“Section 172 of the Companies Act 2006 gives the illusion tothe business community, regulators, certain scholars, and market players alike,that something is being done in the sphere of company law in relation toacknowledging stakeholders’ interests in corporate decision-making.
“1Section 172, found in the Companies Act 2006, introduced thecontroversial notion that directors must promote the success of the company andin doing so, have regard to the interests of not only the company’s shareholders,but also the interests of suppliers, employees, the environment and the widercommunity. This paper will first look at the history of the Act and thedifficulties legislators faced trying to strike a balance between twoconflicting ideologies before discussing whether the Act succeeded in makingthe law more accessible to directors.This paper will argue that while an aim of the 2006 Act wasto reintroduce the concept of commercial morality by seemingly requiringdirectors to take a more holistic approach in running their company, lack ofenforceability of s.172 means that in practice, the section has changed verylittle.HistoryBefore 2006, a director could only find his legal duties,obligations and consequences for breaching those duties in common law.
It wassaid that this “was often perceived as an inaccessible set of obscure rules”2which directors found difficult to navigate without legal advice.The idea of codifying the duties of directors in statute isnot a new idea; the Davey Committee in 1895 believed codification was “morelikely to bring home…the obligations they undertake and to shareholder andothers the standard of commercial morality which they have a right to expect”.3However, in 1926 the Greene Committee commented that “to attempt by statute todefine the duties of directors would be a hopeless task”,4and in fact, things remained unchanged for over a century.The catalyst for the revival of reform came in 1997 whenLabour took Government. There had been several committees prior to Tony Blair’sGovernment, such as the Cadbury Committee in 1992 and the Greenbury Committeein 1995, that made their suggestions on how to improve awareness of corporatesocial responsibility with directors. The Hampel Committee, formed in 1998 wasthe final committee to consider the matter and recommended all prior suggestionsbe placed in the Combined Code, a set of guidelines companies listed on theLondon Stock Exchange had to follow.
Labour, unimpressed and wanting directors to be held toaccount by legislation rather than just the Combined Code, commissioned theCompany Law Review Steering Group (CLRSG) to bring “focus within corporategovernance reform on the moral claims of stakeholders to inclusion in thecorporate decision-making process.”5During its research, the CLRSG was challenged with two conflicting views oncorporate governance: shareholder primacy and the pluralist approach.Shareholder primacy would only require a director to “act inthe interests of the shareholders”,6a view that drew criticism as it “encourages short-term risk taking bydirectors” to promote lucrative dividends for the shareholders “at the expenseof long-term corporate growth”.7On the other hand, the pluralist approach would mandatedirectors to not only consider the interests of shareholders, but to give equalstatus to “employees, customers, suppliers, and indeed even the local communityand the environment”.8The CLRSG rejected this model out of concern that it would be impossible to demonstratethat directors had given equal status to shareholders and stakeholders.
The CLRSG proposed the ‘Enlightened Shareholder Value’, amiddle ground that would “remind directors that shareholder value depends onsuccessful management of the company’s relationships with other stakeholders”.9The proposal found statutory footing in s.172 which states that a director mustpromote 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 ofany decision in the long term, (b) the interests of thecompany’s employees,(c) the need to foster thecompany’s business relationships with suppliers, customers and others, (d) the impact of the company’soperations on the community and the environment,(e) the desirability of thecompany maintaining a reputation for high standards of business conduct, and(f) the need to act fairly asbetween members of the company.The Labour Government was sending out the clear message thatdirectors must not make decisions that promote the success of the company atall costs. However, it was crucial that the new duty would not make itunattractive for businesses to operate in the UK by placing an unreasonableburden on the decision-makers.It was intended that the proposed reforms, not unlike theproposals of the Davey Committee would “enable directors more readily toappreciate the nature of their legal obligations”10and to know what is expected of them.11But if the Act failed to clearly lay out the duties and obligations a directormust adhere to, the Courts might struggle to say whether there had been abreach. Has codification been successful? The Act defined a director as any person occupying thatposition, “by whatever name called”.
12Percival v Wright 1902outlined that a director only owes his duties to the company, not anyindividual shareholder. (There are exceptions to this rule such as if adirector took it upon himself to advise shareholders directly.)13The 2006 Act successfully codifies Percivalin s.170 which states that a director owes his duties to the company. Theclear wording of the section allows directors to understand to whom they owetheir duties, but this results in difficulties of enforceability of thestakeholder’s interests found in s.172.
To evaluate where s.172 is successful in achieving theGovernment’s goal at bringing commercial morality to the forefront ofdecision-making, s.172 can be broken down into three parts:· the subjective test that a director acts in goodfaith,· the requirement that directors act for thebenefit of its ‘members as a whole’, and· the need for directors to have regard to theinterests of those listed in s.172(1)(a)-(f)Subjective TestSection 172 requires that a director must make decisions inthe way he considers, in good faith arelikely to promote the success of the company.
This is in fact nothing new. Asearly as 1854, common law stated that it was the duty of directors “to promotethe interests of the corporation whose affairs they are conducting.”14More recently, Lord Greene MR described that directors must act bona fide in what they consider is inthe interests of the company.15Apart from the substitution of ‘good faith’ for ‘bona fide’ it seems apparent that thetest remains unchanged.
This view was approved in 2008 when Warren J statedthat the two different wordings “come to the same thing with the modernformulation giving a more readily understood definition of the scope of theduty”.16Furthermore, also in 2008, Lord Glennie stated that s.172 merely sets out thepre-existing duty to act bona fide. 17With the test remaining subjective, directors have theability to take risks knowing that a Court will not retrospectively imposetheir view on the decision or what they may have done in the same situation.18This is advantageous as businesses are built on risk and directors need to havethe confidence that, providing they truly believe a decision to be in the interestsof the company, they won’t face proceedings for a breach of duty. Thisadvantage also brings with it a significant disadvantage – it fails to set anythreshold standard for directors which will make it difficult for a Court tofind a director in breach of his s.172 duty as long as he can convince thejudge that he acted in good faith.
19 ‘Members as a Whole’Re Smith and FawcettLtd20stated that directors had to act in the ‘best interests of the company’. Thisambiguous statement was “close to meaningless in providing guidance todirectors”.21One thing that is clear is that the statement did not require a director toconsider interests of anyone other than the company when making decisions. In contrast with common law, there is no longer arequirement for directors to act in the company’s best interests but rather s.172refers directly to member interests.
22The new wording of the duty is likely to “be more readily understandable by thebusiness community”23and prompts directors to look beyond just the interest of the company. This section is unlikely to be interpreted any different by Courtsnor has the concept of corporate social responsibility been given a prominentrole in the new wording. As such, this element is unlikely to bring about anychange in directors. ‘Have regard to’The ‘Enlightened Shareholder Value’ model proposed by theCLRSG finds itself in s.
172 by requiring directors to have regard to thestakeholders listed in s.172(1)(a)-(f). The intent is that directors would be more inclusive intheir decision-making process24by considering the interests of “employees, the environment, the community,suppliers and customers”.25However,there are several reasons why this section does not mark a departure from theprocess of boardrooms pre-2006.
Before s.172 was enacted, it is highly probable that competentdirectors would have fostered good relationships between the shareholders,employees, customers and suppliers as “a matter of common sense”.26 If this is true, then s.172 has notadded anything to what was normal practice and won’t result in a positive shiftin commercial morality.27 After Labour abandoned Clause IV from its constitution in1997 and recognised that nationalisation was not progressive, there may havebeen concern that more private companies would be running public services andthere needed to be further control over them. This rings true as s.172 not only”expresses the law’s view on how directors should discharge their functions ona day-to-day basis”,28it crystallises the notion that good corporate governance should encompasswider considerations.
It is true thatwith the exception of the interests of employees, found in s.309 CA 1985, therewas no express obligation under the old law that directors needed to considerinterests of others.29While s.172 appears to require directors to consider theinterests of others, this is not the case.
What is not clear is what ‘haveregard to’ means. Is it that directors should promote the success ofnon-shareholders whilst ensuring that doing so still promotes the interests ofthe shareholders?30If that is the case, s.172 does not say so. It is likely to be a subordinate tothe primary aim of ‘success of the company’. The Rt Hon Margaret Hodge MP,Minister of State for Industry and the Regions seems to confirm this when shesaid that: “a director will not be required to consider any of the factors beyondthe point at which to do so would conflict with the overarching duty to promotethe success of the company.”31A director has no guidance on how he should balance theinterests listed in s.172.
The Australian Joint Parliamentary Committee reportpublished in 2006 rejected the Act’s approach as it “appears to introduce greatuncertainty into the legal expression of directors’ duties.”32Without an amendment of the Companies Act that clarifies how a director isexpected to balance the interests of s.172, the section fails to have positivechange on current corporate social responsibility.Enforceability of ‘Enlightened Shareholder Value’During the drafting process, Margaret Hodge commented thats.172 was a “radical departure in articulating the connection between what isgood for a company and what is good for society at large”.33It is argued that in fact s.172 is far from radical.
While Labour had anopportunity to legislate a sea-change in how business is conducted, lack ofenforceability means the section is nothing more than a damp squib. It has been shown that directors owe their duties to thecompany, not to the shareholders and especially not to any stakeholders listedin s.172. This means that only the company can bring an action for a director’sbreach of duty. While individual minority shareholders can bring a derivativeaction under s.
260, they are unlikely to embark upon the expensive anddifficult process in order to support an environmental or communal cause. Evenif they were granted leave of the Court to bring an action, the subjectiveaspect of s.172 rears its ugly head again in making enforceability a challenge.Furthermore, it is unlikely that shareholders will have anyinclination to ensure that s.
172 is being followed by the directors. Employing any sort of compliance andoversight of the director will incur cost, which could result in a weakerdividend. Will the company, via its shareholders, really wish to enforce suchthird-party obligations? 34Ironically, it seems plausible shareholders are more likely to bring a derivativeaction against a director that acted solely to the benefit of non-shareholders.The result is a duty on the directors to take account theinterests of the stakeholders but no corresponding right for the stakeholdersto enforce that duty.
35 As mentioned, the entirety of s.172 is based on decisions adirector makes in ‘good faith’. This is a very effective defence when anydecision is questioned. A director can release a statement explaining that hedid indeed consider the interests of the environment, the employees and thesuppliers, and still considered the decision to be in the best interests of thecompany. The Courts will not intervene. The recent case of R (on the application of People & Planet) v HM Treasury36stated that it would be inappropriate for the Court to impose on the directors,their own view on how a company should balance its interest whilst giving considerationto environmental and human right matters.The Government tried to hold directors to account throughthe use of Business Reviews found in s.417, which are designed “to informmembers of the company and help them assess how the directors have performedtheir duty under the Companies Act 2006, s.
172″. However, there is evidence that boards arebeing advised that a safe practice is to minute how any major decisionconsidered s.172, “bringing about the tick box defensive board room practicesit was hoped to avoid.
“37This is in spite of the explanatory notes of the 2006 Act stating it is notenough for directors to pay lip service to the stakeholder interests unders.172.38 Section 170(3) and s.170(4) add a great deal of uncertainty withthe former stating that the general duties found in S171-177 “are based oncertain common law rules” without elaborating which and the latter stating thatthe duties “shall be interpreted and applied in the same way as common lawrules”. This lack of clarity if unhelpful.
If the Act really was meant toassist directors in understanding their duties, it could have completelycodified them and abolished the common law rules. Furthermore, the implicationfrom the choice of wording is that s.172 was not intended to mark a radicaldeparture in how directors conduct their business but rather suggests a “smoothertransition from one era to another.”39Requiring directors to merely ‘have regard to’ the interestsof others is the long and short of the new approach to commercial morality thatis the ‘Enlightened Shareholder Value’. But as stated above, good directors wouldalready have done so, and the obligation is limited. Final thoughtsThe quote that opened this paper rings true: s.172 isnothing more than an illusion to convince those listed in s.
172 that theirinterests are protected. This outcome is confirmed by an evaluation of theCompanies Act by the Department of Business Innovation and Skills in 2010. Whencompanies were asked “Has awareness of the duty to promote the success of thecompany affected the behaviour of directors?” 64 per cent answered no. Perhapsmore disappointingly, whilst the study found that 79 per cent of directors wereaware of their new duty under s.
172, 91 per cent did not believe the duty hadaffected their behaviour.40An explanation for this lack in change of behaviour is that the subjective testfound in s.172 acts as too powerful a defence when a director is accused ofbreach. As such, a director can carry on making decisions as he did prior tos.172, providing he merely states that he did have regard to the interests ofthe stakeholders. It is possible that in the not too distant future this couldchange. The Government has taken recommendations from the Corporate GovernanceGreen Paper published last year about the need for further oversight overdirectors. The Government in response intends to “Introduce secondarylegislation to require all companies of significant size (private as well aspublic) to explain how their directors comply with the requirements of section172 to have regard to employee and other interests”.
41They have invited the independent regulator Financial Reporting Council toinvestigate an effective way to achieve this. However, at this time, nosuggestions have been made public so it is impossible to comment on whetherthese changes will finally affect Corporate Social Responsibility the wayMargaret Hodge suggests. 1 Georgina Tsagas, ‘Section172 of the UK Companies Act 2006: Desperate Times Call for Soft Law Measures'(2017)
2 Stephen Griffin, ‘Theregulation of directors under the Companies Act 2006’ 2008 Company LawNewsletter 1.3 Susan McLaughlin, UnlockingCompany Law (3rd edn, Routledge 2015) 326. 4 Susan McLaughlin, UnlockingCompany Law (3rd edn, Routledge 2015) 327.5 Alan Dignam and John Lowry, Company Law (9th edn, OUP 2016) 431.6 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9thedn, Sweet & Maxwell 2012) 541.
7 David Cabrelli, ‘TheReform of the Law of Directors’ Duties in UK Company Law’ (2008)
8 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9thedn, Sweet & Maxwell 2012) 541.9 John Lowry, ‘Theduty of loyalty of company directors: bringing the accountability gap throughefficient disclosures’ 2009 Cambridge Law Journal 607, 616.10 Stephen Griffin, ‘Theregulation of directors under the Companies Act 2006’ 2008 Company LawNewsletter 1.11 John Lowry, ‘Theduty of loyalty of company directors: bringing the accountability gap throughefficient disclosures’ 2009 Cambridge Law Journal 607, 611.
12 Companies Act 2006, s 250.13 see Allen v Hyatt 191430 TLR 444. 14 Aberdeen Railway Cov Blaikie Brothers 1854 1 Macq 461, 471.15 Re Smith and FawcettLtd 1942 Ch 304. 16 Cobden InvestmentsLtd v RWM Langport Ltd 2008 EWHC 2810 (Ch), para 52.17 West Coast Capital(Lios) Limited 2008 CSOH 72.18 Regentcrest plc v Cohen 2001 2 BCLC 8019 AndreasRühmkorf, Corporate SocialResponsibility, Private Law and Global Supply Chains (Edward Elgar 2015) 37.
20 1942Ch 30421 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9thedn, Sweet & Maxwell 2012) 540.22 David Kershaw, CompanyLaw in Context (2nd edn, OUP 2012) 383.23 Alan Steinfeld, Blackstone’sGuide to the Companies Act 2006 (OUP 2007) 84.24 Andrew Keay, ‘The Dutyto Promote the Success of the Company: is it fit for purpose?’ found in JoanLoughrey, Directors’ Duties andShareholder Litigation in the Wake of the Financial Crisis (Edward Elgar 2012)54. 25 12.4 scope and nature of general duties, page 38326 Stephen Griffin, ‘Theregulation of directors under the Companies Act 2006’ 2008 Company LawNewsletter 1, 2.
27Bourne on Company Law, page 17628 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9thedn, Sweet & Maxwell 2012) 540.29 Alan Steinfeld, Blackstone’sGuide to the Companies Act 2006, (OUP 2007) 84.30 David Kershaw, CompanyLaw in Context (2nd edn, OUP 2012) 382.31 HC Standing Committee D, Fifteenth Sitting, 11 July 2006,Cols 591-593.
32 Corporate responsibility: Managing Risk and CreatingValue, June 2006, para 4.4633 http://webarchive.nationalarchives.gov.uk/20070628230000/http://www.dti.gov.uk/files/file40139.pdf 34 Stephen Griffin, ‘Theregulation of directors under the Companies Act 2006’ 2008 Company LawNewsletter 1, 2.35 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9thedn, Sweet & Maxwell 2012) 541.36 2009EWHC 302037 Susan McLaughlin, UnlockingCompany Law (3rd edn, Routledge 2015) 339.38 ExplanatoryNotes to the Companies Act 2006, para 328.39Dark dark book, 18540https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/31655/10-1360-evaluation-companies-act-2006-volume-1.pdf41 http://www.wlrk.com/docs/corporate-governance-reform-government-response.pdf