“Section 172 of the Companies Act 2006 gives the illusion to
the business community, regulators, certain scholars, and market players alike,
that something is being done in the sphere of company law in relation to
acknowledging stakeholders’ interests in corporate decision-making.”1

Section 172, found in the Companies Act 2006, introduced the
controversial notion that directors must promote the success of the company and
in 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 wider
community. This paper will first look at the history of the Act and the
difficulties legislators faced trying to strike a balance between two
conflicting ideologies before discussing whether the Act succeeded in making
the law more accessible to directors.

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

This paper will argue that while an aim of the 2006 Act was
to reintroduce the concept of commercial morality by seemingly requiring
directors to take a more holistic approach in running their company, lack of
enforceability of s.172 means that in practice, the section has changed very
little.

History

Before 2006, a director could only find his legal duties,
obligations and consequences for breaching those duties in common law. It was
said that this “was often perceived as an inaccessible set of obscure rules”2
which directors found difficult to navigate without legal advice.

The idea of codifying the duties of directors in statute is
not a new idea; the Davey Committee in 1895 believed codification was “more
likely to bring home…the obligations they undertake and to shareholder and
others the standard of commercial morality which they have a right to expect”.3
However, in 1926 the Greene Committee commented that “to attempt by statute to
define the duties of directors would be a hopeless task”,4
and in fact, things remained unchanged for over a century.

The catalyst for the revival of reform came in 1997 when
Labour took Government. There had been several committees prior to Tony Blair’s
Government, such as the Cadbury Committee in 1992 and the Greenbury Committee
in 1995, that made their suggestions on how to improve awareness of corporate
social responsibility with directors. The Hampel Committee, formed in 1998 was
the final committee to consider the matter and recommended all prior suggestions
be placed in the Combined Code, a set of guidelines companies listed on the
London Stock Exchange had to follow.

Labour, unimpressed and wanting directors to be held to
account by legislation rather than just the Combined Code, commissioned the
Company Law Review Steering Group (CLRSG) to bring “focus within corporate
governance reform on the moral claims of stakeholders to inclusion in the
corporate decision-making process.”5
During its research, the CLRSG was challenged with two conflicting views on
corporate governance: shareholder primacy and the pluralist approach.

Shareholder primacy would only require a director to “act in
the interests of the shareholders”,6
a view that drew criticism as it “encourages short-term risk taking by
directors” to promote lucrative dividends for the shareholders “at the expense
of long-term corporate growth”.7

On the other hand, the pluralist approach would mandate
directors to not only consider the interests of shareholders, but to give equal
status to “employees, customers, suppliers, and indeed even the local community
and the environment”.8
The CLRSG rejected this model out of concern that it would be impossible to demonstrate
that directors had given equal status to shareholders and stakeholders.

The CLRSG proposed the ‘Enlightened Shareholder Value’, a
middle ground that would “remind directors that shareholder value depends on
successful management of the company’s relationships with other stakeholders”.9
The proposal found statutory footing in s.172 which states that a director must
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.

The Labour Government was sending out the clear message that
directors must not make decisions that promote the success of the company at
all costs. However, it was crucial that the new duty would not make it
unattractive for businesses to operate in the UK by placing an unreasonable
burden on the decision-makers.

It was intended that the proposed reforms, not unlike the
proposals of the Davey Committee would “enable directors more readily to
appreciate the nature of their legal obligations”10
and to know what is expected of them.11
But if the Act failed to clearly lay out the duties and obligations a director
must adhere to, the Courts might struggle to say whether there had been a
breach.

 

 

 

Has codification been successful?

The Act defined a director as any person occupying that
position, “by whatever name called”.12

Percival v Wright 1902
outlined that a director only owes his duties to the company, not any
individual shareholder. (There are exceptions to this rule such as if a
director took it upon himself to advise shareholders directly.)13
The 2006 Act successfully codifies Percival
in s.170 which states that a director owes his duties to the company. The
clear wording of the section allows directors to understand to whom they owe
their duties, but this results in difficulties of enforceability of the
stakeholder’s interests found in s.172.

To evaluate where s.172 is successful in achieving the
Government’s goal at bringing commercial morality to the forefront of
decision-making, s.172 can be broken down into three parts:

·        
the subjective test that a director acts in good
faith,

·        
the requirement that directors act for the
benefit of its ‘members as a whole’, and

·        
the need for directors to have regard to the
interests of those listed in s.172(1)(a)-(f)

Subjective Test

Section 172 requires that a director must make decisions in
the way he considers, in good faith are
likely to promote the success of the company. This is in fact nothing new. As
early as 1854, common law stated that it was the duty of directors “to promote
the interests of the corporation whose affairs they are conducting.”14
More recently, Lord Greene MR described that directors must act bona fide in what they consider is in
the interests of the company.15

Apart from the substitution of ‘good faith’ for ‘bona fide’ it seems apparent that the
test remains unchanged. This view was approved in 2008 when Warren J stated
that the two different wordings “come to the same thing with the modern
formulation giving a more readily understood definition of the scope of the
duty”.16
Furthermore, also in 2008, Lord Glennie stated that s.172 merely sets out the
pre-existing duty to act bona fide. 17

With the test remaining subjective, directors have the
ability to take risks knowing that a Court will not retrospectively impose
their view on the decision or what they may have done in the same situation.18
This is advantageous as businesses are built on risk and directors need to have
the confidence that, providing they truly believe a decision to be in the interests
of the company, they won’t face proceedings for a breach of duty. This
advantage also brings with it a significant disadvantage – it fails to set any
threshold standard for directors which will make it difficult for a Court to
find a director in breach of his s.172 duty as long as he can convince the
judge that he acted in good faith.19

 

‘Members as a Whole’

Re Smith and Fawcett
Ltd20
stated that directors had to act in the ‘best interests of the company’. This
ambiguous statement was “close to meaningless in providing guidance to
directors”.21
One thing that is clear is that the statement did not require a director to
consider interests of anyone other than the company when making decisions.  

In contrast with common law, there is no longer a
requirement for directors to act in the company’s best interests but rather s.172
refers directly to member interests.22
The new wording of the duty is likely to “be more readily understandable by the
business community”23
and prompts directors to look beyond just the interest of the company.

This section is unlikely to be interpreted any different by Courts
nor has the concept of corporate social responsibility been given a prominent
role in the new wording. As such, this element is unlikely to bring about any
change in directors.

‘Have regard to’

The ‘Enlightened Shareholder Value’ model proposed by the
CLRSG finds itself in s.172 by requiring directors to have regard to the
stakeholders listed in s.172(1)(a)-(f).

The intent is that directors would be more inclusive in
their decision-making process24
by 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 the
process of boardrooms pre-2006.

Before s.172 was enacted, it is highly probable that competent
directors 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 not
added anything to what was normal practice and won’t result in a positive shift
in commercial morality.27
   

After Labour abandoned Clause IV from its constitution in
1997 and recognised that nationalisation was not progressive, there may have
been concern that more private companies would be running public services and
there 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 on
a day-to-day basis”,28
it crystallises the notion that good corporate governance should encompass
wider considerations.  It is true that
with the exception of the interests of employees, found in s.309 CA 1985, there
was no express obligation under the old law that directors needed to consider
interests of others.29

While s.172 appears to require directors to consider the
interests of others, this is not the case. What is not clear is what ‘have
regard to’ means. Is it that directors should promote the success of
non-shareholders whilst ensuring that doing so still promotes the interests of
the shareholders?30
If that is the case, s.172 does not say so. It is likely to be a subordinate to
the 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 she
said that: “a director will not be required to consider any of the factors beyond
the point at which to do so would conflict with the overarching duty to promote
the success of the company.”31

A director has no guidance on how he should balance the
interests listed in s.172. The Australian Joint Parliamentary Committee report
published in 2006 rejected the Act’s approach as it “appears to introduce great
uncertainty into the legal expression of directors’ duties.”32
Without an amendment of the Companies Act that clarifies how a director is
expected to balance the interests of s.172, the section fails to have positive
change on current corporate social responsibility.

Enforceability of ‘Enlightened Shareholder Value’

During the drafting process, Margaret Hodge commented that
s.172 was a “radical departure in articulating the connection between what is
good for a company and what is good for society at large”.33
It is argued that in fact s.172 is far from radical. While Labour had an
opportunity to legislate a sea-change in how business is conducted, lack of
enforceability means the section is nothing more than a damp squib.

It has been shown that directors owe their duties to the
company, not to the shareholders and especially not to any stakeholders listed
in s.172. This means that only the company can bring an action for a director’s
breach of duty.

While individual minority shareholders can bring a derivative
action under s.260, they are unlikely to embark upon the expensive and
difficult process in order to support an environmental or communal cause. Even
if they were granted leave of the Court to bring an action, the subjective
aspect of s.172 rears its ugly head again in making enforceability a challenge.

Furthermore, it is unlikely that shareholders will have any
inclination to ensure that s.172 is being followed by the directors. Employing any sort of compliance and
oversight of the director will incur cost, which could result in a weaker
dividend. Will the company, via its shareholders, really wish to enforce such
third-party obligations? 34
Ironically, it seems plausible shareholders are more likely to bring a derivative
action against a director that acted solely to the benefit of non-shareholders.

The result is a duty on the directors to take account the
interests of the stakeholders but no corresponding right for the stakeholders
to enforce that duty.35
 

As mentioned, the entirety of s.172 is based on decisions a
director makes in ‘good faith’. This is a very effective defence when any
decision is questioned. A director can release a statement explaining that he
did indeed consider the interests of the environment, the employees and the
suppliers, and still considered the decision to be in the best interests of the
company. The Courts will not intervene. The recent case of R (on the application of People & Planet) v HM Treasury36
stated 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 consideration
to environmental and human right matters.

The Government tried to hold directors to account through
the use of Business Reviews found in s.417, which are 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”.  However, there is evidence that boards are
being advised that a safe practice is to minute how any major decision
considered s.172, “bringing about the tick box defensive board room practices
it was hoped to avoid.”37
This is in spite of the explanatory notes of the 2006 Act stating it is not
enough for directors to pay lip service to the stakeholder interests under
s.172.38

 

Section 170(3) and s.170(4) add a great deal of uncertainty with
the former stating that the general duties found in S171-177 “are based on
certain common law rules” without elaborating which and the latter stating that
the duties “shall be interpreted and applied in the same way as common law
rules”. This lack of clarity if unhelpful. If the Act really was meant to
assist directors in understanding their duties, it could have completely
codified them and abolished the common law rules. Furthermore, the implication
from the choice of wording is that s.172 was not intended to mark a radical
departure in how directors conduct their business but rather suggests a “smoother
transition from one era to another.”39

Requiring directors to merely ‘have regard to’ the interests
of others is the long and short of the new approach to commercial morality that
is the ‘Enlightened Shareholder Value’. But as stated above, good directors would
already have done so, and the obligation is limited.

 

Final thoughts

The quote that opened this paper rings true: s.172 is
nothing more than an illusion to convince those listed in s.172 that their
interests are protected. This outcome is confirmed by an evaluation of the
Companies Act by the Department of Business Innovation and Skills in 2010. When
companies were asked “Has awareness of the duty to promote the success of the
company affected the behaviour of directors?” 64 per cent answered no. Perhaps
more disappointingly, whilst the study found that 79 per cent of directors were
aware of their new duty under s.172, 91 per cent did not believe the duty had
affected their behaviour.40
An explanation for this lack in change of behaviour is that the subjective test
found in s.172 acts as too powerful a defence when a director is accused of
breach. As such, a director can carry on making decisions as he did prior to
s.172, providing he merely states that he did have regard to the interests of
the stakeholders.

It is possible that in the not too distant future this could
change. The Government has taken recommendations from the Corporate Governance
Green Paper published last year about the need for further oversight over
directors. The Government in response intends to “Introduce secondary
legislation to require all companies of significant size (private as well as
public) to explain how their directors comply with the requirements of section
172 to have regard to employee and other interests”.41
They have invited the independent regulator Financial Reporting Council to
investigate an effective way to achieve this. However, at this time, no
suggestions have been made public so it is impossible to comment on whether
these changes will finally affect Corporate Social Responsibility the way
Margaret Hodge suggests.

1 Georgina Tsagas, ‘Section
172 of the UK Companies Act 2006: Desperate Times Call for Soft Law Measures’
(2017)

accessed 2 January 2018.

2 Stephen Griffin, ‘The
regulation of directors under the Companies Act 2006’ 2008 Company Law
Newsletter 1.

3 Susan McLaughlin, Unlocking
Company Law (3rd edn, Routledge 2015) 326.

4 Susan McLaughlin, Unlocking
Company 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 (9th
edn, Sweet & Maxwell 2012) 541.

7 David Cabrelli, ‘The
Reform of the Law of Directors’ Duties in UK Company Law’ (2008)
accessed 21 December 2017, page 10.

8 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9th
edn, Sweet & Maxwell 2012) 541.

9 John Lowry, ‘The
duty of loyalty of company directors: bringing the accountability gap through
efficient disclosures’ 2009 Cambridge Law Journal 607, 616.

10 Stephen Griffin, ‘The
regulation of directors under the Companies Act 2006’ 2008 Company Law
Newsletter 1.

11 John Lowry, ‘The
duty of loyalty of company directors: bringing the accountability gap through
efficient disclosures’ 2009 Cambridge Law Journal 607, 611.

12 Companies Act 2006, s 250.

13 see Allen v Hyatt 1914
30 TLR 444.

14 Aberdeen Railway Co
v Blaikie Brothers 1854 1 Macq 461, 471.

15 Re Smith and Fawcett
Ltd 1942 Ch 304.

16 Cobden Investments
Ltd 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 80

19 Andreas
Rühmkorf, Corporate Social
Responsibility, Private Law and Global Supply Chains (Edward Elgar 2015) 37.

20 1942
Ch 304

21 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9th
edn, Sweet & Maxwell 2012) 540.

22 David Kershaw, Company
Law in Context (2nd edn, OUP 2012) 383.

23 Alan Steinfeld, Blackstone’s
Guide to the Companies Act 2006 (OUP 2007) 84.

24 Andrew Keay, ‘The Duty
to Promote the Success of the Company: is it fit for purpose?’ found in Joan
Loughrey, Directors’ Duties and
Shareholder Litigation in the Wake of the Financial Crisis (Edward Elgar 2012)
54.

25 12.4 scope and nature of general duties, page 383

26 Stephen Griffin, ‘The
regulation of directors under the Companies Act 2006’ 2008 Company Law
Newsletter 1, 2.

27
Bourne on Company Law, page 176

28 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9th
edn, Sweet & Maxwell 2012) 540.

29 Alan Steinfeld, Blackstone’s
Guide to the Companies Act 2006, (OUP 2007) 84.

30 David Kershaw, Company
Law 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 Creating
Value, June 2006, para 4.46

33 http://webarchive.nationalarchives.gov.uk/20070628230000/http://www.dti.gov.uk/files/file40139.pdf

 

34 Stephen Griffin, ‘The
regulation of directors under the Companies Act 2006’ 2008 Company Law
Newsletter 1, 2.

35 Paul Davies and Sarah Worthington, Gower & Davies: Principles of Modern Company Law (9th
edn, Sweet & Maxwell 2012) 541.

36 2009
EWHC 3020

37 Susan McLaughlin, Unlocking
Company Law (3rd edn, Routledge 2015) 339.

38 Explanatory
Notes to the Companies Act 2006, para 328.

39
Dark dark book, 185

40
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/31655/10-1360-evaluation-companies-act-2006-volume-1.pdf

41 http://www.wlrk.com/docs/corporate-governance-reform-government-response.pdf

Written by
admin
x

Hi!
I'm Colleen!

Would you like to get a custom essay? How about receiving a customized one?

Check it out