Strategic Management Journal Shareholders and Stakeholders

Question: Discuss about the Strategic Management Journal for Shareholders and Stakeholders? Answer: Section 172 of the Company Act, 2006: Critically Discussed The Company Act, 2006, governs the Company Law in The United Kingdom. The Company law in The United Kingdom can be divided into two parts namely the Corporate Governance and the Corporate Finance. Corporate Governance codifies all the rules and regulation that decide the rights and liabilities of the Companys directors, employees, shareholders, etc. Since the Company Law in The United Kingdom entrusts a lot of power and responsibilities on the director or the board of directors of the Company, setting rules for directors accountability is very vital. [1] Corporate Finance sets two different methods to raise funds for a limited company. Equity Finance refers to the traditional method of collecting funds by the way of issuing shares and Debt Finance refers to obtaining loans using annual interest for repayment.[2] Before the Company Act, 2006, Company Act, 1985, governed the company law in The United Kingdom. This Act did not contain any provisions, which clearly defined the duties of a director in a Company. Few duties were mentioned to be important directors duties, which required compliance like filing an annual return, maintaining annual accounts, etc. However, a complete provision explicitly mentioning directors role in a company was missing. Therefore, a need was felt to codify the duties of the director under one provision, which would increase corporate governance in The United Kingdom, and at the same time be beneficial for the Company.[3] This lead to enactment of Section 172 of the new amended Company Law in The United Kingdom. This Section contained rules relating to duties of a director, which was needed to be followed in the routine dealings of the directors on behalf of the Company. However, one of the most controversial Section, which sets the responsibility for every activity within a Company on a Directors is the Section 172 of the Company Act, 2006. This section had attracted a lot of criticism on the Bill Stage for making Directors liability too high in case the Company undergoes any losses. Section 172 of the Company Act, 2006 in The United Kingdom states the duty of the director of a Company to promote the success of the Company.[4] The said Section states that the Director needs to act in a particular way keeping the success of the company along with the interest of its member as a whole in mind having utmost good faith in his actions and regards with the following: Consequences of every business decision in a long run Interest of the employees of the company The importance of developing companys relation with its vendors, suppliers, etc. The effect of companys operation on environment and community The necessity for the company to maintain business conduct of high standard and reputation The need to be fair in dealing with the members of the company The Section also includes doing every other act not mentioned about which would bring about the success of the company along with its members.[5] This section further goes ahead to cover the interest of companys creditors under certain circumstances and subject to enactment of regulation requiring the directors to do so. The Section 172 of the Company Act, 2006 empowers the Board of Directors of the Company with a lot of duties and responsibilities, which in return makes them more prone to liabilities arising out of infringement of such duties responsibilities. The scope of Section 172 of the Company Act, 2006 is very comprehensive to include almost all the activities within a company to be carried under the supervision and control of the directors. This has made the role of directors in the Company very crucial and attracted much disapproval along with a lot of criticism. The section implies that the directors are required to act in good faith, promote the success of the Company by avoiding misjudgements, and avoid any negligence claim against them.[6] The section also implies that as long as the director of the Company have good faith and are conducting activities honestly in the management of the company with honest decisions about the same, the directors have the right to use their discretion in any judgements about the company. Thus, the first part of the section states the director to be honest in all dealings and then have the power to decide about any activity of the company. The main reason for making amendments to the duties of the directors role in a company was that the previous law relating to the duty of the directors did not provide guiding the interest of the members of the company while deciding the operations of the company.[7] The sub-section (2) of the said Section relates to protecting the non-commercial activities and objectives of the company and the third sub-section protects the rights the creditors of the Company. The primary duty of the director according to this Section is to safeguard the interest of the Company, which refers to shareholders of the company. However, once this section was codified what was important is to define the limits of the duties of the directors not to make the director liability for every small activity within the Company. For example, failure to follow a tax structure that would increase the funds of the shareholder make director liable under Section 172 of the Company Act, 2006 on the grounds that the director failed to act for the interest of the company. [8] The main purpose behind this section is to ensure that the directors of the company manage and work towards the success of the company having a long-term goal. In a recent case, Item Software (U.K) Limited v Fassihi [2004] EWCA Civ 1244 the judgement stated that the primary reason for granting such wide powers on the directors, was to educate them by granting the directors certainty about what law demands from them and bring changes in the duties of the directors making them more accountable which would in return help the company to progress, treating it to be their ultimate goal. However, what the company law in The United Kingdom fails to do is provide safeguards to the Directors.[9] This section applies to the whole board of directors, which include non-active members in the board making them liable for the wrongful actions or misjudgements in the decisions of the company even when they have very little role in the management of the Company. The Company law did not give ant safeguards or exception that helps the director to perform his duties under this Section without any fear. However, the truth is that the interpretation of this section was judged only on its wordings ignoring its essence. In reality, it was not as strict on directors liability as it was feared to be. This section was also criticised for the fact that it influenced the outcome directors judgement because it required the director always to decide in support to promote the interest of the company and its members. Another hardship that the Section was considered to contained during its enfo rcement was that the necessity of the board to take every decision on behalf of the company after judging its effects on the shareholders, employees, environment, etc. will make the decision-making process very complicated and inefficient.[10] The most severe hardship that the directors would face is the numerous litigation against them by the environmental activists, shareholders, employees, etc. that the director has acted negligently in making decisions on behalf of the company not complying with Section 172 of the Companys Act, 2006. The outcome of this could be that the directors would try to keep away from all such litigation by discussing business risks and take this more seriously than the main business itself. The risk of attached liabilities that will be connected to the prestigious role of a director of a company will discourage potential directors from taking up the job of a director in a company. The above states the disadvantages or the fear, which the legal practition ers in The United Kingdom explained this Section would carry when, implemented.[11] However, the scope of this Section was misinterpreted by the wordings of the Section. The supporters of this Section stated that codification of the duties of the director with the powers given to the directors of the overall management of the company with the ultimate goal of success will make the directors work and be more dedicated in performing their duties. Every decision of the director under this Section will be well analysed and after consultation with the professional experts that will benefit the company. The issue of increased litigation also seems over-exaggerated. The Section explicitly states the principle of good faith in the directors decisions. Therefore, as long as the director is honest in his dealings on behalf of the company with reasonable care, diligence and expertise they are in good position to avoid any claim of negligence in their action, which would breach Section 172 of the Company Act, 2006. This section, therefore, will increase corporate governance in The United Kingdom, as directors will be complied to follow the guidelines in Section 172 to in carrying their general duties towards the company and avoid litigation. It would make the board of directors of the company more disciplined in their dealings instead making the board weak as discussed above. One of the most significant reforms that Section 172 of the Company Act, 2006 brought in The United Kingdom was the enlightened shareholder value. The Company Law Review Steering Group (CLRSG) had introduced the concept of enlightened shareholder value in The United Kingdoms company law. The main reason for the CLRSG was to introduce a principle into the corporate governance of the country, which would make the dealings of a company more transparent and fair.[12] The enlightened shareholder value proposes that the shareholders interest shall prevail to be the most important in a company. The enlightened shareholder value is a principle or an approach, which states that maximizing the profits of the shareholders is the best method to of obtaining overall prosperity and success in a company.[13] The entire principle is based on the idea that long-term profit goal will be achieved only the shareholders interest is primary in a company along with the co-operation of other stakeholders li ke employees, creditors, etc. and the environment and the community together. Therefore, this approach makes it the duty of a director to promote the success of the company keeping in mind the shareholders interest to be primary not ignoring the interests of the other stakeholders in the company. Certain critics stated that giving importance to the benefits of stakeholders would not be of much significance because in a conflict of interest between the shareholders interest with that of a stakeholders, the interest of shareholder shall prevail. However in sub-section (1) of Section 172 of the Company Act, 2006 the interest of stakeholders like employees, suppliers, customers along with the effect on environment and community of the companys business operation is included to be given regards by a director while making decisions on behalf of the company. This makes it clear that the law requires the director to simultaneously take care of the interest of the companys members and promot e the success of the company. In the case, Hutton v West Cork Railway Co (1883) 23 Ch D 654 a company based in The United Kingdom concerns the limit of directors decision in spending companys funds for privileges of the non-shareholder in the company. It was a judgement passed in the companys insolvency proceedings concerning the companys employees. [14] The judgement stated that the payments made to employees were invalid as the company was going through an insolvency proceeding therefore, following the rules enforced in Section 172 of the Company Act, 2006 the court came to a conclusion that during the life of a company, the company can make payments for benefits of the stakeholders but only to an extend that in the end its of the shareholders interest.[15] This case law makes it evident that the shareholders interest under Section 172 of the Companys Act will be primary prevailing above the interest of any stakeholder in the company. This principle was a of enlightened shareholder value that increased the efficiency of the director in The United Kingdom by making the directors take long-term profit goals with the principle of shareholders interest in mind. This is an approach, which is most suitable for the modern corporate structure, as it believes in the success of the company along with its shareholders not ignoring the interest of the companys stakeholders.[16] The sub-section 172 of the Company law suggests that if the director is acting in good faith, he has an in exhaustive list of members whose interest the director can protest which ultimately promotes the success of the company. The director here can decide to protect whose interest that will further the success of the Company and according determine the interest of shareholder or stakeholder should be given consideration according to each situation. The benefit in the implication of this principle in The United Kingdom is that the Section 172 of the Company Act, 2006 has made the list of stakeholders very broad to cover every member along with the environment and community under its blanket.[17] The board of director are given the ultimate power to make decisions regarding the company such as how to utilize the companys resources, and deciding on dispute resolution, etc. Therefore, no team or a particular group in the company enjoys the right to exploit or control another. This helps the directors to not just mere agents of the shareholder in the corporate system and considers just the shareholders interest at the cost of the other stakeholders like employees, creditors, etc.[18] Instead, they play an significant role in balancing the conflicting interest between the shareholders and the non-shareholder groups and coming up with a solution that favours the success of the Company. Therefore, Section 172 of the Company Act, 2006 needs to be given a wider interpretation. The interpretation of the term interest in relation to the Company should be looked at broadly to include a collective welfare of all the members who are included in the operations of the company instead limiti ng its scope just ton mean profit maximization for shareholders.[19] The incorporation of this system will only increase the flexibility of the directors decision making the director act more efficiently and with adequate professional help. Therefore, giving the directors the required discretion to judge supporting whose interest in the company will benefit the company is a very revolutionary way to develop and amend the corporate governance in a country. Many countries like Hong-Kong after the implementation of enlightened shareholder value in The United Kingdom went ahead to enforce the same in their country as the principle inevitably contains more advantages than harms. Giving the directors of a company flexibility in decision making process on behalf of the company keeping in mind long-term profit goals depending on the business type, structure and the economic conditions present at each situation is the best possible method to promote success and re-built the definition of corporate governance in the modern era where technology and innovations a re at its peak.[20]. Reference List Adams, R.B., Licht, A.N. and Sagiv, L., 2011. Shareholders and stakeholders: How do directors decide?.Strategic Management Journal,32(12), pp.1331-1355. Chapman, R.J., 2011.Simple tools and techniques for enterprise risk management. John Wiley Sons. Chohan, A., 2012. Is Section 172 of the Companies Act 2006 Capable of Delivering for All Stakeholders?.Available at SSRN 2139528. Collison, D., Cross, S., Ferguson, J., Power, D. and Stevenson, L., 2014. Financialization and company law: A study of the UK Company Law Review.Critical Perspectives on Accounting,25(1), pp.5-16. Council, F.R., 2010. The UK corporate governance code.London: Financial Reporting Council. De Lacy, J. ed., 2013.Reform of UK Company Law. Routledge. Ho, J., 2010. Is section 172 of the Companies Act 2006 the guidance for CSR.Company Lawyer,31(7), pp.207-213. Ho, J.K.S., 2010. Director's Duty to Promote the Success of the Company: Should Hong Kong Implement a Similar Provision?.Journal of Corporate Law Studies,10(1), pp.17-33. Hopt, K.J., 2011. Comparative corporate governance: The state of the art and international regulation.The American journal of comparative law, pp.1-73. Keay, A.R., 2010. The duty to promote the success of the company: is it fit for purpose?.University of Leeds School of Law, Centre for Business Law and Practice Working Paper. Kershaw, D., 2012.Company law in context: Text and materials. Oxford University Press. Macve, R. and Chen, X., 2010. The equator principles: a success for voluntary codes?.Accounting, Auditing Accountability Journal,23(7), pp.890-919. Mordi, C., Opeyemi, I.S., Tonbara, M. and Ojo, I.S., 2012. Corporate Social Responsibility and the Legal Regulation in Nigeria.Economic InsightsTrends and Challenges,64(1), pp.1-8. Okoye, N., 2012. The BIS review and section 172 of the Companies Act 2006: what manner of clarity is needed?.The Company Lawyer,33(1), pp.15-16. Sealy, L. and Worthington, S., 2013.Sealy Worthington's Cases and Materials in Company Law. Oxford University Press. Segarajasingham, S., 2012. Who is Responsible for the Downfall of Companies: A Critical Study of Sri Lankan Law. InAnnual Research Symposium. Slapper, G. and Kelly, D., 2013.The English Legal System: 2012-2013. Routledge. Tate, R.C., 2012. Section 172 CA 2006: The Ticket to Stakeholder Value of Simply Tokenism.Aberdeen Student L. Rev.,3, p.112. Villiers, C., 2010. Directors' Duties and the Companys Internal Structures Under the UK Companies Act 2006: Obstacles for Sustainable Development.International and Comparative Corporate Law Journal, Forthcoming. Wolf, K.D., Flohr, A., Rieth, L. and Schwindenhammer, S., 2010.The role of business in global governance: Corporations as norm-entrepreneurs. Palgrave Macmillan [1] Council, F.R., 2010. The UK corporate governance code.London: Financial Reporting Council. [2] Ho, J., 2010. Is section 172 of the Companies Act 2006 the guidance for CSR.Company Lawyer,31(7), pp.207-213. [3] Kershaw, D., 2012.Company law in context: Text and materials. Oxford University Press. [4] Chohan, A., 2012. Is Section 172 of the Companies Act 2006 Capable of Delivering for All Stakeholders?.Available at SSRN 2139528. [5] Tate, R.C., 2012. Section 172 CA 2006: The Ticket to Stakeholder Value of Simply Tokenism.Aberdeen Student L. Rev.,3, p.112. [6] Slapper, G. and Kelly, D., 2013.The English Legal System: 2012-2013. Routledge. [7] Okoye, N., 2012. The BIS review and section 172 of the Companies Act 2006: what manner of clarity is needed?.The Company Lawyer,33(1), pp.15-16. [8] Sealy, L. and Worthington, S., 2013.Sealy Worthington's Cases and Materials in Company Law. Oxford University Press. [9] Segarajasingham, S., 2012. Who is Responsible for the Downfall of Companies: A Critical Study of Sri Lankan Law. InAnnual Research Symposium. [10] Mordi, C., Opeyemi, I.S., Tonbara, M. and Ojo, I.S., 2012. Corporate Social Responsibility and the Legal Regulation in Nigeria.Economic InsightsTrends and Challenges,64(1), pp.1-8. [11] De Lacy, J. ed., 2013.Reform of UK Company Law. Routledge. [12] Villiers, C., 2010. Directors' Duties and the Companys Internal Structures Under the UK Companies Act 2006: Obstacles for Sustainable Development.International and Comparative Corporate Law Journal, Forthcoming. [13] Macve, R. and Chen, X., 2010. The equator principles: a success for voluntary codes?.Accounting, Auditing Accountability Journal,23(7), pp.890-919. [14] Keay, A.R., 2010. The duty to promote the success of the company: is it fit for purpose?.University of Leeds School of Law, Centre for Business Law and Practice Working Paper. [15] Hopt, K.J., 2011. Comparative corporate governance: The state of the art and international regulation.The American journal of comparative law, pp.1-73. [16] Collison, D., Cross, S., Ferguson, J., Power, D. and Stevenson, L., 2014. Financialization and company law: A study of the UK Company Law Review.Critical Perspectives on Accounting,25(1), pp.5-16. [17] Ho, J.K.S., 2010. Director's Duty to Promote the Success of the Company: Should Hong Kong Implement a Similar Provision?.Journal of Corporate Law Studies,10(1), pp.17-33. [18] Adams, R.B., Licht, A.N. and Sagiv, L., 2011. Shareholders and stakeholders: How do directors decide?.Strategic Management Journal,32(12), pp.1331-1355. [19] Wolf, K.D., Flohr, A., Rieth, L. and Schwindenhammer, S., 2010.The role of business in global governance: Corporations as norm-entrepreneurs. Palgrave Macmillan. [20] Chapman, R.J., 2011.Simple tools and techniques for enterprise risk management. John Wiley Sons