The Potential Influence Of Section Law Company Business Partnership Essay

Published Date: 02 Nov 2017

Introduction:

The Companies Act 2006 "CA 2006" deals with issues of companies working under the English jurisdiction and it has been enforced in different stages instead as a whole. CA 2006 has superseded the Companies Act 1985 and now is main source for provision of rules on corporate governance. A set of rules on the duties of directors is provided in part 10 chapters 2 of the act but the real significance of this Act is the provision of director’s duty in s. 172(1), this obligate to directors promoting the success of the company considering the sections 1(a) to (f), likely long term consequences of his act, take care the interests of the employees of the company, improve the company’s relationship with other stakeholders such as suppliers, customers etc. This section denotes the responsibility of director to grow company for the benefits of its members at large and while doing so stress to act in good faith. The act seems to be reflection of common law obligations with a slightly changed concept of good faith combined with other compulsions. A range of common law obligations and fiduciary duties of directors seem to be covered by CA 2006 under constitutional obligations.

Companies under English law are treated as a separate entity or a legal person which can enter into the binding contracts, it can file the case and also other can file suits against the company it also can own the assets. Director is an important position and authority within the monarchy of company because companies can be held responsible hence is prone to legal actions for the acts which a director does to manage the business and other affairs of the company. S 250 provides a set of rules for number of directors of a company, their authority etc, it illustrates the person using the authority of a director would be considered as a director whether he was a nominated or de facto under CA 2006 he is termed as "director" [1] . Along with their actions making them fiduciaries of the company; they may have some other roles to play. A director is required to act in the best interest regarding both financial and reputation of the company under fiduciary obligation.

This common law fiduciary obligation is now embodied in statute; S 172(1) of CA 2006 requiring the actions of a director for promoting company’s success and benefit of its members. The section also makes it compulsory for a director to act in good faith, behaving in a way which in thinks is compulsory for both success of the company and interest of its members. Provision of the section also requires directors to consider relatively longer terms of outcomes of like decisions and interest of the employees.

s 172(1) in regard of sub sections 1(a) to (f) requires director to promote the success of their company and also obligate the director to consider the possible outcomes of his actions, taking care of employees in regard to their interests, developing good relation with other stakeholders like suppliers, customers etc. obligations narrated in this provision obligates require to act fairly between the members of the company and take into the consideration the impact of the company’s operation on the community and environment which is generally called Corporate Social Responsibility. Director is also obligated by this provision to take care of the reputation of the company and its standards

CA 2006 not only brought a significant change in the common law concept of maximising the benefit and getting most out of the business and moved the concept in the direction of community and environment but also introduced the value of shareholders. Above mentioned significance of CA2006 made it imperative to explore its practical implication provided by the expectation level of the community and civil society.

Paper examines obligations provided in s 172(1) in the light of requirements given in 172(1) (a) to (f) and ss 173 to 177 being necessary to discuss with s172. By applying subjective interpretation and objective test of section 172 of CA 2006 essay will examine the probable authority and capacity of this section to influence the corporate governance. As an argument, under the circumstances of conflicting interests of a director with the company being the violation of act in good faith is also the violation of these provisions itself; acceptance of benefits from a third party also falls in the violation of the CA2006 hence in presence of such conflict of interest it cannot be argued that director acted in good faith for the interest of the company and its members. Analyses of authority and efficacy of S172 is included in this paper by relating subjective and objective test and would find the imperfections and conflicts between the various provisions.

Corporate governance strategies; Subjective interpretation of S 172:

Principle of Good Faith to Promote the Success of Company:

Under common law and equitable principle, directors are obligated to act bona in bona fide in the best interest of the company director must act in good faith that such act is in the interest of the company. Apparently s 172 seems ditto copy of common law and equitable principle which states that;

"Director 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".

Obligations of directors regarding issues and functions of the company are provide in Chapter 2 part 10 of CA 2006. S 172(1) of CA 2006 is significant in this regard; a director is responsible for the success of the company and obliged that the actions of a director must be in a way he thinks are fundamental for the success of the company however he must proceeds in good faith. The director is also obliged to take care of both promoting the success of the company and securing the benefits of its members in a wider perspective under S 172(1) a-f. Moreover, provision of the obligation that the director should also consider the possible long term outcomes of his actions, employees’ interest and also needs to improve the business provisions of the company with stakeholders makes CA2006 more significant. The director is also obliged for considering the impacts of operation of company on the environment and society, maintaining the high standard of business conduct and discouraging discrimination among all the members of the company under provision of corporate social obligation.

The scope in interest of the company was discussed prior to the ratification of the act by Blair and Stout [2] emphasizing to interpret the same on a broader aspect. They were supporter of expanding the meaning of the phrase to the interest and welfare of all stakeholders rather then benefiting shareholders only as the phrase was limited in meaning provided by its standard definition.

A major change regarding the cultural aspect of business decision making was brought by S 172 by obligating to consider the long term interest. High concerns of the legislatures regarding long term relationship can be verified from the drafts of the bill where in second white paper phrased short term has been omitted and directors were bound to look after the long term interest. It will not take much to conclude that an extra support to bring change in corporate governance was added by instant section by replacing the term "short term" by "long term".

The idea of promoting collective interest of all the members as a whole was improved by constitutional support of CA 2006. It also vested vast discretion to the director/s and made it easies to balance the conflicting interest of the members. A more cautious thinking and exploration of more information taking decisions of such kind is considered necessarily by the directors keeping in mind of coded duty in the constitution. [3] Rarely a decision is brought to court and succeed where the director succeeds to make the case that his decision was taken in the good faith along with all the relevant factors been measured carefully. To avoid legal responsibility director as well has to demonstrate the reasons to believe that such act would be beneficial for the interest of the company in the long term. [4] 

Considering the long term benefits, a thorough reading of this obligation is required as the director must consider the benefit of all the members of the company as a whole. According to Keay, the directors may find instant provision to be problematic as it is a possibility that courts may stretch the meaning to the current and future shareholders. A real problematic situation is most likely to occur when the director has to conclude the benefit of present and future members since some decision taken may only benefit the present shareholders as compared to future shareholders. Declaration of a director regarding this situation may say that consideration the benefit of future shareholders was taken regardless of short tem benefit which was most likely to benefit the present shareholders.

Decisions in the interest of company taken by the directory with good faith depends on the decision taken by the director are usually taken on the basis of business judgment rule. Strategies and business plans finalized by the director for the success of the company is a choice of directors subject to "good faith" rather than court’s authority. Consequently if the director successful convince the court that decision taken by him was in good faith considering the success and the best interest of the company, it is most likely to be getting cleared from courts from the charge of breach of the duty. [5] 

B) Subjective and Objective Test:

Under the provision of company law, directors are required to promote the success of the company while taking actions they it is essential to believe in "good faith" and directors are authorized to decide what is in the favor for the company. In this world of competition, reason to authorize the directors to decide the interest of the company most probably is to make instant decision on various important issues as a delay may cause fatal lethal loss to the interest of the company. A director is aware of all the issues of the company and is in better position to take a decision as he performs his duty on daily basis. Company law brought his duty under the constitutional provision by endorsing this duty and conversely obligating them to act in good faith rather then giving them a free hand. [6] A subjective test is required to determine whether a certain act has been taken in good faith or not. This makes no difference if the result of this act was unfavorable for company the only thing which director needs to prove is, that the action has been taken in good faith and then can getaway from taking legal responsibility for the loss or damage to the company. If his act is proved to be in good faith which seems to be difficult to determine he can be exonerated from the charge notwithstanding the result of his action. Despite the outcomes of such decision, it relates to someone’s state of mind that, while doing such act what actually he believed. Subjective test provides test by expecting to act with due diligence and discretion in the way an ordinary person would have acted in same condition.

Similarly to find the element of good faith in certain action of a director it is vital to see if he honestly believed with good intention that his action is genuine. Earlier appears to a bit subjective test while the later entails the objective test. [7] However it is hard to believe that the action was taken in good faith in case a company undergoes a major damage by the decision of a director. Courts may not consider the substantiation provided by the director regarding its state of mind is an arguable question. The case of Extrasure Travel [8] can be taken as a perfect example of the principle where liquidation of the company was brought to the court claiming that the director was suspected to violate his duty regarding good faith. Court held that, "it is vital fact, what the director honestly believed was in the best interest of the company and not what is in the interest of the company in courts view." it is not the responsibility of courts to determine the best interests of the company, but courts concluded the director deviated from his duty but also indicated that if he proves his honesty believing in god faith while taking the decision, he would be exonerated from the liabilities of damaged caused by his actions. Court held that,

"I am satisfied that the defendants did not think, on 17 August 1999, that the transfer of £200,000 was in the best interests of Extrasure. If, having considered all the evidence, it appears that the director did honestly believe that he was acting in the best interests of the company, then he is not in breach of his fiduciary duty merely because that belief appears to the trial judge to be unreasonable, or because his actions happen, in the event, to cause injury to the company."

Except a little amendment (S 172 requires taking into the account interest of the all members whereas common law required interest of the company) it seems that obligation under S. 172 CA 2006 has replicate the common law duties which emphasized on the director to act in good faith. The principle of authorizing directors to in decision making of company’s interest was fortified by s. 172 (1) which was previously seen in common law. Support to director’s decision in the interest of company is on one hand, on the other hand law also puts the director under certain checks such as acing with care and diligence and any violation to this would count as breach of duty. This is another common law test applied in courts to decide the validity of violation of the S 172. In the context, Cobden investment case has important weight being one of the earliest cases on S 172 of CA 2006, in instant case court held that,

"It is accepted that a breach will have occurred if it is established that the relevant exercise of the power is one which could not be considered by any reasonable director to be in the interests of the company." [9] 

Coming with different results on the same issue in different courts is a normal practice in common law authorities which sometimes troubles application of judicial precedents.

As observed by Keay, courts applied other standards like objective test to determine the good faith of the director considering the fact that they have to believe the verbal statement of the director only. In the judgment of Charter bridge Corp Ltd v Lloyds Bank Ltd [10] where courts concluded that director’s failure in considering the company’s interest guides them to ask what would an honest man in the director’s position may have done in this situation. The attention would have shifted to subjective test if the director’s act was in interest of the company. Consequently, application of objective test on disputed act was done as the applicant declared that the director’s act was "not in good faith". A simple director’s statement of acting in good faith is not necessary for court’s belief as the court can question this statement on the basis of evidence provided against good faith and may reject director’s statement. [11] 

"It is, in my judgment, vital to remember that actions of boards of directors cannot simply be justified by invoking the incantation ‘a decision taken bona fide in the interests of the company’." [12] 

The standard superiority of director was discussed in Hutton v West Cork case where court concluded that mere bona fide will not be the single test, otherwise, in relation with the matters of the company probably one will be offensive and "…paying away its money with both hands in a manner perfectly bona fide, yet perfectly irrational." [13] 

C) Impacts on the Environment U/S 172 (D), Corporate Social Responsibility Read with sub section (E):

S172 provides cosmic discretion to the director to act in good faith to promote the company considering other factors described in 172 (a)- (f) together with S. 173- 177. A director is needed to consider the obligation of corporate social responsibility while acting as director. It is a director’s responsibility to take care of corporate social responsibility as well as the interest of stakeholders at the same time. Consequently s 172 makes a director superior for making decisions in the best manner to balance these obligations. In current competing age, it is bit complicated trying to balance the various interests considering the instant requirement. As an example, serious concerns can be observed in the parliament during debate on the bill.

Some NGOs including Trade Justice Movement showed their anger on deviation from customary obligation of loyalty of promoting the success of the company. By considering the activities of some big corporation in the past NGOs asserted that use of phrase "success" signifies the authority of corporation to move ahead with their agenda at the cost of environment and damage it. "…and within a fairly distant time horizon, making large parts of the globe uninhabitable". [14] Because of strong reaction government agreed to bring sub Sec. "d" which obligated the director to assess the environmental effects of the cooperation of the company company’s on the community and environment.

Application of both the obligation at the same time creates uncertainty considering both the corporate social responsibility and success of the company at the same time. It lead the directors towards inconsistency whether to work in company’s interest or consider corporate social responsibility and likewise considering environmental and communal issues may conflict with company’s interest. Similarly considering the obligation described in the 172 (e) the director may have to compromise the primary goals of the shareholders which is financial benefit to maintain a reputation for high standards of business conduct. Application of this sub section and corporate social responsibility with main duty to promote the success results further ambiguity.

Keay points out major concerns arising by applying and interpreting the S 172 (1) considering the confusion on interpretation of the section as a major flaw comparing to other general duties incorporated in the existing common law rules and equitable principles. In West Coast Capital case [15] court explained that this section has specify the pre-existing common law and equitable rules on the subject. In Cobden Investments Ltd v RWM [16] court clarified that the common law is incorporated in this by lawmakers in a modern way by defining the same in the better understandable way. Court further said that "the duty to act bona fide in the best interests of the company is reflected in the terminology of s.172."

Keay is of the view that despite of the fact that courts concluded that constitutional obligation reflects the common law duty to act in bona fide; like the interest of the non shareholders and idea of company’s success separates it in couple of ways. Furthermore the unclear term of "success" seems tricky as the system to calculate the success relating the shareholders interest is not provided. The term "success" as compared to "value" [17] is derived as a general term by many Columnists and it puts the responsibility of deciding what constitute to promote the "success" of the company on the shoulders of directors. [18] According to the views of Wu Chee government meant; increase on a long period of time and it is certain that success is at par to the value for the company in the long run. The superiority over the decision of what constitute to promote and what is good company of the directors is strengthen by this concept.

D) Shareholder Approach vs. Stakeholder Approach:

The risk faced by shareholders by investing in the company even at the cost of their capital is regarded by Shareholder value approach and it gives a sense of the ownership of the company to shareholders. This approach emphasizes on highest gain keeping in view the risk factor. The shareholders can bring a derived claim against the directors under Shareholders approach so it forces the directors to show greater care and sensible approach. Here are some shortcomings of this approach;

Long term gains are affected because the approach lack the trust building with stakeholders due to the reason that this approach prioritizes short term gains over the gains in the long run. Stakeholders approach on the other end comprises of the parties that have an interest in the functions of the company and they are prone to get benefit of adverse affect with the operations of the company. Stakeholders approach distinguishes company’s liability towards the rights of employees, customers, creditors, suppliers and social aspects such as environment. Besides the interests of the shareholders the magnificence of this approach is found in its commitment towards corporate social responsibility as it considers the benefit and interest of employees, environment and other factors in play besides the interests of the shareholders. There is no doubt about the fact that company would achieve long term success and gain good and the companies that do not care about these aspects cannot achieve by considering the social aspect and elements before going into decision making process.

This approach also consists of some shortcomings such as, uncovering the competing interest of stakeholders whether individual group or set of stakeholders in difficult, restriction of shareholders in the management of the company and evaluating director’s performance in the light of the decisions made for the long run interests of the company. Fisher instant approach is of the view that a focus of director is diverted from maximizing shareholders value. [19] 

E) Enlightened shareholder value u/s 172 of CA 2006

It was thought that s 172 has brought major modification in the common law duties by with the passage of time; it turned out to be a simple adaptation of earlier duties. Preliminary statement reveals reproduction of common law obligations and the first appearance took place in the West Coast case in which court found that s.172 is replacement of the common law obligations and equitable principles which requires the directors to regard the interest of the stakeholders while taking decision in relation with his obligation to promote the success of the company. It is argued that regarding director’s duty, in contrast to the pluralist approach, instant approach does not acknowledge the independent value of the stakeholders and is just a modified version of common law. Instant approach imposes very low values by merely requiring the director to consider the interest of the stakeholders while acting for the best interest of the members. Likely enforcement of this duty has very limited scope of as was also seen under common law. Another potential criticism has been brought forward by asking about the likely remedy to the stakeholders in the event director breached his duty to consider the interest of the stakeholders. This ambiguity is basically against the spirit of enactment of CA 2006 and instant provision to create balance between pluralist approach and traditional shareholders approach.

In spite of that an important aspect about enlightened shareholder value under CA is that; in traditional shareholder model, shareholders lack the vital control over the issues of the company meaning that under this approach directors are not bound to the shareholders. This demonstrates that under shareholder value approach it is difficult to hold the directors liable for lacking the good faith in their acts or omission and failure to promote the success of the company. This further demonstrates that due to director’s failure to observe his obligation to act in good faith and promote the interest of the members as whole, shareholder are most likely to make money and maximize profit at the cost of the other stakeholders. Moreover under current position of the CA 2006 stakeholders cannot sue the directors where they are believed to act not in good faith and caused harm or loss to the other stakeholders. Unaccountability gives rise to the possibility that director may take decision with dishonesty which benefits the shareholders or a certain group of stakeholders and cause harm or loss to the interest of the other stakeholders. Key asserts that it will be dangerous for directors to trade off some member’s interests for the benefit of stakeholders and risk derivative action. The problem will occur when there is a conflict between one of the factors and interests of the members.

Sine this approach does not give right to the stakeholders to sue the directors on breach of their statuary duty to act in good faith for the success of the company and in the interest of the member as a whole thus creates uncertainty over the issue of breach of statutory obligation to act in good faith. Explanatory note has also failed to clarify the position and fix the responsibility on the directors for breach of their statutory obligation to act in good faith to promote the success of the company.

Law society indicate that due to the flexibility of instant law courts have vast jurisdiction to develop the law by interpreting the  imprecise provisions keeping in view the changing circumstances and needs.

F) Is there material inconsistency between s 172 and 171?

In case of hostile takeover, a conflict between section 171 and section 172 may be seen in applying "proper purpose rule" as a long term interest and success of company is emphasized in S 172. Under S 172, directors are obliged to promote the success of the company on the basis of long terms. The criteria of compulsory duty in promoting the success in good faith is provided by section 172 as compared to section 171 which only provides "proper purpose rule". According to Davies and Gower it is essential to ascertain the level of force imposed on the directors by s 172 to consider the interest of the company. An honest director should allot the shares considering harm to company and intimidation towards long term goals to avoid a "looming takeover". In this situation allotment of shares cannot be deemed for "proper purpose" as required by s. 171 thus would amount to breach of instant section at the same time if director allows the takeover bid to succeed and does not defend then it would be considered as clear violation of s. 172(1).

In Cadbury’s takeover Lord Mandelson discussed the scope of s. 172 during hostile takeovers and urged to develop the strong norm of lasting commitments for durable development of the company. He emphasized that; this section must be recognized in the context of rapidly changing situation of takeovers, when number of new shareholders might not have lasting commitments with the company.

It reveals from abovementioned discussion that confusion seems to be existing on the application of the rule narrated in S 171 and 172 in the event of hostile takeover. There is big difference of opinion between scholars on the application of "proper purpose rule" and "promoting the success rule."

According to Ogowewo application of s 172 is only possible where application of s 171 and 173 is unclear; Alcock asserts that, application of s 171 would only be logical when it override the bona fide rule whereas according to Davies and Gower, s 172 provides most vital duty for the director which he is required to follow, instant section could provide immunity to the director. It seems this confusion on conflict of the statutory duties will continue as was seen in takeover of Cadbury because no judicial precedent is available to resolve this perplexity.

Conclusion:

It is found that main aim of the enactment of this Act was to incorporate the directors’ duties in statutory framework in order to bring clarity in rules and regulations as compare to common law. Before concluding the debate on s 172 CA 2006 it is important to see that Section 170 CA 2006 has acknowledged incorporating common law obligations; s 170(3) and (4) in particular states that the general duties of directors are based on certain common law rules. Similarly s (4) states that statutory duties, as provided by the Act, shall be interpreted in the same manner as common law obligations were interpreted and regard shall be given to relevant common law and equitable principles. These provisions clearly give impression that legislators did not intend to bring any significant change in the directors’ obligations; it also strengthens the presumption that statutory obligations are not incompatible with existing common law and equitable principles.

Chapter 2 of part 10 has embodied various common law duties and equitable principle which were established and developed over the centuries. The discussions in preceding paragraphs demonstrate that the duty to act in good faith under s 172 is based upon the duty under common law and equitable principle. Therefore unless otherwise repugnant this statutory duty is likely to get interpreted through judicial precedents that are settled on common law obligations. Keeping in view the dictums laid down by the courts on common law duty to act in good faith/ bona fide, it can be concluded that where the director is alleged to act in bad faith or not in the best interest of the company; court may apply subjective and/or objective test to ascertain the fact. The courts may not be inclined to accept the simple statement of the director and is most likely to make assessment of his intention on the basis of evidence and circumstantial evidence. Director may be held responsible for breach of duty and bear the liability where he is found to have failed in exercising his duty to act in good faith. On the other hand if director successfully proves that he acted in good faith he would be exonerated from the charge and liability notwithstanding that such act resulted harm and loss to the company or/and its shareholders/stakeholders interest. In the event of the actual failure of the director to regard the interest of the company court would raise the question if in similar condition an honest and intelligent person holding same office would have acted in the same way and believed that such action will be in the interest of the company.

Nevertheless after its enactment in very short period, this law had to face too much criticism on various issues. Conflict between the provisions of CA 2006 such as proper purpose rule u/s 171 and to act in good faith for success of the company u/s 172(1) has increased the uncertainty. CA 2006 where attempted to shift from the traditional common law approach of corporate benefit and maximizing the profit to corporate social responsibility it has failed to balance the both obligations in one go e.g. corporate social responsibility and success of the company. Although CA 2006 attempted to codify the common law and equitable principles on duties of director, it has failed to provide the complete explanation of said duties. This debate clearly demonstrates that s172 is pretty much unclear and unsolved hence now depends upon interpretation of the courts. It would be right to end the debate in the words of Menzies;

"Company law is statute law, but nobody could hope to become a company lawyer merely by reading and understanding the words of the statute."