Law of Organisations Oral Prep- Part B Flashcards
Q1. What was the old law and why was it changed
○ Under the old law, directors had a common law duty to act ‘bona fide in the interests of the company’.
○ A criticism of the common law bona fide duty was that it only prioritised the interests of shareholders but failed to consider the impact that directors actions can have on other stakeholders. ○ S 172(1), now requires that a director ‘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’ , as well as considering other factors laid out in s172(1) that include various stakeholders (employees, customers, suppliers and others)
Q2. How does the duty set out in s172 affect other duties
Section 172 is a broad duty and often impacts on other duties;
Item Software U.K. v Fassihi
○ Fiduciary duty to act bona fide in interests of a company requires defendant’s to disclose his own or others’ misconduct/breach of duty to the to company.
Failure to disclose a breach of duty, might lead to a breach of s 172 (as well as a breach of the original duty) as it will be in the company’s best interests to know about this breach.
Q3. Is a director automatically in breach of s172 if he does an act that negatively impacts a company
- The directors duty to act in a way he considers promotes the success of the company for the benefit of its members is a subjective duty.
- If a directors act/decision/omission is being challenged, the court must determine objectively by examining evidence whether the director honestly believed their decision would promote the success of the company, NOT whether the decision itself promoted the success of the company- Jonathan Parker J
- The directors duty to act in a way he considers promotes the success of the company is a subjective duty meaning that if the decision of a director was honest, and the director generally believed it would promote the success of the company, it doesn’t matter if it was an unreasonable decision, shown in Regentcrest v Cohen
Explain Regent Crest v Cohen
○ Here a company (Regentcrest), wished to purchase all the shares in another company (Greenground), in order to own and subsequently develop land that Greenground owned.
○ Two of the shareholders of Greenground, were directors for Regentcrest, and a third shareholder was a former director for Regentcrest. ○ The terms of the share purchase contained a ‘clawback provision’ in which, if the land to be developed reduced significantly in value before the date of development, then then the two current directors and former director of Regentcrest would have to pay the difference between the lands worth and how much it was bought for. ○ The value of the land did drop substantially by £1.5 million, but the directors of Regencrest decided to waive the clawback provision (to maintain a united board). ○ Soon after Regentcrest went into liquidation and the liquidators challenged the decision of the directors claiming that by waiving the clawback provision they were not promoting the success of the company. ○ The courts however found for the directors of Regentcrest, as they honestly acted in a way they considered would promote the success of the company by wanting to maintain a united board.
Q7. What are some instances/circumstances that show a director does NOT have to act only in the interests of shareholders but can take into account other stakeholders- s172(2) and s172(1)(d)
S 172(2)-
· Section 172(2) of the CA 2006, allows for companies i.e. non profit companies with objectives and purposes that fall outside of just ‘promoting the success of the company for the benefit of its members’ to pursue these other objectives.
· They are allowed to prioritise these 'unselfish interests' e.g. social, charitable and environmental objectives, above the 'selfish interests of its members'. Prioritising these types of interests will require directors to act in the interests of the local community/public- a stakeholder. · S 172(2) provides that achievement of these objectives promotes the success of the company for its members.
S 172(1)(d)
- Section 172(1)(d) sets out that companies must consider ‘the impact of their operations on the community and the environment’- Therefore, the local community/wider public is a stakeholder directors must consider.
- Nowadays a company’s environmental and social impact is judged (alongside financial performance), and this has seeped into business disclosure information, where such information must include environmental and social metrics.
▪ The directors report of a public company, must include information about the annual greenhouse gas emissions produced by business activity. ▪ Some companies are required to publish a statement on slavery and human trafficking, that outlines the steps the organisation has taken to ensure these practices are not part of its business activity or supply chains ▪ The strategic report of a public company must include information about the businesses position/impact on the environment, social community and human rights issues.
Q4. How is success defined
- There are various financial and non-financial performance indicators that can be used to define the success of a company.
- However in a commercial setting, the success of a company is usually measured financially.
- Lord Goldsmith states that ‘for a commercial company success is defined as the long-term increase in value’.
Q5. What was a criticism of the old law and how does the new law improve on this
A criticism of the common law bona fide duty was that it only prioritised the interests of shareholders but failed to consider the impact that directors actions can have on other stakeholders.
This led to the Company Law Review Steering Group looking at two alternative approaches that aimed to include stakeholder interests;
- Enlightened Shareholder Value Approach
- Pluralist Approach
What are the enlightened Shareholder Value and Pluralist Approaches
The enlightened shareholder value approach- (Today’s position)
- Under this approach, the main aim of the company is to maximise shareholder value, which should in turn promote welfare and overall prosperity.
- It goes on to say that primarily focussing on a company’s short term profits does NOT equate to enhanced shareholder value, but instead directors should work towards promoting collaborative relationships, which may involve short term costs but will bring greater benefits in the long term.
The pluralist approach- (Rejected by the CLRSG)
- Under the pluralist approach, directors should run companies in a way that maximises welfare and prosperity for ALL instead of making shareholders the most important stakeholder.
- Shareholders should be seen as simply one of many different stakeholders which include, employees, customers, suppliers and local communities, and under this approach directors would be allowed to prioritise the interests of one of these groups above shareholders if justified by the circumstances.
Q6. How much can a director have regard to the other factors set out in s172(1) + Criticisms of the new law
The position today
- Whilst directors must have regard to the factors sets out in 172(1), when promoting the success of the company for the benefit of its members, they are not allowed to prioritise these factors above the duty to promote the success of the company, and if a director does so he will be in breach of s 172.
- None of the stakeholders set out in s 172(1) can bring a claim against the directors for breach of duty. Only the shareholders can bring a derivative claim on behalf of the company.
- Some argue this has rendered the effect of s172 which aimed to increase the consideration directors give to stakeholders when making their decisions ‘toothless’, because these stakeholders are powerless to do anything if a director makes a decision/does an act when promoting the success of a company that doesn’t consider them or actively disadvantages them in favour of the members.
Q7 cont- What are some instances/circumstances that show a director does NOT have to act only in the interests of shareholders but can take into account other stakeholders; Employees/Reputation
S 172(1)(b)- Employees and s 172(1)(e)- Reputation of the company
· Sections 172(1)(b) and 172(1)(e), set out that when promoting the success of the company , directors need to consider the interests of the company's employees and consider the reputation of the company by maintaining/ensuring a reputation for high quality regarding business conduct. · Failure to consider these factors can have disastrous consequences/negatively affect the success of a company financially Antuzis v DJ Houghton Catching Services Ltd ▪ Lithuanian workers were employed as chicken chasers by DJ Houghton catching services. ▪ They worked in appalling conditions, were paid below minimum wage, often had their wages kept from them as punishment and were denied bereavement leave. The workers brought a claim against the company and the directors for how they were treated. ▪ Whilst the directors argued that they paid these workers below minimum wage to maximise profits, the court held that the actions of the directors ‘were NOT in the best interests of the company or its employees’ and they had in fact breached s 172. ▪ By failing to take into account the employees welfare and maintaining high quality business conduct (factors B and E), they had ruined the company’s reputation in the eyes of the public.
This in turn damaged the company’s long term financial prospects, because its poor business practices meant other companies did not wish to conduct business with them, so their fortunes declined heavily.
Q7.cont cont What are some instances/circumstances that show a director does NOT have to act only in the interests of shareholders but can take into account other stakeholders; Creditors
S 172(3)- Creditors
· Section 172(3) summarised sets out that in certain circumstances the directors need to act in the interests of or consider the needs of the company’s creditors. · Nourse LJ outlined in the case of Brady v Brady- If a company is solvent (assets exceed liabilities), shareholders interests are prioritised, but where a company is insolvent or on the verge of insolvency the interests of the creditors alone are prioritised as the interests of the company.
When does the duty to consider creditors arise?
There are two approaches that will determine when the directors duty to consider creditors arises;
Approach 1
The courts set out that the directors have a duty to consider creditors when;
○ The directors know or should know that the company IS or LIKELY To Become insolvent. ○ There is criticism of this approach however, as waiting until the company is insolvent or on the verge of insolvency to prioritise the interests of the creditors, might make it too late for the creditors to have a chance of being paid.
Approach 2
The second approach for when the duty to consider the creditors occurs comes from the case of Re HLC Environmental projects
○ Under this approach the creditors interests must be prioritised when there is a risk of the creditors not being paid/the risk of non-payment. ○ If a director’s action/decision could really reduce the likelihood of the creditors being paid, then they will not be allowed to take those actions, without first considering the interests of creditors rather than that of the company and its shareholders. ○ By considering the risk of the creditors not being paid, then the directors do not have to wait for the company to be insolvent/close to insolvency, which severely decreases the chance that creditors will be paid.
What happens when the duty to consider the creditors is triggered;
○ When the company is insolvent the interest of the creditor’s is paramount, and displace the interests of shareholders.
○ When a company is close to insolvency some authorities suggest the interests of creditors becomes paramount, whereas other suggest that if the company is not insolvent but having difficulties which could put the creditors at risk, then the directors have a duty to the company to consider both the interests of creditors AS WELL AS shareholders.
Q8. What are some instances/circumstances that show a director does have to act only in the interests of shareholders-
Position Today
- Whilst directors must have regard to the factors sets out in 172(1), when promoting the success of the company for the benefit of its members, they are not allowed to prioritise these factors above the duty to promote the success of the company, and if a directors does so he will be in breach of s 172.
- None of the stakeholders set out in s 172(1) are can bring a claim against the directors for breach of duty. Only the shareholders can bring a derivative claim on behalf of the company.
- Some argue this has rendered the effect of s172 which aims to aimed to increase the consideration directors give to stakeholders when making their decisions ‘toothless’, because these stakeholders are powerless to do anything if a director makes a decision/does an act when promoting the success of a company that doesn’t consider them.
Why the pluralist approach was rejected;
- It gave the directors too much discretion.
- The aims of achieving welfare and prosperity (in promoting the success of the company) might not be achieved via this approach, as the scope of directors discretion is too large and it would be difficult to police their behaviour if they were able to prioritise ‘predominantly non-financial interests’ in their view of what constituted company success.
- Directors could block the wish of shareholders in actions like a takeover bid (where a company makes an offer to purchase another company), by having the power to prioritise other interests such as ‘public interests’.
