section 172 notes for exam PDF

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UK Company Law has traditionally given primacy to the interests of shareholders. Prior to the 2006 Act, directors’ duties were based on common law rules and equitable principle including a duty to act in the interest of the company, interpreted as the best interests of present and future shareholder...

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UK Company Law has traditionally given primacy to the interests of shareholders. Prior to the 2006 Act, directors’ duties were based on common law rules and equitable principle including a duty to act in the interest of the company, interpreted as the best interests of present and future shareholders. Shareholder value reflects the view that shareholders are the owners of the company and bear the residual risk.

There is some merit in giving shareholders status in company law as other parties may be protected elsewhere in legislation. But it is not true to see them as bearing the sole residual risk and too simplistic to see companies as a nexus of private contracts when their impact on the wider community may be huge. However, there were suggestions for inclusion of more stakeholders’ interest. The Company Law Steering Group (1999:37) called for a shift in the shareholder value doctrine and suggested an enlightened shareholder value that is, striking a balance between the competing interests of the different stakeholders in order to benefit the shareholders in the long run (Company Law Review Steering Group (1999:37)). The Steering Group favored a restatement of duties in which there would be primary shareholders but requires a long-term approach and permits the director to consider other interests as the best way of securing prosperity and welfare overall. This was encapsulated in s.172 (1) of Companies Act 2006 which came into force on October 1, 2007.

Success in s.172 is to be determined on a company-by-company basis. It is for the directors to interpret the company’s objectives and make practical decisions about how best to achieve them. The question of what will promote the success of the company is one for the director’s good faith judgment. This appears to be a purely subjective test but it seems highly unlikely that this interpretation will stand primarily because it makes monitoring of directors practically impossible. Since in s.170 (3) and (4), the stated that regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties’ an objective element is likely to be incorporated. In Charterbridge Corporation Ltd Vs Lloyds Bank Ltd Pennycuick J believed the court should consider whether an honest and intelligent man in the position of the director could have reasonably believed the transaction was for the benefit of the members. Time will tell whether this honest and intelligent man’s approach will be adopted and whether this intelligent and honest man interprets this duty for the sake of shareholders only or takes into account shareholders' issues.

S.172 (3) states that the duty to promote the success of the company has effect subject to any rule of law requiring directors to act in the interests of creditors. In this respect English and Australian courts have reasoned that where a company is insolvent directors must have regard to the interests of the creditors (West Mercia Safetywear Ltd V Dodd).

Stakeholder’s standing: It is proposed that the Companies Act 2008 has attempted to establish a midway point between a shareholder and stakeholder approach; Parliament’s aims seem clearly apparent in the White Papers and Explanatory Notes surrounding the Act. It appears that s.172 (1) may be of minimal use to stakeholders because it will be, at best, extremely difficult to advance an action or to prove a breach. This raises the prospect that Parliament has created a right without a remedy, which the law abhors.

Social and environmental concerns were a major focus of parliamentary debates over the proposal to replace a director’s traditional duty of loyalty with a duty to promote the success of the company. Social and environmental concern led to the litigation in R, (on the application of People & Planet) Vs HM Treasury. People & Planet (NGO) objected to HM Treasury’s policy as inconsistent with s.172. While “the environment is explicitly recognized in s.172 (1) (d) CA 2006, or the “desirable of the company maintaining a reputation for high standards of business conduct” within s.172 (1) (e) CA 2006. S. 172 (1) (f) not only requires directors to have regard to impact on the environment but also to the need to act fairly as between members of the company. So, it is hard to see how the policy which protects shareholders can be said to be inconsistent with s.172.

Stakeholder’s issue in defence by directors: S.172 CA 2006 however enables directors to take other interests into consideration by providing a defence if shareholders challenge a stakeholder’s approach. However, their primary goal remains the interests of members. Indeed, it is true that the corporate governance regime in the UK ensures that stakeholders’ primacy is maintained.

Shareholder’s activism: Director’s cannot easily get away with increased payment as this will be monitored by independent non-executive directors serving the interest of shareholders. Shareholder ‘Say on Pay’ a binding vote at least every three years is mandatory as to the company’s remuneration policy- i.e., directors can only make payments that are in accordance with a remuneration policy that has been previously approved by the shareholders (The Enterprise and Regulatory Reform Act 2013, sections 79-82). Shareholders will be ever vigilant to enforced codified directors’ duties and the threat of takeovers will be that shareholders' interest remains paramount. Increasing shareholder activism is apparent in the UK Stewardship Code 2012. But recent reforms proposed the UK Corporate Governance Code aimed to strengthen the voice of the company’s stakeholders. The hard law will be in the form of new legislation that will: a) require all companies of a significant size to give a more detailed explanation in their annual reports about how their directors apply s.172 CA 2006; b)

oblige quoted companies to provide some information, in their annual remuneration reports, about the ratio between the pay of the company’s CEO and the average pay of the company’s UK workforce. Such legislation will definitely make the non-executive directors take the role seriously to take into account stakeholders’ interest to promote the success of the company in the long run.

The soft law will be in the form of changes to the UK Corporate Governance Code, which will require listed companies to explain which of three alternative methods they have adopted to strengthen the voice of the company’s stakeholders. Those three alternatives are: a) to designate a non-executive director as the voice of employees; or, b) to create an employee advisory council; or, c) to allow employees to appoint a director. If the company chooses not to adopt any of these three alternatives, it will have to explain why it has chosen not to do so. This reflects the ‘comply or explain’ approach on which the UK Corporate Governance Code relies.

While s.172(1) cannot guarantee directors will consider third party interests, it must be seen as a normative measure which, combined with stakeholder pressure, the prevailing commercial climate and a few enlightened shareholders, will firmly encourage a more inclusive, longer term view of what will promote success....