82 Hoffmann J. held that the directors' failure to realise the best price for the company's principal asset, its freehold premises, was an honest attempt to save the business and the jobs of the employees. He therefore dismissed the liquidator's misfeasance summons brought under s.212 of the Insolvency Act 1986.

*C.L.J. 622 CONCLUSION

It seems clear that the anxiety expressed by those who see s.172 as holding the potential to expose directors to increased litigation is misplaced given the requirements laid down in Part 11 of the 2006 Act governing derivative claims.83 But placing the difficulties of enforcement to one side, it is noteworthy that the framing of s.172 does go further than the pre-existing law it replaces. At common law the considerations to be taken into account in discharging the good faith duty were seen as matters of process or diligence. Whereas the factors listed in the provision are matters which go to the issue of a director's good faith or loyalty. In other words, action otherwise than in good faith, which will now, but did not at common law, include the failure to consider the various factors listed in s.172(1), will be treated as a breach of trust which carries the full range of remedies, not merely compensation for incompetence. Given the likelihood that the new derivative claim will not lead to the spectre of directors being routinely hauled before the courts, the real significance of s.172(1) may well lie not with the question of its enforceability, but rather in its value as serving a normative function that the long term should predominate over the short, not vice versa, but that both should be evaluated and balanced, in determining what contributes best to company success.84 And as part of this function the attention of directors is now specifically drawn to the stakeholder interests listed in the provision,85 a process which is reinforced by s.417 when the directors come to choose the particular KPIs which best measure the development, performance or position of the business. The emphasis on long-term wealth generation, albeit not at any price, is nothing new,86 and perhaps it is only where directors decide to favour short-term interests against the wishes of the company's shareholders that they will be confronted with a derivative claim. Most certainly, the inter-relationship between sections 172 and 417 does much to further the objective of constructing a disclosure regime which underpins the core duty of loyalty and which is economically efficient in its operation. Professor of Law, UCL. This article is based on my paper delivered to the [Australian] Corporate Law Teachers Association 2009 Conference held in Sydney. I owe a debt of gratitude to the delegates for their insightful questions and comments. I also thank Arad Reisberg for his views on an earlier draft, I-san Tiaw for her research assistance and the anonymous referees for their helpful comments. The usual disclaimer applies. C.L.J. 2009, 68(3), 607-622 1. In Item Software (UK) Ltd v. Fassihi [2005] 2 B.C.L.C. 91, Arden L.J., at [41], having noted that the fundamental duty [of a director] is the duty to act in what he in good faith considers to be the best interests of his company concluded that this duty of loyalty is the time-honoured rule (citing Goulding J. in Mutual Life Insurance Co of New York v. Rank Organisation Ltd [1985] B.C.L.C. 11, at 21). Part 10 of the 2006 Act restates seven duties: duty to act within powers (s.171); duty to promote the success of the company (s.172); duty to exercise independent judgment (s.173); duty to exercise reasonable care, skill and diligence (s.174); duty to avoid conflicts of interest (s.175); duty not to accept benefits from third parties (s.176); duty to declare interest in proposed transaction or arrangement (s.177); (the duty to declare interest in an existing transaction or arrangement is laid down by s. 182). 2.

Page36

Company Law for a Competitive 5552/5k/7/01/NP), para. 3.7. 3.

Economy:

Final

Report,

July

2001

(DTI/Pub

In addition to its Final Report, Consultation Documents issued by the Company Law Review Steering Group, the body established by the then DTI (now DBERR) to oversee the reform process, include: The Strategic Framework (URN 99/654) February 1999; Company General Meetings and Shareholder Communication (URN 99/1144) October 1999; Company Formation and Capital Maintenance (URN 99/1145) October 1999; Reforming the Law Concerning Overseas Companies (URN 99/1146) October 1999; Developing the Framework (URN 00/656) March 2000; Capital Maintenance: Other Issues (URN 00/880) June 2000; Registration of Company Charges (URN 00/1213) October 2000; Completing the Structure (URN 00/1335) November 2000; and Trading Disclosures (URN 01/542) January 2001. 4. The Limited Liability Act 1855. 5. Company Law for a Competitive Economy, March 1998 (DTI/Pub 3162/6.3k/3/98/NP). 6. Such additions were generally introduced to address deficiencies of the existing legislation in protecting investors and as knee jerk reactions to particulars scandals of the day. See, for example, the White Paper, The Conduct of Company Directors (Cmnd. 7037, 1977)). 7. Above, n. 5. The UK has not been alone in its quest for a modern economically efficient regime for companies. For example, a corporate law reform programme along similar strategic lines has been ongoing in Australia since 1990: see the Corporations Law Scheme which commenced operation on 1 January 1991; the Corporations Legislation Amendment Act (No 1) 1991; the Corporate Law Reform Act 1992; the Corporate Law Reform Act 1994; the Company Law Review Act 1998; the Corporations Act 2001. See also, the policy discussion papers of the Corporate Law Economic Reform Programme (Canberra, AGPS, 1997). 8. http://www.hm-treasury.gov.uk/press/2001/p67_01.html 9. See the Strategic Framework, above, n. 3, para. 5.6.3. For a detailed analysis of the policy objectives see, E. Ferran, Company Law Reform in the UK [2001] Singapore Journal of International and Comparative Law 516. 10. Above, n. 5, para. 7.1. 11. Above, n. 5, para. 7.2. 12. For the range of consultation documents issued by the CLR, see n. 3, above. The list of respondents to the CLR's consultations can be found on the DBIS website, see http://www.berr.gov.uk/whatwedo/businesslaw/co-act-2006/clr-review/page22794.html 13. Company Law for a Competitive Economy: Final Report, above, n. 2. 14. Published in two volumes, Modernising Company Law (Cm 5553-I); and Modernising Company law-Draft Clauses (Cm 5553-II). 15.

Page37

Company Law Reform (Cm 6456). 16. The title of the Bill was changed during committee stage in the House of Commons in July 2006. 17. Final Report, above, n. 2, para. 9. 18. At the end of the 1997/98 year, when the CLR was launched, there were 1.32 million companies on the (UK's) Companies House register of which 12,000 (amounting to 1%) were public limited companies. See The Strategic Framework, above n. 3, Annex D. 19. Final Report, above, n. 2, para. 1.27. 20. Final Report, para. 1.53. 21. Final Report, para. 1.54. 22. For example, the Financial Reporting Standard for Smaller Entities and the DTI's (as it was called) work on simplifying SME accounts. See the Companies Act 1985 (Accounts of Small andMediumsized Companies and Minor Accounting Amendments) Regulations 1997. 23. The Strategic Framework, above, n. 3, para. 5.2.5. The point in reinforced at para. 5.2.13 where the CLR concludes that the complexity of the 1985 Act is such that, from the perspective of smaller companies, it is burdensome and unwieldy: These are general concerns, but smaller companies are precisely those which do not have the time or funds to devote to legal advice; their owners and managers cannot delegate and must focus on day-to-day survival and growth. 24. Company Law Reform (Cm 6456), at 16. 25. See the joint consultation paper, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties, Consultation Paper No 153; Discussion Paper No 105. See also, the Law Commission and the Scottish Law Commission joint report, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties (Nos 261 and 173, respectively), Cm 4436, (London, TSO, 1999). 26. The Law Commissions favoured partial codification: a statement of the main, settled duties, including the director's duty of care. It would not be exhaustive so that the general law would continue to apply in those areas not covered by statute. 27. All of which are rehearsed in the Final Report, above, n. 2, para. 3.7. See also the March 2005 White Paper, above n. 4, at 20. 28. Final Report, above, n. 2, para. 9 of the Foreword. Although the Companies Act 1985 and its predecessors did contain provisions regulating directors' duties, particularly in relation to shareholder approval of conflict transactions, these operated as a gloss on the common law and could not be readily understood absent a sound understanding of the jurisprudence spanning some 150 years or more. See P. Davies and J. Rickford, An Introduction to the New UK Companies Act [2008] E.C.F.R. 49, at 61.

Page38

29. Final Report, above, n. 2, para. 3.7. 30. Above, ns. 14 and 15, respectively. 31. In 2004 the DTI launched a further consultation exercise, Company Law: Flexibility and Accessibility, http://www.dti.gov.uk/cld/condocs.htm, which reiterated the Government's commitment to introduce a major Bill, albeit after further consultation, clauses of which will provide: clarity on the responsibilities of directors by making statutory provisions setting out the duties of directors via a statement of duties, and introducing related reforms to the rules governing directors' conflicts of interests. 32. See the March 2005 White Paper, above, n. 15, at 21. 33. See, in particular, the Companies Act 2006, ss.170(3) and (4), considered below. 34. Companies Act 2006, s.417(2). 35. See, for example, the concern expressed by the Law Society to the effect that the statutory duty could raise the spectre of courts reviewing business decisions taken in good faith by subjecting such decisions to objective tests, with serious resulting implications for the management of companies by their directors: the Law Society's Proposed Amendments and Briefing for Parts 10 & 11, (issued 23 January 2006). Doubtless s.172 generated more debate in Parliament than any other of the duties contained in Part 10 of the Act. 36. As is made clear by s.179. 37. Which provides:1) A director of a company must exercise reasonable care, skill and diligence.2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with-(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and(b) the general knowledge, skill and experience that the director has. 38. Section 170(1). See Percival v Wright [1902] 2 Ch. 421. 39. This begs the proverbial question, what is meant by the company? The question itself has long been debated. One possible solution was put forward by Lord Evershed M.R. in Greenhalgh v. Arderne Cinemas Ltd [1950] 2 All E.R. 1120, where he said, at 1126, the phrase the company as a whole means the corporators as a general body. He therefore seemingly rules out a free floating corporate interest that corporate realists would advocate and identifies the company's interests with the shareholders as a general body indicating a contractarian bias. The debate is likely to continue unless s.172 is taken as settling the matter. 40. See Part 11 of the Companies Act 2006 which places the derivative action on a statutory footing. See A. Reisberg Derivative Actions and Corporate Governance (Oxford 2007), ch. 4. 41. See n. 52, below.

Page39

42. This is particularly true for s. 177 (duty to declare interest in proposed transaction or arrangement). The decision to cast this as a disclosure duty rather than a situational disability is not well documented and can be confusing in relation to remedies. On the other hand, although the statutory formulations of the no-conflict duty (see ss. 175 and 176) depart from the common law rules or equitable principles, the decision to incorporate deliberate policy changes in relation to these particular duties is explained in the consultation papers and the Explanatory Notes to the Act. 43. See Chapter 3 of the Final Report, above n. 2. 44. [1942] Ch. 304. A century earlier Lord Cranworth LC in Aberdeen Railway Co v. Blaikie Bros (1854) 1Macq. 461, noted, at 471, that: The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. 45. This non-interventionist policy (the internal management rule) was explained by Lord Eldon L.C. in Carlen v. Drury (1812) 1 Ves. & B. 154, who said: This Court is not required on every Occasion to take the Management of every Playhouse and Brewhouse in the Kingdom. Indeed, Lord Greene M.R. in Smith & Fawcett, placed particular emphasis on the point. 46. Above, n. 44, at 306. The meaning of the term company in this context was construed by the courts as referring to present and future members: see, for example, Gaiman v. Association for Mental Health [1971] Ch. 317, at 330, in which Megarry J. said I would accept the interests of both present and future members of the company as a whole, as being a helpful expression of a human equivalent. Similarly, in Dorchester Finance v. Stebbing [1989] B.C.L.C. 498, at 501-502, Foster J. stated [a] director must exercise any power vested in him as such, honestly, in good faith and in the interests of the company 47. See Developing the Framework above n. 3, para. 3.52. 48. Mills v. Mills (1930) 60 C.L.R. 150. In the Lords Grand Committee, 6 February 2006 (column 256), Lord Goldsmith summarised the scope of s.172 thus: it is for the directors, by reference to those things we are talking about - the objective of the company - to judge and form a good faith judgment about what is to be regarded as success for the members as a wholethe duty is to promote the success for the benefit of the members as a whole - that is, for the members as a collective body - not only to benefit the majority shareholders, or any particular shareholder or some of shareholders, still less the interests of directors who might happen to be shareholders themselves. 49. See Howard Smith Ltd v. Ampol Petroleum Ltd [1974] A.C. 82, PC; and Regentcrest plc v. Cohen [2001] 2 B.C.L.C. 80. 50. [2005] 2 B.C.L.C. 91. 51. This provision replaces s.309 of the Companies Act 1985. 52. A notable omission from the list is any reference to creditors. However, s.172(3) goes on to provide that: The duty imposed by this section has effect subject to any enactment

Page40

or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. It therefore leaves space for the continued operation of the wrongful trading provision in the Insolvency Act 1986, s.214; and the common law (that the CLR noted should be left to develop), which recognises that where the company is insolvent or is of doubtful solvency, the interests of creditors supersedes those of the company's members so that the focus of the duty switches accordingly. See, for example, West Mercia Safetywear Ltd v. Dodd [1988] B.C.L.C. 250, in which the Court of Appeal cited, with approval, the view expressed by Street CJ in Kinsela v. Russell Kinsela Pty Ltd (1986) 10 A.C.L.R. 395, at 401, that where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company's assets. It is in a practical sense their assets and not the shareholders assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration See also, Winkworth v. Edward Baron Development Co Ltd [1987] B.C.L.C. 193, HL. 53. See The Strategic Framework, above n. 3. 54. See Percival v. Wright, above n. 38 and Greenhalgh v. Arderne Cinemas Ltd, above, n. 39. See further the text in n. 39, above. 55. That is to say, whether UK company law should continue to uphold the primacy of members long term interests as the driver underlying directors duties, but with the proviso that the interests of others should be taken into account. See, J. Parkinson Corporate Power and Responsibility: Issues in the Theory of Company Law (Oxford 1993). See also, J. Parkinson, Inclusive Company Law, in J. de Lacy (ed), The Reform of United Kingdom Company Law (London 2002). 56. See G Kelly and J. Parkinson, The Conceptual Foundations of the Company: A Pluralist Approach in J. Parkinson, G. Kelly and A. Gamble (eds), The Political Economy of the Company (Oxford 2001). 57. See, Developing the Framework, above, n. 3, paras. 2.19-2.22; Completing the Structure, above, n. 3, para.3.5). The pluralist theory was rejected because it would have required the law to be fundamentally reformed so that a company would be required to serve other constituency interests in their own right. See Strategic Framework, above, n. 3, at para. 5.1.13.l. 58. [2004] 3 S.C.R. 461. 59. [2004] 3 S.C.R. 461, at [42]-[43]. It is noteworthy that in Re West Coast Capital (Lios) Ltd [2008] C.S.O.H. 72, a Court of Session decision, Lord Glennie expressed the view that although there was no equivalent in the earlier Companies Acts, this section does little more than set out the pre-existing law on the subject (at para. [21]). It will be interesting to see whether this interpretation is followed, because the provision sets out, for the first time in the companies legislation, certain factors that directors are required to consider. 60. Developing the Framework, above, n. 3, para. 3.51. 61. (1883) 23 Ch. D. 654, CA.

Page41

62. [1962] Ch. 927. 63. That said, the specific duty to have regard to the interests of employees introduced by the Companies Act 1985, s. 309 gave employees no means to enforce the obligation against directors. Other statutory controls such as the power to provide for company employees on cessation or transfer of the company's business contained in s.719 of the 1985 Act were framed in permissive rather than mandatory terms (see now s.247 of the 2006 Act). 64. (1972) 33 D.L.R. (3d). 288. 65. (1972) 33 D.L.R. (3d). 288, at 314. 66. June 2007. See www. dberr.gov.uk/files/file40139.pdf 67. A point emphasised during the parliamentary debates: see HL Rep, Hansard HL 681 9/05/06 Cols 845-846. 68. See further A. Reisberg, Derivative Claims under the Companies Act 2006: Much Ado About Nothing?, in J. Armour and J. Payne (eds), Rationality in Company Law: Essays in Honour of D. D. Prentice (Oxford 2009). 69. As will be seen below, the real test here lies with whether the courts will adopt a liberal approach towards the leave requirements for bringing a derivative claim now contained in Part 11 of the 2006 Act. 70. [2005] 2 B.C.L.C. 91. Noted by J. Armour and M. Conaglen, [2005] C L.J. 48. 71. It is notable that American judicial and academic views are cited in reasoning towards this conclusion: see Cardozo J. in Meinhard v. Salmon 164 NE 545, at 548; and Professor R. C. Clark, Corporate Law (New York 1986), respectively. See also, British Midland Tool Ltd v. Midland International Tooling Ltd [2003] EWHC 466 (Ch). 72. [2005] 2 B.C.L.C. 91, at [63]. 73. [2005] 2 B.C.L.C. 91, at [65]. 74. [2005] 2 B.C.L.C. 91, at [65]. 75. [2005] 2 B.C.L.C. 91, at [65]. 76. Efficiency in economic terms had informed the Law Commission and the Scottish Law Commission's proposals for increased disclosure obligations in their joint report, Company Directors: Regulating Conflicts of Interests And Formulating A Statement Of Duties (Nos 261 and 173, respectively), above, n. 25. Perhaps it is no coincidence that at this time Dame Mary Arden DBE was Chair of the English Law Commission. For a fuller discussion of the proposals, see, J. Lowry and R. Edmunds, Section 317: Injecting Rationality into Directorial Disclosure, in D. Sugarman and M. Andenas (eds), Developments in European Company Law (London 2000).

Page42

77. Directive 2003/51/EC. 78. See s.417(1). There are also specific exemptions for medium sized and larger unquoted companies: see ss.465-467 and 385. 79. Developing the Framework, above, n. 3, paras. 2.19-2.26, 3.85, 5.74-5.100. See also, the Final Report, Vol. 1, above, n. 3, paras. 3.28-3.45; and Completing the Structure, above, n. 3, paras. 3.7-3.10; 3.32-3.42. 80. Developing the Framework, above, n. 3, para. 5.74. 81. The provision does not adopt the term stakeholders presumably on the basis that it could lead the courts towards holding that the requirement amounted to a change in the law. 82. [1990] B.C.L.C. 833. See J. Lowry and R. Edmunds, The Continuing Value of Relief for Director's Breach of Duty [2003] M.L.R. 195. 83. Early indications suggest that the courts will be loath to grant permission under s.263(3) to continue a derivative claim: see, Mission Capital plc v. Sinclair [2008] EWHC1339 (Ch); and Franbar Holdings Ltd v. Patel and others [2009] 1 B.C.L.C. 1. 84. Developing the Framework, above, n. 3, at para. 3.54. See also Lord Goldsmith's speech in the House of Lords Grand Committee, 6 February 2006 (column 258). 85. As commented above, the factors are now matters of substance going to good faith. 86. See, for example, H. Hansmann and R. Kraakman, The End of History for Corporate Law [2001] Georgetown Law Journal 439; and M. Jensen, Value Maximisation, Stakeholder Theory and the Corporate Objective Function [2001] European Financial Management 297.
2011 Cambridge University Press

Page43

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

An accidental change to directors' duties?

Alistair Alcock. Comp. Law. 2009, 30(12), 362-368 [Company Lawyer] Publication Date: 2009 Subject: Company law Keywords: Directors' powers and duties Abstract: Examines the common law view of the duties of company directors prior to the Companies Act 2006 and analyses the extent, if any, to which those duties have been changed by the Act. Investigates the courts' view of the duties of directors to comply with the company's constitution, to use their powers for a proper purpose and to act bona fide in the interests of the company. Considers whether that necessarily meant acting in the interests of shareholders. Compares the common law interpretation of the duties with the terms of the Companies Act 2006 ss.171 and 172. Legislation Cited: Companies Act 2006 s.171, s.172

Page44

Company Lawyer
2009

An accidental change to directors' duties?

Alistair Alcock Subject: Company law Keywords: Directors' powers and duties Legislation: Companies Act 2006 s.171 , s.172 *Comp. Law. 362 The Companies Act 2006 (2006 Act) was a long time in gestation. An important stage in formulating proposals that eventually became part of the 2006 Act was the creation, by the then Department of Trade and Industry (DTI) of a Company Law Review Steering Group (CLRSG) in 1998.1 Among the many subjects the CLRSG tackled were the general duties of directors, in particular, whether they should be codified2 and if so, should the principal duty be changed from one thought to be owed to shareholders to one owed to a variety of stakeholders. With such fervent supporters of the stakeholder or pluralist viewpoint as Professor Parkinson3 on the CLRSG, the arguments in its favour were bound to be put forcefully.4 However, at an interim stage, the CLRSG dismissed this approach as impracticable, pointing out that: If directors had a power to decide that other interests should override those of shareholders, this discretion would be unpoliced; if directors had a duty to take other interests into account, the effect could be to give a similarly wide discretion to the courts.5 In dealing with responses to this position, the CLRSG later commented: A few still supported a pluralist approach, imposing a duty to balance the interests of relevant parties without necessarily giving priority to those members; but none of these responses suggested a practicable means of dealing with the crucial question of how such a duty could be enforced. This is to our mind a key objection.6 Instead, the CLRSG endorsed an enlightened shareholder value approach which, as it put it in its final report: makes clear the obligation of each director to act to serve the purposes of the company as laid down in the constitution and as set for it by its members collectively: that is, it sets as the basic goal for directors the success of the company in the collective best interests of shareholders. But it also requires them to recognise, as the circumstances require, the company's need to foster relationships with its employees, customers and suppliers, its need to maintain its business reputation and its need to consider the company's impact on the community and the working environment.7 It seems that the CLRSG really considered this to be a restatement of three existing common law duties imposed on directors: 1. compliance with the company's constitution; 2. exercising any power (under that constitution) for its proper purpose; and 3. acting bona fide for the benefit of the company. From this arise two key questions: 1. did these pre-existing common law duties really amount to an enlightened shareholder value approach; and 2. does the wording of the equivalent duties adopted in the 2006 Act merely re-enact this pre-existing common law position? A careful exploration of both questions is important because of the continuing relationship between pre-existing common law duties and new statutory ones as explained in s.170(3) and (4) of the 2006 Act which states: (3) The general duties are based in certain common law rules and equitable principles

Page45

as they apply in relation to directors and have effect in place of those rules and principles as regards the duties owed to a company by a director. (4) The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties. If the wording in the 2006 Act replaces the common law duties (subs.(3)), but is to be interpreted in the light of those pre-existing duties (subs.(4)), that would appear to create a presumption that directors' duties have not been changed by the 2006 Act except to the extent that the statutory wording is not compatible with the pre-existing position.

The proper purpose rule

The duty to comply with the constitution was obvious (though the consequences of not doing so, whether ultra vires or merely a breach of duty has required statutory intervention)8 ; but it was, perhaps, something of a surprise how ill-defined the common law position on the proper purpose and bona fide rules was after a century and a half of company law. The courts had ruled that where directors' had powers to issue shares, those powers were restricted to the proper purpose of raising capital (and not also to changing voting majorities) in cases like Punt v *Comp. Law. 363 Symons & Co Ltd9 and Piercy v S Mills & Co Ltd10 ; but proper purpose only emerged as a clearly separate rule taking precedence over the bona fide rule in Hogg v Cramphorn Ltd. In that case, the directors issued shares to a trust in order to deter a threatened takeover bid from one Mr Baxter. Buckley J. accepted: that the board acted in good faith and that they believed that the establishment of a trust would benefit the company and that avoidance of the acquisition of control by Mr Baxter would also benefit the company,11 but nevertheless he found the directors to have misused their undoubted power to issue shares. A key element of the proper purpose rule was that it was assessed objectively, i.e. what in a court's view was the proper purpose of the directors' powers in question. By contrast, it had been established in Smith & Fawcett Ltd, Re12 that the duty to act bona fide was subjective. The distinction was later well summarised by Jonathan Parker J. in Regentcrest Plc v Cohen: The duty imposed on directors to act bona fide in the interests of the company is a subjective one The question is not whether viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director's state of mind. No doubt where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company's interests; but that does not detract from the subjective nature of the test The position is different where a power conferred on a director is used for a collateral purpose. In such circumstances it matters not whether the director honestly believed that in exercising the power as he did he was acting in the interests of the company; the power having been exercised for an improper purpose, its exercise will be liable to be set aside .13 It was clear, therefore, that to be effective, the proper purpose rule must take precedence over the bona fide rule. Apart from restricting the use of a power to issue shares,14 the proper purpose rule appears15 to have restricted the use of directors' powers concerning forfeiture or transfer of shares to avoid liability for a call,16 making discriminatory calls,17 non-commercial refusal to pay dividends18 and non-commercial transfers of assets.19

Page46

The bona fide rule

The objective nature of the proper purpose rule allowed courts some limited scope to intervene where they considered directors to be abusing their powers; but the subjective nature of the bona fide rule otherwise maintained the courts' position of being very reluctant to review business decisions, a position that pre-dated registered companies as can be seen in one of Lord Eldon's judgments in the early 19th century: This Court is not to be required on every Occasion to take the Management of every Playhouse and Brewhouse in the Kingdom.20 This non-interventionist attitude was reiterated in the corporate age, most famously by Bowen L.J.: A railway company, or the directors of the company, might send down all the porters at a railway station to have tea in the country at the expense of the company. Why should they not? It is for the directors to judge, provided it is a matter which is reasonably incidental to the carrying on of the business of the company The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company. Now that, I think, is the principle to be found in the case of Hampson v Price's Patent Candle Co.21 The Master of the Rolls there held that the company might lawfully expend a week's wages as gratuities for their servants; because that sort of liberal dealing with servants eases the friction between masters and servants, and is, in the end, a benefit to the company.22 The language may be dated, but clearly Bowen L.J. had enlightened shareholder value in mind. However, on the facts of the case, the court disallowed the payments to the directors and employees because the company was to be wound up and so the payments could serve no continuing benefit to the company. An unusual example of the non-interventionist attitude of the courts was found in Charterbridge Corp Ltd v Lloyds Bank Ltd where the directors admitted that, in creating cross-guarantees of the debts of different companies in a group, they had considered the benefit to the group but not to each of the companies separately of which they were directors. Pennycuick J. said: The proper test, I think, in the absence of actual separate consideration, must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company.23 *Comp. Law. 364 Pennycuick J. concluded that cross-guarantees could reasonably have been considered by the directors as for the benefit of each company. The case was originally brought on the basis of ultra vires rather than breach of duty, important for the purpose of standing (see below), but now the distinction has largely disappeared.24 One of the most striking examples in the 20th century of the courts allowing directors a wide discretion in determining what was in the interests, or for the benefit, of the company was the case of Evans v Brunner Mond & Co Ltd. A large chemical company had resolved in general meeting to make generous donations to universities and other institutions for scientific research. Eve J. rejected claims that the resolution was ultra vires because, considering the cost, any benefit to the company would be too indirect, would benefit competitors and would really only amount to a benefit to the community at large. This case might even be going beyond enlightened shareholder value towards a pluralist approach, allowing what Professor Parkinson would have described as profitsacrificing social responsibility. However, Eve J. did, rather contentiously, conclude: [T]he company has proved that the proposed expenditure will not only be to the direct advantage of the company, but is also conducive to, and indeed necessary for, its continued progress as chemical manufacturers.25 Of course, companies could always write into their constitutions non-profit making objectives, as Buckley L.J. pointed out in Horsley & Weight Ltd, Re,26 though it has to

Page47

be admitted that first instance courts did not always take a generous view of such noncommercial provisions.27 Where the courts remained most reluctant to allow interests other than those of shareholders to prevail was on the closing down of businesses. The most striking 20th-century case was Parke v Daily News Ltd.28 As in the West Cork Rly case, this involved payments to employees on the winding up of a business, if not here of the actual company. Despite supposed ratification by vote in a general meeting, Plowman J. held that the payments could in no way be a benefit to the company in these circumstances and could not be ratified, though not it seems on the basis of the original claim of ultra vires, but as being intra vires but nevertheless non-ratifiable.29 The Daily News decision led to a specific statutory intervention allowing such quasiredundancy payments on the cessation of a company's business, what is now s.247 of the 2006 Act. It also led to a more general statutory amendment to directors' common law duties which has not been carried forward into the 2006 Act. This provision, which was to be found in s.309 of the Companies Act 1985 (1985 Act), read: (1) The matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company's employees in general, as well as the interests of its members. (2) Accordingly, the duty imposed by this section on the directors is owed by them to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors. Although subs.(1) seemed to create a primary duty to consider the interests of employees, parallel to any duty to consider the interests of members, subs.(2) excluded any easy way for employees to enforce this duty against directors ultimately reliant upon members' votes for their positions. In effect the section merely created a defence for directors who might have allowed employees' interests to override those of members.30 One case where this may have played a unspoken part in the decision was Welfab Engineers Ltd, Re31 where Hoffmann J. held directors not liable for favouring the sale of the company's business to a party prepared to take on the employees rather than to a party prepared to offer a higher price but without the employees.

What is for the benefit of the company?

What became s.309(1) of the 1985 Act seems to have assumed that the pre-existing common law position was that the directors' bona fide duty to the company was solely to have regard for the interests of its members. In support of this, attention was often drawn to the words of Evershed M.R. in Greenhalgh v Arderne Cinemas Ltd: In the first place, I think it is now plain that bona fide for the benefit of the company as a whole means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase the company as a whole does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators; it means the corporators as a general body.32 The refusal of the court to stop a change to the articles favouring one group of members over another could be said to show a reluctance at common law to impose a fairness between members duty on directors. Shareholders can now resort to the unfair prejudice provisions of ss.994 to 996 of the 2006 Act.33 However, Greenhalgh was not about directors' duties, but about shareholders using their proprietary right of voting to amend articles.34 The equating of the interests of the company with those of the current corporators was not clear in the 19th-century cases which just referred to the benefit or interests of the company, and this did seem to have been considered a duty to the company as an entity which could include, for example, regard as to the interests of creditors35 (albeit not employees in a business being closed down). It was only in the 1980s in cases like Horsley & Weight *Comp. Law. 365 Ltd, Re,36Multinational Gas and Petroleum Co v Multinational Gas and Petrochemical Services Ltd37 and West Mercia Safety Ltd v Dodd38 that it became clearly established that the bona fide rule only concerned itself with creditors' interests when a company

Page48

was in financial distress. Even then, these decisions did not say directors could not consider creditors' interests while the company was a going concern, merely that they did not have to in normal circumstances; but by contrast, once it was clear a company was no longer a going concern, a duty to creditors replaced any duty to shareholders. This was reinforced by the wrongful trading provisions in s.214 of the Insolvency Act 1986. Even after these cases, there remained some uncertainty about whether shareholders' interests were supreme. Generally the commercial prosperity of a company and the interests of its shareholders coincide, but the interests of the company as an entity may not always coincide with those of (at least the majority of) the current shareholders. These tensions particularly emerge amid takeover bids. As we have already seen, even if directors genuinely believed the success of a threatened takeover might not be in the interests of the company, including those of the then current shareholders, the proper purpose rule restricted the directors from using any power to issue shares or dispose of assets to obstruct the takeover.39 Still, that left the question of what directors should recommend. In Heron International Ltd v Lord Grade, where the directors had concluded that the company would be taken over and merely had to recommend between competing bids, it was held that the interests of the company became those of the current shareholders.40 However, that did not necessarily require recommendation of the highest bid in all circumstances. In another case, it was held that, although the directors must be clear about the terms of rival bids, they did not have to make any recommendation, particularly where the higher bid was in competition with one from the directors themselves.41 In Dawson International Plc v Coats Patons Plc , a Scottish case, a distinction was maintained between the interests of the company as a continuing entity and those of the current shareholders (in contrast to the dicta in Greenhalgh ). Lord Cullen said: What is in the interests of current shareholders as sellers of their shares may not necessarily coincide with what is in the interests of the company. The creation of parallel duties could lead to conflict. Directors have but one master, the company.42 A similar point was later made by Neill L.J. in Fulham Football Club Ltd v Cabra Estates Plc: The duties owed by the directors are to the company and the company is more than just the sum total of its members. Creditors, both present and potential, are interested, while section 309 of the Companies Act 1985 imposes a specific duty on directors to have regard to the interests of the company's employees in general.43 This distinction between interests of the entity and its shareholders could be an explanation for the decision in Welfab Engineers Ltd, Re even if there had not been a s.309. It could also come into play where there was a highly geared bid for a company, perhaps a management buyout. Any independent directors required to give advice to shareholders under rr.3 and 25 of the Takeover Code, might consider it was their duty not just to consider the value of the bid for current shareholders, but the risks to the future of the company as an entity (and with that, at least its creditors and employees) because of the cash extracting measures that a successful bidder would have to resort to, to pay down the gearing. It is interesting to note that such an entity maximisation and sustainability approach has received recent theoretical backing from Professor Keay. He describes it has having two elements: First, there is a commitment to maximise the entity. This involves, inter alia , enhancing the company's wealth, but unlike with profit maximisation, this is not always measured by how much profit has been made. The second part is to sustain the company as a going concern, that is, to ensure its survival and more. An important aspect of the model is that there is focus on the company as an entity or enterprise, that is the company as an institution in its own right.44 Still, while a UK company was a going concern, it was shareholders ultimately that had the right, by ordinary resolution, to remove directors.45 Rather than voting directors off

Page49

a board, the mechanism had normally been to sell voting shares to a bidder. Where, because of the closed nature of the company, a hostile bid was not practical, an individual shareholder wishing to challenge the decisions of the directors, found the courts not just reluctant to define too closely what bona fide for the benefit of the company might mean, but resistant to allowing a case to be heard at all under the rule in Foss v Harbottle.46 Since most breaches of directors' duties were ratifiable and only the company (controlled by the directors) could then bring an action, such challenges as there were, had to claim the directors had acted, not just in breach of their duties, but ultra vires (so not ratifiable). The need in many cases to frame the claim in terms of ultra vires to have it heard at all may itself have deterred court intervention.

*Comp. Law. 366 What was the pre-existing common law position?
Prior to the 2006 Act, the common law position on the directors' three duties of compliance, proper purpose and good faith could be summarised as follows: 1. In addition to the restrictions imposed by a company's constitution on the directors' powers, the directors had a duty to use those powers only for what (the courts determined) were proper purposes. 2. In using their powers, the directors had a duty to act in what they believed (not what the courts determined) was for the benefit of the company. 3. Although the benefit of the company might normally coincide with the interests of the current shareholders, the courts did not equate them in all circumstances and allowed a very wide discretion to directors. 4. That discretion allowed an enlightened shareholder value approach, perhaps entity maximisation and even some profit sacrificing social responsibility. It did not enforce rigid shareholder supremacy. 5. However, where the company and/or its business had no long-term future: (a) if it was no longer a going concern, any duties owed to shareholders became duties owed to creditors; and (b) if it was still solvent but going to be wound up, the duties owed to shareholders were paramount (except for payments to employees made within the terms of what is now s.247 of the 2006 Act)

Section 171--compliance and proper purpose

The eventual statutory form of the three duties is contained in ss.171 and 172 of the 2006 Act, but the exact form of these provisions went through a number of public drafts, namely: 1. Developing the Framework (2000)47 ; 2. Final Report (2001)48 ; and 3. Government White Paper (2005).49 This last drafted the duties as a set of instructions to directors, reflecting perhaps the recommendation of the Law Commissions that a statement of duties: should be set out on forms 10(2) and 288a; that when a director signs such a form he should acknowledge that he has read this statement; and that the DTI should consider how pamphlets explaining a director's duties might be made available to directors.50 Otherwise, the drafting of the compliance and proper purpose rules remained reasonably constant through to s.171. The general reference to exercising powers honestly in the 2000 version was dropped as being open to too wide an interpretation.51 The extension of the term constitution to decisions taken under it (including class decisions) in the 2000, 2001 and 2005 versions is now incorporated into the extended definition of constitution contained in ss.17 and 257 of the 2006 Act. Specifying the overriding nature of the compliance and proper purpose rules in the 2000 and 2001 versions was dropped. However, as directors' powers only exist within the framework of a company's

Page50

constitution and the proper purpose rule only makes sense if it takes precedence over the bona fide rule, their overriding nature is obvious without specifying that giving them top billing in the list of duties gives these duties priority.52 Section 171 of the 2006 Act reads: Duty to act within powers A director of a company must-(a) act in accordance with the company's constitution, and (b) only exercise powers for the purposes for which they are conferred. The absolute nature of these duties (must act in accordance and only exercise ) makes it clear that they are objective in nature, which contrasts with the wording of s.172.

Section 172--good faith

Section 172 of the 2006 Act reads: Duty to promote the success of the company (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to-(a) the likely consequences of any decision in the long term, (b) the interests of the company's employees, (c) the need to foster the company's business relationships with suppliers, customers and others, (d) the impact of the company's operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company. (2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes. (3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company. Subsection (2) is clearly designed to preserve the position on non-commercial objectives highlighted in Horsley & Weight.53 Subsection (3) maintains the position in West Mercia Safety Ltd v Dodd as reinforced by the wrongful trading provisions that directors' duties are owed to creditors once a company is no longer a going concern. The main issues therefore concern subs.(1). Act in the way he considers, in good faith clearly indicates a subjective test which follows Smith and Fawcett, Re and the 2000, 2001 and 2005 versions, although the verb in those versions changed from believes to decides, to considers. Compared with believing at least, considering does imply conscious focusing on the issue, though perhaps *Comp. Law. 367 not as strongly as deciding. That could mean that in a future case like Charterbridge Corp Ltd v Lloyds Bank Ltd where the directors did not consider each separate company's benefit at all, the directors could technically be found to be in breach of their duties, though what damages could be claimed if the nonconsidered act was still objectively reasonable is hard to see. However, what is even more problematic is what has to be considered. Would be most likely to promote the success of the company appeared in both the 2001 and 2005 versions, but the 2000 version differed slightly, the wording being best calculated to promote the success of the company. Is this the same as the common

Page51

law's for the benefit of the company? The statutory version(s) do seem rather more demanding. The directors in a future case like Evans v Brunner Mond & Co Ltd might be able to claim they considered the funding of university research could benefit the company, but could they claim that, compared to other uses of the money, they honestly considered it would be most likely to promote the success of the company? This narrowing of focus is reinforced by the success of the company being stated as for the benefit of its members as a whole. This wording is taken from Greenhalgh v Arderne Cinemas Ltd and appeared in all of the 2000, 2001 and 2005 versions. This suggests that, except where subss.(2) or (3) comes into play, there is no longer any room for a distinction, as expressed in Dawson International v Coats Patons and Fulham Football Club Ltd v Cabra Estates , between the interests of the shareholders and those of the company as a separate entity. Given this strident affirmation of shareholder supremacy, what can the remainder of subs.(1) with its list of other interests achieve?

Other interests
In the 2000 version non-intervention by the courts was also encouraged by references in the good faith duty to practicability and circumstances (e.g. limited information, time or resources). In the 2001 and 2005 versions these references were confined to the consideration of the list of other interests. Practicability survived into the Bill presented to the House of Lords, but was removed during the passage through Parliament, so that in s.172 there is no reference to either. As s.172 remains subjective, why directors held a mistaken belief should not matter in determining a breach of this duty. However, it could affect the application of the duty to exercise reasonable care, skill and diligence in s.174, which is objective in nature. The author will have to return to the interaction between these duties. The list of factors that directors are to have regard to has remained consistent over the various versions, but as the bracketed amongst other matters makes clear, is not comprehensive. 2000 version 2001 version 2005 version 2006 Act s.172

Short term Long term Employees Suppliers/custo mers/others

X X X X

X X X X

X X X X X X X

Community/envi X ronment Business reputation Fairness between members X

The introduction of the need to act fairly between members may just be a reminder to directors of the statutory unfair prejudice provisions, just as subs.(3) is, inter alia, of the wrongful trading provisions. As directors owe their duties to the company (and through that to the members as a whole), it is hard to see how an individual member treated unfairly could bring an action (except perhaps for an injunction) for breach of directors'

Page52

duty, unless he could show the unfairness had damaged the company itself. The wide discretion as to substance and remedies under the unfair prejudice provisions is going to remain more attractive, except perhaps for shareholders in quoted companies, where the courts have been reluctant to allow such actions.54 Taking account of both the short and the long term consequences did govern the whole good faith duty in the 2000 version and has been demoted to just a reference to the long term as a factor in s.172. Short-term consequences, particularly in the current climate of just trying to survive, must be amongst other matters directors need to have regard to. However, this emphasis on the long term does imply that the benefit of the members as a whole could include future members where appropriate, although the CLRSG was resistant to this interpretation, preferring the argument that current company value was determined by prospective revenue generation.55 Still, this may help to counteract the sharper immediate commercial focus of the good faith duty, as the subordinate nature of the listed interests does not permit any interests other than those of shareholders (current and possibly future) to take priority, except as allowed under subss.(2) and (3). Any scope the common law may have allowed directors of a company with purely commercial objectives to indulge in entity maximisation or even a degree of profit-sacrificing social responsibility seems to have been removed. So, for example, having regard to the interests of the company's employees might not justify a future decision like that in Welfab Engineers Ltd, Re , nor the impact of the company's operations on the community a decision like Evans v Brunner Mond since directors might find it hard to convince a court they that believed either was most likely to promote the success of the company for the benefit of its members . Marks & Spencer's recent decision to become carbon neutral could be justified on environmental grounds because the directors can claim that their customers are concerned about this, will be attracted to their stores because of it, and will be prepared to pay a premium price to pay for it, all benefiting shareholders. The directors of a discounter like Aldi, however, would find *Comp. Law. 368 such justifications much harder. Indeed, it is interesting that Marks & Spencer itself used to make much of having 90 per cent British suppliers, but under pressure from cheap imports, had to abandon them all overnight in order to survive, and the need to foster the company's business relationships with suppliers proved illusory.56 Does this mean that the list of other interests in s.172(1) counts for nothing? For directors of quoted (and even large private) companies, subject to public scrutiny,57 the listed interests almost certainly featured in their boardroom deliberations long before s.172 came into force. One imagines that the appearance of the statutory list will lead company secretaries to ensure that, whenever key decisions are before the board, the minutes will formally record consideration of each of the elements of the list.58 With a new statutory derivative action removing some of the absolute bars on shareholders bringing actions that existed under the rule in Foss v Harbottle,59 this degree of caution would be wise. Section 260(3) of the 2006 Act appears to contemplate derivative actions for any type of directorial breach of duty. Still, to launch an action, an applicant needs to show the court a prima facie case, and in effect, good reason for bringing it,60 which may bar pressure groups from buying a few shares and claiming the directors have failed to consider their pet interest. However, the list does not just apply to large or quoted companies and private companies are no longer required to have a company secretary, which could give rise to some unintended consequences. The majority of private companies are owner-managed and while going concerns, unlikely to find directors' decisions challenged by shareholders as breaches of duty. However, sale to new owners or winding up can lead to scrutiny of past directorial decisions by new eyes. Detailed minutes of formal board meetings are unlikely to have been created. Should the company be in financial difficulties because of say, a falling out with a key supplier or customer, a public scandal about environmental pollution, or a protracted strike of key disgruntled workers, the directors may not have any evidence of prior consideration of these risks.

Page53

Although the listed interests may look like non-comprehensive guidance, courts have a habit of treating such guidance as establishing new expected standards. Soft law can quickly become hard law. Take for example, guidance given to auditors.61 Directors will still be able to point out that the duty to promote the success of the company remains one of good faith, i.e. honest subjective belief, but failure to consider interests on the list may be viewed not just as going to that duty, but also to the objective duty to exercise reasonable care, skill and diligence.62 Where a company goes into insolvent liquidation, this might affect the directors in either of two ways: 1. the liquidator might be emboldened to bring an action under s.212 of the Insolvency Act 1986 for breach of duty if any director has assets worth pursuing; or 2. the courts may become stricter in imposing disqualification orders for unfitness under s.6 of the Company Directors Disqualification Act 1986.

Conclusion
Returning to the two key questions posed earlier, it seems that the two duties of compliance and proper purpose contained in s.171 have not altered the pre-existing common law duties. However, the position of s.172 is less clear. The CLRSG seems to have believed that putting enlightened shareholder value into statutory form was taking the pre-existing common law duty and making explicit its true character.63 Given the presumption against change created by s.170(3) and (4), other commentators have taken the same view. For example, Professor Birds has said: On the whole it is thought that the effect of s 172 is more likely to be educational rather than in any sense restrictive and that business decisions taken in good faith will not be any more easily challengeable than they were before this provision existed.64 The present author is slightly less sanguine. Even without s.309 of the 1985 Act, he is not as certain as the CLRSG that the pre-existing common law bona fide duty was one purely based on enlightened shareholder value, although he accepts that part of the historic reluctance of courts to intervene was the need for many claims to be framed on the basis of ultra vires rather than just breach of duty. The statutory provision is clearly focused on shareholder supremacy. As for the listed other interests, these may almost give rise to a Catch-22 for directors. If directors pay too much attention to one of these interests (creditors, employees, the environment, etc.) they may be challenged for being in breach of the primary duty towards shareholders. If they ignore any of these interests and that proves disastrous for the company, they may be challenged for breach of their duty to exercise reasonable care, skill and diligence. In practice, the most likely circumstance in which a challenge may be raised is during an insolvent liquidation, either to obtain a contribution from the directors or to seek their disqualification. As all these duties are still owed to the company rather than individual shareholders,65 challenges while a company is a going concern will require the case to be brought by or on behalf of the company. That might occur after a change of ownership (and with it a change of directors), but otherwise will require a derivative action.66 How much easier pursuing a derivative action will be under the new statutory provisions, only time will tell. Professor Alistair AlcockProfessor of Commercial Law, Salford Law School Comp. Law. 2009, 30(12), 362-368 1. Modern Company Law for a Competitive Economy (DTI, March 1998). 2. An issue also examined by the Law Commission and Scottish Law Commission, Company Directors: Regulating Conflicts of Interests and Formulating a Statement of Duties (Law Com. No.261 HMSO, 1999) (Law Commission Paper). 3.

Page54

Late Professor of Law at Bristol University and author of Corporate Power and Responsibility: Issues in the Theory of Company Law (Oxford: Clarendon Press, 1993). 4. See Ch.5.1.24 of the interim report, Modern Company Law for a Competitive Society: The Strategic Framework (URN 99/654, DTI, February 1999) (Strategic Framework ). 5. See Ch.3.24 of a later interim report, Modern Company Law for a Competitive Society: Developing the Framework (URN 00/656, DTI, March 2000) (Developing the Framework ). 6. See Ch.3.5 of Modern Company Law for a Competitive Society: Completing the Structure (URN 00/1335, (DTI, November 2000) (Completing the Structure ). 7. See Ch.3.8 of Modern Company Law for a Competitive Society: Final Report (URN 01/942, DTI, July 2001) (Final Report ). 8. See 2006 Act ss.39 and 40. 9. Punt v Symons & Co Ltd [1903] 2 Ch. 506 Ch D. 10. Piercy v S Mills & Co Ltd [1920] 1 Ch. 77 Ch D. 11. Hogg v Cramphorn Ltd [1967] Ch. 254 Ch D at 266G. 12. Smith & Fawcett Ltd, Re [1942] Ch. 304 CA. 13. Regentcrest Plc v Cohen [2001] 2 B.C.L.C. 80 at Ch. D [120] and [123]. 14. Hogg v Cramphorn [1967] Ch. 254; Howard Smith Ltd v Ampol Petroleum Ltd [1974] A.C. 821 PC (Aus). 15. Even since Hogg v Cramphorn the cases have not always been explicit about the basis of court intervention. For example, in Bishopsgate Investment Management Ltd v Maxwell (No.1) [1993] B.C.L.C. 1282 CA, Hoffmann L.J. described the gratuitous transfer of assets as improper, but whether in breach of the proper purpose rule restricting the directors' powers to dispose of assets or a breach of a separate trustee like duty in respect of company assets was not stated. 16. Stanhope's Case (1865-66) 1 L.R. Ch. App. 161; Bennett's Case (1854) 5 De G.M. & G. 284. 17. Galloway v Hall Concert Society [1915] 2 Ch 233. 18. A Company (No.00370 of 1987) Exp. Glossop, Re [1988] B.C.L.C. 570 Ch D. 19. Bishopsgate Investment Managment Ltd v Maxwell (No.1) [1993] B.C.L.C. 1282; Criterion Properties Plc v Stratford Properties LLC [2003] 2 B.C.L.C. 129 CA although the House of Lords considered the enforceability of the poison pill depended upon actual or apparent authority, requiring full trial to ascertain: [2006] 1 B.C.L.C. 729 HL.

Page55

20. Carlen v Drury (1812) 1 V. & B. 154 at 158. 21. Hampson v Price's Patent Candle Co (1876) 45 L.J. Ch 437. 22. Hutton v West Cork Rly Co (1883) 23 Ch. D. 654 at 672 CA. 23. Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch. 62 Ch D. 24. 2006 Act ss.39 and 40. 25. Evans v Brunner Mond & Co Ltd [1921] 1 Ch. 359 Ch D at 369. 26. Horsley & Weight Ltd, Re [1982] 3 All E.R. 1045 CA (Civ Div) at 1052d. 27. Lee, Behrens & Co Ltd, Re [1932] 2 Ch. 46 Ch D; W & M Roith Ltd, Re [1967] 1 W.L.R. 432 Ch D; Simmonds v Heffer [1983] B.C.L.C. 298 Ch D. 28. Parke v Daily News Ltd [1962] Ch. 927 Ch D. 29. [1962] Ch. 927 at 957 and 963 following the West Cork Rly case. 30. For a discussion of the effect of this section, see Strategic Framework , 1999, Ch.5.1.2123. See also Fulham Football Club Ltd v Cabra Estates Plc [1994] 1 B.C.L.C. 363 CA, discussed below. 31. Welfab Engineers Ltd, Re [1990] B.C.L.C. 833 Ch D. 32. Greenhalgh v Arderne Cinemas Ltd [1951] Ch. 286 CA. 33. The change in the articles in Greenhalgh had been rushed through because the predecessor to the unfair prejudice provisions, Companies Act 1948 s.210, was due to come into force. 34. Though it was cited by Plowman J. with approval in Parke v Daily News Ltd [1962] Ch. 927 Ch D at 963. 35. Of most concern was capital maintenance, Exchange Banking Co, Re: Flitcroft's Case (1882) L.R. 21 Ch. D. 519 CA; Trevor v Whitworth (1887) L.R. 12 App. Cas. 409 HL. 36. Horsley & Weight [1982] Ch. 442. 37. Multinational Gas and Petroleum Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch. 258 CA. 38. West Mercia Safety Ltd v Dodd [1988] B.C.L.C. 250 CA which in turn relied heavily on the Australian case of Kinsela v Russell Kinsela Pty Ltd (1986) 4 N.S.W.L.R. 722 at 730. 39.

Page56

Hogg v Cramphorn [1967] Ch. 254; Howard Smith v Ampol [1974] A.C. 821 PC (Aus); Criterion Properties v Stratford Properties [2006] 1 B.C.L.C. 729 HL. This contrasts with the acceptance of poison pill arrangements as legitimate in the US: see Paramount Communications Inc v Time Inc 571 A. 2d 1140 (Del. 1989); Unitrin v American General Corp 651 A. 2d 1361 (Del. 1995). 40. Heron International Ltd v Lord Grade [1983] B.C.L.C. 244 CA at 265. The position here is the same as in the US: Revlon Inc v MacAndrews & Forbes Holdings Inc 506 A. 2d 173 (Del. 1986). 41. A Company, Re [1986] B.C.L.C. 382. 42. Dawson International Plc v Coats Patons Plc (1988) 4 B.C.C. 305 CS (OH). 43. Fulham Football Club Ltd v Cabra [1994] 1 B.C.L.C. 363 CA at 393 et seq. 44. Professor of Corporate and Commercial Law, University of Leeds, in Ascertaining the Corporate Objective: an Entity Maximisation and Sustainability Model (2008) 71 M.L.R. 663, 679. 45. What is now 2006 Act s.168. The courts have, however, upheld provisions in articles or shareholders agreements that tend to defeat this provision; Bushell v Faith [1970] A.C. 1099 HL; Russell v Northern Development Corp Ltd [1992] 1 W.L.R. 588 HL. 46. Foss v Harbottle (1843) 2 Hare 461; see also Prudential Assurance Co Ltd v Newman Industries Ltd (No.2) [1982] Ch. 204 CA. 47. See Ch.3.40. 48. See Vol.I, Annex C largely followed in Draft Clause 19 in Modernising Company Law: White Paper (Cm.5553, DTI, July 2002). 49. See Ch.7, Pt B of Company Law Reform (Cm.6456, DTI, March 2005). 50. Law Commission Paper, 1999, Pt 4, para.68. 51. Completing the Structure , 2000, Ch.3.13. 52. See Completing the Structure , 2000, Ch.3.15. 53. As, after October 1, 2009, a UK company was no longer required to have any objects clause, such specified non-commercial objectives may become rarer; 2006 Act s.31(1). 54. Blue Arrow Plc, Re [1987] B.C.L.C. 585 Ch D. 55. Strategic Framework , 1999, Ch.5.1.18, fn.31. 56. For a case generated by this dramatic volte face, see Baird Textiles Holdings Ltd v Marks & Spencer Plc [2002] 1 All E.R. (Comm) 737 CA.

Page57

57. Also for companies fully listed on the Stock Exchange, the requirement to comply or explain non-compliance with the Combined Code on Corporate Governance (Financial Reporting Council, June 2008). 58. The CLRSG dismissed the danger of pedantic, legalistic minute taking as unlikely; Completing the Structure , 2001, Ch.3.24. It would be interesting to do some empirical research on whether boardroom behaviour has changed in response to the statutory duties. 59. 2006 Act ss.260-269. 60. 2006 Act ss.261 and 263. 61. Thomas Gerrard & Sons Ltd, Re [1968] Ch. 455 Ch D; Lloyd Cheyham & Co Ltd v Littlejohn [1987] B.C.L.C. 303 QBD. 62. 2006 Act s.174. 63. See Ch.5.1.22, though the CLRSG did accept that repeal of 1985 Act, s.309 was needed to remove an element that might go beyond shareholder value towards pluralism. 64. Professor of commercial law, University of Manchester, in Ch.15[10A] of Gore-Browne on Companies , 45th edn (Jordans, as at March 2009). 65. 2006 Act s.170(1). 66. A challenge for breach of duty could form part of an unfair prejudice action; 2006 Act ss.994 to 999.
2011 Sweet & Maxwell and its Contributors

Page58

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

The enlightened shareholder - leaving stakeholders in the dark: will section 172(1) of the Companies Act 2006 make directors consider the impact of their decisions on third parties?
Deryn Fisher. I.C.C.L.R. 2009, 20(1), 10-16 [International Company and Commercial Law Review] Publication Date: 2009 Subject: Company law Keywords: Corporate Stakeholders governance; Directors' powers and duties; Shareholders;

Abstract: Outlines the difference for company directors between a requirement to prioritise shareholder value, with its emphasis on share value and short-term profits, or stakeholder value, considering the interests of all affected by a company's activities. Explores the theoretical bases for preferring one over the other and discusses the advantages and disadvantages of each. Considers whether the Companies Act 2006 s.172(1) introduces an element of stakeholder value into UK company law. Questions the potential effectiveness and enforceability of s.172(1) in practice. Legislation Cited: Companies Act 2006 s.172(1)

Page59

International Company and Commercial Law Review

2009

The enlightened shareholder - leaving stakeholders in the dark: will section 172(1) of the Companies Act 2006 make directors consider the impact of their decisions on third parties?
Deryn Fisher Subject: Company law Keywords: Corporate Stakeholders governance; Directors' powers and duties; Shareholders;

Legislation: Companies Act 2006

s.172 (1)

*I.C.C.L.R. 10 Introduction
A decade of debate over the future of English company law ended with the Companies Act 2006. At the heart of its conception has been a deceptively simple question--in whose interests should company law be formulated?1 The Company Law Review Steering Group (CLRSG) considered three options: maintaining the status quo of shareholder value, a pluralist approach and a new regime of enlightened shareholder value (ESV). The latter was recommended and adopted by Parliament under s.172(1) as part of the new statutory formulation of directors' duties. The provision has been criticised as all but impossible to enforce and seen variably as a radical move or as making little, if any, practical difference. This article will review the cases for shareholder and stakeholder value as a basis for the decision to adopt s.172(1) before examining whether it will ensure that directors consider third parties in their decision-making. It will be argued that s.172(1) poses little threat to directors intent on maximising profits at the expense of stakeholder relationships, but provides a strong normative element which, coupled with other forms of stakeholder pressure and the prevailing business climate, will encourage boards to consider an increasing range of interests. Prior to the 2006 Act, directors' duties were based on common law rules and equitable principles including a duty to act in the interests of the company,2 interpreted as the best interests of present and future shareholders.3 Thus shareholder value, predominant in Anglo-American corporate law, requires a company to maximise the interests of shareholders above those of other parties with potential claims by focusing on share value and short-term profit.4 Alternatively, stakeholder value, found in some continental and Asian jurisdictions and influenced by communitarian principles of teamwork, trust and sustainability,5 allows the interests of all those affected by a firm's activities to be considered in its objectives. The CLRSG stated its reform objectives as achieving competitiveness, efficient creation of wealth and other benefits for all participants in the enterprise. Where appropriate, the negative impacts of corporate activity should be minimised and welfare maximised on a wider scale.6 It concluded this would be best served by enlightened shareholder value, a hybrid of the two approaches which maintains the primacy of shareholders but requires a long-term approach and permits directors to consider other interests as the best way of securing prosperity and welfare overall.7 This was encapsulated in s.172(1) which came into force on October 1, 2007: 172. Duty to promote the success of the company (1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to: (a) the likely consequences of any decision in the long term, (b) the interests of the company's employees, (c) the need to foster the company's business relationships with suppliers, customers

Page60

and others, (d) the impact of the company's operations on the community and the environment, *I.C.C.L.R. 11 (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company. Bearing this in mind, the arguments for stakeholder and shareholder value will be examined.

Foundational philosophies
Shareholder value and its objectives of maximising profits and share value have been predominant in UK company law, but its theoretical underpinnings may be challenged and it is possible to argue that the concept is not a foundational principle of company law.

Shareholders as owners
Shareholder value reflects the view that shareholders are the owners8 of the company and bear the residual risk. By investing in the hope of receiving profit, they are last to receive an income after employees, suppliers, creditors and the taxman are satisfied, which may leave nothing if a company goes into liquidation.9 However, it has been argued that this is not evidence of its status as the basic model of company law, rather a reflection of the United Kingdom's history of individualism and laissez-faire.10 Such philosophies encourage the accumulation of private wealth with minimal governmental interference, allowing social and welfare concerns to be met by the state.11 Shareholder value was bolstered by the focus on short-term profits to gauge success after a string of hostile takeovers followed privatisation of state-owned utilities in the 1970s. This argument is supported by the view that no single strain of judicial authority supports shareholder value and so it is not as legally embedded as its proponents argue.12 It may be misleading to see shareholders as the sole bearers of residual risk. While they face losing their cash investment should a company fail, employees may lose their pension contributions and their livelihoods,13 their community may be devastated by mass redundancies and suppliers may have invested in specialist machinery to meet contractual obligations.

Agency theory
Shareholder value is also supported by agency theory, which holds that directors manage the company on behalf of its principals, the shareholders, but Goldenberg argues that this is a misconception.14 Directors owe a duty to the company not to any third party, though they must have regard to the interests of shareholders (or creditors during insolvency) in discharging that duty. This obligation relates to shareholders present and future15 and so the duty must be to maximise value on a sustainable basis.16 Therefore the needs of stakeholders could be considered if conducive to successful trading, and indeed directors may fail to properly discharge their duty otherwise, he argued.17 On this reading, agency theory does not appear to preclude company law adopting a more pluralist approach to foster trust and long-term relationships over the thirst for fast profit.18

Nexus of contracts
Shareholder primacy has been justified by nexus of contracts theory, which contends that a company is a collection of complex private agreements with each participant free to negotiate in their best interest.19 Unlike employees, suppliers, customers and creditors, shareholders are bound by the statutory contract which they cannot negotiate and so have the most interest in being able to control the company.20 This applies in particular to unlisted companies where it can be difficult to sell shares quickly.21 Additionally, they are protected by the fiduciary duties of directors who would be less focused if they had to consider other interests.22 In reality, the degree of bargaining power available *I.C.C.L.R. 12 to stakeholders is debatable. A supplier who has

Page61

invested heavily in machinery may be reliant on renewal of his contract and employees are often expected to accept standard terms. Nonetheless, stakeholders are often protected via employment, insolvency or environmental law so it may be right for shareholders to be privileged by company law.23

Organic model
The organic model's view is that the company should be viewed not as the private property of shareholders but as a social institution with an independent identity. Not only is shareholder ownership separated from managerial control of the company, but there is considerable public interest in the exercise of corporate power.24 Business should be socially responsible and public companies in particular have a much wider societal role than can be described by a series of private contractual arrangements.25 Some theorists classify large corporations as political and of public rather than private character because of their power and the potentially far-reaching consequences of their actions.26 From this perspective, directors may legitimately consider non-shareholder interests as prosperity relies on using company assets for the good of all concerned.27 Stakeholders may be widely defined as anyone affected by the company's activities,28 such as employees, customers, environmentalists or residents. Dean seeks to reconcile organic and contract-based theories by recognising implicit and explicit agreements between the company and stakeholders, particularly where lengthy relationships exist.29 However, the company may also be viewed as a community, emphasising the importance of trust, interdependence and reciprocal benefit.30 Since all stakeholders contribute to the success of the company all should be allowed to benefit from it.31 As society allows the company a corporate personality by way of concession, so the company can be reasonably obliged to act responsibly.32 These arguments demonstrate that, while shareholder value is traditional in the United Kingdom, it is not embedded. Laissez-faire philosophies suited Britain's trading dominance in the 19th century but more recently contractual freedom has been regulated especially where the bargaining positions are unequal. There is some merit in giving shareholders special status in company law as other parties may be protected elsewhere in legislation, but it is not true to see them as bearing the sole residual risk and too simplistic to see companies as a nexus of private contracts when their impact on the wider community may be huge. It is contended that a stakeholder approach could be theoretically justified and would not have required a fundamental shift in UK company law doctrine.

Shareholder versus stakeholder

Having established scope for a pluralist approach, it must be considered whether it is preferable to the shareholder model. A perceived strength of shareholder value is that members monitor directors' behaviour and objectives, safeguarding against the temptation to maximise their interests at the expense of the company, through inflated salaries and bonuses33 and saving on costly monitoring procedures.34 This view is questionable, especially when a shareholder may control a small minority of the votes and be understandably apathetic given the small chance of achieving change and the cost of bringing other members on side.35 Unrestrained management has been an issue of the corporate governance debate, although less so since institutional investors controlling large blocks of shares have demanded regular management contact.36 Stakeholders become members of public companies to influence management objectives. Shareholder value has been preferred for allowing directors to serve the interests of a fixed group rather than an indefinable mass of stakeholders.37 *I.C.C.L.R. 13 Pluralism requires directors to balance wide-ranging interests, an inherently subjective process, which might encourage them to choose the option of most benefit to themselves.38 It would be unreasonable and inefficient39 to distract directors from business with the conflicting needs of stakeholders and may lead to poor decisions40 especially as they are not experts in the various stakeholder interests.41 Deliberations

Page62

could directly conflict with the needs of business, for example when considering the position of a supplier with whom they are negotiating. However, directors are classed as fiduciaries, a role which entails making difficult yet fair decisions,42 particularly where there are different classes of shareholding.43 Shareholders themselves can have diverse interests--some will seek quick profits and others long-term sustainability--so directors have long managed competing interests without undue difficulty.44 Advocates of shareholder value argue it gives directors a single, clear objective and that maximising profits results in economic efficiency and competitiveness. Thus the market ensures that consumers get the goods and services that they want, employees gain job security and the wider community benefits from tax revenue and profitable businesses.45 Shareholder value measures success in profits and share price46 which are easily compared to those of other companies.47 Further, as owners, members can demand primacy in line with their proprietorial rights. To allow stakeholders to profit from shareholders' investment is a redistribution of wealth more properly carried out by state measures such as taxation,48 and which could infringe on the right to peaceful enjoyment of possessions.49 In contrast, stakeholder theory argues that concentration on share price and profits encourages short-termism and poor corporate governance. The best conditions for generating profit are where there is teamwork between everyone involved and directors recognise the importance of community interests.50 Stakeholders will invest time and effort in a business where relationships are built on trust. For example, a staff member may train in highly specific skills with little relevance outside the firm if he believes his job is secure, or a supplier may invest in equipment of use to a single customer.51 Lack of trust has been seen as a cause of poor performance by UK firms in research and development and physical capital.52 The CLRSG agreed that shorttermism was not conducive to trust, but believed it possible to take a long-term view while maintaining shareholder primacy. However, investments based on trust support the view that shareholders are not the sole owners of companies. Indeed, in an age when information and skills vested in employees may be its main assets it can be argued that the shareholders are not the only ones investing in the company.53 As such, that company's objectives should be broader than maximising profits for members. Stakeholder value recognises all parties affected by corporate activity by giving them a role in decision-making or ensuring their interests are considered54 as is intended by s.172(1). Their interests are no longer wholly subordinate to shareholders.55 This inclusive approach enhances social justice and creates trusting relationships arguably leading to the CLRSG's goal of economic prosperity for all.56 However, it considered that shareholder value must be given primacy to overcome problems of balancing conflicting interests. Directors are used to dealing fairly with conflict, but there are other appropriate hierarchies than shareholder value. Stakeholders can be classified into primary groups containing essential parties, such as customers, employees, shareholders and suppliers, and secondary stakeholders who may be merely influential, such as the media, Government, community and the environment.57 The former can be seen as voluntary investors who may have a moral right to see their agreement honoured, while the latter may be involuntary and better served by effective enforcement of existing *I.C.C.L.R. 14 regulations such as planning or environmental law.58 Stakeholder value does not have to be enforced via a legal formulation of directors' duties as in s.172(1). It can be facilitated by direct participation and board representation,59 interests can be addressed at the AGM or protected by non-executive directors or companies can be asked to supply information about their impact on stakeholders so that informed decisions can be made.60 Germany's codetermination system lets workforce representatives sit on the supervisory board,61 while Japan's relational board structure includes representatives of employees, creditors and suppliers.62 Australia rejected the English approach, preferring soft law. So the CLRSG could have adopted a stakeholder-friendly approach without embroiling directors in weighing up conflicting needs if this was a primary concern. Stakeholder value may directly enhance long-term success by encouraging social

Page63

responsibility. Potential investors are as likely as anyone to object to ethical issues--they may also be customers, employees or local residents concerned with environmental issues.63 Bad practices such as using sweatshops or child labour may reap short-term profits but sow long-term damage to reputation, or even customer boycotts as with Nestl and Nike.64 Even suppliers may be willing to help cut the cost of production if there is a strong long-term working relationship based on trust.65 Indeed, the undue focus of shareholder value on immediate profit may sacrifice long-term performance and be an unreliable indicator of success. In a strong economy, share prices may remain high despite poor performance but drop if capital is spent on new research or technology to increase its future potential.66 When coupled with poor corporate governance, this can be dangerous. Focus on Enron's share value prompted dubious accounting practices to mask large debts and aggressive management techniques demoralised staff and encouraged them to chase short-term success over sustainability.67 Its collapse hit not just shareholders but many stakeholders, including employees who lost jobs and pensions, other companies embroiled in the scandal, pension scheme beneficiaries68 and even the energy market itself.69 It has been argued that particular features of the UK market have led to increasing focus on stakeholder value.70 Institutional investors have pressurised boards to behave more ethically using their powerful block votes and by attaching conditions to investments.71 They typically require corporate responsibility such as sensitivity to stakeholder needs and sustainable business, and may utilise socially responsible investing where companies are screened for ethical standards. This has combined with financial analysis and shareholder activism to encourage businesses to meet their societal obligations.72 The United Kingdom is home to leading non-governmental organisations such as Oxfam, Amnesty International and Christian Aid who prefer to create relationships of trust with businesses instead of dealing as adversaries.73 Stakeholder-style practices may be only adopted insofar as they increase shareholder value, but that can be gauged by longterm measures of good reputation and the loyalty of customers, employees and suppliers and as well as share price.74 There is also EU pressure to adopt stakeholderorientated policies of other Member States, particularly with regard to employment law, such as entitlement to consultation over mergers, large-scale redundancies and insolvency.75 Corporate scandals and resulting reports into corporate governance have also raised the profile of stakeholder thinking. As has been shown, there are compelling arguments in favour of an inclusive and longterm view of which party's company law should benefit. These are not just theoretical but of practical relevance to the UK context and have been tried and tested in other jurisdictions. It is important to note that a statutory formulation of directors' duties was not the only method open to the CLRSG, which could have opted for soft law or other forms of representation.

*I.C.C.L.R. 15 The legislation

Having seen that some element of stakeholder value could and possibly should have been introduced into UK company law, we will now examine whether enlightened shareholder value, as manifested in s.172(1), accomplishes that task. The provision requires directors to recognise that success is best achieved by considering the longand short-term views and stakeholder interests. However, they appear to have unfettered discretion providing they act as they consider most likely to promote success for the benefit of members as no objective criteria are provided.76 This is surprising given that the drafting referred to material factors that a person of care and skill would consider relevant77 and given the CLRSG's concern that pluralism would leave directors unaccountable.78 The phrase have regard to is not explained so it is unclear whether directors should consider stakeholder interests per se, or only as far as they benefit shareholders.79 For example, it fails to indicate whether directors can pick from all options with an equal chance of success or if they must opt for the one most beneficial to shareholders.80 The list is non-exhaustive, referring to amongst other matters.81 This could be taken to include creditors, who are notably absent from the

Page64

provision though referred to in s.172(3). Ultimately, this may be irrelevant as stakeholders will only be considered as far as it benefits members. Section 172(1) offers no standards against which to measure directors' good faith, making their position virtually unassailable.82 Courts have previously found subjective measures problematic and added objective criteria,83 which Keay argues could still apply under s.170(3) and (4), which refer to the ongoing application of the common law and equitable rules.84 Worthington agrees that the CLRSG did not intend to change the law but to clarify it and so old case law should remain applicable,85 yet the fact the subjective test is enshrined in statute must carry weight. The lack of criteria by which to measure success has been criticised86 but may reflect judicial unwillingness to become embroiled in assessing business strategy. It seems that a director can fail providing he believed his methods were likely to promote success.87 The statute does not require reasonable care but there might be a breach of duty under s.174 where the common law duties of care and skill were codified. Clearly a breach of s.172(1) will be extremely difficult to prove, but there may be no one able or willing to bring an action. Directors must consider stakeholder interests but only owe a duty to the company enforceable by its members. A similar regime under s.309 of the Companies Act 1985 requiring directors to have regard to employees' interests with a duty only to the company proved unusable.88 Shareholders may be granted leave for a derivative action89 but this can be hard to advance against the wishes of the majority and members are unlikely to embark on expensive court action unless to compel directors to act fairly between them. A member might act if they are interested in longterm success, live locally, are an employee or worried about poor business relationships,90 but given current shareholder apathy this is doubtful. A liquidator could also bring an action but might struggle to show breach or to prove financial loss which would be hard to calculate from a failed duty to promote success.91 Alternatively a stakeholder could seek an injunction against harmful behaviour but it is unclear that courts would accept a non-member application even with sufficient evidence92 which may not be available until the harm is done.93 It appears that s.172(1) may be of minimal use to stakeholders because it will be, at best, extremely difficult to advance an action or to prove a breach. This raises the prospect that Parliament has created a right without a remedy, which the law abhors. The provision may enable *I.C.C.L.R. 16 directors to take other interests into consideration by providing a defence if shareholders challenge a stakeholder approach.94 However, their primary goal remains the interests of members. Indeed the provision enshrines this element of shareholder value into statute for the first time, even if it is of an enlightened variety.95 Coupled with the fact that shareholders now have a statutory right to derivative proceedings,96 they may be more likely to risk a technical breach of s.172(1) than fail to promote the interests of the company.

Conclusion
Will s.172(1) make directors consider the interests of third parties? The short answer appears to be no, given the difficulty of proving breach even if an action can be brought. This could be disappointing as shareholder value is not embedded in English company law and pluralism could provide a better rationale for the way in which stakeholders invest their time, talent and trust in modern businesses. However, the legislation must be seen in the context of the wider debate about stakeholder value and corporate governance in England. Successful businesses now recognise the importance of brand reputation and are encouraged to behave responsibly by ethical investors, pressure groups, non-governmental organisations and their customers. They will promote good relationships with suppliers and communities, and may acknowledge employee expertise as among their most valuable commodities. While s.172(1) cannot guarantee directors will consider third party interests, it must be seen as a normative measure which, combined with stakeholder pressure, the prevailing commercial climate and a few enlightened shareholders, will firmly encourage a more inclusive, longer-term view of what will promote success.

Page65

The author wishes to thank Dr Paul Omar of the University of Sussex for casting a critical eye over the contents of this article. Any errors or omissions, however, remain the author's own. I.C.C.L.R. 2009, 20(1), 10-16 1. A. Keay, Enlightened shareholder value, the reform of the duties of company directors and the corporate objective [2006] L.M.C.L.Q. 335, 346. 2. Percival v Wright [1902] 2 Ch. 421 Ch D. 3. Hutton v West Cork Railway Co (1883) L.R. 23 Ch. D. 654 Ch D. 4. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 336. 5. S. Kiarie, At Crossroads: Shareholder Value, Stakeholder Value and Enlightened Shareholder Value: Which Road Should the United Kingdom take? [2006] I.C.C.L.R. 329. 6. Department for Trade and Industry. Company Law Review, Modern Company Law for a Competitive Economy: The Strategic Framework. 1999, para.5.1.8. 7. Company Law Review: The Strategic Framework. 1999, para.5.1.12. 8. Committee on the Financial Aspects of Corporate Governance (Cadbury Report) (1992), para.6.1. 9. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 338. 10. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 338. 11. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 330. 12. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 341-346 provides detailed analysis of case law and concludes no single strain of authority for shareholder value exists. 13. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332-333. 14. P. Goldenberg, IALS company law lecture, Shareholders v Stakeholders: the bogus argument (1998) 19(2) Company Lawyer 34, 36. 15. Gaiman v National Association for Mental Health [1970] 2 All E.R. 362 Ch D. 16. Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 36. 17. Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 37. 18.

Page66

Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 38. 19. F. Easterbrook and D. Fischel, The Corporate Contract (1989) 89 Columbia Law Review 1416, 1428. 20. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 338. 21. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 339. 22. J. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 67. 23. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 330. 24. J. Parkinson, Corporate Power and Responsibility (Oxford: Clarendon Press, 1993), p.23. 25. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 67. 26. Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 34. 27. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 67. 28. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332 fn.34. 29. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 67. 30. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 341. 31. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332. 32. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 330. 33. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 330. 34. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 339. 35. Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 34. 36. Goldenberg, Shareholders v Stakeholders (1998) 19 Company Lawyer 34, 35. 37. G. Vinten, Shareholder versus stakeholder--is there a governance dilemma? (2001) 9(1) Corporate Governance 36, 41. 38. J. Parkinson, Models of the Company and the Employment Relationship (2003) 41(3) British Journal of Industrial Relations 481, 498. 39. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332.

Page67

40. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 339. 41. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 353. 42. R. Campbell Jr, Corporate Fiduciary Principles for the Post-Contractarian Era [1996] Florida State University Law Review 561, 593. 43. Mills v Mills (1938) 60 C.L.R. 150 at 164. 44. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 354. 45. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332. 46. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 338-339. 47. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 332. 48. B. Pettet, Company Law (London: Longman, 2005), p.63. 49. European Convention of Human Rights art.1. 50. Company Law Review: The Strategic Framework. 1999, para.5.1.9. 51. Company Law Review: The Strategic Framework. 1999, para.5.1.20. 52. J. Parkinson, Inclusive Company Law in J. De Lacy (ed.), The Reform of United Kingdom Company Law (London: Cavendish, 2002), p.46. 53. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 333. 54. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 69. 55. Company Law Review: The Strategic Framework. 1999, para.5.1.13. 56. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 69. 57. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 69. 58. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 69. 59. Dean, Stakeholding and Company Law (2001) 22 Company Lawyer 66, 69. 60. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 333. 61. M.J. Roe, German Codetermination and Securities Markets (1999) 5(3) Columbia

Page68

Journal of European Law 3, 9. 62. J. Salacuse, Corporate Governance in the New Century (2004) 25 Company Lawyer 69, 75. 63. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 334. 64. Parkinson, Inclusive Company Law in The Reform of United Kingdom Company Law (2002), p.47. 65. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 334. 66. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 334. 67. T. Clarke, Accounting for Enron: shareholder value and stakeholder interests (2005) 13(5) Corporate Governance 598, 602. 68. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 335. 69. Clarke, Accounting for Enron (2005) 13(5) Corporate Governance 598, 602. 70. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 336. 71. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 336. 72. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 336. 73. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 337. 74. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 338. 75. Kiarie, At Crossroads [2006] I.C.C.L.R. 329, 337, where Kiarie uses the examples of Directive 98/59 relating to collective redundancies [1998] OJ L225/16, Directive 94/45 on the establishment of a European Works Council or a procedure in Community-scale undertakings and Community-scale groups of undertakings for the purposes of informing and consulting employees [1994] OJ L254/64 and Directive 2002/14 establishing a general framework for informing and consulting employees in the European Community [2002] OJ L80/29. 76. A. Keay, Section 172(1) of the Companies Act 2006: an interpretation and assessment (2007) 28 Company Lawyer 106, 108. 77. Draft 2002 Bill cl.2(b) of Sch.2. 78. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 352. 79. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 108. 80.

Page69

Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 352. 81. D. Arsalidou, Shareholder primacy in cl 173 of the Company Law Bill 2006 (2007) 28 Company Lawyer 67. 82. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 109. 83. Charterbridge Corp Ltd v Lloyds Bank Ltd [1970] Ch. 62 Ch D at 75, per Pennycuick J. 84. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 109. 85. S. Worthington, Reforming Directors' Duties (2001) 64(3) Mod. L.R. 439, 456. 86. See Law Society comments in Department for Trade and Industry, Company Law Reform. 2005. Cmnd.6456, p.34. 87. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 109. 88. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 109. 89. Companies Act 2006 s.178(2) allows the duties in ss.171-177 to be enforced like as other fiduciary duties owed to the company by the directors, which would include a derivative claim under s.260(3). 90. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 110. 91. L. Sealy and S. Worthington, Cases & Materials in Company Law (Oxford: Oxford University Press, 2007), p.295. 92. Keay, Section 172(1) of the Companies Act 2006 (2007) 28 Company Lawyer 106, 110. 93. Keay, Enlightened shareholder value, the reform of the duties of company directors and the corporate objective [2006] L.M.C.L.Q. 335, 357. 94. Sealy and Worthington, Cases & Materials in Company Law (2007), p.295. 95. Keay, Enlightened shareholder value [2006] L.M.C.L.Q. 335, 360. 96. Companies Act 2006 s.260(1).
2011 Sweet & Maxwell and its Contributors

Page70

Legal Journals Index

2011 Sweet & Maxwell

Journal Article - Legislative Comment

Section 172(1) of the Companies Act 2006: an interpretation and assessment.

Andrew Keay. Comp. Law. 2007, 28(4), 106-110 [Company Lawyer] Publication Date: 2007 Subject: Company law. Other related subjects: Legislation Keywords: Companies; Directors' powers and duties; Discretion; Good faith; Statutory interpretation Abstract: Traces the legislative background to the enactment of the Companies Act 2006 s.172(1), imposing a broad duty on directors to act in the best interests of the company. Analyses the language of s.172(1), noting directors' unfettered discretion, the matters to which directors are to "have regard", the duty to act in good faith, and the meaning of "the success of the company". Considers what action may be taken for a breach of s.172(1), whether shareholders would be likely to succeed in a derivative action, and argues that the provision lacks a procedure to hold directors accountable for their decision-making process. Legislation Cited: Companies Act 2006 s.172(1)

Page71

Company Lawyer
2007

Legislative Comment Section 172(1) of the Companies Act 2006: an interpretation and assessment
Andrew Keay Subject: Company law. Other related subjects: Legislation Keywords: Companies; Directors' powers and duties; Discretion; Good faith; Statutory interpretation Legislation: Companies Act 2006 s.172 (1)

*Comp. Law. 106 Introduction

At long last we have a new Companies Act on the statute books. On November 8, 2006 the royal assent was given to the Companies Act 2006 (the Act). Most of the statute is not in force as yet, with parts of it being put into force over the next year or so, with completion of this process being set at October 2008. It all began with the commissioning in March 1998 by the Department of Trade and Industry of a review that was ultimately to formulate proposals for the reform of UK company law.1 The review was to be overseen by a committee that became known as the Company Law Review Steering Group (CLRSG). The CLRSG published several substantive papers that set out its views and asked questions, thereby soliciting feedback. In July 2001 it submitted a Final Report to the Secretary of State for Trade and Industry. Subsequently, the Government drafted two White Papers that provided its response to the CLRSG's Final Report. After receiving feedback from the community the Government introduced into Parliament in November 2005 the Company Law Reform Bill 2005. The Bill was subjected to considerable debate in both Houses of Parliament and was re-branded as the Companies Bill 2006, before it finally became an Act in late 2006. The new legislation seeks to do many things, including modernising our company law, which is effectively based on 19th-century foundations. Arguably one of the most important aspects of the new statute is the codification of the duties of directors.2 The Parliament has taken this opportunity, on the recommendation of the CLRSG, to amend common law rules and equitable principles, although the codified duties will draw on common law rules and equitable principles. As part of the codification, Parliament has decided to introduce a broad duty that is to guide directors in determining what the objective of their activities should be. This latter duty is found in s.172(1), and it is obviously a pivotal part of the legislation as far as it deals with directors and their duties. Arguably, it is also of importance to thinking on wider issues in corporate governance. This article seeks to explore a number of questions that the drafting of the subsection precipitates, especially in terms of interpretation and application.

The emergence of s.172(1)

For the first time UK companies legislation provides what the objective of the directors, in conducting the affairs of the company, is to be. Hitherto, it has been left to the courts to make this determination. While the case law has generally stated that the directors are to act in the best interests of the company, it has not been unequivocal as to what is the meaning of this objective. Section 172(1) purports to do that. It provides: A director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to-(a) The likely consequences of any decision in the long term

Page72

(b) the interests of the company's employees (c) the need to foster the company's business relationships with suppliers, customers and others (d) the impact of the company's operations on the community and the environment (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly between the members of the company. Before considering the meaning and application of the provision, it is quite instructive to see how it originated and developed. In its review, the CLRSG saw the issue concerning in whose interests companies should be conducted as a central one.3 It identified two possible approaches to addressing the issue, namely either a shareholder value approach or a pluralist approach.4 The CLRSG noted that shareholder value has generally been implemented in the United Kingdom, and noted that the issue of for whose benefit a company should be managed has been widely debated. The CLRSG stated5 that the present law reflects the fact that companies are managed for the benefit of the shareholders, and it confers on the shareholders ultimate *Comp. Law. 107 control of the undertaking, such that [t]he directors are required to manage the business on their behalf .6 It went on to say that the ultimate objective of companies is to generate maximum wealth for shareholders.7 The pluralist or stakeholder approach requires, inter alia, that directors are to conduct the affairs of the company for the benefit of all stakeholders, and they should balance the interests of a multitude of stakeholders (including the shareholders) who can affect or be affected by the actions of a company. The CLRSG ended up proposing, in its Final Report, an approach which it referred to as enlightened shareholder value, and which it felt would better achieve wealth generation and competitiveness for the benefit of all. This approach is clearly based on shareholder value and involves directors having to act in the collective best interests of shareholders,8 but does not support exclusive consideration of short-term financial benefits; rather it seeks a more inclusive approach that values the building of long-term relationships.9 The concept of the enlightened shareholder value approach was adopted by the Government in its White Papers of July 2002 and March 2005, the Company Law Reform Bill 2005 and ultimately the Act. Clause 19 of a draft Bill included in a White Paper in July 200210 stated that Sch.2 to the draft Bill set out the general principles by which directors were to be bound. Paragraph 2 of the Schedule stated that A director of a company must in a given case-(a) act in the way he decides, in good faith, would be the most likely to promote the success of the company for the benefit of its members as a whole; and (b) in deciding what would be most likely to promote that success, take account in good faith of all the material factors that it is practicable in the circumstances for him to identify (emphasis added). The paragraph then went on to enumerate the material factors. In a second White Paper entitled Company Law Reform11 and published in March 2005 there were some interesting changes in how the approaches advocated in the CLRSG's Final Report and the first White Paper would be implemented. Relevantly, as far as we are concerned, the later White Paper provided, as with the earlier one, that there are two elements to be considered in the way in which directors are to run the company.12 First, they are to do that which they consider, in good faith, is most likely to promote the success of the company for the benefit of the members as a whole. Secondly, in carrying out the first element, the directors are to take into account, where relevant, and as far as is reasonably practicable, several factors (in order to reflect wider consideration of responsible business behaviour) that were listed, but not intended to be exhaustive. The factors enumerated in cl.B3 of the draft Company Law Reform Bill that was part of the

Page73

White Paper were stated to be: (a) The likely consequences of any decision in both the long and the short term (b) any need of the company-(i) to have regard to the interests of its employees (ii) to foster its business relationships with suppliers, customers and others (iii) to consider the impact of its operations on the community and the environment, and (iv) to maintain a reputation for high standards of business conduct. The directors also had to consider the need to act fairly as between members of the company who have different interests. Clause B3 indicated that the long-term performance of the company has to be considered by directors, and an array of interests of those who might be categorised loosely as stakeholders. On November 1, 2005, the Company Law Reform Bill was introduced into the House of Lords. Clause B3 in the draft Bill included with the Second White Paper had now become cl.156. Clause 156(1) and (3) stated: (1) A director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of the members as a whole. (3) In fulfilling the duty imposed by this section a director must (so far as is reasonably practicable) have regard to-(a) The likely consequences of any decision in the long term (b) the interests of the company's employees (c) the need to foster the company's business relationships with suppliers, customers and others (d) the impact of the company's operations on the community and the environment (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly between the members of the company. With a minor change in the order of the terms of the provision and the omission of the words so far as is reasonably practicable this provision effectively became s.172(1) of the Companies Act 2006.

Interpreting s.172(1) Discretion

The first thing to note about the provision is that it grants an unfettered discretion to the directors provided that they act in a way that they consider would most likely promote the success of the company for the benefit of the members. Prima facie there are no objective criteria that can be used to assess what the directors have done. Earlier, in the 2002 draft Bill, it was provided in cl.2(b) of Sch.2 that in deciding what would be most likely to promote that success [of the company], [a director must] take account in good faith of all the material factors that it is practicable in the circumstances for him to identify. Material factors were defined as: *Comp. Law. 108 (a) The likely consequences (short and long term) of the actions open to the director, so far as a person of care and skill would consider them relevant; and (b) All such factors as a person of care and skill would consider them relevant. Section 172(1), as did the relevant clause in the Company Law Reform Bill (cl.156), omitted any reference to the fact that the directors are to consider the factors that a

Page74

person of care and skill would consider relevant. Nevertheless, and somewhat surprisingly, the Guidance on Key Clauses to the Company Law Reform Bill stated that in having regard to the factors in cl.156 directors must comply with their duty to exercise reasonable care, skill and diligence.13 There is no explanation for the fact that the Government removed the words that were included in the draft Bill in the 2002 White Paper, so far as a person of care and skill would consider them relevant.

Have regard to
Directors are obliged, in the course of acting in the way that is most likely to promote the success of the company for the benefit of the members, to have regard to matters mentioned in s.172(1). But there is no explanation in the Act as to what is meant by the fact that a director is to have regard to the interests, or how directors are to consider such interests of the members in the decisions that they are making. Are directors merely to take the interests of constituencies other than those referred to in s.172(1) into account in so far as this promotes benefits to shareholders or does it enable, or even require, directors to be concerned with such interests as ends in themselves? The background to the provision, together with the way that it is drafted, suggests that the former interpretation is probably correct. It is noteworthy that s.172(1) does not, when it lists the matters to which the directors are to have regard, purport to be exhaustive. It states that the directors are to have regard to (amongst other matters) and then lists some matters. What are these other matters likely to be? It is difficult to say, for s.172(1) refers to the stakeholder interests to which reference is often made when debating the objective of companies and whose interests the directors should consider, and these are employees, suppliers, customers and the community. There is no reference to creditors, other than suppliers. This constituency might be covered by the catch-all others in s.172(1)(c), but if that is envisaged then it is perhaps strange that creditors were not expressly mentioned. It might be said that the reason that they are not mentioned is that they are protected by s.172(3), which provides that the duty imposed by s.172 is subject to any rule of law requiring directors in certain circumstances to take into account the interests of creditors. This is a clear reference to the case law that has developed over the past 20 years in the United Kingdom and elsewhere and which provides that if a company is in some form of financial difficulty the directors must consider the interests of creditors in the decisions which they make.14 Creditors might respond that this does not protect them sufficiently, but that is another issue. The fact is that it really does not matter what is a good result for any of the constituencies mentioned in the provision, after directors have had regard for these interests, for the ultimate concern of directors is that their action promotes the success of the company for the benefit of the members as a whole.

Good faith
Section 172(1) states that directors must act in the way that they consider is most likely to promote the success of the company for the benefit of members, and the consideration undertaken by the directors is to be in good faith. During the evolution of s.172(1) the issue of good faith has been integral. While the Guidance on Key Clauses published when the Company Law Reform Bill was introduced into Parliament states that in having regard to the factors enumerated directors must comply with their duty to exercise reasonable care, skill and diligence,15 it went on to say that the decision as to what will promote success [of the company], and what constitutes such success, is one for the directors' good faith judgment. This ensures that business decisions on, for example, strategy and tactics are for the directors, and not subject to decision by the courts, subject to good faith.16 The difficulty with this is that there are no definite standards against which the actions of directors can be assessed. Directors can merely say that they acted in good faith, and their position then becomes virtually unassailable. The Guidance states that it will not be sufficient to pay lip service to the factors. Yet it might well be difficult to prove that

Page75

directors have just paid lip service to the requirements in s.172. The courts have said previously, in considering claims made against directors that they acted in breach of their duty to act bona fide in the best interests of the company, that it was a problem merely having a subjective test for determining whether a director had breached the duty. As a result objective considerations were introduced by courts to supplement the subjective test. In Charterbridge Corp Ltd v Lloyds Bank Ltd,17 Pennycuick J. said that the court had to ask whether an intelligent and honest man in the position of a director of the company involved, could, in the whole of the circumstances, have reasonably believed that the transaction was for the benefit of the company.18 If that interpretation is not imported to a judicial consideration of s.172(1), there seems little to stop directors from asserting that they considered, in good faith, the interests of constituencies, but thought that what was done was appropriate. Consequently, it might be submitted that the old cases should be applied to guide the proper application of the law.19 The problem with this is that the legislation unequivocally refers only to a subjective test. Nevertheless, it is contended that given the fact that the legislation states expressly in s.170(3) and (4) that *Comp. Law. 109 [t]he general duties are based on certain common law rules and equitable principles The general duties shall be interpreted and applied in the same way as common law rules or equitable principles, and regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties. Parliament impliedly accepted, knowing the state of the common law, that the courts would introduce objective considerations into an assessment of a director's actions.

The success of the company

The first thing to note is that there is no indication in s.172(1) as to the meaning of the success of the company, an issue which attracted substantial criticism from the Law Society when it responded to the March 2005 White Paper.20 What will be the criteria used for judging whether the action of the directors led to the success of the company? It might well be argued that the directors' action does not necessarily need to lead to success in objective terms, whatever they might be, provided that the directors in good faith believed that the action which they took would be most likely to promote the success of the company. The reason is that according to the Guidance on Key Clauses in the Company Law Reform Bill,21 and as indicated previously, the decision as to what will promote success, and what constitutes such success, is one for the directors' good faith judgment. This ensures that business decisions on, for example, strategy and tactics are for the directors, and not subject to decision by the courts, subject to good faith.22 Section 172 does not require directors to give any guarantee of success and there is no reasonable care requirement contained in the section. Yet it might be contended that if directors took action which did not lead to the success of the company and the action could be regarded as lacking care and skill, the directors could be held liable for a breach of s.174, a provision which codifies the present common law duty of care and skill. This conclusion seems to accord with what was stated in the Guidance on Key Clauses to the Company Law Reform Bill. It said that directors are required to have regard to the factors that are now listed in s.172(1), and in doing so, their duty to exercise reasonable care, skill and diligence will apply.23 The test as to whether directors have met the obligation in s.172(1) is whether the directors considered in good faith that their action would be most likely to promote the success of the company for the benefit of the members as a whole. The expression members as a whole has been used on several occasions in company law and, consequently, one would assume that the judicial comments on the meaning of the expression would be pressed into service here. The courts have tended to hold that it means the present and future shareholders.24

Page76

Commencing actions for breach

If someone who is a member of one of those constituents that are referred to in s.172(1) is of the view that directors have breached the provision in that they, the directors, failed to have regard for the interests of his or her constituency, is that person able to take any legal action against the directors? The plain answer appears to be no, certainly under the Act. This has been one of the problems with s.309 of the present legislation, as acknowledged by the CLRSG in its deliberations.25 This section requires directors to consider the interests of employees in determining what is in the best interests of the company. Most, if not all, have accepted the fact that s.309 is something of a lame duck,26 and next to useless. The provision has hardly been used and there is very little case law on the section. It has been said that a right without a remedy is worthless,27 so this causes one to ask whether a breach of s.172(1) can be subject to any proceedings, and therefore whether s.172(1) has any teeth, certainly as far as nonshareholders are concerned. The only stakeholders in the company who are able to take action under the Act appear to be the shareholders. Shareholders are, under the Act, given the right to bring derivative proceedings (subject to court approval) against directors in respect of a cause of action vested in the company (s.260(1)(a) of the Act). So, if directors fail to comply with s.172(1) in some way, does that lead to a claim that is vested in the company so that the members could initiate derivative proceedings? It would appear that the answer is in the affirmative given the fact that s.l 78 provides that the consequences of breaches of ss.171-177 are the same as would apply with the corresponding common law rules or equitable principles. Under these rules and principles a right of action would redound to the company where directors breached one of their duties. Also, s.260(3) of the Act provides that a derivative claim may be brought only in respect of a cause of action arising from an actual or proposed act involving, inter alia, a breach of duty by a director of the company. Hence it would seem that a cause of action would vest in the company, within the meaning of s.260, and members would be entitled to commence derivative proceedings. This is confirmed by s.178(2) when it states that, duties in those sections [171-177] are, accordingly, enforceable in the same way as any other fiduciary duty owed to a company by its directors. Therefore, if directors breach s.172(1), the members could seek to take action on the part of the company. One could envisage them doing so if the directors either fail to act so as to promote the success of the company for the benefit of the members or fail to have regard for the need to act fairly as between members (s.172(1)(f)), but this is not so likely to occur, if at all, in circumstances where the directors fail to have regard for the other interests adumbrated in s.172(1), especially when one takes into account the fact that there is likely to be a cost element in any derivative claim. There are only a few situations where one could envisage an *Comp. Law. 110 action being brought by a member other than in the cases mentioned above. First, where a member invested in the company for the long haul, and he or she feels that the action of the directors does not have regard for the long term. The member might feel that the directors are overly myopic and that could well mean that the member will receive less in the long run. Secondly, a member is also an employee of the company and is concerned that the directors did not have regard to the interests of the employees. Thirdly, a member is concerned that the directors have not had regard for the need to promote business relationships with suppliers, customers or others and it is likely to damage the company in the future. Fourthly, there are members of the company living in the community in which the company operates, and they believe that the community will be adversely affected by the actions of the directors, and that will, as a consequence, affect the lives of those members. An example might be where a company which operates several factories decides to close one that is in the community where a member resides or has other business interests. Fifthly, a member has concerns wider than his or her own interests and feels obliged to take proceedings because of a heightened sense of community interest, and he or she believes that directors failed to consider community interests in the decisions which they have made.

Page77

The upshot is that except where one has a member with a social conscience, the only likely derivative proceedings are those brought by members whose self-interest in another capacity will be affected deleteriously in some way. Even if derivative proceedings are commenced, directors might well argue that they did have regard for all of the matters mentioned in s.172(1)(a)-(f) and simply believed that what they did promoted the success of the company for the benefit of the members. If so, as indicated earlier, it might well be difficult for a member to challenge such an assertion successfully, and to establish that the directors did not have regard for the relevant matters. Of course, the company might end up in administration or liquidation, and the administrator or liquidator will be able to take action against the directors for a breach of s.172(1), but it is likely at this stage (and it might depend on the period of time between the controversial decision of the directors and the entry into administration or liquidation) to be difficult to establish that the directors should not have done what they did. First,28 any administrator or liquidator would have to impugn successfully any claim on the part of the directors that they had acted in good faith in a way that was most likely to promote the success of the company for the benefit of members. Secondly, the courts have made it plain that they will not use hindsight in making their decision when assessing the actions of directors,29 and it might be argued, certainly when one studies the cases involving claims of wrongful trading under s.214 of the Insolvency Act 1986, that courts have tended to place a benevolent interpretation on what directors have done, and they have not found them liable save where they have acted in a completely irresponsible manner.30 Perhaps the only possible action available to those who make up the constituencies covered in s.172(1) might be to seek injunctive relief, in an attempt to prevent directors from doing something where the directors have failed to have regard to the matters set out in the subsection. It is questionable whether a court would accede to the application of a non-member, and even if they did, the courts would have to consider evidence in order to make a decision as to whether directors did intend to act appropriately and this would be far from easy at an interlocutory stage. It is more likely that non-member stakeholders will have to rely on rights that are provided for outside of company law, and certainly this is where the CLRSG thought that stakeholders' safeguards lay.31 For instance, creditors are protected if directors engage in wrongful trading, in breach of s.214 of the Insolvency Act. But, as the author has argued elsewhere,32 these give partial and imperfect cover to stakeholders and only allow for some sort of remedy or relief ex post, while protection ex ante is often needed in order for it to be truly effective.

Conclusion
Section 172(1) is an interesting innovation in that it provides, for the first time, a legislative mandate as to for whose interests directors are to act in their management of the affairs of companies. How the provision is applied might well depend on a number of factors. Perhaps the main point to note is that there does not seem to be any framework in place to ensure that directors are held accountable for their decision-making process. As it is there are likely to be few occasions, if any, where a director is going to have to justify what he or she did. Of course, very often, and especially with what might be regarded as the daily affairs of the company, those constituencies who are mentioned in s.172(1) will not know what the directors have done, and when they do, it will too late to do anything that is effective. Members might be able to institute derivative proceedings against directors where there is thought to be a breach of s.172(1), but save where directors have failed to benefit the members from the action that they have taken, such proceedings are likely to be few and far between. Those who are numbered among other constituencies in the provision will not be entitled to initiate any legal proceedings against directors, so where directors fail to have regard for the interests set out in the subsection, it is unlikely that they will called to book. As a consequence it is questionable whether the hope of the CLRSG that the law will achieve wealth generation and

Page78

competitiveness for the benefit of all will come to fruition. Andrew KeayProfessor of Corporate and Commercial Law, Centre for Business Law and Practice, School of Law, University of Leeds Comp. Law. 2007, 28(4), 106-110 1. Company Law Review, Modern Company Law for a Competitive Economy (DTI, 1998), p.1. 2. See ss.171-177 of the Act. 3. See Company Law Review, Modern Company Law for a Competitive Economy: The Strategic Framework (DTI, London, 1999), para.5.1.1. 4. These are explained in A. Keay, Enlightened shareholder value, the reform of the duties of company directors and the corporate objective [2006] L.M.C.L.Q. 335. 5. Above fn.3, para.5.1.4. 6. ibid. , para.5.1.5. 7. ibid. , para.5.1.12. For a consideration of this concept, see, for example, S. Bainbridge, In Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor Green (1993) 50 Washington and Lee Law Review 1423; D Gordon Smith, The Shareholder Primacy Norm (1998) 23 Journal of Corporate Law 277; M. Roe, The Shareholder Wealth Maximization Norm and Industrial Organization (2001) U. Pa. L.Rev. 2063; S. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance (2003) 97 Northwestern University Law Review 547; Keay, above fn.4. 8. Company Law Review, Modern Company Law for a Competitive Economy: Developing the Framework (DTI, London, 2000), para.2.22. 9. ibid. 10. Modernising Company Law , Cm 5553, DTI. 11. Company Law Reform , Cm 6456, DTI, 2005. 12. ibid., Explanatory notes at para.B17. 13. Guidance on Key Clauses to the Company Law Reform Bill (DTI, 2005), para.63. The Guidance can be found at www.dti.gov.uk. 14. See A. Keay, Company Directors' Responsibilities to Creditors (Routledge-Cavendish, London, 2007), pp.151 et seq. 15. Above fn.13. 16.

Page79

ibid. , para.64. 17. [1970] Ch.62; [1969] 3 All E.R. 1185. 18. ibid. , 75; 1194. Also, see Shuttleworth v Cox Bros (Maidenhead) Ltd [1927] 2 K.B. 9 at 23. 19. See S. Worthington, Reforming Directors' Duties (2001) 64 M.L.R. 439 at p.456. 20. Above fn.11. The Law Society response was published in June 2005. The criticism was set out on p.34 of the Response. 21. Above fn.13, para.64. 22. Above fn.13. 23. ibid. , para.63. 24. For instance, Gainman v National Association for Mental Health [1971] Ch. 317 at 330; Brady v Brady (1987) 3 B.C.C. 535 at 552, CA. 25. Above fn.3, para.5.1.21. 26. For example, see L. S. Sealy, Director's Wider Responsibilities--Problems Conceptual Practical and Procedural (1987) 13 Monash University Law Review 164 at p.177. 27. M. McDaniel, Bondholders and Stockholders (1988) 13 Journal of Corporation Law 205 at p.309. 28. The author first made these points in the article mentioned above fn.4. 29. For instance, see Re Welfab Engineers Ltd [1990] B.C.C. 600; Re Sherborne Associates Ltd [1995] B.C.C. 40. 30. For example, see Re Continental Assurance Co Ltd [2001] B.P.I.R. 733; The Liquidator of Marini Ltd v Dickensen [2003] EWHC 334 (Ch.); [2004] B.C.C. 172. 31. Company Law Review, Modern Company Law for a Competitive Economy: Developing the Framework (DTI, London, 2000), para.2.12. 32. Above fn.4.
2011 Sweet & Maxwell and its Contributors

Page80

Legal Journals Index

2011 Sweet & Maxwell

Journal Article

Sustainability, the environment and the role of UK corporations.

Mark Stallworthy. I.C.C.L.R. 2006, 17(6), 155-165 [International Company and Commercial Law Review] Publication Date: 2006 Subject: Company law. Other related subjects: Environment Keywords: Climate change; Company law; Corporate governance; Directors powers and duties; Environmental policy; Operating and financial review; Sustainable development Abstract: Discusses potential reforms to the UK company law regime which may increase corporate responsibility for environmental issues and sustainability. Reviews the threats posed by climate change, the challenges of promoting adjustments in macro economic behaviour and the extent to which the concept of enlightened shareholder value in the Company Law Reform Bill 2005 may contribute to broadening directors' environmental duties. Examines the scope for modifying the corporate reporting mechanism to make environmental issues part of a company's core business under its operating and financial review (OFR) and anticipates possible future developments. Legislation Cited: Company Law Reform Bill 2005

Page81

International Company and Commercial Law Review

2006

Sustainability, the environment and the role of UK corporations

Mark Stallworthy Subject: Company law. Other related subjects: Environment Keywords: Climate change; Company law; Corporate governance; Directors powers and duties; Environmental policy; Operating and financial review; Sustainable development Legislation: Company Law Reform Bill 2005

*I.C.C.L.R. 155 Introduction

Commercial activities have in recent decades increasingly been made subject to state environmental regulation. Debates meanwhile continue about the value of command and control legal mechanisms and the potential utility of measures (such as green taxes and subsidies) with greater emphasis on market-based incentives.1 The premise underlying this article, however, is that current environmental challenges, and in particular the accelerating pace of climate change, dwarf traditional arguments as to conflicting goods and bads. The very foundations of ourmacro-economy and the societies that it serves face a severe challenge, and commitments to a sustainable future demand major adjustments in patterns of investment, production and consumption. It is argued that whereas commercial sectors are to a large degree capable of accommodating necessary change this cannot be achieved without a co-ordinated and coherent exercise of political will. From a UK perspective, political progress thus far has been ambivalent and continues to frustrate those reflective environmentalists and business leaders alike who believe that effective responses are now urgent. This article concentrates on current debates over two key adjustments to the English company law regime that it is argued could make a considerable contribution towards achieving more sustainable solutions.

Environmental degradation and meeting human needs

Just as sustainability has become a key part of political discourse over the past decade a growing awareness of the threats posed by climate change is shifting the focus of debate. The most recent G8 political summit achieved an acknowledgement of the warnings of a preponderance of scientific opinion concerning causes and potential threats of climate change.2 There is now a common, informed belief that the world faces severe consequences from global warming, estimated in a major United Nations scientific report in 2001 at between 1.5 and 4.5C during this century.3 Indeed many scientists involved in the preparation of a follow-up report to be produced during 2006 now believe that that upper figure is likely to prove a significant underestimation.4 While there is debate as to what political priorities should be,5 it seems that no serious science is today being produced as to suggest that even current rates of emissions (and resource depletion) can safely be maintained.6 Pressing concerns include continuing impacts of increased carbon emissions, exacerbated by such factors as melting ice sheets and permafrost (as in Siberia and Alaska), with glacial retreat (Greenland, the Antarctic), ocean acidification and rising sea levels. Taking just sea level rise, problems must be seen in light of the proximity to the coast of a high proportion of the world's major conurbations.Moreover, within the Western world recent decades have seen greatly intensified development in vulnerable locations.7 The plight of New Orleans in the wake of Hurricane Katrina *I.C.C.L.R. 156 in August 2005 offers a stark illustration of the consequences of breached armoured defences. Meanwhile, in the developing world, vulnerable communities are severely threatened: for instance, along coastlines on the Indian subcontinent and islands in the Indian and Pacific Oceans.8 Meaningful international risk-sharing and delivery on differentiated responsibility,

Page82

initiated under the UN's Environment and Development sustainability agenda at the Rio summit in 1992 and its follow-up at Johannesburg in 2002, is in this respect barely advanced.9 Particularly in the United States, the response has been a perplexing state of denial on the part of the Bush administration, marginally tempered by reference in the February 2006 State of the Union address to a national oil addiction (firmly linked to faith in greater efforts to secure technological solutions). Though this may hearten some concerned atwhere US geopolitical solutions have led thus far, much more is required in order to undo the damage done by US rejection of even the limited aspirations of the Kyoto Protocol towards securing carbon emission reductions by developed economies.

The task of securing macro-economic adjustments

The climate change debate is meanwhile shaping to be a damascene moment for the ordering of the global economy: the consequence of longstanding environmental profligacy by the developed world, and the accretions in carbon emissions to come as fast-developing economies themselves industrialise at a high pace. What is environmentally at stake need not be recited at length here, but the economic and social implications in the wake of accelerating climate change will be obvious. In the light of the prevailing political torpor as to the big strategic questions, some environmentalists are pressing arguments to the effect that the economic system has failed.10 Others, however, such as Jonathon Porritt, the chairman of the United Kingdom's independent Sustainable Development Commission, insist that it is only by harnessing the reciprocal capacities of both democratic values and the markets that we can emerge from this high-risk period with human societies in good order.11 This latter perspective will be explored as this article seeks to address from the perspective of English law the kinds of corporate transformations that might stimulate change, assuming that politicians are able to refocus the democratic will in favour of more sustainable solutions. The commercial world is showing increased willingness to read warning signs; and many of the larger quoted companies in the United Kingdom are now working in co-operation with realists in the environmental movement to press for appropriate regulatory responses.12 Assuming, however, that such problems are surmountable, environmental protection measures can often conflict with other important priorities. Unsurprisingly, problems are encountered when we seek to value the costs of environmental harm as against other economic and social interests. Risk assessment is inevitably a contested area from which subjective influences and pressures, even affecting technical experts, are hard to exclude.13 That there are political dimensions to public risk can be illustrated by straightforward reference to existing burdens of proof, which in circumstances of nonreciprocal impacts (often attended by high levels of scientific uncertainty) tend to favour risk creators.14 In applying cost-benefit evaluations the ascription of value to environmental resources and environmental degradation is notoriously resistant to standard economic conceptions.15 Some environmental commentators would dismiss cost-benefit approaches out of hand: as for example a form of shadow-pricing forcing environmental values into inappropriate market calculations.16 Yet such scepticism does not resolve problems in justifying environmental protection when economics points in the other direction.17 A commitment to sustainability suggests that the answer should lie in fuller cost internalisation, with allocations of true cost brought into line with growing awareness of external subsidies inherent in non-renewable resource depletion and harmful *I.C.C.L.R. 157 levels of environmental degradation. Problems in securing fuller internalisation are pursued further below. Lawyers in these circumstances are faced with a challenge in achieving their own environmental transformations. Foremost perhaps is that common law instincts alone are seldom on all fours with coherent responses to environmental harm.18 The hardest aspects to address are those of cause, scale, irreversibility, or uncertainty that commonly affect environmental harms. Impacts may be spatially or temporally remote, and may arise from diffuse or multiple sources. The effectiveness of legal responses is restricted in another respect, relating to important functional aspects of the law's role in

Page83

relation to property, contract and priorities for commercial certainty. In the end, though incremental adjustments are possible, we look to regulation for real shifts in direction. Sustainability objectives therefore, just as in other areas of economic activity (such as the law of competition), rely on effective regulatory responses. Furthermore, a main justification for any commercial regulation is to redress cost externalisations that would otherwise lie beyond legal control. Maximal energy and resource use and continuing expansion are the logic of unchecked markets.19 Sustainability objectives by contrast seek to confront dilemmas associated with the externalities of environmental harm. This is not solely a supply-side problem. O'Riordan for instance has suggested that the pursuit of sustainability requires millions of people to undertake hundreds of consumer and leisure choices differently, without necessarily any price signals to guide them, and with no guarantee that their own contribution will be matched by others. It takes dedication of a high order, or a coalescence of regulatory and economic institutions, to overcome this paradox of converting micro-behaviour to macro-sustainability.20 At many points on the production and consumption chain, therefore, there is a need to review mechanisms for determining values that are not solely dictated by the market. At the heart of this task lie problems in finding a common denominator to enable the comparison of costs and benefits of environmental measures.21 In a world of genuine socio-economic aspirations, sustainability regulation needs to nudge prices in the direction of true costs in maximising the efficient use of scarce resources. With a view to securing fuller levels of cost internalisation, successful engagement in the debate about values has another, fortuitous consequence. Policy-makers should benefit from securing a rational, transparent basis on which to pursue change. Unfortunately, thus far, governmental interests have typically proved resistant to more thorough-going change. As Rose has put it, political leaders need to provide some education of our preferences in matters relating to public affairs; after all, they are in office, and are supposed to have the time to think about these things and explain them to the rest of us.22 For their part, political decision-makers in the United Kingdom appear to find key problems of short-termism intractable, the effect magnified by deregulatory postures, of the kind discussed below, in deference to electoral cycles and the agendas of those who dominate much of the mass media. This has an unfortunate feedback loop in that those businesses wishing to lead the way in investment in green solutions (where baseline costs might rise if the shorter term) can face potential disincentives of competitive disadvantage. According to Caroline Lucas MEP, referring to measures to address climate change, government seeks to answer the wrong question: How do we tackle climate change without affecting the economy? The irony is that the measures we really need would provide so many economic and social benefits--more employment opportunities, stronger communities--as they brought down emissions. The question the government should be asking is: How do we create new economic and social opportunities as we tackle climate change? .23 Here the primary task is therefore to address the externality quandary and its essential short-termism. Although sustainability objectives demand commitment to addressing long-term value and implications for everyone, including those that generate wealth, the financial markets on which key enterprise sectors depend have traditionally been heavily influenced by the short term. And yet by contrast commentators increasingly point to the growth of environmental concern among responsible businesses.24 As for company law, corporate duty structures--still largely the domain *I.C.C.L.R. 158 of the common law in England--are ambivalent as to the accommodation of longer-term perspectives. Two potentially significant corporate law responses to the challenge of adopting more sustainable approaches are considered in the following sections. These respectively concern structural reforms affecting key corporate objectives and duties, and

Page84

mindset changes affecting company reporting and related transparency measures.

Structural company law reform: reconsidering the corporate interest

The greater challenge concerns structures: in particular, whether, to achieve sustainability objectives, a reform (or at least a re-interpretation) of those obligations recognised as owed by those responsible for running corporations is a feasible aim. Any proposal faces numerous conceptual and practical obstacles. A fundamental common law assumption has traditionally been that company directors are obliged to act bona fide in the interests of the company. There has been wide agreement that corporate interest is translatable into the interests of the body of shareholders as a whole.25 This approach however has its challengers, emphasising for instance that there is no explicit legal requirement to maximise shareholder value and that the most that members can expect is that the company will be operated in accordance with stated objectives.26 Thus Worthington suggests that where a company is a going concern, directors are subject to restraint from acting for improper purposes, but otherwise have almost unconstrained discretion to deliver additional, non-contractual or non-compulsory benefits to any stakeholder.27 This argument reflects early radical trust-based approaches by US jurists, during a time of widespread concerns at deficiencies in the financial markets.28 By comparison perhaps, the modern focus on ideas of corporate governance can be seen as a response today to concerns at failures in the markets to control abuses (particularly in the United States) that have arisen in our own time. Nevertheless the central premise underlying our understanding of the limits placed on directors persists: by reference to shareholder entitlements. True, other interests have some recognition in company legislation, though either in very much diluted form (as in the case of employee interests) or applied in limited circumstances. In this latter respect, in the event of threatened corporate insolvency, directors must have regard to the interests of creditors.29 This amounts to an acceptance that at that stage in a corporate lifecycle realistically it is creditors rather than shareholders that are interested in any corporate assets.30 Modern insolvency legislation unlocks opportunities to challenge director performance through the vesting of powers in the liquidator to issue proceedings in circumstances of misfeasance or wrongful trading.31 Any review of the standard duty-beneficiary nexus would accordingly be problematic, and would require a thorough overhaul of the accepted incidents of incorporation in English company law. Similarly, just as a company's identity is separate from those who own and manage it, so the idea of owner-investor limited liability has come to manifest an essential bargain that underlies incorporation. Even so, especially in the context of corporate groups the effect of the corporate veil can create difficult issues of accountability.32 A further illustration is the case of corporate crime, where the more complex a corporate structure the greater the likelihood of a shield against liability.33 It can be argued that the criminal law should restrict itself to sanctioning individuals, on the basis that its controls inhibit natural persons as moral agents, and should not extend to corporate processes.34 Nevertheless, with the corporation the vehicle of choice for organising our economic activities, in so far as the criminal law is in turn a key enforcement mechanism of choice, then any exclusion from liability would create an important gap. Liability after all is not necessarily limited to ideas of moral agency but can also be a response to processes and their potential for unacceptable harm.35 English law appears in principle to have no qualms about extending criminal accountability to corporations, *I.C.C.L.R. 159 although a substantial doctrinal obstacle persists towards ascribing a blameworthy state of mind to an artificial person whose every action (and inaction) must be mediated through human agency. Unlike elsewhere in the common law world, the English law approach remains mired in an identification doctrine whereby criminal liability may only follow where a defaulting individual can be described as the company's directing mind and will.36 This limits potential liability, given that such an agent must have full discretion to act independently of instructions from the board.37 Yet in English company law, no officers and employees and arguably few directors have such authority, unless attribution under a statute-based exception is recognised.38 This somewhat unrealistic

Page85

approach ensures that in circumstances especially of managerial neglect corporate criminal liability can seldom attach, save in the case of absolute or strict liability. And yet the English judiciary has insisted on maintaining this general approach, the Court of Appeal rejecting the cogent argument that a test based on a finding of gross negligence could be established without the need to inquire into the corporate mind at all.39 That criminal liability remains the governing enforcement regime under English law in the case of commercial regulatory breach has been achieved by a pragmatic sleight of hand: through the application of strict liability, thereby obviating questions of attribution of blameworthy states of mind to corporations.40 The approach raises questions of justice, alongside concerns as to efficiency, effectiveness, and (in often highly technical fields) judicial expertise.41 However, more importantly for present purposes, it can be seen that questions of personality--or, today, citizenship--are difficult to resolve in the corporate context. The extreme conclusion arrived at by Bakan is that corporations are psychopathic, as being characteristically resistant to the kind of self-imposed restraints that deter natural persons from extreme anti-social acts.42 Likewise, viewing corporations in the environmental context, the duty-emphasis on shareholder interests (especially if viewed in terms of bottom-line profitability) suggests an institutional reluctance to accommodate other values. The economic underpinnings of traditional legal approaches acknowledge scarcity in individualistic terms rather than by reference to natural capital and related environmental valuations. Such a mismatch is not confined to company law, for key private law principles were seldom conceived with a view to securing environmental protection.43 This can be seen in settled liberal approaches to individual interests, as in property law and contract, and also through equitable fiduciary and other doctrines. Yet when viewed in such a broader framework arguably the idea of there being a duty on management to act in the interests of the shareholders does not require radical revision. Ironically, just as judicial control over corporate activities in the form of ultra vires was long ago curtailed by approval of the manipulation of objects clauses,44 there has been no useful judicial elaboration of the principles at issue here. A common argument for the assumed focus on maximising shareholder wealth is that this acts as a simple constraint on directors from running amok given their control over most aspects of asset deployment. And yet a reappraisal of the notion of improper purposes could justifiably lend emphasis to the arguably more central concern of corporate benefit. Here it is possible to accommodate a broader range of interests within the purview of board decision-making, without deviating from the realities of market pressures.45 At the same time it is increasingly misplaced to overplay shareholder-stakeholder conflict. In particular, from the perspective of a sustainable business, consideration of shareholder interests can justifiably take account of members both present and future. In this way directors' duties may justifiably be described as to maximise the company's value on a sustainable basis.46 It is *I.C.C.L.R. 160 not a large step to suggest that there might be a derivative shareholder's right (and perhaps at some stage extending to other stakeholders) to require the board to protect the ongoing health of the corporation as a viable concern.47

Proposed company law reforms

The Company Reform Bill currently progressing through the Westminster Parliament appears to recognise a similarly broader notion of what is in the corporate (and investment) interest. The Government's stated aim is to reflect business needs today while introducing wider expectations of corporate behaviour. The Bill is the fruit of a fundamental review of company law initiated by the Government in 1998.48 One of its objectives was to strike a proper balance between the interests of various groups concerned with corporate activities. As will be seen below a significant consequence of the review has been the proposal that wider recognition of the impacts of business on the community and the environment be accommodated within extended disclosure and reporting requirements. However, for present purposes another substantive result is a

Page86

proposal for a statutory statement of directors' duties. This is to be supplemented by a degree of formal emphasis on long-term consequences. More specifically, common law (and equitable) principles concerning directors' duties would be largely codified under the terms of the Bill.49 At the same time, greater clarity concerning what is required would be provided, in particular as to the interests in which companies should be run. Under the proposal directors would continue to owe their duties to the company,50 to include the promotion of corporate success.51 In order to enhance shareholder participation within the company--and, crucially, with a view to a longer-term perspective--the reform seeks to embed within the Companies Act the idea of enlightened shareholder value (a term embraced under the independent review). Thus as a matter of good faith directors must act in such ways as they consider promote the company's success for the benefit of members as a whole. This would apply so far as reasonably practicable having regard to a non-exhaustive list of factors of particular importance, including the environment, and so reflecting the broader expectations referred to above. Subject to the limit of practicability, and a partly subjective formulation, therefore, the long-term consequences of decisions must be addressed. Thus the idea of enlightened shareholder value appears in the expectation that the interests of shareholders can only be furthered through taking account of interests beyond the short term. Accordingly, one of the key stated objectives for the proposal has been the enhancement of shareholder engagement alongside a long-term investment culture.52 Much is expected of this somewhat subtle shift in direction for the purposes of interpretation of duties to act in the corporate interest. In so far as the law has declaratory potential then the consequences may in time prove to be far-reaching. While the reform scheme may be over-tentative on the question of shareholder value, it can readily be seen that the way forward is linked fundamentally with the need for realistic assessment of the broader consequences of corporate decision-making, including as to future prospects. From an environmental perspective this has obvious attractions, as more wide-ranging ideas of profitability will increasingly need to be tackled within company processes. It would also be a mistake to interpret this reform in a vacuum, for a supplementary factor that will also impact upon shifting perspectives is an additional proposal for fuller, and forward-looking reporting mechanisms, to which the argument now turns.

Reform of reporting mechanisms: performance and prospects

In light of the cautious approach to broadening the idea of the corporate interest, proponents of reform have focused in particular on an area that has attractive benefits across a range of regulatory activities: transparency requirements. This is staple fare in the law of environmental regulation. For instance process, rather than substantive constraint, is the underlying premise of environmental impact assessment (of development projects and policies) with the aim that decisions will at least be thought through and subject to public input.53 There has in recent years been gradual progress in regard to voluntary forms of corporate environmental reporting.54 Thus a detailed study *I.C.C.L.R. 161 produced for the Environment Agency noted that 89 per cent of FTSE all-share companies discussed environmental policy in their annual reports. Against this, the overall conclusionswere, if not of lip service then of a lack of rigour: with only 17 per cent referring to climate risks, reducing to 11 per cent reporting on actual performance, and just 5 per cent on the relevance of environmental performance to shareholder value.55 This may be indicative of the weakness inherent in corporate social responsibility more generally, which has been described as a mere band-aid which will soon be seen as the palest imitation of genuinely sustainable behaviour.56 That said, Porritt does point to good practice in the United Kingdom, especially those ventures, alongside supporting commercial organisations, instigated by Forum for the Future, such as the Five Capitals Framework and the Sustainability Integrated Guidelines for Management Project.57 A fresh, and potentially significant, response in the United Kingdom has been the development of the idea of the Operating and Financial Review (OFR). The aim is to

Page87

create a broader, more flexible, report mechanism, within a mandatory framework, whereby those responsible for corporate management must report publicly on issues that they consider important to the continuing health of their companies. This for the private sector echoes standard environmental assessment processes at work in environmental assessment, referred to previously. The idea underlying OFRs is to impose a formal requirement to explain to the outside world clearly and concisely just how the directors were running the business, and to provide an understanding of its operating environment, particularly the opportunities and threats it faces.58 The objectives therefore are to improve levels of information to the benefit of both shareholders and others, while enabling management to engage in a reflective view of business conditions and prospects. Following a lengthy gestation period,59 regulations were produced in March 2005, to amend Pt 7 of the Companies Act (concerning matters to be dealt with in directors' reports).60 These both comply with and in key respects extend beyond requirements under a 2003 EC Accounting Directive.61 The effect was to place obligations on directors of (around 1,300) quoted companies to prepare OFRs from the 2005-06 financial year and, thereafter, to be regulated from 2007 by the Financial Reporting Review Panel. Auditors would be required to check for the consistency of OFRs with the remainder of the report and accounts, and the regulator could seek criminal enforcement in the event of non-production of OFRs or reckless content. In pursuit of the objective of securing a balanced and comprehensive analysis, consistent with the size and complexity of each business, there would be a number of requisite themes. These would include: performance through the financial year, with main applicable trends and factors; year end position, and main future trends and factors likely to impact on development, performance and position.62 More specifically, the OFR must include information about corporate policies to include the extent of successful implementation in respect of environmental matters (including the impact of business of the company on the environment).63 Likewise, the OFR must contain to the extent necessary analysis using financial and other appropriate performance indicators, once again including as to environmental matters. Such indicators consist of recognised factors by which development, performance and position can be measured effectively.64 Thus OFRs should shift reporting towards a forward-looking orientation, identifying those trends and factors relevant to the members' assessment of the current and future performance of the business and the progress towards the achievement of long-term business objectives.65 *I.C.C.L.R. 162 The determination of appropriate forward perspectives must depend on the nature of the industry, and where a project is likely to have a long-term environmental impact it should be recognised that this is likely to affect long-term value and therefore determine the time perspective for reporting in the OFR.66 Clearly risks and uncertainties are inherent in environmental considerations, and to a degree will potentially impact upon all commercial activities. Separate, illustrative Implementation Guidance indicated ways in which environmental information might be germane: as in connection with regulatory compliance, themanagement of energy, natural resources (such as water), waste, emissions, supply chains and products, as well as the impacts of climate change.67 Related issues of directors' exposure to liability have been contentious, with concerns expressed at the lack of a safe harbour protecting directors against liability for forward-looking statements. Yet given not only the fairly limited circumstances in which any liability to outsiders for alleged negligent misstatement is likely to be established but also the nature of the OFR, the risks can arguably be overestimated. Directors in such circumstances would recognise advice to the effect that content should be provided in good faith and in line with normal diligence requirements (compliant with duties to exercise due care and attention). Directors should be used to exercise of due care in putting appropriate procedures in place alongside appropriate sourcing of data. In

Page88

addition, recourse to appropriate qualifications would surely be justified in respect of predictive statements in OFRs. The furthest that the Accounting Standards Board has been willing to go in recognising any potential risk where information, while given in good faith, cannot be objectively verified is to suggest cautionary statements explaining the uncertainties underpinning such information.68 After all, it seems reasonable for members to expect to receive focused and relevant information and not to be misled as a result of the omission of any information on unfavourable aspects.69 A degree of protection would appear to apply in any event in so far as compliance with (what were intended to be statutory) reporting standards would lead to a presumption of compliance with the legal requirements contained in the Regulations.70 Moreover the attention now paid by insurers not only to traditional environmental problems (such as contaminated sites) but also now to potential carbon emission litigation, suggests that OFRs' reflective focus might prove more to be welcomed than dreaded by those concerned to avoid liability.71 An apparently less radical aspect of a statutory OFR requirement is that it would reflect the ruling company law focus on the role and rights of shareholders. Accordingly the purpose of preparing OFRs has been stated to be to assist members to assess the strategies adopted by the company and the potential for those strategies to succeed.72 According to the Reporting Standard, the OFR focus must be on matters that are relevant to the interests of members Members' needs are paramount when directors consider what information shall be contained in the OFR.73 And yet there is an important limited shift toward a broader recognition of interests. Information, according to the Accounting Standards Board, will also be of interest to users other than members, for example other investors, potential investors, creditors, customers, suppliers, employees and society more widely. The directors will need to consider the extent to which they shall report on issues relevant to those other users where, because of those issues' influence on the performance of the business and its value, they are also of significance to members. The OFR should not, however, be seen as a replacement for other forms of reporting addressed to a wider stakeholding group.74 Despite what appears to be a carefully calibrated reform to reporting on the part of major corporations, politicians retain their capacity to surprise. Indeed, with little forewarning, in late 2005 the Chancellor of the Exchequer announced to a Confederation of British Industry conference that the Regulations would be withdrawn.75 They would be replaced by a more limited measure going no further than a close transposition of the 2003 Directive. This would apply to 6,000 large and medium UK companies, although the enhanced reporting, to include information to the extent necessary for any understanding of the development, performance or position of the business of the company, is not subject to a requirement to address future prospects. It is hard to see what had changed so suddenly after a lengthy period of the Government extolling the virtues of OFRs, *I.C.C.L.R. 163 as reflected in the enabling Bill (with Regulations already in place) that was already in the course of being piloted through the House of Lords. The best that can be said is that it was a response to accusations of overregulation, before an audience that would likely be sympathetic to such an initiative. This led to widespread criticism, from bodies such as the Association of British Insurers, the UK Society of Investment Professionals, the Association of Corporate Treasurers and the Corporate Responsibility Coalition. The Chief Executive of the Environment Agency trenchantly observed that should the largest UK companies not be capable of identifying their environmental risks and reporting something simple on them then they aren't going to hack it in the global marketplace.76 OFRs were arguably a logical consequence of progress thus far and the need for broader coverage, by producing coherence as well as transparency within a field where many large companies already buy into a variety of initiatives and approaches. Alongside the management process schemes referred to above, for instance, the Institute for Social and Ethical Accountability has produced a scheme that extends further, to focus on

Page89

outputs, and already adopted by numerous big UK businesses, including in the environmental field BP and numerous water companies.77 As seen above, in recent financial years a clear majority of the top 250 UK companies have been reporting on environmental performance. The value added through the formal arrangements of OFR is that reporting standards are enhanced (especially for free riders) and the process offers a structured means to consider ongoing threats and opportunities. At present therefore the reform is on hold, although with the Bill still progressing through Parliament the hiatus is likely to be speedily resolved. The Government's peremptory withdrawal of OFRs has necessitated a lightning-quick revocation of the March 2005 Regulations that were already law.78 Instead, so-called Business Reviews (in accordance with the 2003 Directive) would be required also of quoted companies.79 A simpler, fairer review of the business, alongside a statement as to principal risks and uncertainties, would replace the requirement for a statement of objectives, strategies and available resources. Information concerning stated areas, including the environment, would no longer be required to be linked to corporate policies including as to how far the same were being successfully implemented. The foremost aspect of the departure from OFRs appears to be that there would be no requirement for members to receive information with a view so as to assess strategies adopted by the company and the potential of those strategies to succeed in the future. It is significant therefore that just as business reviews do not mandate formal review of main trends and factors underlying corporate performance over the year, they will not extend to those likely to impact in the future. Other players are, however, marking time, in view of the ongoing legislative process and the somewhat arbitrary way in which the change of course was signalled. OFRs had after all emerged from a gradual, six-year long process of consultation. In consequence of the current state of the proposal, OFRs are no longer to be statutory,80 and the Accounting Standards Board Reporting Standard itself ceases (for now) to be statutory and has been (again speedily) transformed into a best practice statement.81 Following an application for judicial review of the Government's change of policy, settlement of proceedings was reached and a new consultation process was instigated.82 The Standards Board, in withdrawing the Reporting Standard and introducing the Best Practice Statement, pointedly observed that no consultation on its part was required as this process had already been accomplished.83 It is at the time ofwriting too early to tell whether the Government will seek to push through the earlier amendments or reinstitute the proposal for OFRs that has been argued here to be such a central component of attempts to put our economic activities on to more sustainable pathways.

Sustainable notions of the corporate interest

While the shift that has occurred in relation to the duties of those responsible for corporate management, discussed above, has perhaps been a subtle one, the new reporting reforms could amount to a significant repositioning. Unusually, in light of profligate use elsewhere in government circles, there is no specific reference to sustainable *I.C.C.L.R. 164 development or sustainability. Yet should OFRs emerge unscathed from the political process, an important benchmark will exist, whereby attention must be given to the need publicly to consider prospects for the future. It would become fundamental that members would be entitled to expect reporting with forward-looking perspectives and offering long-term objectives for the business. This adjustment in reporting focus can also be seen as partially addressing the practice of trading ahead of book values, and goes beyond the limitations of historic cost accounting.84 This would be consistent with a broaderwillingness in the accountancy profession to consider radical ways of addressing cost externalities and implications for natural capital.85 Surely the most significant return from the idea of prospective reporting is that--even without a potentially contentious review of the primacy of the objective of enhancing shareholder value-- questions of sustainability are confronted directly and in a formal way. In essence such an approach identifies objectives for increasing investment value

Page90

with consideration of the sustainable basis of the enterprise. It is essential to engage members in this process. A similar benefit was identified in the 2004 Environment Agency report referred to above. Thus unless shareholders are made aware of why a good environmental policy and management structure is good or, in some cases, imperative for the business, there is no reason for them to support it unless the link is made, it is all too easy for shareholders to see environmental management as a non-core business issue rather than being an integral part of a company's operations, risk management and profitability.86 Such focus as outlined above is conducive to views as to corporate interest (including shareholder profitability) being seen in explicitly sustainable terms.

Conclusions
The attempt to redirect the political economy on to more sustainable pathways, through wider stakeholder engagement, is therefore a vital long-term project. The ultimate sustainability challenge is about how prepared we are to value our future. Traditional temporal perspectives by which we discount future benefits against present-day costs allocate typically 30-year timeframes--beyond which the future can take care of itself. As Heal has pointed out, we have grossly undervalued natural assets by applying valuation techniques that ignore the totally different time scales of the capital assets that humans and nature produce.87 In a situation of such potential seriousness it has to be hoped that the corporate initiatives discussed above contribute in a substantial way. The measures may not be sufficient: in which event, should other players up their awareness and see necessary transformations then some very hard questions will need to be raised concerning expectations of the financial markets. Though leading politicians have mostly been slow to see this in the round, a key task of themodern regulator is to establish broad sustainability priorities and to refocus market activities accordingly. The idea of profit maximisation in this new context is greatly more complex than has prevailed through the industrialised age thus far. Yet, once convinced, and nudged in sustainable directions, commercial sectors have the hard-headed capability to lead the way. As a UK economic commentator has recently pointed out: (t)he argument that business would not be able to cope with curbs on greenhouse gases is a fallacy; the longevity of capitalism is due almost entirely to its ability to adapt to any regime. What business lacks now is a clear steer; it has the expertise.88 It is necessary therefore for government to reframe those boundary conditions by which businesses operate, urgently, and in radical new ways.89 It is to be hoped that the cautious adjustments to corporate responsibilities and reporting requirements discussed above prove to be meaningful steps in the direction of sustainable, longtermist economic frameworks. For political decision-makers and consumers are also externalisers, for all that Bakan singles corporations out as externalisingmachines,whose compulsions lie at the root of many of the world's social and environmental ills.90 The many business leaders who acknowledge the increasing threats to our environment, and consequent challenges, are contributing significantly more to these debates than those who peddle standard political deregulatory rhetoric for the most short-term of reasons. *I.C.C.L.R. 165 Finally, a wider conception of corporate interest, and even shareholder value, could move the debate toward the identification of corporations, through recognition of inherent environmental limits, with ideas of stewardship and public trust.91 The proposed reforms, to corporate reporting in particular, point in this direction. Furthermore, procedural requirements can impact upon substantive consequences, in that procedures and outcomes can be mutually reinforcing.92 It is in other words valid to link statutory transparency measures, through the introduction of wider values into difficult decisions, with the generation of sustainable solutions.93 Just as in the case of wider public decision-making,94 corporate activities can benefit through wider acceptance, stronger legitimation and the opening up of both co-operative and competitive opportunities. The more that corporate and other decision-making and

Page91

reporting structures can acknowledge the extent of environmental externalities, and engage in appropriate responses, then the more likely that a virtuous circle, engaging both public and private policies, can be created. Few now would deny that the need is urgent. Norwich Law School, University of East Anglia, Norwich, UK. I.C.C.L.R. 2006, 17(6), 155-165 1. See R. Macrory, Regulating in a Risky Environment [2001] Current Legal Problems 619; C. R. Sunstein, Paradoxes of the Regulatory State (1990) 57 University of Chicago Law Review 407; R. B. Stewart, A New Generation of Environmental Regulation? (2001) 29 Capital University Law Review 21. 2. Gleneagles, Scotland, June 2005, attended by G8 leaders together with leaders from China, India and Brazil. 3. United Nations, Climate Change 2001: J. T. Houghton, Y. Ding, D. J. Griggs, M. Noguer, P. J. van der Linden, D. Xiaosu, K. Maskell and C. A. Johnson (eds), The Scientific Basis, Contribution of Working Group I to the Third Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) (Cambridge University Press, Cambridge, 2001). 4. UN Scientists Issue Dire Warning on Global Warming, The Guardian, February 28, 2006. 5. B. Lomborg, The Skeptical Environmentalist: Measuring the State of the World (Cambridge University Press, Cambridge, 2001). 6. The subject for instance of the Joint Science Academies' Statement: Global Response to Climate Change, June 7, 2005. 7. For instance, Eurosion, Living with Coastal Erosion in Europe: Sediment and Space for Sustainability--A Guide to Coastal Erosion Management Practices in Europe (European Commission, DG XI, Brussels, 2004). 8. For instance most urgently the Tuvalu islands in the South Seas (west of Samoa and north of Fiji): M. Lynas, High Tide (Harper Perennial, London, 2005). 9. See M. Faure and G. Skogh, The Economic Analysis of Environmental Policy and Law (Edward Elgar, Cheltenham, 2003), pp.282-285; also, C. R. Sunstein, Valuing Life: a Plea for Disaggregation (2004) 54 Duke L.J. 385. 10. R. Newman, It's Capitalism or a Habitable Planet --You Can't Have Both, The Guardian, February 2, 2006. 11. J. Porritt, Capitalism as if the World Matters (Earthscan, London, 2005), especially Ch.4. 12. ibid. , Ch.14. 13. See for instance K. S. Shrader-Frechette, Evaluating the Expertise of Experts (1995) 6

Page92

Risk: Health, Safety & Environment 116-117. 14. J. Holder, The Sellafield Litigation and Questions of Causation in Environmental Law [1994] Current Legal Problems 287. 15. A. Boyle, in Environmental Damage in International and Comparative Law: Problems of Definition and Valuation (M. Bowman and A. Boyle ed., Oxford University Press, Oxford, 2002), Ch.2. 16. M. Sagoff, The Economy of the Earth: Philosophy, Law and Economics (Cambridge University Press, Cambridge, 1988). 17. H. Doremus, The Rhetoric and Reality of Nature Protection: Toward a New Discourse (2000) 57 Wash. & Lee L. Rev. 11 at 70. 18. R. J. Lazarus contrasts judicial values with the needs of a coherent environmental jurisprudence: Restoring What's Environmental about Environmental Law in the Supreme Court (2000) 47 U.C.L.A. Law Rev. 703. 19. Porritt, fn.11 above, at pp.76-80; also, H. E. Daly and J. B. Cobb, For the Common Good: Redirecting the Economy toward Community, the Environment and a Sustainable Future (Beacon, Boston, Mass., 1989). 20. T. O'Riordan, Environmental Science for Environmental Management (2nd edn, Prentice Hall, Harlow, 2000), p.40. 21. R. J. Lazarus, The Neglected Question of Congressional Oversight of EPA: Quis Custodiet Ipso Custodes? (1991) 54 Law & Contemporary Problems 205 at 223. 22. C. M. Rose, Environmental Faust Succumbs to Temptations of Economic Mephistopheles, or, Value by any Other Name is Preference (1989) 87 Michigan Law Review 1631 at 1638. 23. Guardian, November 16, 2005. 24. G. Monbiot, It would Seem that I was Wrong about Big Business, Guardian, September 20, 2005. 25. See Multinational Gas & Petrochemical Co v Multinational Gas & Petrochemical Services Ltd [1983] Ch. 258 at 288. 26. S. Worthington, Shares and Shareholders: Property, Power and Entitlement (2001) 10 Co.Law. 307 at 311. 27. ibid. , at 312. 28. See especially A. A. Berle and G. C. Means, The Modern Corporation and Private Property (Macmillan, New York, 1932); E. M. Dodd, For whom are Corporate Managers Trustees? (1932) 45 Harvard Law Review 1145.

Page93

29. West Mercia Safetywear Ltd v Dodd [1988] B.C.L.C. 250; also Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 W.L.R. 627. 30. Kinsela v Russell Kinsela Pty Ltd (1986) 4 A.C.L.C. 215. 31. Insolvency Act 1986, ss.212, 214. 32. Adams v Cape Industries Plc [1991] 1 All E.R. 929. 33. B. Fisse and J. Braithwaite, Corporations, Crime and Accountability (Cambridge University Press, Cambridge, 1993). 34. J. R. Macey, Agency Theory and Criminal Liability of Organisations (1991) 71 Boston Univ. L.R. 315 at 319. 35. Law Commission for England & Wales, Report No.237, Legislating the Criminal Code: Involuntary Manslaughter (1996), from Pt VI onwards; also C. Wells, Corporations and Criminal Responsibility (2nd edn, Clarendon Press, Oxford, 2002). 36. A term derived from a civil case: Lennard's Carrying Co v Asiatic Petroleum [1915] A.C. 713 (Viscount Haldane); see also Denning L.J.'s distinction between brains and hands: HL Bolton Engineering v TJ Graham & Sons [1957] 1 Q.B. 172. 37. Tesco Supermarkets v Nattrass [1972] A.C. 153; Woodhouse v Walsall MBC [1994] B.C.L.C. 435. 38. Meridian v Securities Commission [1995] 3 All E.R. 918. 39. Att-Gen's Reference (No.2 of 1999) [2000] 3 All E.R. 182 at 191. 40. R. v British Steel Plc [1995] I.C.R. 586; R. v Associated Octel [1994] 4 All E.R. 1051; R. v Board of Trustees of the Science Museum [1993] I.C.R. 876, concerning s.3(1), Health and Safety at Work Act etc. 1974. 41. G. Richardson, Strict Liability for Regulatory Crime: the Empirical Research [1987] Crim. L.R. 695; A. Ogus and C. Abbot, Sanctions for Pollution: Do We Have the Right Regime? (2002) 14 J.E.L. 283. 42. J. Bakan, The Corporation: the Pathological Pursuit of Profit and Power (Constable, London, 2004). 43. See L. Roach, The Paradox of the Traditional Justifications for Exclusive Shareholder Governance Protection: Expanding the Pluralist Approach (2001) 22 Company Lawyer 9 at 13. 44. Compare Ashbury Railway Co v Riche (1875) L.R. 7 H.L. 653, Cotman v Brougham [1918] A.C. 514; see J. Dine, The Governance of Corporate Groups (Cambridge University Press, Cambridge, 2000), pp.122-127; also R. Nolan, The Proper Purpose

Page94

Doctrine and Company Directors, in The Realm of Company Law (B. Rider ed., Kluwer, London, 1998). 45. See Worthington, fn.26 above, at p.314. 46. P. Goldenberg, Shareholders Versus Stakeholders: the Bogus Argument (1998) 19 Company Lawyer 34 at 37. 47. Dine, fn.44 above, at p.188, citing S. Leader, Private Property and Corporate Governance, Defining the Interests, in Perspectives on Company Law (F. Patfield ed., Kluwer, London, 1995). 48. Company Law Review Steering Group, Modern Company Law for a Competitive Economy: Final Report (2001); also, White Paper, Modernising Company Law, Cm.5553 (HM Stationery Office, 2002). 49. Company Reform Bill 2005, cl.154(3)(4). 50. ibid. , cl.154(1). 51. ibid. , cl.156. 52. See for instance Consultation Paper, Company Law Reform (Department of Trade & Industry, 2005), Pt 3. 53. S. Hertz, Parallel Universes: NEPA Lessons for the New Property (1993) 93 Columbia L.R. 1668. 54. Mirroring a bewildering range of voluntary approved management systems: including, as well as the Global Reporting Initiative's Sustainable Reporting Guidelines, the EC's EMAS programme, and ISO 14001, ISO 9000, Investors in People, Accountability 1000. 55. Environment Agency, Environmental Disclosures in the Annual Report and Accounts of Companies in the FTSE All-Share, compiled by Trucost Plc (July 2004). 56. Porritt, fn.11 above, at pp.242-243. 57. ibid. , Chs 11 and 14, also detailing the following: the Prince of Wales's Business and the Environment Programme; Corporate Responsibility Index of Business in the Community; and WWF/Cable & Wireless, To Whose Benefit: Building a Business Case for Sustainability (2001). 58. D. Phillips and P. Wyman, Do Not Confuse Good Practice with Red Tape, Financial Times, December 1, 2005. 59. For instance in 1999 the Turnbull Report (the Stock Exchange) recommended that all listed companies be required to take measures to manage risk exposure and identify control systems put in place. 60.

Page95

The Companies Act 1985 (Operating and Financial Reviews and Directors' Report etc.) Regulations, SI 2005/1011, coming (for a short period) into force in April 2005. 61. Accounts Modernisation Directive 03/51 amending Directives 78/660, 83/349, 86/635, 91/674 on the Annual and Consolidated Accounts of Certain Types of Companies, Banks and Other Financial Institutions and Insurance Undertakings, [2003] O.J. L178/16. 62. Para.1 of new Sch.7ZA to the 1985 Act, introduced by reg.9. 63. ibid. , para.4(1)(a) and (2). Other heads include information about employees and about social and community issues: para.4(1)(b)(c). 64. ibid. , para.6; and see Accounting Standards Board, fn.65 below, Appendix A. 65. Accounting Standards Board, Reporting Standard I: Operating and Financial Review (May 2005), para.9 (produced following a consultation paper issued in November 2004). 66. ibid. , para.37. 67. ibid. , IG 21-22. 68. ibid. , para.11. 69. ibid. , paras 21, 24. 70. ibid. , para.2. 71. Association of British Insurers, Financial Risks of Climate Change (June 2005). 72. See fn.2 above. 73. Accounting Standards Board, fn.65 above, paras 7, 8. 74. ibid. , para.8. 75. November 28, 2005: this was arguably the most receptive audience from industry to which to address such a statement. See further Friends of the Earth, Hidden Voices: The CBI, Corporate Lobbying and Sustainability (June 2005). 76. Baroness Young, Environmental Data Services Report No.371, Brown's OFR Bombshell, December 2005. 77. See Environmental Data Services Report No.348, AA 1000-Assured CSR Reports Begin to Emerge, January 2004. 78. The Companies Act 1985 (Operating and Financial Review) (Repeal) Regulations, SI 2005/3442 (in force January 12, 2006). 79.

Page96

Requirements for such business reviews are currently set out in the Company Reform Bill 2005, cl.390. 80. cf. White Paper, Modernising Company Law, fn.48 above. 81. Accounting Standards Board, Reporting Statement: Operating and Financial Review (2006). 82. Department of Trade and Industry, Consultation on Mandatory Narrative Business Reporting--Whether Further Amendments are Required (February 2006). 83. Accounting Standards Board, fn.81 above, at p.4. 84. R. Donkin, For Once, Bureaucracy is Good For Business, Financial Times, December 8, 2005. 85. See for instance, Association of Chartered Certified Accountants, Full Cost Accounting: an Agenda for Action (2001); Chartered Institute of Management Accountants, Environmental Accounting: an Introduction and Practical Guide (2002); Institute of Charted Accountants of England and Wales, Sustainability: the Role of Accountants (2004). 86. Environment Agency/Trucost report, fn.55 above, at p.51. 87. G. Heal, Markets and Sustainability, in Environmental Law, the Economy, and Sustainable Development (R. L. Revesz, P. Sands, R. B. Stewart ed., CambridgeUniversity Press, Cambridge, 2000), p.421. 88. L. Elliott, Winds of Climate Change are about to Make their Impact felt in Many a Boardroom##, Guardian, February 6, 2006. 89. Porritt, fn.11 above, at p.266. 90. Bakan, fn.42 above, Ch.3. 91. See D. C. Korten, When Corporations Rule theWorld (Kumarian Press, West Hartford, Ct, 1995). 92. J. Holder, EIA: The Regulation of Decision-Making (Oxford University Press, Oxford, 2004). 93. J. Steele, Participation and Deliberation in Environmental Law--Exploring a ProblemSolving Approach (2001) 21 O.J.L.S. 415. 94. T. Prosser, Democratisation, Accountability and Institutional Design: Reflections on Public Law, in Law Legitimacy and the Constitution (P. McAuslan and J. McEldowney ed., Sweet & Maxwell, London, 1985).
2011 Sweet & Maxwell and its Contributors

Page97

Page98