the legal fraternity and the business personnel regarding the effectiveness and practicability of Section 172
For a decade and a half since the enactment of the U.K. Companies Act 2006, there have been debates among scholars, the legal fraternity and the business personnel regarding the effectiveness and practicability of Section 172. In particular, section 172 is criticized as “bringing little to the table”[1] due to the lack of realistic sanctions for non-observance, and the lack of legal standing to sue for the stakeholders whose interests were purportedly being protected.[2] These debates, and particularly the exposition of the inherent weaknesses of Section 172, amidst financial scandals, have arguably culminated into the proposals for the reforms to legislation, and have yielded considerable results as reflected in the novel Corporate Governance Code 2018.[3] Provision 5 of Section 1 of the U.K. Corporate Governance Code 2018 requires companies to report their compliance with section 172,[4] and arguably this calmed down the clamours for the ethical consciousness and social responsibility in business for a while, until the emergence of the coronavirus pandemic. Notably, the impact of the coronavirus pandemic on the global economy has exposed the seriousness of the weaknesses of Section 172 because of its particular inability to safeguard the interests of the stakeholders. Consequently, this warrants major radical reforms to the section for the protection of the stakeholders, regardless of its perceived strengths.
To appreciate the seriousness of the weaknesses of Section 172 in its protection of the stakeholders, there exists a need for the valuation of the impact of the coronavirus pandemic on the United Kingdom, and the global economy. Summarily the coronavirus pandemic has wreaked havoc on the economies, particularly due to the lockdowns and quarantine measures to control its spread. The novel coronavirus, a respiratory virus originating from China, has a very high rate of spreading, and its effects are lethal, particularly on the elderly and those with preexisting medical conditions. The high mortality rate of the virus averaged at 5 %, has seen 284,000 deaths and 4.3 million infections globally as of 11th May 2020[5]. Notably, even the current Prime Minister, Boris Johnson, also underwent about of the infection, which culminated into hospitalization in the Intensive Care Unit.[6]
In attempts to address the gravity of the pandemic, the government initiated a lockdown to minimize the spread. This lockdown, essentially, meant the closures of numerous businesses. To stay viable, some companies had to initiate radical changes such as pay cuts and layoffs to ensure their survival. The falling of the oil products prices to unprecedented lows is arguably the most notable illustration of the havoc the pandemic has on the global economy. In the United States of America, for instance, the price of oil fell to negative 37 U.S. dollars, with some oil firms paying consumers to take the oil off their hands.[7] This fall in prices is majorly due to the low demands for oil, which essentially do not match the production levels, and the lack of storage capacity by the firms to store the produced oil. In light of the economic breakdown and the consequent radical business changes, the seriousness of the weaknesses of section 172 in failing to safeguard the interests of the stakeholders is exposed.
The purported safeguard of the interests of the shareholders is intimidated in the provisions of Section 172, which obligates the directors, in their undertakings, to promote the success of the company by acting in good faith and being diligent. In doing so, the directors are expected to take into consideration various factors such as the long-term interests of the company, and the interests of the stakeholders. Section 172(1) stipulates that “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 (amongst other matters) to various stakeholder interests. The six key factors are:
- the likely consequences of any decision in the long term;
- the interests of the company’s employees;
- the need to foster the company’s business relationships with suppliers, customers and others;
- the impact of the company’s operations on the community and the environment;
- the desirability of the company maintaining a reputation for high standards of business conduct; and
- the need to act fairly between members of the company.”[8]
Essentially, the provisions of Section 172 seek to strike a balance between the interests of the shareholders, who are the owners of the company, and the stakeholders, who are inclusive of the customers, employees, and the general public. This seeking of balance was albeit very controversial during the discussion of the bill in parliament.[9] The balance was in light of the financial scandals and the malpractices of the unscrupulous businesses. Such warranted regulation in order to protect the public from the foreseeable negative effects, such as unemployment due to massive layoffs, and the exploitation of the labor force. As such, the drafters of the section arguably intended to ensure the maximization of the profits of the company to the shareholders as per the shareholder primacy theory. However, such maximization of the profits and the advancement of the business interests was not to be at the expense of the society, and the environment, as per the corporate social responsibility theory.
The shareholder primacy theory, as advanced by Milton Friedman, argues that the sole purpose of the companies was to maximize profits and returns for their shareholders.[10] By perpetuating to engage in charitable activities which did not prioritize on making money for the shareholders, the directors would actively be engaging in the thorough undermining of the very foundation a free society, private property system. Such activities by an executive employee are detrimental to the owners, and instead, if the shareholders wished to engage in such social activities, they would instruct the directors, rather than have them, mere employee to them, act in their own accord. Additionally, the spending of such money by the directors would be imprudent as it did not belong to them, and companies, being mere artificial persons created for the purpose of their owners, did not have a social and moral responsibility. Notably, this theory, pioneered by American thoughts, is firmly grounded in the Dodge v. Ford Motor Company, 204 Mich. 459, 170 N.W. 668 (Mich. 1919)[11].
Despite several consequent rejections by judges in cases such as AP Smith Manufacturing Co v. Barlow 2 39 ALR 2d 1179 (1953)[12]or Shlensky v. Wrigley[13], the ruling in Dodge V Ford Motor Company advanced even further. In the case, the court was called upon to decide whether the minority shareholders could prevent the directors of the company from operating the company for the charity, to which it affirmed. In its ruling, the noble court directed that the company president, Henry Ford, had to operate the Ford Motor Company in the interests of its shareholders, instead of a charitable manner for the benefit of the employees and customers. At the same time, the court affirmed the discretionary powers of the director in business judgements, hence granting him considerable latitude in running the company.
The facts in Henry v Ford were that Ford Motor Company, worth 60 million dollars as of 1916, had been successively cutting the price of its main product Model T, while at the same time increasing the wages and numbers of the workers. Henry Ford, the company president and majority shareholder, sought to end special dividends for shareholders so as to invest massively in new manufacturing plants that would enable to increase productions and the workforce, while at the same time enjoying the economies of scale productions. This move was unpopular to significant minority shareholders such as Dodge and Horace Elgin Dodge, who moved to court to challenge the strategy. In his philanthropic defence, Ford stated that his drive was to spread the benefits of the industrial system to as many people as he could and improve their lives. The affirmation by the court arguably formed the basis for the theory, which has notably been heavily criticized by proponents of corporate social responsibility.
Proponents of the corporate theory argue against the tenets of the shareholder primacy theory. They stipulate that prioritization of the maximization of the profits by companies at the expense of the social and environmental impact was distasteful for any moral society[14]. To the proponents, companies, in light of their deriving of benefits from the society, have a social responsibility to cater for the societal needs, and contribute to the solving of the problems. Even though they are artificial persons, companies have a moral and social responsibility in their acts for the interests of the shareholders.
In light of the conflicting evidential interests of the preceding theories, section 172 arguably desired to reach an amicable compromise between the two warring interests. Prima facie, the provisions of the section are seen to encourage directors to make better-informed decisions, while at the same time considering the prevailing societal needs and issues. Notably, the principle in section 172 of the companies act is not foreign. It is reflected in Section 309 of the Companies Act 1985[15], which was arguably implemented in light of the clamours of the workers’ rights by labour movements. Despite being undeniably problematic in relation to its enforceability, the controversial section was still accepted as part of the novel Companies Act 2006. The critical discussions that ensued only involved the practicality of the section, and whether it was juridical sound, without appreciating its implications. Such discussion was partly due to the revolution of the culture demanding for ethical business practices, with businesses complying in order to protect their reputations and ensure sustainability.[16] However, this prevailing corona virus pandemic has invariably exposed the cruel reality of the seriousness of the weaknesses of Section 172.
The corona virus pandemic has exacerbated the seriousness of the weaknesses of the section, particularly in light of the lack of legal standing of the stakeholders to sue for the protection of their interests. The lack of legal standing of the stakeholders is explicit in that the directors do not owe a duty to the stakeholders. The directors only owe a duty to the company to promote its success. Notably, the consideration of the factors mentioned does not necessarily create a duty to the stakeholders. This wording, therefore, effectively locks out the stakeholders from claiming breach of the section in court on their own, as they lack the requisite locus standi, necessary for a successful application.
The seriousness of this weakness gets highlighted currently in the way that employees of companies, who are stakeholders, are helpless in light of the massive layoffs, and pay cuts. Even though these are extraordinary times, some layoffs are not warranted and unprocedural. Some workers are summarily dismissed, even without severance packages. These acts are an utter disregard for the welfare of the workers, and in some cases, even unnecessary to preserve the interests of the business. Such unethical practices are not unique to the United Kingdom, as reflected by the uproar in the United States of America over the decision of Amazon, an online global market platform whose fortunes have risen with this pandemic, to sack employees protesting for the provision of personal protective equipment necessary to insulate them from contracting the coronavirus in the workplace[17]. Unfortunately, due to the lack of locus standi, the workers cannot make a claim in law, as they are mere stakeholders not owed a duty by the directors.
Notably, the requirements for attaining such a standing are extraneous, as they require the support of the shareholders who would act on their behalf in court. Normally, it is understandable that the shareholders would be hesitant to sue the company, as the ruin it would occasion on the company reputation would harm the value of their shares. Additionally, the shareholders understand that such a move of layoffs by the company is in light of the preservation of their financial interests. As such, the seriousness of the lack of legal capacity of the stakeholders, as exposed by the coronavirus, greatly intimate their helplessness and lack of recourse for the protection of their rights. However, even if the stakeholders obtained such legal standing, courts are normally hesitant to allow applications for judicial review of administrative decisions.
The lack of effective, realistic sanctions against the directors in case of guilt of breach of the provisions of the code is also problematic, and its seriousness exposed by the coronavirus. The deficit in effective sanctions is arguably due to the vagueness in terms of the provisions, such as success, and have regard. The term success is problematic as it is not quantifiable. On the other hand, having regard is vague and largely poses issues with evidencing it in a court of law. In particular, the wording of section 172 only provides that the directors should consider the mentioned factors and the interests of the shareholders. However, the section does not mandate that the directors should expressly take into account the terms but may ignore them in consideration of other superseding interests. Additionally, in case of a claim in court, the director in defence, may evidence a paper trail of the consideration of the factors through minutes of the board meeting, which would suffice. The lack of the necessity of the consideration of the stakeholders’ interests arguably renders the legislation useless, as evidenced in the case of R.(on the application of People and Planet) v H.M. Treasury.[18]
In the aforementioned case, a pressure group had applied to the court that the government should run the Royal Bank in accordance with the interests of section 172 of the companies’ act 2006, in particular the stakeholder’s interests on climate change and human rights. In dismissing the application and denying permission for judicial review, the court noted that the Treasury had taken account of such matters, but there were other matters to be considered, and due weight be given to them; hence a balance of interests was needed. In any case, while the Treasury could put its views across to the board of the directors, ultimately, it was for the directors to manage the bank and not the Treasury. Essentially, this judgement highlighted the uselessness of the provisions in light of the stakeholders’ needs.
To find such a liability on the part of the directors, the stakeholders would have to evidence a gross and erroneous disregard for the provisions. However, even if they tabled such evidence, the court would still be hesitant to find the directors liable. Additionally, such a decision requires that the court would find that the decision was erroneous and unreasonable, as per the Wednesbury standard of reasonableness[19]. This indeed, renders the provisions substantially useless. Enforcing the obligations, therefore, would be on the willingness of the directors.
The preceding indicates the seriousness of the defectives in section 172 in the protection of social interests due to the denial of locus standi to the society, and the deficit in practical sanctions in cases of breach. As such, there is a need for more reforms for the section to ensure the protection of the stakeholders in law. However, such reforms should be cautionary to avoid the damnation of businesses and the repelling of the investors due to an unfavourable business environment.
[1] Lynch, Eliane. “Section 172: a ground-breaking reform of directors’ duties, or the emperor’s new clothes?” Company Lawyer 33, no. 9(2012), 196.
[2] Harper Ho, Virginia E. “‘Enlightened Shareholder Value’: Corporate Governance Beyond The Shareholder-Stakeholder Divide”. SSRN Electronic Journal, 2010. doi:10.2139/ssrn.1476116.
[3] U.K. Corporate Governance Code of 2018.
[4] U.K. Corporate Governance Code 2018 publicly.
[5] BBC. “How Many Confirmed Cases Are There In Your Area?”. BBC News, 2020. https://www.bbc.com/news/uk-51768274.
[6] BBC. “PM In Intensive Care As Virus Symptoms Worsen”. BBC News, 2020. https://www.bbc.com/news/uk-52192604.
[7] BBC. “U.S. Oil Prices Turn Negative As Demand Dries Up”. BBC News, 2020. https://www.bbc.com/news/business-52350082.
[8] U.K. Companies Act of 2006.
[9] Harper Ho, Virginia E. “‘Enlightened Shareholder Value’: Corporate Governance Beyond The Shareholder-Stakeholder Divide”. SSRN Electronic Journal, 2010. doi:10.2139/ssrn.1476116.
[10]Milton Friedman, Rose D Friedman and Binyamin Appelbaum, Capitalism And Freedom, University of Chicago Press 1sted.(1962).
[11] Dodge v. Ford Motor Company, 204 Mich. 459, 170 N.W. 668 (Mich. 1919)
[12] Shlensky v. Wrigley, 237 N.E. 2d. 776 (Ill. App. 1968).
[13] AP Smith Manufacturing Co v. Barlow 2 39 ALR 2d 1179 (1953)
[14] Macey, Jonathan. “A Close Read of an Excellent Commentary on Dodge v. Ford”. Virginia Law & Business Review. (2008)
[15] U.K. Companies Act 1985
[16] Harper Ho, Virginia E. “‘Enlightened Shareholder Value’: Corporate Governance Beyond The Shareholder-Stakeholder Divide”. SSRN Electronic Journal, 2010. doi:10.2139/ssrn.1476116.
[17] Sainato, Michael. “Amazon Is Cracking Down On Protesters And Organizing, Workers Say”. The Guardian, 2020. https://www.theguardian.com/technology/2020/may/05/amazon-protests-union-organizing-cracking-down-workers.
[18] R (on the application of People & Planet) v. H.M. Treasury. Reporter Info: [2009] EWHC 3020.
[19] Associated Provincial Picture Houses Ltd. v Wednesbury Corporation [1948] 1 KB 223