The Companies Act 2006 s.172 introduced a directorial duty of promoting the success of the company. This new session purports to encapsulate the ‘enlightened shareholder value’ (ESV) approach in common law. This article argues that s.172 merely codifies the common law, but it is still a positive development in terms of providing a clearer direction and framework for directors’ duties.
The ‘Enlightened Shareholder Value’ Approach
In 1998, the Company Law Review Steering Group (CLRSG) was set up with an objective to develop a framework of company law that ‘facilitates enterprise and promotes transparency and fair dealing’. This project included the codification of directors’ duties, which had been used to be developed by common law and equity.
In drafting the new sections regarding directors’ duties, one of the hotly contested issues was whether directors owed duty towards shareholders only or both shareholders and other stakeholders. There were two possible approaches to address the issue, namely the ‘shareholder value’ approach and the ‘pluralist’ approach. Under the ‘shareholder value’ approach, directors’ duties are to maximize the wealth for shareholders. This had generally been adopted by English courts and US courts in cases like Dodge v Ford Motor Co. On the other hand, the ‘pluralist value’ approach suggests that directors should strike a balance between interests of different stakeholders, including shareholders, employees and customers etc.
With a view of the pros and cons of these two approaches, the CLRSG finally adopted a hybrid of them – the ESV approach – other stakeholders’ interest should be taken into consideration, but it ought to be subordinate to the central purpose of promoting the success of the company for the benefits of its shareholders.
As a matter of fact, the ESV approach is not something new to the English law. It was suggested by Bowen LJ in Hutton v West Cork Railway when he stated, ‘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.’ Therefore, s.172 is essentially based on the already-existing ESV approach. In deciding whether it is a positive development to company law, one shall examine if it brings any new element or substantial interpretation to the common law ESV principle. This article argues that s.172 provides a direction and framework for the application of ESV approach, but in substance, it merely codifies the existing law.
Direction and Framework
As mentioned above, before the enactment of s.172, there had been at least three possible approaches for the courts to choose from. However, after s.172 came into effect, it becomes clear that directors should exercise their duties in accordance with the ESV approach. The fact that the ESV approach is finally backed by statutory authority has significant implications.
First and foremost, s.172 provides directors with certainty of whom they should be responsible to. In directors’ decision-making process, there are often a lot of considerations, some of which may be even conflicting. S.172 resolves this problem by reaffirming the idea of shareholder primacy. Directors can be clear that the ultimate yardstick is whether certain decisions can promote the company’s success for the benefit of its members as a whole.
In addition, by putting it in black and white, s.172 encourages directors to pay attention to other stakeholders’ interests in making decisions, and thus be more informed of the long-term consequences of each option available to them. This in turn promotes the value of sustainable growth of companies instead of short term profit maximization. As suggested by John Kong Shan Ho, ‘This [s.172] could orientate them [directors] to more inclusive and integrated decisions.’
In short, s.172 sets out a legal framework and a direction that directors should work towards. This is best concluded by Deryn Fisher’s remark that s.172 ‘must be seen as a normative measure which…. will firmly encourage a more inclusive, longer-term view of what will promote success’.
S. 172 in Practice
Although s.172 has a significant normative effect in laying down the framework of directors’ duties, when it comes to details, it merely reflects the existing rules.
Firstly, prima facie s.172 adopts a subjective test in assessing directors’ decisions. Directors are only required to ‘act in the way he considers, in good faith, would be most likely to promote the success of the company’. This is surprising as the 2002 draft Bill referred to ‘material factors that a person of care and skill would consider relevant’. Due to this change, s.172 merely codified the subjective test approach in previous cases: In Re Smith and Fawcett Ltd, Lord Green MR expressly pointed out, ‘They [Directors] must act bona fide in what they consider – not what a court may consider – is in the interest of the company.’ In a more recent case, Regentcrest plc (in liquidation) v Cohen, Jonathan Parker J adopted the same approach.
On the other hand, s.172 leaves it open for the courts to import some objective elements in deciding whether the director is acting in good faith. For instance, in Item Software (UK) Ltd v Fassihi, it was held that the director’s duty of disclosure of his own wrongdoing was an aspect of his duty to act bona fide because he could not have reasonably believed that it was in the interests of his company to be uninformed of that breach. Despite the subjective test in s.172, s.172 does not preclude the courts from introducing objective elements as in the case of Fassihi in assessing a director’s good faith. Therefore, the enactment does not bring any change since ‘parliament impliedly accepted… that the courts would introduce objective considerations into an assessment of a director’s actions’.
‘Members as a whole’
Secondly, the main test of s.172 is that the director’s decision should be ‘most likely to promote the success of the company for the benefit of its members as a whole’. The phrase ‘members as a whole’ indicates that directors cannot just promote interests of a particular group of shareholders. This merely codified the court’s decision in Mills v Mills. In other words, s.172 does not bring any change to this area of law. The idea of shareholder primacy embodied in s.172 was also upheld in a recent case, R. (on the application of People & Planet) v HM Treasury.
‘Have regard to’
Besides these, s.172(1) contains a list of stakeholder values that directors need to ‘have regard to’. Certain aspects such as interests of the whole corporation group, which was highlighted in Charterbridge Crp v Lloyds Bank, are missed out. However, the phrase ‘amongst other matters’ in s.172(1) shows that the list is non-exhaustive. Therefore, the previous case law is still relevant.
In fact, even if a particular factor is listed in s.172(1), there is no substantial change in that area of law. A very obvious example is s.172(1)(b), which states that directors ought to have regard to the interests of employees. This essentially stems from s.309 of the older Companies Act 1985, which also states the same thing. And this was applied in a previous case: In Re Welfab Engineers Ltd, it was held that the directors were not liable for taking into accounts employees’ interests when considering whether to accept a higher or a lower bid of the business. Again, s.172 merely codifies the previous law.
More importantly, by using the word ‘must’ in s.172(1), it seems to make it mandatory for directors to ‘have regard to’ all those stakeholders’ interests. Nevertheless, when must be a particular group of stakeholders’ interests be considered and to what extent must they be considered? Unfortunately, as criticized by Fisher, s.172 fails to give an answer due to the lack of definition of ‘have regard to’. Thus, it is insurmountable to hold directors accountable under s.172. As a result, it is other already-existing regulations that regulate directors’ behaviours in certain aspects, such as consumer protection and environmental protection. Although s.172 provides a list of factors that directors ‘must’ have regard to, it does not guarantee any change in directors’ behaviour.
Fourthly, according to s.172(3), the duty imposed on directors by s.172 is partially qualified by their duties towards creditors under relevant legislations (mainly Insolvency Act 1986 s.214) and the common law.
In essence, s.172(3) merely preserves directors’ duties towards creditors in circumstances specified in relevant legislations, without introducing any new statutory duty on top of those already in place. For instance, under Insolvency Act s.214, the director’s duty is not triggered until there is proof of insolvency. There have long been a lot of controversies about whether directors owe creditors any duty before insolvency. And if so, when are such duties triggered. Unfortunately, merely stating that directors have to comply with the existing legislations, s.172(3) fails to address this issue.
Nonetheless, by preserving not only existing legislations, but also any ‘rule of law’, s.172(3) leaves it open for the common law to develop. Until now, the case law is still unclear about at which point before companies’ insolvency, directors start to owe duties towards creditors. As Keay suggested, ‘Further development and clarification to produce greater certainty’ are needed for creditor protections. Since s.172(3) does not bring any new element to the existing law, the issue of when a director starts to owe duties towards the creditors is as unclear as before.
Last but not least, the difficulty in enforcing s.172 reinforces the argument that it does not bring any substantial change to the behaviours of directors. Although s.417(2) makes it compulsory for directors’ report to contain a business review ‘to inform members… and help them assess how the directors have performed their duty under section 172’, due to the lack of an objective test, it is extremely difficult for members to prove a breach of s.172.
Furthermore, as pointed out by David Howarth from House of Commons, the class of potential litigants is limited.# Based on the principle of shareholder primacy, the proper claimant is the company. Stakeholders such as consumers and employees have no proper standing, and thus, often find it almost insurmountable to succeed in a claim under s.172. R. (on the application of People & Planet) v HM Treasury is a case in point. In this case, Sales J held that shareholders’ value should be the core consideration for directors and it should not be subordinate to any other stakeholders’ concern. Therefore, for stakeholders other than shareholders, s.172 just creates ‘a right without a remedy’. As one can imagine, unless a shareholder also falls into the category of other stakeholders, it is very unlikely that he will embark on expensive legal actions to fight for other stakeholders’ interests. With a view to the enforcement of s.172, it is concluded that its practical effect is extremely limited.
The lack of objective standard to assess directors’ decisions makes it very difficult to hold a director liable under s.172. This is worsened by the lack of objective criteria to decide whether directors actually have regard to other stakeholders’ interests. Moreover, since stakeholders’ value is subordinate to shareholders’ value, s.172 essentially creates a ‘right’ for stakeholders but without remedy. All of these point to the conclusion that s.172 does nothing more than codifying the ESV value existing in previous legislations and case law.
However, this is not followed by the conclusion that s.172 is not a positive development in company law. As mentioned at the beginning, before the enactment of s.172, there are different inconsistent approaches in dealing with issues arising from directors’ duties. By putting it in black and white, s.172 gives the ESV approach a statutory status. Although it does not really bring changes to the existing law, it lays down the framework and direction for the courts to develop on. It is therefore a positive development in company law.