Directors Duties Towards Stakeholders

Introduction

It is established that the role of directors and officers under the Corporations Act is to discharge their duties and power to act in the best interest of the corporation and for a proper purpose (s 181). In other words, they are expected to exercise their duties in the best interests of shareholders and to maximise wealth. However, recent disputes have surfaced as to whether the law needs to be clarified and to require directors’ duties to incorporate responsibilities that go beyond the shareholder interest responsibility. That is, whether the law should require directors to take into account the interests of suppliers, customers, and the broader community when making decisions.

It has been argued by legal critics that the existing laws should remain unchanged as there is already sufficient flexibility within case law that permits directors and officers to have regard for the interests of shareholders and other stakeholders by exploiting corporate opportunities that are the long-term interests of the company. A legislative amendment to oblige directors to take into account stakeholder interests as part of a statutory duty to the company could have adverse consequences in confusing the primary role of directors, innovation in corporate responsibility practices, and therefore is unfeasible, unnecessary and potentially counterproductive.

Additionally, many non-shareholder activities in regards to suppliers and customers and the community are perceived as a means to further the organisation’s image and prestige. Moreover, the activities of stakeholders are seen as opposing and contrary to the best interests of the corporation, that is, the prime interests of shareholders. However, this is not the case. Taking into account stakeholder interests should not be seen as a compliance approach or through a “narrow” lens as one legal commentator proposed but recognising it as part of what is best interest for the company in the long run.

Furthermore, it is suggested by most legal commentators that corporations should take the ‘stakeholder-oriented’ approach to corporate governance. This allows directors to make corporate decisions whilst incorporating stakeholder interests at their own discretion and should ultimately be left to the company and its own integral governance arrangements as oppose to complying with external regulations in the form of rules by the legislature. By mandating directors’ duties to take into account stakeholder interests will not necessarily result in promising outcomes, as the requirements in addition to the current legal framework will force directors to take the ‘tick the box’ approach, which is not desirable and defeats the purpose and intent behind corporate social responsibility.

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Current framework on Directors’ Duties: The existing legal framework does not constrain directors from taking into account stakeholder interests when making decisions.

The recent calls for reform to the Corporations Act resulted from the general belief that directors are simply focusing on increasing shareholder investments and ignoring the interests of stakeholders. However, with the decisions made by the controversial company, James Hardie, has proved that this is not the case. After encountering reputational lost as well as financial decreases in regards to share prices for protecting its shareholder interests, and disregarding the interests of asbestos victims by under-funding the medical research and compensation fund. As a result of this, James Hardie’s later decision has proved to be a beneficial one to the survival of the company by recognising the interests of its stakeholders (the asbestos victims) in joining up with the NSW Government and the ACTU, which in turn have boosted the company’s share price and overall financial stability. This therefore has benefited the overall best interests of the company and its shareholders. As a result of the James Hardie’s crisis and recent reforms in corporate governance which has deterred companies from excluding stakeholder interests but instead they are encouraged to foster relationships with stakeholders as they are also an important factor in efficient performance.

As stated above, companies already have sufficient laws that guard them in regards to stakeholders in making corporate decisions. In particular, listed companies in Australia are required to conform with the Australian Stock Exchange (ASX) Corporate Governance Council’s ‘Principles of Good Corporate Governance and Bes Practice Recommendations’, which requires companies and directors to produce an annual report revealing the extent to which they have followed the recommendations during a particular period. Additionally, companies are required to have in place on their website outlining ways they would deal with stakeholder interests under a ‘Code of Conduct’ and ‘Ethics’. A Code of Conduct, which involves setting out the values and important policies of the company, can help directors take into account the interests of stakeholders when making decisions as well as to assist in weighing out the company’s risks management practices.

In regards to the 28 Recommendations established by the ASX of ‘Good Corporate Governance Principles’, Principal 10 seems to have the most regard for stakeholders as it dictates that in order to have good corporate governance, companies need to “recognise the legitimate interests of stakeholders”. It further suggests that directors also have the duty to establish ‘tone and standards’ for the company and also keeping adequate watch on these standards.

Not only do listed companies in Australia has to conform with corporate governance standards either contained in the Corporations Act or ASX Listing Rules, but non-listed companies such as government departments and not-for-profit organisations, under Standards Australia are required to develop effective corporate governance procedures. In 2003, the Australian Standard created a non-rigid guidance called the ‘AS 8003’, which sets out the elements guided to implementing and achieving effective Corporate Social Responsibility. The purpose of the standard is for companies to maintain a culture of corporate social responsibility through having a self-regulatory approach that can be monitored and assessed within the company. (pdf from standards aus). Additionally, in order for companies to meet legal obligations, Standards Australia has also developed other standards to assist companies in implementing an effective corporate governance in regards to risk management, Occupational Health and Safety (OH&S), and environmental management just to name a few.

Furthermore, in conjunction with the standards and regulations discussed above, there are other regulations in regards to corporate governance, which requires directors to take into account stakeholder interests as part of fulfilling their overriding duty to act in the best interests of the company. Under Section 180 of the Corporations Act outlines the duties of directors to act in the best interests of the company. In particular, Section 180(1) of the Corporations Act provides that a director must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise. Additionally, under Section 181; a director must exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose.

Section 180(2) provides that a director meets their duty of care and diligence where they make a business judgement that is in good faith for a proper purpose; where they don’t have material personal interest; and they inform themselves about the subject matter of the judgement to the extent they reasonably believe to be appropriate, and that they rationally believe the judgement is in the best interests of the company.

In regards to director’s fiduciary duties with the company, companies are also required to conform with other range of Commonwealth, State and Territory statutes in regards to health and safety, anti-discrimination laws, industrial relations, equal opportunity and environmental impact laws. In particular, environmental impact laws such as the Environment Protection and Biodiversity Conservation Act (EPBC Act) 1999, which provides a framework to protect and manage matters of national environmental significance. Additionally, in 2009, a company Rocky Lamattina and Sons Pty Ltd were fined $220,000 for clearing trees that were likely nesting habitat for the endangered south-eastern red-tailed black cockatoo. It was held by Justice Mansfield: “…it was appropriate to fix an amount that would have a strong deterrent effect and demonstrate that such conduct was seriously regarded by the community and would not be tolerated by the court.” Therefore, directors’ duties involve exercising care, skill and diligence in the best interests of the company, that being the company as a whole, reflecting wider expectations.

“Australian courts have successfully applied directors’ duties to different circumstances and adopted the law where appropriate (for example, gradually increasing the standard of care and diligence expected of directors as community expectations have increased). Importantly, the existing law allows directors to consider the interests of stakeholders other than shareholders … A fundamentally important issue is how directors balance the interests of various stakeholders in the company and the role of the law in this process”. (ramsay (2005), directors’ duties and stakeholder interests. Company Director, 21 May 2005)

In summary, with both the current statutory obligations and industry standards in place that encourages directors to have regard for stakeholder interests as well as shareholders, there is no need for a reform to the Corporations Act in order to formally oblige directors to take into account stakeholder interests, because as previously discussed, corporate decision makers are not constrained by existing legal framework. The law does not impede companies from taking account of the interests of other stakeholders. With that being said, fostering relationship with stakeholders and potential shareholders is now a vital part of the existing legal and corporate governance framework in Australia.

Over-regulating could damage the objective of ‘Best interests of the company’.

In further discussing whether the Corporations Act should be clarified and revised to require directors to uphold the interests of specific classes of stakeholders when making corporate decisions, it is vital to discuss the main objective of a company, that is, to act in the best interests of a company. It is believed that acting in the best interests of a company is to act in the best interests of the owners of the company (i.e. the shareholders). As their duty is to act in the best interests of the company, directors must consider both existing and future shareholders; this requires them to maintain both the short-term and long-term growth of the company. With that in mind, directors are also required to consider both the internal and external governance of the company. As Ford, Austin and Ramsay noted: “Although there may be no direct obligations in company law on directors to take extraneous interests into account, it does not follow that directors cannot choose to do so … Management … may be justifiably concerned to ensure that the company is a good corporate citizen”. (LexisNexis, Chatswood, 2005, p 275)

In the report by CAMAC for ABA, ABA contends that directors should make decisions in good faith and for the proper purpose that benefits the community, consumers and environment. It is noted in the report that where there is a lack of attention is paid to the shareholders of a company, this could be considered as breach of the duties to the Board of the company. However, where the interests of stakeholders are defective, this would also be considered not to be acting in the best interests of the company and could also have drastic consequences and expose the company to risks.

Recognising the significance of stakeholder interests and communicating it towards the employees and shareholders on how it will ultimately benefit the company in the long run as well as improving corporate image and growth. Additionally, in the article by James McConvill, he contends that companies should not approach stakeholder responsibility through a “narrow lens” but acknowledging their interests as part of what is best for the company, both in the short-term as well as long-term corporate sustainability.

“Not only will the shareholders and other investors benefit, but the company will continue to offer jobs to employees and serve the community in various ways.” (Corporations Law: a fragile structure article, by Bob Baxt 2005)

Moreover, it is argued by the ABA in the CAMAC discussion paper by amending the Corporations Act to contain a provision to mandate a directors’ duty to consider the interests of stakeholders may stifle the way in which corporate decisions are made and lead to inefficient decisions, this could have detrimental effect on both shareholders and stakeholders, thus, impacts on the overall duty of directors to act in the best interests of the company. As further pointed out by the ABA, the Corporations Act, specifically under Section 181(1) covers enough to authorize directors to take into account shareholder interests and other stakeholders, and conveys enough instructions for a director to act in the best interests of the company. This further supports the argument that company law already allows for directors to have regard for stakeholder interests. Therefore, by amending the Corporations Act to further oblige directors will unlikely change the corporate behaviour of directors to consider the interests of stakeholders.

In addition, by conforming to legal requirements to take stakeholder interests into consideration when making decisions would create risks on the decisions made by the Board as the company may be challenged by the interests of small minority groups which do not correspond with the overall best interests of the company or responsibility. Additionally, in the quest to satisfy legal requirements, directors may become distracted by court proceedings and other legal actions in order to conform with the laws that in turn they there could be a shift in focus of the Board of directors and management, which could result in not fulfilling their duties and responsibility of acting in the best interests of the owners of the company (shareholders). As a result, this could have detrimental effect on both the shareholders and the broad stakeholders.

“To require directors to sacrifice their primary obligations would be to further stifle the entrepreneurial spirit that is seriously in danger of being extinguished as a result of over-regulation.” (bob baxt article)

To further elaborate on the argument above, with the implementation of a mandatory provision requiring directors to consider stakeholder interests would most likely to turn companies in taking a compliance system to corporate social responsibility, that is, a ‘tick the box’ approach, which does not follow the concept of corporate social responsibility. (parliamentary publication http://www.aph.gov.au/Senate/committee/corporations_ctte/completed_inquiries/2004-07/corporate_responsibility/report/b02.htm)

Self-regulation and Imposed Law

Companies are slowly deterred from excluding stakeholder interests and are now moving towards building relationships and upholding stakeholder interests when making decisions. This proves that directors will gradually engage with stakeholders without rigorous imposition of laws. It has been argued by many legal critics, in particular James McConvill as well as in the discussion paper by the ABA for CAMAC that these requirements and regulations should be dealt with solely by the company.

The sole duty of a director is to act in the best interests of the company and it is in their authority and a matter for the Board to decide, when, and what stakeholders should be taken into account. They should have the flexibility and ability to make decisions and balance competing interests in good time. As previously discussed above, the issue with James Hardie, and their subsequent decision to take into account asbestos victims was not done on the imposition of law but was at their own discretion in wanting to further stabilise their company. As articulated by the Senate Standing Committee on Legal and Constitutional Affairs (1989) (Company Director’s Duties: Report on the Social and Fiduciary Duties and Obligations of Company Directors – November 1989 para 6.51) as to whether a mandatory provision is necessary in regards to directors’ duties:

“If company law were to impose new and, at times, contradictory duties (such as looking after interests, who may be directly opposed to those of the shareholders) directors’ fiduciary duties could be weakened, perhaps to the point where they would be essentially meaningless.”

Additionally, better outcomes would result if companies were given the flexibility to implement stakeholder oriented approach as a central part of their decision making process instead of replacing it with a mandatory provision under imposed law. (page 100 of 3 assumptions). Moreover, by implementing the mandatory provision forcing directors’ to comply would have adverse results, that is, directors would be not appreciate stakeholder interests and would only comply with the regulations due to the consequences of sanctions and threats. Therefore, in the 3 assumptions article, McConvill suggests that forming a corporate culture, which involves stakeholder oriented approach, would encourage directors to uphold stakeholder interests. This would have a better result on the performance of the company rather than complying with imposed laws. It is also further supported by Murphy and Wrick in the Harvard Business School Paper, which they suggested that stakeholder interests should incorporated into the company’s long-term objective and approach. Moreover, companies should create statements of vision and strategy that would encourage directors to achieve the objective to improve the company’s image and growth. (Murphy and Wrick (K J Murphy and E G Wrick, ‘Remuneration: Where We’ve Been, How We Got Here, What Are the Problems and How to Fix Them’, Harvard Business School Research Paper, July 2004)

Moreover, James McConvill in his article, proposes that instead of prescribed regulations, companies should implement ‘norms of best practice’ that would involve all the key players of the organisation; the Board, and executives. This supports the notion that it is unnecessary for formal rules, when the company at its own discretion, can create and achieve its own ‘self-regulatory objectives’. As noted in the Cooney Committee (Cooney Report, at [2.25]. The report is available online at http://www.takeovers.gov.au/content/542/Download/companyd.rtf (accessed on 8th April, 2010): “Self-regulation, if it works, in many aspects is better than regulation imposed by law.”

An example of an industry that develops its own ‘stakeholder oriented approach’ is the Banking industry. The banking industry develops programs as a way to engage with its stakeholders and making it part of their corporate social responsibility. Some of their day-to-day programs in engaging with the broad stakeholders include customer research; this is to help them understand the needs and wants customers. Additionally, they also have employee consultations as well as stakeholder forums to manage and meet concerns and expectations. Other programs include community service principles such as financial literacy and taking part in philanthropic activities (i.e. sponsoring cultural events).

Conclusion

Overall, due to the existing legal framework in Australia, as outlined in the Corporations Act as well as the ASX Listing rules; these have shown to be sufficiently effective enough in detailing the overriding duties of directors to take into account stakeholder interests in the best interests of the company. Additionally, by not excluding the interests of stakeholder in the overall best interests of the company could benefit the company in both short-term and long-term sustainability and profitability. By building healthy relationships and developing corporate strategies without imposition of laws would allow directors to freely act instead of taking the ‘tick the box’ approach. Thus, a rigorous law would only have adverse consequences by decreasing directors’ abilities to make efficient decisions for the best interests of the company. For the reasons outlined above, the Corporations Act should not be revised or clarified to add another provision as the result would only stifle the originality of companies in making decisions and balancing the interests of stakeholders.