The Law Relating to Directors Duties

“The law relating to directors’ duties remains cumbersome, complex and inaccessible to most except those immersed in this area.”

Critically analyze the law relating to directors’ duties.

1. 1. Introduction

The enactment of the Companies Act 2006 knows as (“CA’ 2006”) has raised more concerns on the issue of CSR since Directors’ duties have been codified into legislation by the Parliament under a new approach called “enlightened shareholder value” (“ESV”) and based on the Company Law Review Steering Group’s recommendation (“CLRSG”). The “ESV” approach is so important that directors are required to “promote the success of the company in the collective best interests of their shareholders, but in doing so they will have to have regard to a wider range of” interests by a wide range of stakeholders including employees, customers, directors and suppliers etc. Rt. Hon Margaret Hodge M.P. responses to the debates and concerns on the Company Act 2006 by arguing that s. 172 “marks a radical departure in articulating the connection between what is good for a company and what is good for society at large”. Remarkably, CSR is associated with s. 172 of the Company Act 2006, as directors are required to pursue the “ESV” approach by taking both environmental and employee issues into account. Moreover, the “ESV” approach plays an important role to achieve the goal of CSR.

CSR not only has played an important role in the field of company law, but also has shown its significance in other fields, for example, business and non-government organizations. Therefore, there is no criterion for defining the concept of CSR as Hohnen argued that CSR “can and does mean different things to different people.” However, there are two well-known types of defining CSR. For example, the World Bank Group focuses on the outcomes and the European Commission focuses on the CSR’s voluntary nature. The practice of CSR has received much debate. It is common sense that many multinational corporations have been responsible for lacking of social responsibility in carbon emissions in poor and undemocratic countries. On the other hand, many advocates of the practice of CSR argue that multinational corporations should focus on long-term interests rather than solely on short-term interests as those corporations may benefit more by adopting a long-term CSR strategy. For instance, proponents of CSR might highlight the correlation between the social performance of a company and the financial outcome of that company. This generates the thinking that a company that adopts a good and accepted CSR strategy is likely to perform well for the long-term perspective because its employee, customers, suppliers and other stakeholders etc are satisfied with what it has done and what it will be doing in the future. On the other hand, theoretically speaking, CSR is defined by Givens as “the concept that power implies responsibility is a deep one in human consciousness.”

Villiers put an emphasis on the formidable power of corporations in arguing it is required that corporations naturally to take more social responsibilities in terms of their power and responsibility. Undoubtedly, more and more companies have started showing their concerns on the issue of CSR. For example, Nike, known as the world’s leading supplier of athletic shoes has developed a focus on improving its contracted factories’ conditions and aiming for carbon neutrality in developing countries. Therefore, it is by no means significant to define the relationship between CSR and company law. There are various means of promoting social responsibility by corporations. For example, Kiarie proposed a way in which informed decisions made by shareholders on behalf of the stakeholders. He further argued that the annual meetings could be used to protect the stakeholders’ interests.

II．Whether Directors’ Duties Can Promote CSR

S.172 of the CA 2006 requires directors to act “in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”. With the attempt to improve the competitiveness of the UK companies, the DTI had undertaken a review of the British company law system from 1998 to 2001 and DTI’s CLRSG adopted the “ESV” approach based on their conclusion that directors’ concern on both social and ethical factors can maximize shareholder value that can be achieved to maximize competitiveness. Kiarie supports the “ESV” approach by arguing that it enables directors to target a clear objective that will accomplish the goal of efficiency and competitiveness. Efficiency can be achieved as the company keeps its ultimate duty while competitiveness can be achieved as the company takes its long-term interests and stakeholders’ interests into account. At first glance, the “ESV” approach appears to be omnipotent, but it fails to consider the nature of a profit making company is to maximize its profits. This reflects what Vagts worried about that “once the profit-maximizing conception of the corporation is abandoned it is not easy to construct an attractive and logical new framework to guide and legitimate management”.

Directors, as fiduciaries of the companies, are entitled to make decisions based on their statutory and fiduciary duties when dealing with conflicts of interests of different groups of stakeholders. It is common sense that those groups of stakeholders are different in achieving their own interests. Thus, the existing conflicts of interests cannot be avoided by merely regarding shareholders’ interests as the primacy. Vinten argues that it is not reasonable and not efficient that directors are required to make decisions based on different levels of interests of different stakeholder groups.

Regarding the “ESV” principle, mangers will consider of stakeholders’ interests when these interests are beneficial to the company, indicating that directors will only take into account those stakeholders’ interests that are beneficial to both the stakeholders and to the company itself. Moreover, the “ESV” approach also suggests that shareholders’ interests are prior to stakeholders’ interests as the former group has a direct impact on the company. Therefore, as Parkinson suggested, directors are not likely to satisfy those stakeholders before those shareholders’ interests are satisfied. If those shareholders’ interests are not satisfied, the directors may have to face “any incurrence of uncompenzable costs for socially desirable action.” Friedrich further emphasize the importance of satisfying those shareholders’ interests by arguing that “so long as the management has the one overriding duty of administering the resources under its control as trustees for the shareholders and for their benefit, its hands are largely tied.” To conclude, company law is paradoxical as Sealy pointed out that it will be “pointless to seek to impose co-existing duties towards shareholders and employees, or towards preference and ordinary shareholders, or towards the contributors of risk capital and future creditors, in any situation of actual or potential conflicts.”

Section 172 purports that directors should promote the success of the company as they are in good faith and fails to provide a criterion that measures directors’ good faith. Thus, the section has been criticized for providing directors with “virtually unassailable” accuse when confronting with doubts. However, Davies argues that it is difficult to find any defects of s. 172 of the CA 2006 unless “egregious cases” contrary to good faith are established.

Since the distinct feature of the company is the privilege of limited liability that combined with separate legal personality. Thus, the limited liability restricts the company’s shareholders from taking moral responsibility while the separate personality minimizes the social responsibilities associated with companies. Creditors are often restricted from taking their claim against directors and shareholders due to the existence of the theory of limited liability and separate personality. Creditors are important groups of stakeholders of a company; however, Section 172(1) does not contain any interests of this group. Although s. 172 (3) of the CA 2006 stated that directors are required to act in the interests of creditors under certain circumstances. This reflects that directors will worry about creditors in situations that the company is insolvent. Directors’ duty to creditors is exerted through a way that benefits the group of creditors; this may provide the directors with the opportunity to choose competitive creditors and thus undermining other creditors’ confidence.

DTI’s CLRSG proposed a new corporate disclosure requirement that contains the considerations of environmental factors within the company board decision-making process in order to promote CSR. There is no doubt that those non-governmental organizations may play a significant role in protecting the environment from the perspective of environmental factors. However, the environment, unlike the human being, cannot be regarded as a necessarily legitimate claimant that requires directors to act in the environment’s interests.

There is the existence of practical handicaps when regarding the environment as one of the stakeholders for which directors must satisfy, is the lack of proper representative. This reflects the emptiness of reporting duties. Taking the proposal of mandatory Operating and Financial Review (“OFR”) as an example, the “OFR” aims to “accounting for and demonstrating stewardship of a wide range of relationships and resources which are of vital significance to the success of modern business, but often do not register effectively, or at all, in financial accounts.” Moreover, it also attempts to promote both directors’ accountability and statutory duties to stakeholders. Comparatively, according to s. 417 of the CA 2006, the director’s report must include a business review that contains all social, community issue and environmental issue. The business review requires less detail than does the OFR. As Gordon argues that, the OFR was rejected because the corporate managerial burden might be exaggerated. Nevertheless, there is possibility that directors would abuse s. 172 of the CA 2006. For example, there are “donations to charities involving the arts or those with high social profiles where the ‘giver’ will be the recipient of preferential treatment in exchange for the funds.” Moreover, the secret behind companies making charitable donations is that directors attempt to achieve special interests that are regarded as a misuse of the company’s resource that is against the directors’ fiduciary duty. The reform of ultra vires made by the Companies Act 1985 and 1989, the objective of failing out of company is to protect the recipients of gratuitous donations by not considering directors’ attempt because of gratuitous donations would not be questioned. There is one thing that must be mentioned is that when the director makes any gratuitous donations, shareholders normally do not know until the gratuitous have been donated. In addition, Griffiths argued that “the managers’ own self-interest may prevail and lead them to use the company’s resources for other purposes such as increasing their remuneration and perquisites, or working with less diligence, or retaining profits within the company to finance growth and expansion designed to enhance their own prestige. Such behaviour does not ensure the most efficient deployment of resources.” As a result, it can be seen that there is a risk that directors are likely to abuse their power to act in their own interests over the interests of their companies. Thus, this generates an answer that CSR could not be promoted by directors’ statutory duties. Instead, there are some new thoughts that could be regarded as solutions to promoting CSR.

III．New Thoughts Of The Company’s Nature

Traditionally, there are two models of corporate structure one is viewing the corporate structure as “the nexus-of-contracts” and another is viewing the corporate structure as social entity, the former is advocated by Fama and Jensen and the latter is advocated by Berle. Strine, nevertheless, presents a balanced view of corporate structure by arguing that:

“Both management and labor are likely to view a public corporation as something more than a nexus of contracts, as more akin to a social institution that, albeit having the ultimate goal of producing profits for stockholders, also durably serves and exemplifies other societal values. In particular, both management and labor recoil at the notion that a corporation’s worth can be summed entirely by the current price the equity markets place on its stock, much less that the immediate demands of the stock market should thwart the long-term pursuit of corporate growth.”

What Strine reflects is that improving the standard of disclosure can both empower shareholders” value and identify a company’s strategy towards long-term interests. On the one hand, Zumbansen et al support Strine’s balanced view by arguing that “the unceasing flow of literature demanding shareholder empowerment against management, that stands in bizarre contrast to the disassociation of employees’ ownership from exercising long-term focused, pension-oriented rights vis-à-vis ‘their’ corporation.” On the other hand, Bainbridge criticizes Strine’s view of corporate structure by arguing that with regard to the fact that the various groups of stakeholders have certain degree of diversity that should not be neglected, thus shared interest and common sense would not be found easily.

At first glance, Strine’s point of view on the corporate structure has some merit that directors are more likely to be focused on or acted in the long-term and a more sustainable development of the corporations within improved disclosure requirement. Moreover, an improved reporting standard that regulates and reinforces the collection and analysis process associated with CSR would help stakeholders monitor what directors do. Additionally, Bainbridge’s criticism that no microcosmical shared interest could be found was not necessarily reasonable because Strine’s shares interests among stakeholders could be found and improved within the long-term and sustainable development of the corporations.

Further, there are some particular measures in solving CSR problems. Herrmann argues that it is necessary to keep a constant dialogue between a company’s directors and its stakeholders. By doing so, it must ensure that related regulations are coordinated with both directors and stakeholders’ efforts. Teubner, has proposed using procedural mechanisms to impose a duty that requires all constituents into the dialogue. This reflects that the challenge to achieve a constant dialogue is the difficulty of establishing an efficient mechanism.

IV．Conclusion

The enactment of the s.172 of the CA 2006 has raised more concerns over directors’ statutory duties and the issue of corporate social responsibility in order to make a company more successful. The discussion for CSR includes some normative arguments and their drawbacks that restrict the promotion of CSR. CSR is so important that the CA 2006 that frames the companies’ behavior that relates to promote CSR. Nevertheless, since the distinct feature of the company is the privilege of limited liability that combined with separate legal personality that also influences the promotion of CSR. More importantly, stakeholders such as creditors, employees are not provided with any remedies in terms of directors’ breach of duty, therefore may result in the abuse of the directors’ statutory duties. To promote CSR, there are some possible solutions to be taken into account. Firstly, it is vital that appropriate remedies for breach of directors’ duties to enforce stakeholders’ interests and that codifying CSR into legislation. Secondly, Strine’s thought on the corporate structure that shared interests among stakeholders could be found and improved within the long-term and sustainable development of the corporations is sensible. Because that thought would reinforce the collection and analysis process associated with CSR and help stakeholders monitor what directors do. Thirdly, the importance of keeping constant dialogues between directors and stakeholders is associated with promoting CSR. It must ensure that related regulations are coordinated with both directors and stakeholders’ efforts to keep constant dialogues working. The challenge to achieve a constant dialogue is the difficulty of establishing an efficient mechanism; therefore, a proposal made by Teubner to use procedural mechanisms to impose a duty that requires all constituents into the dialogue is reasonable. Additionally, directors’ duties to act in stakeholders’ interests must be further regulated and enforced and specific legal departments are required to monitor remedies for directors’ breach of duties.

Bibliography

Bainbridge, S.M. (2007), “The shared interests of managers and labor in corporate governance: acommon on Strine”, UCLA Pubilc Law &Legal

Berle, A. A., (1954), “The 20th Century Capitalist Revolution”, New York: Harcourt Brace &CO

Boeger, N. and Murray, R et al,(2008), Perspectives on Corporate social Responsibility, Glasgow :Edward Elgar Publishing Limited

Davies, P.L., (2008) Principles of Modern Company Law, London: Sweet & Maxwell (08th ed).

Friedrich, H. (1944), “The Road to Serfdom”, London: Routledge and Kegan Paul 1982

Parkinson, J (1993), “Corporate Power and Responsibility: Issues in the Theory of Company Law” Oxford: Oxford University Press

Sheikh, S. and Rees, W., (1995) Corporate Governance and Corporate Control (Cavendish Publishing Limited)

Klaus J. Hopt and Gunther Teubner (ed.), (1985), Corporate Governance and Directors’ Liabilities, Legal Economic and Sociological Analyses on Corporate Social Responsibility, (Walter de Gruyter: Berlin. New York)

Villiers, C., “Corporate law.corporate power and corporate social responsibility”

Journals

CLRSG, “Modern Company law for a competitive Economy: Completing the structure” (2000, URN 00/1335)

Eugene, F and Jensen, M.C. “Separation of ownership and control” Journal of Law and Economics (1983) 301 page at 325

Givens, R.A., “The banking and currency power, technology and the future of the market economy”, Santa Clara Computer and High Technology Law Journal, 1996 (August) page at 381

Herrmann, K.K. “Corporate social responsibility and sustainable development: the European Union initiative as a case study”, (2004) 11,Indiana Journal of Global Legal studies, 205 page at 232

Keay, A. “s.172 (1) of the Companies Act 2006” Company Lawyer 106 (2007) 28

Kiarie, S. “At crossroads: shareholder value, stakeholder value and enlightened shareholder value, which roads should the United Kingdom take?” (2006) International Company and Commercial Law Review page at 329

Margolis, J.D. and Walsh, J.P. “Misery loves companies: Rethinking social initiative by business” (2003) 48, Administrative Science Quarterly , 268 page at 305

Sealy, L.S. “Directors’ ‘Wider’ Responsibilities – Problems Conceptual, Practical and Procedural” (1987) 13, Monash University Law Review page at 163

Slaughter, C. M. “Corporate social responsibility: a new perspective” Company Lawyer (1997) page at 313

Vagts, Detlev “Reforming the Modern Corporation: Perspectives from the German,” (1966) 80 Harvard Law Review page at 23

Vinten, G. “Shareholder versus stakeholder–is there a governance dilemma?” (2001) 9(1) Corporate Governance page at 36

Other Documents

CLRSG, “Modern Company law for a competitive Economy: Developing the Framework” (2000, URN 00/656)

Company Law Review, Modern Company Law for a Competitive Economy: Developing the Framework (DTI, London, 2000)

Darling, Alistair, Hansard, HC, col.125 (June 6.2006)

Department of Trade and Industry (DTI), “Companies Act 2006: Duties of Directors: Ministerial Statements” (London, June 2007)

DTI (1998), “Modern Company Law for a Competitive Economy”, http://www.err.gov.uk/files/file23241.pdf

Gordon Brown , CBI annual conference November 28, 2005, at www.hm-treasury.gov.uk

Hohnen, P. (2005),”Can corporate social responsibility survived 2005?” http://ead.uniethos.org.br

Rt. Hon Margaret Hodge M.P., Minister of State for Industry and the Regions, “Companies Act 2006: Duties of company directors”, (Ministerial statement, June 2007)

Strine, Jr. L.E. (2007) “Toward common sense and common ground? Reflections on the shared interests of managers and labour in a more rational system of corporate governance,” The Dorsey & Whitney Foundation Lecture, 10 March 2007, Journal of Corporation Law, Fall, at Http://ssrn.com/abstract=989624