Section 172 of the Companies Act 2006 is nothing more than statutory window dressing.

It adds nothing at all of substance to the directors traditional fiduciary duty of loyalty. It is also confusing and creates unnecessary uncertainty for directors with regard to their legal liability risk.

Introduction The Companies Act 2006 was enacted in order to modernise UK company law, which has variously been criticized for being archaic and inefficient. Previously, directors duties were contained within the common law, making their identification difficult for those without professional advice. This is a concern for directors, who occupy a position analogous to that of trustees, thereby coming under onerous duties to act in the best interests of the company the fiduciary duty of loyalty and good faith, which requires that they place the companys interests ahead of their own.

It is crucial that directors have a clear understanding of the nature and scope of their responsibilities, and s.172(1) lays out considerations directors are to have regard to when making their decisions. Specifically, it identifies in whose interests decisions should be taken, as this can be difficult due to the multi-faceted nature of companies. However, s.170(4) stipulates that general duties are to be interpreted in light of existing common law and equitable principles. It thus raises questions about whether the Act makes any substantive changes to a directors fiduciary duty of loyalty, and if so, whether these duties are now clearly understood. This essay proposes that the Act has changed little for directors, with s.172 largely embodying developments in the common law. It is doubtful that their legal liability risks have changed much though, due to the difficulty of bringing directors to account, and the highly subjective content of the duty.

To that end, this essay will begin by analysing directors duties prior to the CA 2006, followed by an assessment of s.172 and how it differs from previous common law duties

before examining enforcement mechanisms for errant directors in order to ascertain whether their legal liability risks have been altered.

Pre-Companies Act 2006 Prior to the enactment of the CA 2006, the main rule which constrained the actions of directors was s.303 of the Companies Act 1985, which allowed for the premature removal of directors by ordinary resolution during a general meeting. This thereby incentivises directors to act in the best interests of shareholders, lest they be removed though it should be read in light of s.309 which requires consideration to be taken of employees as well. As is apparent, this is a vague standard, giving directors little substantive direction on how they should behave. Dobbie argues too that s.303 may have been a toothless threat as shareholders are rarely fully engaged with the companys dealings, and can provide little impact on directors decisions1.

Instead, the bulk of directors duties come from the common law. They come under fiduciary obligations (Aberdeen Railway v. Blaikie2), and this essay will focus on the question of scope in whose interests powers should be exercised for. Eady J in Percival v. Wright3 defined the scope of directors duties as being towards the company as a whole, rather than towards individual shareholders. Subsequently in Re Smith & Fawcett Ltd4, Lord Greene added a subjective element to the exercise of the powers, which should be used bona fide for any purpose that the director, and not the court, considers to be in the best interests of the company. This subjective element is quite substantial due to the reticence of courts to replace their judgment for that of the companys, unless there is no basis on which the director could reasonably have come to the conclusion that this was in the interests of the

1 2

Dobbie, F. Codification of Directors Duties: An Act to Follow?. 11 Trinity CLR 13 (2008). p.14. (1854) 1 Marcq 461. 3 (1902) 2 Ch. 421. 4 (1942) Ch 304.

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company (Item Software (UK) Ltd v. Fassihi5). It was accepted also in Dorchester Finance v. Stebbing6 that these duties are to be performed with good faith and honesty, which is presumed in the absence of evidence to the contrary (Gaiman v. National Association for Mental Health7). Directors thus have a fairly wide discretion when they act.

However, while the director is to act in the best interests of the company, it can be unclear what exactly this means. Unlike trustees who are simply to act in the best interests of the defined beneficiaries, directors serve the company, which is a legal construct and represents a multitude of potentially competing interests. A shareholder primacy approach was adopted by Nourse J in Brady v. Brady8: the companys and the shareholders interests are indistinguishable. Thus where the company is a going concern, shareholder interests are primary (where the company is insolvent, the primary interests are those of its creditors (West Mercia Safetywear Ltd v. Dodd9)). This approach was recognized by the CLRSG to have generally been the dominant approach in UK company law, which reflected that directors are required to manage the business on their [shareholders] behalf, with the ultimate objective being the generation of maximum wealth for shareholders.10

While this may have been so for a time, the common laws flexibility together with the subjective nature of the duty grants directors the ability to adopt more pluralist approaches, elements of which are embedded within the concept of Enlightened Shareholder Value (ESV): the approach purportedly codified in the CA 2006. This can be seen in Lord Diplocks dicta in Lonrho Ltd v. Shell Petroleum Co Ltd11 that the best interests of the company are not exclusively those of its shareholders, but may include those of its creditors. More

5 6

(2004) EWCA Civ 1244. (1989) BCLC 498. 7 (1971) Ch. 317. 8 (1987) 3 BCC 535. 9 (1988) 4 BCC 30. 10 Company Law Review, Modem Company Law for a Competitive Economy: The Strategic Framework, URN 99/654 (London, DTI, 1999). para. 5.1.12. 11 (1980) 1 WLR 627.

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persuasively, in Fulham Football Club Ltd v. Cabra Estates12 Neill LJ acknowledged that the company is more than just the sum total of its members. Bowen LJs judgment in Hutton v. West Cork Railway Co13 is also a clear affirmation of ESV, where he commented that the law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company, with cake and ale being gratuitous benefits for employees. Lynch therefore submitted that prior to the CA 2006, it was possible to draw from the relevant case law whichever approach was required14. Accordingly, the best interests of a company are not restricted solely to maximising fiscal returns for shareholders in the short-run. Thus, while the ESV approach adopted by the CA 2006 may be interpreted as an attempt to prevent the adoption of a strict shareholder primacy approach, the genesis of this former approach can clearly be seen in prior case law. Given that s.170(4) requires the general duties to be interpreted in light of prior case law, it is difficult to see s.172 of the CA 2006 as more than merely a small incremental step rather than a fundamental, substantive overhaul of directors duties.

CA 2006 s.172 of the CA 2006 codifies the directors duty to promote the success of the company. It requires him to act in good faith for the benefit of its members as a whole. It also lays out a non-exhaustive list of factors to which directors should have regard to when making decisions, such as the likely effect of decisions in the long-run, and its effect on employees, etc. As mentioned earlier, this embodies the ESV approach, which is supposed to be a middle ground between the shareholder value and pluralist approaches, and an attempt by the CLRSG to prevent short-termism in decision-making by encouraging directors to maintain long-term relationships and consider the interests of relevant stakeholders in addition to those of shareholders. Whether this adds anything new is doubtful, and the CLRSG

12 13

(1994) 1 BCLC 363. (1883) 23 Ch D 564. 14 Lynch, E. "Section 172: A Ground-breaking Reform of Director's Duties, or the Emperor's New Clothes?" Company Lawyer (2012). p.199.

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themselves believed that enshrining ESV into statute was simply taking pre-existing common law duties and making explicit [their] true character15.

Prima facie, this offers welcome clarity due to the identification of stakeholders whose interests should be taken account of during decision-making. While this is ameliorated somewhat by the non-exhaustive nature of the list, the factors listed are sufficiently wide to cover most conceivable situations, and it would be difficult to foresee an extraneous factor that is still reasonably connected to the objective of promoting the success of the company. Like the common law, the codified duty is also subjective s.172 is phrased such that a director need only act in the way he considers, in good faith, echoing the standard set in Re Smith & Fawcett. There may be confusion over the comparative importance of each of the factors, but s.174 also requires directors to act with reasonable care and skill a requirement that previously existed in the common law as well in Charterbridge Corp Ltd v. Lloyds Bank Ltd16. Thus favouring certain factors over others would be defensible as long as the decision was reasonably taken and in good faith.

In any case, these factors are subservient to the requirement to promote the success of the company for the benefit of its members as a whole. This is more nebulous as in the past the common law duty was phrased as merely having to take decisions for the benefit of the company. Alcock suggests that this may evidence a more stringent standard, which could differ from past judgments like that in Evans v. Brunner Mond & Co17 where the funding of university research may simply have benefited the company, but not necessarily have promoted the success of the company18. The CLRSG has however stressed that what promotes and constitutes success is in the purview of the directors good faith judgment19, and would not be revisited by courts, subject to good faith. Not only can directors use this to
15 16

Chapter 5.1.22. (1970) Ch 62. 17 (1921) 1 Ch 359. 18 Alcock, A. An accidental change to directors' duties? . Company Lawyer 30 (2009). p.373. 19 Guidance on Key Clauses to the Company Law Reform Bill (DTI, 2005), para.63.

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justify their acts, but it can also complicate any assessments on their decision-making as short-term and long-term interests are not necessarily aligned, and decisions may legitimately favour either.

Keay has suggested that the phrase members as a whole would also likely be subject to the standard common law interpretation to mean present and future shareholders as established in Brady. Consequently, this appears to be a ratification of a shareholder supremacy approach, despite the ESV rhetoric the Act is couched in. In addition, s.172(3) also echoes the requirement in West Mercia to take into account the interests of creditors where the company is under threat of insolvency. The test in s.172 therefore ends up appearing to be much like the prior common law one or at least not being incompatible with most prior case law and prompting Lord Glennies opinion in Re West Coast Capital (Lios) Ltd20 that it did little more than set out pre-existing case law, and the result is that directors will likely see little change to their legal liability risk.

If anything, Dobbie suggests that the modern formulation may in fact allow greater discretion to directors over what interests to consider as the requirement to take a variety of factors into account may give directors more grounds on which their actions may be defensible. This is illustrated by the decision in Re Welfab Engineers Ltd21, which was based on the CA 1985 and involved directors selling the company at an undervalue in order to maintain it as a going concern, and to keep on the employees. Lynch argues that a similar result would be reached if the case was decided under the CA 2006, with the factors listed under s.172(1) potentially being used to render the directors immune from suit by the shareholders. The concern is therefore less that directors may find themselves with higher

20 21

(2008) CSOH 72. (1990) BCLC 833.

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legal liability risks, but instead whether it makes it extremely difficult to make them accountable at all22.

This is reinforced by the difficulty of bringing actions against errant directors after all a right without a remedy is worthless23. While shareholders may take advantage of the new statutory derivative action under s.260(1)(a) to hold directors to account over a cause of action by the company, other stakeholders who may benefit from consideration under s.172(1) have no similar recourse. Under s.178, the general duties contained in s.171-177 lead to the same consequences for breaches as under corresponding common law rules or equitable principles, under which a right of action accrues only to the company. Consequently, unless the stakeholders are also shareholders of the company, such as an employee owning shares, they would only be able to rely on actions taken by actual shareholders on behalf of them. Given the cost and effort of bringing such an action along with the slim likelihood of success, such altruism would likely be exceedingly rare. Instead, Keay postulates that it would be far more likely that any actions brought against directors would be borne out of shareholders who fear that the directors acts may impinge negatively on their self-interests24. Thus, rather than the inclusive ESV approach that the CLRSG claims s.172 embodies, Alcock asserts, ironically, that it is instead clearly focused on shareholder supremacy25.

Conclusion As can be seen, overall it is doubtful that s.172 has served to radically alter directors fiduciary duty of loyalty, instead being merely a statutory restatement of previously established duties. There is yet little case law on this section, which Lynch suggests may be representative of a judiciary holding the opinion that there is little of substance requiring

22 23

Lynch. p.204. McDaniel, M. Bondholders and Stockholders (1988) 13 Journal of Corporation Law 205 at p.309. 24 Keay. p.109. 25 Alcock. p.383.

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clarification in s.17226. While it appears to embody a more inclusive ESV approach, the lack of effective enforcement mechanisms mean that practically a shareholder value approach is much more likely to prevail, though this does not preclude directors from considering various stakeholder interests, similar to the common law position. Consequently, rather than making the content of the duty uncertain, it instead has the effect of making it more flexible, arguably giving directors even more discretion than they previously enjoyed under the common law. As a corollary, this in turn means reduced legal liability risks for directors.

This is not to say that the Act would have no effect on decision-making. It may nonetheless play a role in reminding directors of other factors to be taken account of, which would likely lead to substantively better business decisions, despite a tendency to prioritise the interests of shareholders. Shareholders themselves will also be more aware of the various other factors that deserve consideration, leading to fewer unsubstantiated challenges against directors.

Conversely, it has been suggested that the new Act may in fact result in a greater number of derivative actions. While few of these will likely result in the imposition of liability, they may still be leveraged for tactical purposes in order to pressurize management, as even unsuccessful actions require significant amounts of time to defend, and could result in reputational harm27. Therefore, while s.172 may have been an inadequate attempt to ensure the introduction of an ESV approach to corporate decision-making, it may nonetheless still tend to such an approach in the real world, as shareholders may include stakeholders mentioned in s.172(1). Further, even without being a radical change, it is a helpful codification of existing law, which should make the content of the duty more accessible to directors of small companies that do not benefit from in-house counsel, allowing for more confident decision-making, and limiting defensive-directing.

26

Lynch. p.206.

27

Loughrey, Keay and Cerioni. Legal Practitioners, Enlightened Shareholder Value and the Shaping of Corporate Governance. 8 JCLS 79 (2008). p.101. 8 of 9

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