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Directors’ duties

C H A R L E S M AY O

Perspective

Individual and collective board responsibility

There is an increasing link between individual success or failure as a director and the collective success or failure of the board of directors as a whole. The duties of directors, and the expectations others place upon them, have increased so considerably in scope and level that we have arguably reached a position where the effect of the law is to impose collective responsibility on all directors on the board, even where failure is directly attributable to only one or some of those directors.

The law has historically concentrated on the skill, care and diligence of an individual director, deciding that individual’s responsibility by reference to his own honesty, culpability, competence, functions and qualifications and other factors personal to that individual director. However, there are now many instances where the failure of one or some directors could well indicate a collective failing by the board as a whole or, increasingly, where the board as a whole must take responsibility. This is likely to be the case increasingly in the future.

If this is correct, how has this happened and where has it come from? This chapter covers some significant developments which, when viewed as a whole, support the proposition about the increasing alignment of the individual and collective responsibility of directors.

But where does this proposition come from? It comes from a combination of the following factors.

The demands and expectations of society and the extent to which it is seen as good business to take into account non-financial considerations, most notably the impact on the community, environment and employees.

Increased regulation as a reaction to corporate collapses and scandals with the aim (misguided some would say) of restoring trust and confidence.

Increasing transparency in the capital markets, where institutional investors are investing on a cross-border basis to a greater extent and generally becoming more active in exercising their votes and in managing their investments. Greater use of technology ensures that inside or price-sensitive information not only is made available on a very timely

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basis but is also equally available to different types of investor, both institutional and retail.

Additional responsibilities of directors which require the board to act collectively and effectively to facilitate the individual director’s compliance with those new duties. Examples concern the responsibilities to comply with the Listing Rules, to certify disclosure of relevant audit information to auditors, to prepare true and fair accounts and to comply with the Takeover Rules.

Significantly increased obligations on companies to report more extensively and more frequently. And it is not just in relation to financial reporting that very significant changes are underway. In some senses the reporting required now in relation to non-financial matters may be just as significant. Examples include reporting on principal risks and uncertainties, publishing forward-looking information, and publishing key performance indicators (KPIs) on environmental, human capital and other non-financial matters. In policy terms, there is a deliberate link between this additional reporting and the accountability of directors for the ‘stewardship’ of the company in the light of the concerns and expectations of society at large.

There is no single point in time at which one could specifically say the law moved from individual responsibility of directors to collective responsibility. It is a change that has been developing for some time. It would be a mistake to think of this change as very new or radical or even very different from the effect of the law at present. In many instances, codification of directors’ duties and a plethora of governance standards and best-practice guidance reinforce and merely serve to highlight changes which are already implicit in the law.

The proposition that the law has now moved to collective responsibility of directors might seem bold. Some may question whether it is correct at all or in specific instances. Perhaps most importantly, from a director’s standpoint, it does not matter whether the proposition is right or wrong because what is inevitably true is that the reputation and personal standing of a director can be seriously damaged where there has been a failure by any one or more directors on that board. So, from an individual director’s point of view, there is much to be said for all directors approaching their responsibilities as directors, mindful not just of the standards required of themselves individually, but also of the need for all directors to perform collectively as an effective and successful board.

Enlightened shareholder value versus pluralism

The pressures and expectations of society and the community come to the forefront in the debate as to whether directors should be required to follow an approach based on ‘enlightened shareholder value’ (in which directors promote the success of the company for the benefits of its shareholders as a whole) or

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a pluralist approach (under which directors act in the multiple interests of the different stakeholders).

What happens when there is a clash of interests between the shareholders and the other stakeholders? Do the interests of the shareholders have priority? Does the duty to promote the success of the company create one duty or a set of potentially conflicting duties which directors are required to balance?

The Company Law Review steering group concluded: ‘the present scheme of the law fails adequately to recognise that businesses normally best generate wealth where . . . managers . . . recognise the wider interests of the community in their activities’.1

More recently, it has been suggested that pressures from shareholders, or managerial perceptions of such pressures, have inhibited long-term investment in value-creating internal and external relationships, as well as in physical assets and other intangibles.

This concept (having regard to these external relationships) is often referred to in the literature as ‘enlightened self-interest’. The steering group preferred the label enlightened shareholder value, because the concept is that of a broad and well-informed view being taken of what is required to enhance the value of the business by both directors and shareholders.

The steering group accepted the argument that exclusive focus on the shortterm financial bottom line, in the erroneous belief that this equates to shareholder value, will often be incompatible with the cultivation of cooperative relationships, which are likely to involve short-term costs but to bring greater benefits in the longer term.

The background to the reasons why the steering group preferred the enlightened shareholder value approach is salient. Most importantly, their reasoning puts into context some of the heat and light which the codification of directors’ duties under the Companies Act 2006 has generated. The modern realities of business require directors to take into account a very wide range of considerations in order to promote the success of their companies; however, not only do directors in well-run companies do so already but, some would argue strongly, the law is already such that they were already required to do so. The steering group wrote (eloquently) as follows:

We consider the most appropriate formulation of directors’ duties is to give effect to the enlightened shareholder value perspective. The argument is that these duties, as currently expressed, and as interpreted in practice, often tend to lead to an undue focus on the short term and the narrow interest of members at the expense of what is in a broader and a longerterm sense the best interest of the enterprise, and thus its value to them as ultimate controllers able to realise that value.

1Company Law Review Steering Group (1999), Modern Company Law for a Competitive Economy: The Strategic Framework, p. 36.

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The key company law provision is for the fiduciary duties of directors. These require them honestly (‘in good faith’) to manage the undertaking for the benefit of the company. That benefit is defined by case law as the interest of members present and future. The duties of directors to exercise their powers for their proper purpose are also relevant. These, for example, prevent directors from using their powers to impede the exercise by members of their rights to dispose of their shares, such as by issuing new shares to allies to defeat a takeover bid.

It is in our view clear, as a matter of policy, that in many circumstances directors should adopt the broader and longer-term (‘inclusive’) view of their role. This is indeed now widely acknowledged. But we do not accept that there is anything in the present law of directors’ duties which requires them to take an unduly narrow or short-term view of their functions. Indeed they are obliged honestly to take account of all the considerations which contribute to the success of the enterprise.

There is nevertheless considerable evidence that the effect of the law is not well recognised and understood. This may be in part because the relevant principles are not enacted, but have to be derived from quite extensive case law, developed over 250 years and rooted in the eighteenth century law of trusts.2

From the steering group’s perspective, the fact that the law is widely misunderstood suggests that there was a strong case for making explicit its true character. The group maintained that the object of the law should be to ensure that directors recognised their obligation to have regard to the need, where appropriate, to build long-term and trusting relationships with employees, suppliers, customers and others, as appropriate, in order to secure the success of the enterprise over time.

But, it should be acknowledged that, even before the Companies Act 2006, the law already required directors to have regard to the interests of employees. Section 309 of the Companies Act 1985 requires that ‘the matters to which’ the directors of a company are to have regard in the performance of their functions include the interests of the company’s employees in general, as well as the interests of its members.

The steering group recognised that section 309 is arguably a statutory declaration of an enlightened shareholder value duty, requiring that directors consider the interests of employees in reaching a view of what is in the best interests of the company.3

The Government determined to follow the enlightened shareholder value approach, since that approach is ‘most likely to drive long-term company performance and maximise overall competitiveness and wealth and welfare for

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