Section 172 – Fit for Purpose?
10 August 2021
A relatively small change to section 172 of the UK's Companies Act 2006 could have a transformative impact on company law, directors’ duties, corporate governance, businesses and ultimately, the wider economy, society and the environment.
Recently, a coalition of over 500 companies signed a proposal asking the Government to deliver a new contract between business and society through a proposed 'Better Business Act' (“BBA”). The draft BBA changes the focus of the director's duty set out in section 172 of the 2006 Act from being a duty "to promote the success of the company" to being a duty "to advance the purpose of the company." The new "purpose" would be to benefit not only the members, but also operate in a manner that benefits wider society and the environment and reduces harms on society and the environment "with the goal of eliminating any such harm."
It is a fundamental principle of UK company law that directors have a duty to act in a way that promotes "the success of the company for the benefit of its members as a whole." In complying with this duty, directors are required to have regard to a list of matters, including the interests of the company's employees and the impact of the company's operations on the community and the environment.
However, the current drafting of section 172 has been called into question given that it may actually discourage directors from making decisions for the benefit of wider stakeholders. Yes, directors are required to "have regard" to the interests of employees, the community and the environment, but in measuring success the interests of each of these stakeholders are secondary to the interests of the company’s members. This has led to a mindset in some boardrooms that shareholder profits are to be maximised at all costs, or at least at the cost of other interests, which directors may have regard to but decide to discount.
This mindset is no longer sustainable in the world we live in today. The COVID-19 pandemic, threats of climate change and biodiversity loss and other urgent environmental and social challenges are forcing a rethink about the role and purpose of companies. The aim of the BBA is to change the default position so that directors would be empowered to advance the interests of their members alongside those of wider society and the environment – an approach that has been described as the 'triple bottom line'. The BBA is not seeking to remove a company's commercial objectives, but to require the board to enrich strategy through "a more holistic consideration of stakeholder issues alongside their focus on commercial success."
The BBA campaign wants four principles to be reflected in an amended section 172:
- Ensuring the interests of members are advanced alongside wider society and the environment;
- Empowering directors to exercise their judgment in weighing up and advancing the interests of all stakeholders;
- Default change to apply to all companies; and
- Requiring businesses to report on how they balance people, planet and profit in a strategic or impact report, where one is currently required.
Although the proposed amendments to section 172 are significant, they do not create new rights for stakeholders (other than the shareholders) to hold the directors to account. The current position under company law would be maintained so that the directors would continue to owe their duties only to the company. Actions against the directors for breach of duty by persons other than the company are possible, but only in very limited circumstances (for example, where a shareholder brings a 'derivative' claim on behalf the company or on insolvency). So if other stakeholders would continue to have to rely on the company itself or shareholders to hold the directors to account – do the proposed amendments go far enough? Whilst some may argue not, the fear is that going any further may lead to companies struggling to find willing directors or boards being paralysed given the risk of an inordinate number of claims by stakeholders who feel that their interests are not being considered.
So where do we go from here? The BBA has cross parliamentary support but it is unclear how the Government will respond. Despite pledges to 'build back better', the BBA has not made it into their legislative agenda for the year ahead. Although the voices for reform are getting louder, it remains to be seen whether they can keep up the pressure and affect change requiring directors to look beyond the interest of shareholders and instead consider the "triple bottom line."
If you would like any further information or advice, please do not hesitate to get in touch with the Corporate team at Carson McDowell.
*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.