Directors Duties and Environmental Issues

Introduction

In 2006, the Companies Act has undergone a dramatic metamorphosis whereby directors’ duties were mostly affected. For the first time directorial duties were statutorily codified and the legislator pioneering sustainable development in company law provides in Section 172(1) of the Companies Act 2006 that henceforth social, environmental and ethical factors should be considered when exercising theses duties.

The embedding of corporate social responsibility considerations in a company legislation framework is considered as a strong signal sent to the business community that these considerations are critical issues which need to be dealt with by a radical change of corporate attitude. According to the inquiries conducted by the Environmental Audit Committee’s, into environmental crime, the criminal justice system currently offers no effective deterrent. The likelihood that an offender will be caught is relatively slim. The penalties handed down, in the vast majority of the comparatively very few cases that make it to court, are derisory and in no way reflect the damage caused to the environment or indeed the cost of making good that damage. In 2008 the Environment Agency took 250 companies to court. More than £3 million was awarded in total fines and yet environmental crimes are increasing. The solution therefore seems to be located ab initio at the decision making process. A memorandum from the Economic Industries Commission stated that “making directors and other decision-makers in a company responsible for the activities of their companies, is increasingly regarded as an effective mechanism for increasing standards.

Pursuant to the s. 172(1) director has to exercise his duty in the way he or she considers, in good faith that would be most likely to promote the success of the company for the benefit of its members as a whole. It lists a number of matters to which, amongst other matters, the directors must have regard to. One of these factors is the “impact of the company’s operations on the community and the environment.” The then Secretary of State for Trade and Industry said that “companies [are expected] to create wealth while respecting the environment and exercising responsibility towards the society and the local communities in which they operate. The reputation and performance of companies which fail to do these things will suffer.”

In order to understand the legal upheaval created by the reform, it must be reminded that prior to the Act, UK’s company law corresponded with a model in which companies are managed for the benefit of the shareholders, and confers on the latter ultimate control of the company, to the extent that “the directors are required to manage the business on their behalf…” This model is known as the shareholder value theory or shareholder primacy. It is based on the members’ wealth maximization norm. In the previous common law’s position the director of companies have owed duties of loyalty and good faith to act bona fide for the benefit of their companies as a whole. That position has been equated with the shareholder value principle: companies exist to maximize the interests of the shareholders ahead of any other interested parties who might have claims against the company. The shareholder’s value principle has been challenged by those holding a communitarian or progressive approach to company. They argued that directors should be required to consider the interest of other besides shareholders, those whom we can call stakeholders such as employees, creditors, suppliers, customers and all the communities in which the company operates. The stakeholders’ approach, inter alia, those directors are to conduct the affairs of the company for the benefit of all stakeholders, and that they should balance the interests of a multitude of stakeholders (including the shareholders) who can affect or be affected by the actions of the company.

The Company Law and Reporting Commission has come to a compromise by adopting a middle way approach, the “enlightened shareholder value”, which it fell would better “achieve wealth generation and competitiveness for the benefit of all”. This view is clearly based on shareholder value, but does not support exclusive consideration of short term financial benefits. In brief, through the 2006 Act UK’s legislator tends one hand to preserve its shareholder-centric view tradition and on the other hand, it recognizes the significance of corporate social responsibility and intends to justify its importance by virtue of a regulatory line. This is a tightrope act.

Regulation’s methods were hoping to be more efficient that the CSR voluntary based OECD approach initially adopted by UK and which was mainly relied on the business-led agenda. In year 2000, all large UK-listed companies were urged by the government to publish an environmental report by the end of 2001. It was revealed that 118 out of 250 FTSE companies did not report on their environmental performance. UK government’s earlier attempt of the 1991 campaign “Making a Corporate Commitment” is another failing example of the voluntary approach. During this campaign, the UK’s top 2,000 businesses were required vainly to sign a declaration committing them to set energy saving targets.

The fact that no enforceable rewarding or punishing mechanism was attached to those political invitations to UK’s corporations to adhere to these ecological schemes, can explain these failures. “Environmental obligation or environmental managerial responsibility” is a very recent concept. However, surprisingly there is no express enforcement mechanism attached to s. 172(1)(d) in CA 2006 neither. Does that mean that the environmental consideration mentioned at the contentious section is more a recommendation than a legal obligation?

Based on this lack of proper enforcement mechanism, it will argued that s. 172(1) poses little threat to directors’ intent on maximizing profits at the expense of stakeholder relationships and renders the provision impractical. But, however it provides a strong normative element which, coupled with other forms of stakeholder pressure and the prevailing business climate, will encourage boards to consider an increasing range of interests. Besides, there are several provisions in the Act which concern environmental issues in the corporate context.

Therefore, in this paper, we will show that the new provision of s. 172(1)(d) fails as to its finality for making corporate directors more ecological and despite the might of law to challenge managerial business strategy prejudicial to environment, directors’ liability can be severely limited not say exempted in a way that deprives the law of its substance.

I The Impraticability Of Ca 2006, S. 172(1)(D)

II Limitations To Directors Liabilities

I The Impracticability Of Ca 2006, S. 172(1)(D)

For the first time UK’s company law provides what must be the objective of the directors, in conducing the affairs of the company. Prior to the statutory law reform, the case law has generally stated that the directors need to act in the “best interests” of the company. “Best interests” has been assessed on a case to case basis without any precise definition. Paradoxically, it does not appear that the statutory terms are much more explicit not to say meaningless.

Pursuant to s. 172(1)(d) “a director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to inter alia the impact of the company’s operations on the (…) environment ”.

The first thing to note is that s. 172(1) grants an unfettered discretion to directors as to the routes they can employ to promote the success of the company. But, there is no indication in the law as to the meaning of “the success of the company”. Its signification can be determined by reference to the sentences “have regard to” and “good faith”. They laid down the modus operandi for the directors to exercise their duties.

According to the Ministerial Statements the expression “have regard to” means “give proper consideration to …”. This definition is extremely vague too. Does this involve a subjective (from the director own vision) or an objective test (a bona fide agent at the place of the director)?

According to CERIONI “the obligation to have regard” implies that the aforesaid factors have already been identified. Following this author’s analysis, attention is placed on the “ex post consequence” and would seem to suggest that failure to have regard may consist of a “negligence in the decision making or a lack of full analysis after the factors have identified”. The text therefrom should be read that the director will always consider the factors listed in s. 172(1)(a)-(f). This is pure presumption. But if this line of reasoning is adopted, instead of assessing whether directors have considered the factors, the courts will need to weigh director’s presumed consideration. So doing, the court will not fear to be charged of using hindsight when assessing director’s actions. Indeed, magistrates are reluctant to overturn director’s commercial decisions provided they have been made in good faith. This is commonly called business judgment rule.

A company might make a decision that causes serious environmental damage without giving proper prior consideration to its environmental effects but having rightly considered other constituent’s interest i.e. the employees, shareholders and creditors etc. If the decision results in loss to the company it may incur environmental liabilities or lose sales following injury to its reputation. In that respect, it could be shown that the failure to take account of the environmental implications of the decision was negligent, and then in principle liability could ensue. But what is the legal threshold (between wrong business judgment and improper analysis of the environmental factors) that can activate magistrates’ intervention? In fact s. 172(1) gives no guidance on the relative importance of each of the factors mentioned, although in practice the court will have to weigh one against the other. Before the Act and the emergence of enlightened shareholder value doctrine the shareholders’ interests prevail. So far, the Act has not departed from the shareholders primacy. Therefore, we can presume that shareholder’s interest will be set apart only in exceptional circumstances. As far environment is concerned a dramatic pollution consequences can be considered as exceptional. And, it should be remembered that, while directors are now required under section 172 to have regard to a number of ‘environmental’ factors, none of those factors are stand-alone requirements and the overriding duty in that section is for directors to make decisions which they consider, on balance, are in the best interests of their company. At the same time directors can argue that they owe their duties to the company and not to individual.

Thus the 2006 Act by requiring the director to regard the matters specified at ss. 1, appears to have given scope for some change in directorial practice. Nevertheless, a powerful consideration is whether the shareholder is receiving proper recompense for being kept out of the immediate benefit of his investment in case of environmentally sound decision but which will jeopardize shareholder future income flows. This balance is quite difficult for a corporate director to strike and his liability can be engaged for maladministration if he is viewed as too environmentalist. On the other hand as no test exist, directors might well argue that they did have regard for all the matters mentioned in s. 172(1)(a)-(f) and simply believed that what they did, promoted success of the company for the benefit of the members. Adding to that, “the promotion of the success of the company” is not defined and must be read more as a political programmatic pamphlet too imbued with subjectivity and thence cannot be subject to any contravention. Directors have therefore room for manoeuvre for any counter argument in this infinitely variable concept.

But, in general with regards to legal certainty and security, it can be affirmed at this stage that the wording “of having regard to” is too puzzling to be applicable. The concept of “good faith” echoing back to the subjective trend of s. 172 (1)(d) adds to the confusion. A director of a company must act in a way that he considers, in good faith, would be most likely to promote the success of the company.

The Attorney-General, Lord Goldsmith, said that the government’s intention is that the duty to have regard to these factors should be subordinate to the overriding duty to act in what the director considers, in good faith, would be most likely to promote the company’s success. The Attorney-General went on to say that “a director [is not intended] to be required to do more than good faith and the duty of skill and care would require, nor do we want it to be possible for a director acting in good faith to be held liable for a process failure where it could not have affected the outcome.”

Here again, difficulties arouse as there are no definite standards against which the actions of directors can be assessed. Directors can merely say that they acted in good faith, and their position then becomes virtually unassailable. Following KEAY “it might well be argued that the directors’ action does not necessarily need to lead to success in objective terms … provided that the directors in good faith believed that the action which they took would be most likely to promote the success of the company”. The Guidance on Key Clauses states “the decision as to what will promote success (of the company), and what constitutes such success, is one for the directors’ good faith judgment. This ensures that business decisions on, for example, strategy and tactics are for the directors, and not subject to decision by the courts, subject to good faith”.

However, the Explanatory Notes institute certain limits to this discriminatory managerial latitude and provide that “it will not be sufficient to pay lip service to the factors and, in many cases the directors will need to take action to comply with this aspect of the duty”. Yet it might well be difficult to prove that recommendation. The vagueness of the Notes, and the notional subjectivity of “good faith” invite inevitably judiciary interpretative intrusion. The courts have judged under the ancient legislation’s reign that it was problematic merely having a subjective test for determining whether a director had breached the duty. As a result, objective considerations were introduced by courts to supplement the subjective test. Pennycuick J. ruled that the court has to ask whether an intelligent and honest man in the position of a director of the company involved, can, in the whole of the circumstances, have reasonably believed that the transaction was for the benefit of the company. Apparently this interpretation can be imported to s. 172. Hence, objective considerations can be judicially employed despite the fact that s. 172(1) refers only to the subjective element of ‘good faith’. If this stance is defeated nothing can stop directors from asserting that they considered, in good faith, the interest of constituencies, and thought what was done was appropriate. KEAY’s asserted that parliament impliedly accepted, knowing the state of the common law, that the courts would introduce objective considerations into an assessment of a director’s actions. Therefore, when applied to subsection (d), director’s good faith would be measured, when dealing with environmental issues, according to a bona fide agent concerned by environmental consideration when exercising his duty.

Furthermore, under the aegis of ex-CA 1989, acting in the “best interest” of the company meant in the shareholders’ interest, whereas the new Act refers to the “members as a whole”. While directors did not owe fiduciary duties to shareholders as such, the position was redressed to some extent by defining their duty to act bona fide in the interests of the company in terms of the interests of shareholders, albeit according to the directors’ view of those interests. Can we import this old reasoning while the shareholders primacy concept has yielded ground to the enlightened shareholder value theory? We are tempted to answer by the affirmative. Indeed, law reports suggest that section 172 CA 2006 simply codifies the common law obligations of company directors. The courts have judged that the new form of words and the old mean the same thing. But although the case law prior to the Act can be expected not to lose its force, it cannot eliminate the uncertainty created by the lack of judicial precedents on s. 172(1) .

In light of the above, it appears that the wordings of the commented provision are too vague to be practical or can have any legal effect. At first sight, it seems to be a right without a remedy. But knowing that it is unanimously admitted that the previous common law has not loose its force, it will be sustained that any company law principles dealing with managerial duties in force before 2006 and which remains in force can be used to challenge breach of directors’ environmental duties. These principles were encapsulated in the defunct Companies Act 1989 and have been reproduced in the 2006 Act.

II Enforcement Of Director’s Environmental Duties

The question here is how can the constituents mentioned at s. 172(1) take any legal action against the directors if they believed that the latter have failed to have regard to paragraph (d)?

Despite the lack of proper enforceability mechanism, it seems nevertheless that the obligation laid down at paragraph (d) can be enforced by other statutory mechanism. The Companies Act 2006, the Companies Act 1985, and the Company Directors Disqualification Act 1986, provide some tools in case of maladministration. Without being specifically adopted to deal with environmental issues they can be employed to challenge directorial decisions if the latter are charged of contravening 172(1)(d) CA 2006.

The fact that the duties are owed by directors to the company rather than to individual shareholders, means that, as long as boards remain united, litigation by companies against individual directors will not be easy work. But when the harmony of the board is disrupted, it will then be possible for the boards’ majority to bring proceedings against one of their member. But, one of the big changes made by the Act is to extend the rights of shareholders to challenge directors’ decision. Shareholders can contest the management politics either through derivative claim or by petitioning unfairly prejudicial conduct and ultra vires transaction.

Following s. 260(1)(a) of the Act shareholders are given the right to bring derivative proceedings against directors in respect of a cause of action vested in the company. Generally, according to the claimant principle only directors are empowered to institute legal proceedings in the name of the company to claim redress for the injury. A derivative claim is necessary only where there is a dispute between a member of a company and its directors over the merits of bringing a claim. A dissentient member must normally accept the decision of those who under the companies constitution have the authority to decide on litigation. So a derivative claim is allowed only if the court is willing to ignore the company’s decision not to sue.

Furthermore, the claim is possible if the director’s act or omission involves negligence, default, breach of trust by a director.. Directors would be not be liable even if his decision has an environmental negative impact if s. 260(3) is not breached. But, in case directors infringe theirs environmental obligations, members would be entitled to commence derivative proceedings. This is confirmed by s. 178(2) when it states that, “duties in … are accordingly, enforceable in the same way as any other fiduciary duty owed to a company by its directors”. But as observed only a “member who has concerns wider than his or her own interests and feels obliged to take proceedings because of a heightened sense of community interest” will bring action against directors suspected of failing to consider the environmental factor. However, it’s unlikely that members seek to take action on part of the company where directors fail to have regard for the interest enshrined in s. 172(1), if the director’s action have benefited them and there is a cost element in any derivative claim.

But, this proceeding seems to be also limited by the complexity of its mode of functioning . The applicant will first have to satisfy the court that there is a prima facie case against the director concerned, and then if satisfied on this count, the court will consider a number of other factors, including whether the applicant was acting in good faith, whether the shareholders had authorised or ratified the breach being complained of and whether the conduct of the director concerned was consistent with the requirements of section 172(1). If the court is not satisfied on all these counts it will have to dismiss the shareholder’s application. The “battery” of conditions attached to the exercise of the new derivative action are intended to ensure that directors are not unreasonably exposed to the threat of litigation at the hands of disgruntled shareholders, especially ‘single-issue’ shareholders who might feel that the company should be paying more attention to their favoured cause. But at the same time, these obstacles will discourage any actions against directors. This explains why there are very few reported decisions in relation to this procedure. Besides, a torrent of derivative claims is unlikely because the relief is for the company’s, rather than the shareholder’s, benefit. Furthermore, as noted there is a tight judicial control. The courts are generally reluctant to second guess the actions of a Board “doing its best”.

However, Part 30 of CA 2006 gives the court a wide-ranging power to remedy conduct of a company’s affairs ‘that is unfairly prejudicial to the interests of its members generally or of some part of its members’. It is permissible for a petitioner to complain that a company’s affairs are being conducted in contravention of criminal law. Thus, it can be contended that there is nothing that can prevent a petitioner to complain that a company’s affairs are breaching environmental law. In the same line, any company’s members may ask a court to restrain it from doing something that is ultra vires, in the sense of being beyond the company’s restricted objects or contrary to the general law or the Companies Act. This is an example of the court permitting a claim in respect of a member’s interest in having the affairs of the company conducted constitutionally and it seems that such a claim should not be classified as a derivative claim. But the right of a member to bring an action to prevent the company to act illegally is limited. In Anderson v Midland Railyway Co [1902] Buckley J held that “the breach of the [law] is not one which gives right to any rights as between the corporator and the corporation, but one which gives rights as between the corporation and other customers of the corporation.” Buckley J’s statement has lead academics to doubt whether a member of a company could restrain the company from trading contrary to consumer protection or environmental protection legislation. We are in the opinion that this contention is not beyond reproach. Indeed, in the reported case under the relevant statutory provision a customer who suffered from undue preference to another customer was entitled to contest this situation. Under the Companies Act, the legislator has not restricted in someway or another shareholders action to prevent unconstitutional directorial decision.

Perhaps the only possible action available to those who are concerned by the environmental issues covered in s. 172(1)(d), might be to seek injunctive relief, in an attempt to prevent directors from violating the obligation set up in the subsection. But it is argued that it is questionable whether a court would accede to the application of a non-member. And even if they did, the courts would have to consider evidence in order to make a decision as to whether directors did intend to act appropriately and this would be far from easy at an interlocutory stage.

If it is unlikely that members can succeed in bringing directors decision into courts, the authorities have much chance to achieve this ….

The Companies Investigation Branch of the Department for Business, Innovation and Skills and the Registrar are the main authorities to assure the good application of the company law. Subsection 172(1)(d) can indirectly be enforced by the threat of the Damocles sword which are the authorities’ disqualification and police powers. Indeed, registered companies are subject to having their affaires investigated by the CIB which may use extensive powers to collect evidence and pass it on to regulatory or prosecuting authorities. Shareholders can write to the CIB if there are serious breaches of a director’s duty to have regard to social and environmental issues over a sustained period of time. An example might be where a company has caused serious environmental harm to a local community and has failed to respond to repeated complaints. Moreover, under s. 431 and s. 432(2) of the CA 1985 inspectors may be appointed to report on a company’s affairs if it appears the directors have been guilty of misconduct towards the company or its members. Misconduct is likely to include omission of environmental consideration in the decision making which has led to harmful consequences on the environment. Some of CIB’s powers include disbanding a company or barring directors from taking on such positions in future although affected companies and directors.

Another important feature of the company reform is the obligation for large companies to report the environmental impact of the company’s affairs. This obligation can be mandatory for example a business review or can be effected on a voluntary basis for instance a Corporate Responsibility report. Unless the company is entitled to the small companies exemption, a directors’ report must contain a business review . It is purported to inform members and help them to assess how the directors have performed their duty to promote the success of the company. In accordance to 417(6) a business review must include analysis using financial key performance indicators’ (KPIs) pertaining, inter alia, to environmental matters. For a quoted company the report must also include the impact of the company’s business on the environment.The question therefore here relates to the enforceability of the mandatory corporate reporting. There is no issue concerning voluntary reporting and the application of ABS reporting statement’s view as these are only guidelines. However, we believed that the principles laid down in these guidance’s notes can influence the court in case of litigation. The mandatory reporting duty can be enforced under the threat of disqualification orders. In case of a defaulting business review the director can be disqualified.

The CDDA 1986 was seen to raise the standards expected from directors. Academics assumed that directors were going to bring greater care and skill to their positions as they attempt to avoid the personal liability and disqualification. With the newly environmental duties and the related reporting obligations, the aforesaid statement is more than obvious.

In the whole, the existing solutions and actions to contest a prejudicial corporate decision to the environment are unsatisfactory either because of their complexity or their poor results.

III Conclusion

The legal remedies described above to counter the commission of environmental offence by corporate decision makers, are subject to too many conditional criterion to be applicable. In addition to the complexity of the litigation process against a board member due to the subjectivity which encapsulate the finality of their duties as described in s. 172(1) of the CA 2006, plus the veil of incorporation and the weak deterrence effect of the penalties in case of condemnation drive us to the conclusion that the provision set at the aforementioned section is meaningless and ineffective from a managerial perspective.

Directors owe certain duties to the company: in particular, fiduciary duties and duties of care and skill. Among other things there are no doubt that in law, the director is obliged to exercise those duties in order to minimise corporate costs and liabilities. Such a well-established duty is difficult, if not impossible, to reconcile with developing perceptions of a company’s wider social and environmental responsibilities.

Moreover, the law’s requirement is quite explicit: directors ‘… must exercise their discretion bona fides in what they consider – not what a court may consider – is in the interests of the company”. As noted above, in its assessment of “good faith” and “best interest” the court will apply the business judgment rule and will refuse to intervene in business decision. The line between bad business decision and the lack of consideration to the environmental matters as required by s. 172(1)(d) which can activate judicial activism is difficult to draw and explain that magistrates refused to cross the Rubicon.

The legal rights of a company belong to the latter as a separate person and not to its members. Thus, they do not have authority to enforce theirs rights by legal action. Whether or not a company sues to enforce its legal rights must be decided by the persons who, under the company’s constitution, have authority to institute legal proceedings in the company’s name. This will normally be the directors. Obviously, directors will not take actions against themselves save when the boards are not united.

Furthermore, in case a company director is found personally liable for any environmental wrongdoing and is condemned to that effect, the corporate body can take at its charge the penalty. A director may be relieved from liability for an act in breach of duty to the company in other two ways: if the company authorizes director to act or ratifies any act afterwards, it will not have a cause of action and will not be able to bring a claim against the director. Second, if the company does bring a claim, the court may, under CA 2006, s. 1157, relieve the director from liability if it finds that the act is honest and reasonable.

Directors can also be insured or rely on other indemnity protection in respect of personal liabilities for environmental wrongdoing. Subject to the provisions of sections 232 to 234 of the Act companies can purchase insurance to protect their directors and officers from personal liability for environmental wrongdoing or provide indemnities directly to them. It must be underlined that any cost incurred in relation to environmental offence is being considered in the budget plan of the company. The scope of cover would typically include inter alia enforced regulatory clean-up costs for on-site contamination and cover for off-site third party injury and asset damage and directors harmful action.