Section 172 of the Company Act 2006: The codification of the duty to act in

One of new provisions introduced by the CA 2006 is the duty found in section 172. It provides, in sub-section (1), that ‘[a] director of a company must act in the way he[/she] considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole’; the sub-section goes on to assert that the director is to do so while having regard for, inter alia, a non-exhaustive list of factors,855 _{such as the}

854 _{See O Hart, ‘An Economist’s View of Fiduciary Duty’ (1993) 43 The University of Toronto Law Journal}

299, 303–303.

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long-term consequences of his/her conduct856 _{and the interests of the company’s}

employees.857 _{It is useful to mention that the general duty laid down in sub-section 172 (1)}

upon which the analysis focuses, is subject to two statutory exceptions. The first one refers to a situation where a company has purposes other than to benefit its shareholders and the directors are required to run the company in a way that achieves that purpose858 _(e.g.,

charitable companies).859 _{The second exception is found in section 172(3), which clearly}

recognises that directors, in certain circumstances, are expected to take into account the interest of the company’s creditors in the course of their decision-making.860

While it is not possible here to detail the background of the enactment of sub-section 172(1), it is useful to say a few words about this matter in order to understand why it is drafted in such a way. The Company Law Review Steering Group (CLRSG) developed section 172 in the course of a review of directors’ duties.861 _{One of the issues addressed by}

the CLRSG was to consider in whose interests a company’s business is managed.862 _The

CLRSG assumed that the shareholder value (also known as ‘shareholder wealth maximisation’863_{) was the approach adopted by UK company law.}864 _{The shareholder value}

approach simply proposes that the company should ultimately be run in the interest of the shareholders.865 _{The CLRSG’s criticism to such an approach centred on the failure of the}

law to sufficiently recognise that the wealth of firms will generally be maximised if all participants in the enterprise (not only shareholders) work harmoniously as groups, and that directors should act according to ‘the wider interests of the community’.866

In its deliberations on for whose benefit a company should be managed, the CLRSG considered whether it was feasible to adopt a pluralist approach867 _{(also known as the} stakeholder theory),868 _{which basically holds that directors should run the company for the}

benefit of all stakeholders (including non-shareholder constituencies), giving priority to

856 _{See section 172(1)(a) of the CA 2006.} 857 _{See section 172(1)(b) of the CA 2006.} 858 _{Section 172(2) of the CA 2006.}

859 _{See para 330 of the Explanatory Notes to the CA 2006.}

860 _{For further discussion on section 172(3) and how it relates to section 172(1), see generally A Keay, The}

Enlightened Shareholder Value Principle and Corporate Governance (London, Routledge 2013) 218–230.

861 _{Ibid 67.}

862 _{See CLRSG, Modern Company Law for a Competitive Economy: The Strategic Framework (February}

1999) para 5.1.1.

863 _{See, for example, S Bainbridge, ‘In Defense of the Shareholder Wealth Maximization Norm: A Reply to}

Professor Green’ (1993) 50 Washington and Lee Law Review 1423, 1423–1425.

864 _{The Strategic Framework (n 862) para 5.1.3.} 865 _{See, for example, Bainbridge (n 863).} 866 _{The Strategic Framework (n 862) para 5.1.9.} 867 _{Ibid paras 5.1.11 and 5.1.24–5.1.33.}

868 _{See, for example, A Keay, ‘Stakeholder Theory In Corporate Law: Has It Got What It Takes?’ (2010) 9}

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none.869 _{Put differently, it is the ultimate aim of directors to operate the company for the}

benefit of all stakeholders by striking a balance between their interests.870

In the view of the CLRSG, the adoption of the pluralist approach was not the best way forward.871 _{Given the fact that not many respondents to the CLRSG’s report supported the}

pluralist approach,872 _{for such a model to apply would require a substantial reform of the}

law on directors’ duties.873 _{To be specific, the CLRSG was not in favour of extending the}

current concept of loyalty to cover broader interests, as required by the pluralist model.874

In addition, the application of the pluralist model would require a major change to the institutional structure of UK corporate governance and such a change did not receive any support and was not favoured by the CLRSG.875 _{In fact, the pluralist approach was viewed}

as unworkable and undesirable in the UK.876

The CLRSG was in favour of the adoption of what is called the ‘enlightened shareholder value’877 _{approach, to guide directors running the company.}878 _{This approach was explained}

by saying that in order to promote the success of the company for the benefit of all shareholders, company directors are expected to have regard for ‘all the relevant considerations for that purpose’ such as ‘the need to sustain effective ongoing relationships with employees . . . and others’, and the necessity to ‘consider the impact of [the company’s] operations on the community and the environment’.879 _{This means that the}

consideration of a wider range of factors (e.g., employees and customers) is a means towards the success of the company for the benefit of all shareholders. Indeed, section 172(1) of the CA 2006 can be seen as an application of the enlightened shareholder value approach.880

869 _{Ibid. 256.} 870 _{Ibid. 257}

871 _{CLRSG, Modern Company Law For a Competitive Economy, Developing the Framework, (March 2000)}

para 3.20.

872 _{Ibid para 3.22.}

873 _{The Strategic Framework (n 862) para 5.1.30.} 874 _{Developing the Framework (n 871) para 3.27.}

875 _{Particularly, a radical change in the director–shareholder relationship (e.g., board composition and rules of}

dismissal and appointment of directors), see ibid para 3.29; The Strategic Framework (n 862) paras 5.1.31 and 5.1.32.

876 _{CLRSG, Modern Company Law For a Competitive Economy, Completing the Structure (November 2000)}

para 3.5.

877 _{See The Strategic Framework (n 862) para 5.1.12 where the CLRSG refers to it in such a way.} 878 _{Developing the Framework (n 871) paras 2.19, 2.21, 2.22, 3.21; Final Report (n 686) para 3.8.} 879 _{Developing the Framework (n 871) para 2.19.}

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It is worth saying that the duty contained in section 172 was introduced as a replacement of the classic duty to act bona fide in the interests of the company,881 _{which had been an}

element of UK company law prior to codification and was set out by Lord Greene in Re

Smith & Fawcett Ltd. case.882 _{Whether or not the duty in section 172(1) merely reflects the}

pre-existing duty is an important issue in determining the extent to which the previous case law is relevant to the interpretation of section 172(1). It seems that this statutory duty reflects the previous one at least from the judicial perspective. In Cobden Investments Ltd v

RWM Langport Ltd,883 _{Warren stated that the common law duty to act bona fide in the}

interests of the company was ‘reflected’ in the terms of section 172.884 _{He also added that}

the previous duty and the one found in section 172 came ‘to the same thing with modern formulation giving a more readily understood definition of the scope of the duty’.885

Notably, although the wording of section 172 suggests that it is somewhat different from the common law duty, the good faith requirement is embedded in both old and new versions of the duty. It should be noted further that the previous case law was referred to in relation to the interpretation of section 172886 _{and will perhaps remain relevant to the}

consideration of how to apply the section in practice.887

4.2.2 The absence of a clear formulation of directors’ duty to act in good faith in