3 The Role of Directors
10. One of the areas where the accumulation of
case law had become confusing was that of the duties of company
directors. The Company Law Review Steering Group concluded that
the law on this matter had become unclear both for the directors
themselves and for those trying to hold them to account. Furthermore,
the Review Group expressed the opinion that the law ought to be
revised to bring it into line with existing best practice, encouraging
directors to look beyond maximising short term returns to institutional
shareholders towards the longer term and to recognise the roles
that relationships with other stakeholders, such as employees,
suppliers, customers and others affected by the companys commercial
activities, play in the success of the company.
11. The Review did not set out detailed specifications
concerning how directors should conduct their everyday activities;
these were properly a matter for each company to determine and
should continue to be set out in the contracts of employment of
the individual directors. Instead, the aim was to provide a generic
statement of duties, sufficiently broadly defined to be applicable
to directors of companies of every size.
12. In early Review documents the debate about
how to approach defining directors duties produced two distinct
positions. They were labelled 'Enlightened Shareholder Value'
(ESV) and 'Pluralist'.
13. The ESV approach towards defining directors'
duties maintained that the primary duty of a company director
was to maximise value for the companys shareholders. However,
it added that other relationships were significant in this and
therefore needed to be taken into account when judging how to
carry out this duty. The interests of employees, customers, suppliers,
and local residents, as well as the environmental impact of the
company's activities and its good standing in the eyes of the
public, all had to be considered when judging what was in the
interests of shareholders.
14. Such an approach would require no fundamental
change to existing company law, which obliges directors to act
in the interests of members of the company; and therefore any
revision of the law along ESV lines would consist of codification
rather than significant reform.
15. The pluralist approach to defining directors'
duties would require a more fundamental change in company law.
Where the ESV approach would have directors consider the impact
on other stakeholders of their attempts to produce shareholder
value, the pluralist approach would force directors to consider
the interests of stakeholders in their own right. Shareholders
would become merely one of a number of parties whose interests
the directors would weigh against each other when making decisions.
16. The Review Group ultimately rejected the
pluralist approach, considering that it would confuse the issue
of directors' duties, giving directors little in the way of guidance
in decision-making. It also ran the risk of creating a litigious
climate for business where those parties who felt they had not
been treated as they would have liked by a company's directors
sought recompense through the courts.
17. The White Paper has drawn on the ESV approach
of the Review Group's final report and has largely adopted its
proposed statement of draft duties,
the relevant section of which states:
"A director of a company must in any given case
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
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.
(1) In this paragraph, 'the material factors' means
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; and
all such other factors as a person of care and skill
would consider relevant, including such matters in Note (2) as
he would consider so.
(2) Those matters are
1. the company's need to foster its business
relationships, including those with its employees and suppliers
and the customers for its products or services;
2. its need to have regard to the impact of its
operations on the communities affected and on the environment;
3. its need to maintain a reputation for high
standards of business conduct;
4. its need to achieve outcomes that are fair
as between its members."
The majority of the evidence we received was generally
supportive of both the ESV approach towards defining directors'
duties contained in the White Paper and to the draft statement
of directors' duties it suggests.
18. The pluralist approach did, however, retain
some strong advocates who did not consider the ESV approach to
provide a sufficiently robust framework to guarantee that the
interests of those other than shareholders would be properly taken
into account in the company decision-making process. Supporters
of the pluralist approach
argued that in order to achieve adequate recognition of the interests
of other stakeholders, it was necessary to oblige directors to
consider these interests independently of the interests of shareholders.
It was also suggested that broadening the range of groups to
whom directors owed a duty would 'dilute' the pressure on companies
from institutional investors to provide short term returns and
would thus improve long term economic performance.
19. There was disagreement even amongst its advocates
about how pluralism might best be implemented. The approach initially
favoured by the TUC would have seen representatives of the various
stakeholder groups included in the companys decision-making process.
This was part of a larger agenda of company reform that implicitly
seemed to challenge the unitary board model, the standard UK single
board comprising both executive and non-executive directors.
The Corporate Social Responsibility Coalition (CORE) supported
the introduction of a 'duty of care' along the lines of that encapsulated
in existing Health and Safety legislation, where there was not
necessarily direct input from the stakeholders into decisions
of company boards but the company, and the directors, remained
responsible for the impact of their activities on other stakeholders
and were forced to consider them fully.
20. In practice, however, even the advocates
of pluralism felt that the ESV approach represented progress on
existing company law and the TUC acknowledged that, if the ESV
approach was implemented sufficiently robustly, the practical
differences between it and the pluralist approach would be small.
Nevertheless, the underlying principles of ESV and pluralism
are not the same and the debate between the advocates of each
position represents a fundamental disagreement about the purpose
of company law. Those supporting ESV do so basically because
they believe that company law exists to promote the long-term
success of companies which, in their view, requires the management
of companies to have regard to factors such as goodwill that involve
interest groups other than shareholders. The pluralists, on the
other hand, while also believing that companies will benefit from
taking account of wider interest groups, regard company law as
an instrument for forcing companies to behave in particular waysfor
example, requiring companies to follow good environmental, employment
and social practice.
21. Our witnesses differed in their interpretation
of the White Papers draft statute. Some saw it as a simple restatement
of the duty of directors to maximise shareholder value.
Others saw it as "putting the company not the shareholders
or other stakeholders at the heart of the [corporate governance]
these are not necessarily incompatible statements, they do indicate
a divergence over the degree of change that might be expected.
This is further highlighted by the TUCs observation that the difference
between the two models of director's duties might be small, depending
on how seriously the relationships with groups other than shareholders
were taken. Overall,
then, there is considerable scope for interpretation and it is
therefore hard to anticipate the impact of the legislation as
currently drafted. It does seem that those seeking an increased
input into company decision making by a broader range of stakeholders
may be disappointed. However, whilst their direct input might
be minimal, under the White Paper's proposals there is an onus
on directors to take such stakeholders' interests into account
and to consider the impact of their decisions on other interested
parties as well as shareholders.
22. We consider that the aim of the law should
be to provide a framework to promote the long term health of companies,
taking into account both the interests of shareholders and broader
corporate social and environmental responsibilities. The specific
duties of care required of companies to their employees and society
at large will normally best be set out in other legislation, covering
areas such as health and safety, environmental and employment law.
However, the proposed statement of directors' duties in the White
Paper does represent a step forward as, for the first time, it explicitly
recognises that good managers will have regard to a broader range
of considerations than value to shareholders, which on its own may
lead to short-termism. The White Papers formulation leaves the responsibility
to make decisions about the company's future where it should beon
the directors, not on the courts.
Duties to creditors
23. A notable area of divergence
between the Review Group and the White Paper is over directors'
duties to creditors. The Review Group recommended the inclusion
of a statement of duty of directors towards creditors in the case
of insolvency. This would hold the directors financially liable
if, once insolvency was imminent, they failed to take all reasonable
steps to minimise the loss to the company's creditors.[
This statement was largely derived from existing insolvency law
and so did not amount to new law in itself. The White Paper rejected
this recommendation on the grounds that it conflated company law
and insolvency law.
24. The Review Group also raised
the possibility ofthough reached no conclusion onintroducing
a duty to act in creditors' interests, jointly with shareholders',
where insolvency was not necessarily imminent but was a possibility.
This proposal was rejected in the White Paper on the grounds that
any decision about the point at which insolvency was a possibility
rather than imminent would necessarily be an extremely finely
balanced one. The risk was that directors, fearing personal financial
liability, would opt for insolvency at the first hint of trouble.
The White Paper claimed that such a measure would discourage risk-taking
by directors and run counter to the 'rescue culture' the Government
favours (and which is the main theme of the Enterprise Act 2002).
The White Paper does raise the possibility of including creditors
in the list of stakeholders but reaches no firm conclusion.[
25. We see no need to include
a duty to creditors in the statement of directors' duties. This
statement is intended to lay out a broad, generic set of obligations
and not a detailed list of the legislation which directors might
be required to adhere to under certain circumstances. The
duties owed to creditors are derived not from company law but from
insolvency law. In the same way that the statement of directors'
duties does not include the detailed obligations they are under
which derive from health and safety legislation, environmental legislation
or employment legislation, neither need it include obligations under
insolvency law. Changes to these obligations are not ruled out but
they should be addressed through the reform ofin this caseinsolvency
law rather than company law.
12 Review Group Final Report, para
Company Law Review Steering Group, Modern
Company Law: For a Competitive Economy - Developing the Framework,
DTI (March 2000), paras 3.30-3.31 Back
Apart from the section on duties to creditors
which is discussed in paras 23-25 below Back
White Paper, Volume II, Schedule 2, p 112-113 Back
For example, Ev 1 (Association of British
Insurers (ABI)), Ev 4 (Centre for Tomorrows Company) and Ev 26 (Institute
of Chartered Secretaries and Administrators (ICSA)) Back
Chiefly the TUC and CORE Back
Q 23 (TUC) Back
Elsewhere in Europe the standard board model
requires companies to have two boards, one comprising executive
directors who manage the company and a second comprising representatives
of the various stakeholder groups who ensure that the management
board is acting in their broader interests. Back
Q 256 (CORE) Back
Q 9 (TUC) Back
See, for example, COREs complaint that the
list of directors duties contained no requirement to minimise, wherever
practical, the social and environmental impacts of a companys activities:
Ev 9. Back
Qq 273-276 (CBI) Back
Ev 4 (Centre for Tomorrows Company) Back
Q 9 (TUC) Back
See Qq 81-83 (Law Society) and 199 (IoD) Back
Review Group Final Report, paras 3.8-3.14 Back
Para 3.13. The ABI is of the same view (Ev
1), but the ICSA agrees with the Review Group (Ev 26). Back
29 Para 3.14 Back