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EMPLOYEES, DIRECTORS & THE FUTURE PATH OF CORPORATE GOVERNANCE REFORM

Shortly before the calling of a General Election the Business and Enterprise Select Committee of the House of Commons published a report on corporate governance. As the report’s reception and subsequent comment have made clear, whatever the outcome of the election the framework set by the report is likely to determine the direction of future corporate governance reform.

In this article, James Bickford Smith and Joseph Bryan discuss the BEIS Committee’s proposed amendments to companies’ reporting duties. James was a member of the ELA working group whose analysis of the current state of the law on s. 172 of the Companies Act was adopted by the Committee. The Committee also endorsed the ELA working group’s substantive recommendation that a reporting duty be created. This article addresses the state of the current law and the role such a duty might play in enforcing compliance with it.

Introduction

The scope of the Committee’s inquiry (the full report of which is available here) was broad: beyond reporting duties, it examined directors’ duties, private companies, executive pay, diversity in the boardroom and worker representatives. This discussion will focus on the relationship between good corporate governance and employee interests.

As the report observes, corporate governance “is there to support effective decision making by companies for their own long-term success. It provides a framework of law, rules and practices by which company boards balance the interests of shareholders with other stakeholders, including employees, customers, suppliers, creditors, pensioners and the local community” (para. 2).

Of special interest to employment lawyers will be the findings on directors’ duties, companies’ statutory reporting requirements and how these interrelate with employee interests. Legislative change is in prospect given the Committee’s recommendations on this point. This article considers, first, the relevant legal principles before turning to the Committee’s recommendations.

Protecting employee interests: legal background

The common law was historically opposed to recognising employee interests in corporate decision-making: see, for instance, Hutton v West Cork Rly (1882) 23 Ch D 654. Despite substantial changes in social environment subsequently that traditional position has proven resilient notwithstanding two statutory interventions. The first of these was s. 309 of the Companies Act 1985. This departed from the common law by requiring directors to have regard to employee interests in general in the performance of their functions. But it was a provision seldom litigated. There was a practical and jurisprudential obstacle to such litigation: the s. 309 duty was owed to the company, so could not be directly enforced by the company’s employees. As treatments in older company law texts show, the duty was viewed as a procedural requirement which conferred no substantive benefit on employees. If an employee was to rely on a breach of s. 309, it would be in the context of an unfair prejudice petition (in which case the employee would therefore also be a minority shareholder) or a derivative claim. In fact the only case in which the s. 309 duty was referred to more than in passing is Re Saul D Harrison & Sons plc [1995] 1 BCLC 14. The role it played in that case was largely forensic: a Petitioner’s failure to address an argument that some of the decisions of which he complained could be justified by the Respondents having regard to employee interests provided a yet further ground for dismissing the Petition.

The question of what weight – if any – interests other than the immediate creation of shareholder value should be afforded in corporate decision making returned to the fore in the debates preceding the passage of the Companies Act 2006. Those with longer memories may reflect wryly on the level of criticism levelled at the then government on the basis that it was seeking to interfere in corporate governance on “political” grounds. As became clear at House of Lords stage, the government was sensitive to such criticisms and at pains to be “business-friendly” while also seeking to reflect some of the concerns expressed in influential treatments that had negatively compared British and German models of corporate governance. The material result was s. 172(1) of the Companies Act 2006:

A director of a company must act in the way 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 –

(a) the likely consequences of any decision in the long term,

(b) the interests of the company’s employees,

(c) the need to foster the company’s business relationships with suppliers, customers and others,

(d) the impact of the company’s operations on the community and the environment,

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company.

Hamlet without the Prince

It is at this stage that a litigator’s perspective can cut through some of the broader debates over s. 172, for a section that cannot be practically litigated must, in the final analysis, be seen as a statement of good intentions. In this regard, litigating a claim predicated on an alleged breach of s. 172(1)(b) faces three difficulties:

  1. Any challenge to a director’s decision-making involves an inquiry as to the director’s state of mind. In Regentcrest plc (in liq.) v Cohen [2001] BCC 494 at [124], Jonathan Parker J explained: “The question is not whether, viewed objectively by the court, the particular act or omission which is challenged was in fact in the interests of the company; still less is the question whether the court, had it been in the position of the director at the relevant time, might have acted differently. Rather, the question is whether the director honestly believed that his act or omission was in the interests of the company. The issue is as to the director’s state of mind. No doubt, where it is clear that the act or omission under challenge resulted in substantial detriment to the company, the director will have a harder task persuading the court that he honestly believed it to be in the company’s interest; but that does not detract from the subjective nature of the test.
  2. There is little case-law on either s. 172(1)(b) or s. 309.
  3. The overarching statutory duty is to act “to promote the success of the company for the benefit of its members as a whole”. It is unlikely that any one of the factors in subsections 172(1)(a)-(f) could override that duty.

In any event, it is highly doubtful that s. 172(1)(b) creates any new substantive right or duty. As the Company Law Review steering group has noted: “The main concern [with the list of factors a director should take into account before acting] […] was that it should be absolutely clear that these are matters which, so long as they are identified and assessed in accordance with the duty of care and skill, are subject to the good faith business judgement of directors both as to whether they are relevant and as to the weight to be attached to them, in considering the promotion of the success of the company” (quoted in Buckley on the Companies Acts (2016) para. 919).

The upshot, in the absence of case-law, is that the s. 172(1)(b) duty is not actionable by employees other than by a cumbersome unfair prejudice or derivative claim, and has never in fact been actioned in any reported case.

Recent debate and the Committee’s recommendations

Thus, as the law stands, employee interests ultimately have little legal weight in corporate decision-making. Some may consider that appropriate, others may not. At a policy-making level, however, there can be little doubt that following highly publicised events at BHS, Sports Direct and elsewhere, the “good intentions” approach of the 2006 s. 172 is less favoured than it was. Indeed, one now has the position where the leaders of Conservative, Labour, Liberal Democrat and Scottish National parties are debating how substantial the departure from that position should be, rather than whether there should be a departure.

One focus of that debate has been as to whether there should be “employee” representatives on boards. Such a provision throws up significant technical issues that the ELA working group considered (while taking no view on the more partisan question of whether such representation was desirable). For example, it would need to be established to whom such representatives would owe which duties, and one would also need to legislate in awareness of the fact that many of the companies that are the current focus of adverse media commentary have very few employees but many people performing work for them under contracts that label those people as self-employed.

Reporting requirements

One interesting development in the Select Committee process was some convergence in the debate between, on the one hand, those instinctively opposed to statutory intervention and, on the other, those highly critical of the current position. In searching for a practical middle road, the Committee conducted a detailed analysis of the technical proposals put forward by the ELA working group, whose chair Jonathan Chamberlain (of Gowling WLG) was called to give evidence. ELA’s written submission proposed that larger companies be required to publish online a “fair treatment of workers statement” to confirm that all staff receive the national minimum wage and are on fair terms. Before the committee Jonathan Chamberlain noted that it was very difficult to evaluate the operation of s. 172 in the absence of any real disclosure as to how it is working in practice, and that this was why ELA was proposing a new reporting duty as a solution to this problem.

The Committee’s finding was that companies:

are not required to explain specifically how they have fulfilled their section 172 duties, including how they have had regard to other considerations and the interests of stakeholders whilst pursuing the success of the company in the interests of its members. As a result, it is very difficult for shareholders to hold directors to account for the fulfilment of their legal duties or understand how they have balanced the interests of various stakeholders over the course of the year (para. 32).

The Committee was persuaded that companies “should be required to provide better information on how they have looked after the interests of employees, fostered relations with suppliers and mitigated any environmental impacts” (para. 34). In summary, its recommendations as to reporting requirements are:

  1. The FRC’s UK Corporate Governance Code should be amended to require informative narrative reporting on the fulfilment of the s. 172 duties to include an explanation of how stakeholder interests have been considered and reflected in financial decisions.
  2. The FRC should encourage companies to be more imaginative and agile in communicating digitally with stakeholders (including employees) throughout the year.
Conclusion

The Committee’s clear view was that at present boards do not (and are not required to) report in sufficient detail to their employees and others to evidence their compliance with s. 172(1). The reporting recommendations made are part of a package of proposed reforms with the aim of restoring confidence in corporate governance and increasing stakeholder engagement. In reaching its view, the Committee bore in mind that public trust in business is lower in the UK than in many other countries, especially in the light of recent high-profile media reports of boardroom failings (para. 9).

The ensuing recommendations may be seen as a further compromise in a difficult area, but they should have the advantage of giving some practical edge to the existing law. More stringent reporting requirements under the FRC Code have realistic prospects of promoting best practice by obliging directors to take their existing statutory duties more seriously. Ensuing legislative change is mooted by the report, which (at para. 33) cites with approval ELA’s suggestion that the new reporting obligations could drafted in a way analogous to those under the Modern Slavery Act 2015. Such change would no doubt require Government backing in Parliament, but the committee’s cross-party endorsement of them marks a potentially significant change of legislative direction in company law.
Posted: 09.05.2017 at 15:36
Tags:  Comments  Employment Law
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