Companies Act 2006
Businesses are an important part of an economy as well as of society. This is the reason that it consists of various stakeholders such as the government, shareholders, society, environment and many others. In such a situation, the lead issue is a determination of the way in which companies are required to carry out their business activities. Different countries have their separate legislation to regulate the workings of companies. Here, this is necessary to understand that the lead objective of a company is a generation of profit, until unless the same is not a non-profit organization. However, the issue is that check that up to which level a company should focus on it is profits. In the past time, these corporations were used to develop their focus on profits only, but now the situation has been changed. With the development of economy and globalization, the concept of corporate governance has been developed. Corporate governance can refer to a set of principles, system, and processes that regulates and control the dealings of a corporation.
On the other side, the legislation with respect to corporations is also important for another reason, which is a separate legal entity feature of a corporation. It was held in the case of Salomon v A Salomon and Co Ltd [1897] AC 22 that a company has it is different legal identity from it is members, shareholders, and directors. Therefore, many of the cases have been reported where directors used this unique feature of corporate for their personal benefits. To control such issues, countries have developed legislation to regulate the behavior of companies as well as directors. These legislations imposed some duties on directors and officers of the company in order to ensure good corporate governance practices. Profit can be the focus of a corporate but the same cannot be the only focus. With the changing of scenario, companies are now expected to consider the interest of all stakeholders instead of the shareholders. The lead issue is the absence of a universal set of practice. Directors and officers of each company have their different visions, missions, and priories that regulate their behavior. The lead objective to present this report is to develop an understating on the duties of directors and corporate governance requirements mentioned under corporation act of the United Kingdom. In the presented report, the focus will be made on section 172 of the Companies Act 2006. This is the lead legislation of UK that set out rules, regulations, and provisions related to companies. Further, in the presented report, the discussion will also include the topics such as issues with the section 172 of the act, corporate governance theories, history of corporate governance in the UK, and the relation of EU law with the corporate governance concept in the UK.
This legislation consists over 1300 sections and is the longest act of UK . The act provides many provisions in respect to corporates, such as the procedure of incorporation, share capital rules, shareholders right, director duties and so on. Section 171 to 177 of the act states the general duties of directors. As the topic of discussion is corporate governance, this is mention that this legislation ensures the existence of the same by introducing director duties. Section 172 is one of the significant sections of the subjective act, which contain one of the duties of officers and directors of the company. According to the provisions of this section, a director of the company has duty to promote the success of the company in a best suitable manner according to his/her good faith, which is beneficial for the members as a whole. The definition of success, however, is not granted under this section. In addition to this, sub-section 1 of the act provides some aspects that directors are required to consider while performing their duties for the success of the company. Section 170 states the scope of the duties contained by section 172. As per the provisions of section 170 of the act, duties prescribed under section 172 are required to interpreted and shall applicable in the same manner as common law and equitable principles. Many of the times, it has been noted that the explanation of section 172 is not enough or it may say that the same is a confusing section and therefore requires a level of clarity. However, to check the issues with this section, the study of the same is necessary and therefore the section is mentioned below:-
Issues with Section 172
In the following section, some problems are discussed, section 172 is not able to answer thereof. These are the main issues in respect to section 172 of the act among most of them is about the interpretation of the act. These issues are discussed as hereunder:-
- The first and lead issue with the meaning of this act is with the term “have regard to”. It is not clear that whether directors need to consider the interest of stakeholders or only of the shareholder. It may understand as the confusion that whether directors should pick an option, which is beneficial for all the stakeholders in an equal manner, or another option, which is best for the shareholders.
- Another confusing term is the success of the company. There is no clear definition under this section or in any other part of the act that what success of the company stands for. This is the reason that directors of different company treat this term in a different manner. Many of the times, a particular task does not adhere to the success of the corporation, yet the management of a company can have believe that he did an act for the success of the company.
- In respect to the term “amongst other matters”, the list is non-exhaustive. It means the directors will only consider the interest of stakeholders when an act or decision is beneficial for the shareholders. The issue is irrelevancy of this section in such situation. Without the existence of interest of shareholders, the interest of other stakeholder does not take any matters.
- To check the fact that whether the performance of a director is in good faith of the company and member, there is no measure. This creates an issue for judges while considering the cases of director duty breach.
- When it comes to the mismanagement of the company, provisions of the case of Carlen v Drury(1812) 35 ER 61 are applicable. In the decision of the case, Lord Eldon state that court often does not interfere in the business judgment of a director as far as the same is not acting in the bad faith.
- There is no specific standard by using which a court or a private party can prove the breach of this section, The phrase ‘good faith to promote the success of the company for the best interest of members’ is very general and need certain clarification on each term.
Aforesaid issues are few out of many that are there with section 172 of the act. At the time of the case Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch), it has been noted that it is very typical to decide for the courts that whether the director has used his/her best interest in the promotion of the success of the company or not.
Provisions of this section have been marked as difficult and problematic to apply. In the case of R (People and Planet) v HM Treasury [2009] EWHC 3020 it has stated that the consideration of the provisions stipulated under clauses a to f of subsection 1 of section 172 is a subjective matter for the company directors. Many other cases have reported there by which it is proved that the principal test related to this section is a subjective one. Another important case to review is Re Southern Counties fresh foods Ltd [2008] EWHC 2810 that is related to director duty and practice of corporate governance. In this case, it has been highlighted that according to the provisions of section 172 of the act the directors are required to act in a manner that they find best suitable for the success of the company. In this course, another issue was to check that whether the personal judgments and decisions of the directors would fulfill the purpose and would help in the promotion of success of the company. It may say that in this case, the court has made a comparison between the following two terms
- best interest of the company with the success of a company and
- for the benefit for its members
Subsection 2 of section 172 provides that the personal judgment of a director concludes that whether the purpose of the company is in the best interest of the members . In this manner this would not be wrongful to state that the studied section mainly develops, it is focused on the shareholders and not all stakeholders. Further, many of the terms are not clear and therefore they required clarification on a certain level. When it comes to corporate governance, many of the theories are there. Some of them make their focus on shareholders only and some of them consider the interest of all the stakeholders. Section 172 of the act is far way related to corporate governance but has the same issues that interest of whom to be considered? For instance:- imagine a situation where the closing of a production site is expected to provide financial benefits to the company but the same will lead a redundancy of more than 100 employees. Now according to the provisions of section 172, the directors of the company should take the decisions of the closure of this site as the same is adhere to promote the success of the company but on the other side, this decision will ignore the interest of other stakeholders i.e. employees. This is the reason that this section often ignores the interest of other stakeholders and works on the basis of shareholder theory of corporate governance.
Corporate Governance Theories
The requirements mentioned under this section get influenced by the personal judgment and behavior of the directors and this is the reason that different people being in the capacity of director consider different things and acts as good. This cannot say that the provisions of this section regulate the behavior of a person because they all are open for interpretation and implementation and a standard measure is missing to evaluate that whether an act or decision of directors is in the best interests of the company or not. In conclusion, this is to say that yes, there are many issues with the application of section 172 which needs to be get resolved.
As mentioned earlier, corporate governance is can be termed as the control of management in the best interest of the company. Many of the ways are there which can ensure corporate governance in an organization. Before moving towards the discussion of the corporate governance rules of UK, the two lead theories i.e. shareholder theory and stakeholder theory and their importance are required to understand. Both of these theories are mentioned below:-
Milton Friedman introduced this theory. As the name implies, this theory of corporate governance believes that while taking business decisions, management of the company must consider the interest of shareholder over and above of all the other stakeholder. The lead logic behind this theory is that the shareholders are the most important stakeholder of a company as they invest their money in the form of capital and expect a good return. The following are the supporting points of this theory:-
- Directors are needed to be accountable towards the real owner of the company, which are shareholders. They are required to provide a proper justification for their dealing with the shareholder as they use their money in the business.
- According to cardinal rule no. 1, a company needs to consider the financial aspect of a business and in such a manner, management of the company needs to develop their focus on the profit maximization. The reasoning of this point is that a company cannot take steps ahead to social responsibility until the same will not be financially strong.
- Profit maximization is necessary to increase the efficiency of the business. When a company creates, it is wealth, the same becomes eligible to provide the goods and services with good quality, and efficiency to it is a customer.
This theory is completely adverse from the shareholder theory. This makes the focus on the all the stakeholder rather than the shareholders only. According to this theory, a company owes a duty towards all the stakeholders as all of them perfrom an important role in the affairs of the company. For instance, an employee of the company helps in providing goods and services to customers and contributes their efforts to profit generation. In addition to the employees, other stakeholders such as government, customers, and suppliers are also important and while developing the plans and policies, directors of the companies are required to consider their interest. Similar to shareholder theory, stakeholder theory also have some supporting points, which are mentioned below-
- The success of the company defines by the fact how responsible a corporation is in respect to society and it is stakeholders. Therefore, to ensure the overall success of the company, directors are required to keep the interest of all the stakeholders in consideration.
- A company, which ignore the interest of other stakeholder and only divert the focus towards the profit maximization, can only make a profit for the short time period.
- Cause of globalization and development of businesses, now it is necessary to evaluate the interest of all the stakeholders as ignorance of the same can lead many adverse issues for the working of the company. For instance, if a company employ child labour, the same can be held liable and penalized under respective legislation of the nation.
After reviewing the shareholder and stakeholder theories, this is to be stated that corporate governance is not a local concept and exist at a global level. Many of the companies use shareholder theories and many of them use stakeholder theory. Both of the discussed theories have their own arguments. They both ensure corporate governance in an organization using different approaches. In the codification of director duties in Companies Act 2006, the focus has been made on the enlightened shareholder Value that is a happy medium in between of shareholder and stakeholder theory. It changes the business goals from short term to long term and considers the interest of society and environment.
While discussing the corporate governance and different approaches of the same, the topic named is UK corporate governance code is also necessary to discuss. The UK Financial Reporting Council has published the latest edition of the subjective Code. The code also includes changes in the reporting structure of companies as introduced by Companies (Miscellaneous Reporting) Regulations 2018. The code is mainly focused on the stakeholder engagement. The new code includes culture, social engagement, and social purpose as the key responsibility of the board of directors in order to promote the long-term sustainable success of the company. Apart from the shareholder, this new code emphasis on the value of stakeholders and marked the same as a tool for effective management. According to the provisions of this rule, the directors of the company are responsible to provide a declaration in the annual report that while performing their duties under section 172 of the act, how they have considered the interest of all the shareholders. The same include elements such as employee interest, the need to improve the relationship with customers and suppliers, impact on the community and environment and so on. In addition to this, under this statement, directors also need to state that what method and procedure they have used to be in touch with stakeholders. This would wrongful to state that the code and regulation only focus on the other stakeholders and ignore the interest of shareholders as the provisions are also there where the interest of shareholder have been considered. Nevertheless, unlike the provisions of the code and regulation can be termed as a reform in the sector of corporate governance. This can be stated that these new regulations and code that have been enacted in the year 2018 supports the stakeholder theory as they develop the focus towards the stakeholders and not only shareholders.
History of Corporate Governance in the UK
Corporate governance is not a new concept and exists there for years. However, this is to state that in recent years, the word has made it is huge significance and become an important part of almost every sector such as local and global authorities, business, and charities. To review the development of corporate governance in the UK, this is to mention that the same has been evolved when the Cadbury committee has released it is report on a financial aspect of corporate governance. As a good boardroom practice, the Cadbury code has been adopted by the stock exchange and the city. In May 1991, the following four have established this committee:
- London Stock Exchange
- An independent regulator supported by accountancy organization
- UK Government
- Key members of the accountancy profession and the Financial Reporting Council
Cadbury committee has it’s huge significance in the development of corporate governance in Britain. This significance can be understood by having a look at the following chart:
Although many of the critics have stated that the Cadbury code provided the guidance, which was, too vogue and improvement was required in the same. Further, they also argued that the development of the code was of no use as the same was not required to be followed under any law.
This code was aimed at the listed companies and consisted the standards of corporate ethics and behavior. Afterward, in the year 1995, the Greenbury report provided another set of principles in respect to executive director’s remuneration. In the year 1998, the Hampel Report produced the first ever-combined code with the help of a combination of two codes stated earlier. According to this report, the code raised the standard of governance. By mentioning the significance of Cadbury code, the Hampel Report stated that the subjective code was a yardstick in against of that standard of CG in other markets can be checked and measured. After Cadbury, Greenbury, and Hampel report, it has been realized that there was a requirement of combined code in the subject of corporate governance and therefore it has been decided to develop a code consisting principles and guidelines of all the three committees i.e. Cadbury, Greenbury and Hampel Committee. The result of this decision was a combined code that set out principles and best practices in respect to corporate governance in the UK. London Stock Exchange has adopted this code and the code became a part of UK Listing Rules in the form of Appendix.
In the year 1999, a working party of the Institute of Chartered Accountants in England and Wales produced another report that is known as Turnbull report. The lead objective of this report was to provide additional guidance to listed companies to make them understand that how to use the combined code for their internal control. In such a manner, this report was another step in the process of development of corporate governance in the UK. The guidelines provided by this committee were significant, as they have made the directors responsible to look forward rather than to think about past performances only. In addition to this, the committee has stated that in an organization risk must be reviewed on a regular basis in order to ensure good corporate governance. After this report, another development was Director’s remuneration Report Regulation that has come out in the year 2002. This regulation has amended the Companies Act 1985.
Relation of EU Law with Corporate Governance Concept in the UK
By the introduction of the provisions of this regulation, listed companies became liable to provide an annual remuneration report, consisting the details of remuneration provided to each director. Further, companies are also required to present this report to the shareholders in their annual meeting. To provide the guidelines with respect to the non-executive directors, a review on the effective and roles of such directors have been made in the form of Higgs Report. The report was mainly focused on the non-executive directors and let out the responsibilities of the same. In addition to this, the report suggested a definition of independence and the role of non-executive directors for the inclusion in the revised code. Further, the Financial Reporting Council has established a committee, which has published its report under the title of Smith Report in the year 2003. The report was focused on the roles of individual members of the audit committee. Following the last two reports, i.e. Higgs and Smith Report, Financial reporting council published another combined code in 2003. Similar to the combined code of 1998, this code is also divided into 2 sections, one is for institutional shareholders, and another one is for companies. Soon, it has been noted that all the codes and guidelines of corporate governance were mainly applicable to listed companies. Therefore, in the year 2004 and 2005, some guidelines have been made for the unlisted and small companies as well. However, these companies are not required to practice these guidelines in a mandate manner. Some other codes and guidelines have also been enacted which have developed the corporate governance in the UK and played a vital role. Cause of some corporate governance failure cases in recent years, UK corporate governance code has been developed, that now provide guidelines and working requirements to all the companies in the UK. The present situation of corporate governance is the result of all the discussed developments. There is always a scope of betterment and hence some developments are expected in the coming future.
While discussing the corporate governance development in the context of UK, the mention of EU laws is mandatory. The reason behind the same is that the UK is still a part of Europium Union. The company laws, as well as corporate governance arrangements of EU and UK, have been intertwined from ever and the influence does not seem to disappear with immediate effect. The important term, which is necessary to study, is Bretix. It means British exit and the same denote the withdrawal of UK from the European Union. The impact, which will come to the UK after such withdrawal in actual, is known as Bretix impact. To talk about the EU Law on the subject of corporate governance this is to mention that EU Company law addresses the issue of corporate governance and develop the focus on the relationship among stakeholders and company’s management. The company law rules of UK also provide the provisions on the subject of corporate governance and transparency for investment firms and banks. These provisions are mentioned in Directive 2013/36/EU and Regulation (EU) No 575/2013. If talk about the company law legislation of UK, this is to say that no particular legislation is there on this topic and the same is codified in Directive (EU) 2017/1132 partially. The directive is available in different languages as different members states have a different national language.
The EU company law provides rules related to issues of capital and disclosure requirements, merger, division, and incorporations of the companies. The reason for which EU has no separate legislation on company law is that every member state has it is separate company law. For instance, UK has Companies Act 2006. However, every member state needs to consider the company law and corporate governance provisions in their dealings being a part of the union. Efforts are ongoing in order to establish an efficient company law with the objective of improving the economic environment in EU. The subjective directives is a forwarding step in the sector of corporate governance as the same explained many of the requirement related to various aspect incorporation, capital and reporting in order to ensure good corporate governance practices. Further, EU Company law (as mentioned in Directive (EU) 2017/1132) provides the provisions related to the division of companies. As in the UK, Companies Act 2006 act as a route map in the field of corporate governance, similarly in EU, these directives play this role.
Commission Implementing Regulation (EU) 2018/1212 provides the provisions related to shareholder identification, facilitation of shareholder rights and transmission of information. Apart from the company law too, there are many policies on corporate governance in EU. If to compare the situation of corporate governance in past and present in EU, this is to mention that EU Policy Process welcomed the action plans and green papers that made the positive developments in the sector of shareholders rights, corporate disclosures, voting, and so on but some requirements of betterment are still there. Shareholder right directive II (SRD II) is EU directive, which states the strong position of shareholders and ensures that all the decision taken by the directors are in favour of the company in a long term. These directives have amended the previous directives named shareholder right directive I (SRD I). The objective behind SRD II is to improve the level and standard of corporate governance in the companies, securities of which are traded on the regulated market of EU. These directives are the lead guidelines, which regulate many of the subject and issues. By controlling the related party transactions, these directives are doing well in the sector of corporate governance. These directives are applicable on 8000 and more companies and this would not be wrong to state that the same is an important part of EU Law when it comes to regulate corporate behavior.
Conclusion:
To conclude the discussion on the given topic, this is to mention that corporate governance practices are an important part of every organization and the value of the same has been enhanced in recent years. It depends on the management of a company that how the same take care of their policies considering the interests of stakeholders. In the aforesaid discussion focus has been made on the theories of corporate governance, deficiencies in section 172 of Corporations Act 2006, history of corporate governance in UK and EU Law. Some of the organization works on the basis of shareholder theory and only make their focus on profit maximization. However, this does not seem to be a correct working style. Every stakeholder is important for a business organization and therefore directors of the company are required to follow a good corporate governance practice. Many of the efforts have been made by the government and authorities to ensure the good corporate governance practices. Nevertheless, there is no standard available according to which a corporate should behave.
For a short period, it can be in the best interest of the company to be as profitable as possible, but to go in a long run; a company is advised to be sustainable considering the interest of all. The duties imposed by section 172 of Companies Act 2006 ensure the good governance to a certain level but some ambiguities are still there which are need to be removed. Cases have happened there when directors of the company took the unfair advantage of these deficiencies and this is the reason that clarification is required in concern of this section. History of corporate governance is almost 30 years old in UK and government is still putting it is efforts to meet out the expectations of the corporate stakeholders. It is expected that in the coming future, corporate will be more regulated and will divert their focus towards every stakeholder instead shareholders only.
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