Select Committee on Trade and Industry Sixth Report


3 The Role of Directors

Directors' duties

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.[12]

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.[13]

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,[14] 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.

"Notes

(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."[15]

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.[16]

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[17] 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.[18] 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.[19] 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]

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.[21] 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 ways—for example, requiring companies to follow good environmental, employment and social practice.[22]

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.[23] Others saw it as "putting the company not the shareholders or other stakeholders at the heart of the [corporate governance] process".[24] Whilst 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.[25] 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.[26]

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 be—on 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.[ 27] 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.[28]

24.  The Review Group also raised the possibility of—though reached no conclusion on—introducing 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.[ 29]

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 of—in this case—insolvency law rather than company law.


12   Review Group Final Report, para 3.11 Back

13   Company Law Review Steering Group, Modern Company Law: For a Competitive Economy - Developing the Framework, DTI (March 2000), paras 3.30-3.31 Back

14   Apart from the section on duties to creditors which is discussed in paras 23-25 below Back

15   White Paper, Volume II, Schedule 2, p 112-113 Back

16   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

17   Chiefly the TUC and CORE Back

18   Q 23 (TUC) Back

19   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

20   Q 256 (CORE) Back

21   Q 9 (TUC) Back

22   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

23   Qq 273-276 (CBI) Back

24   Ev 4 (Centre for Tomorrows Company) Back

25   Q 9 (TUC) Back

26   See Qq 81-83 (Law Society) and 199 (IoD) Back

27   Review Group Final Report, paras 3.8-3.14 Back

28   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


 
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Prepared 13 May 2003