Directors duties and stakeholder interests Viewpoint

On 22 March 2005 the Parliamentary Secretary to the Treasurer, Chris Pearce, announced that he would ask the Corporations and Markets Advisory Committee to consider whether the Corporations Act should be amended to require directors to take account of the interests of groups other than shareholders when making corporate decisions.

On 22 March 2005 the Parliamentary Secretary to the Treasurer, Chris Pearce, announced that he would ask the Corporations and Markets Advisory Committee to consider whether the Corporations Act should be amended to require directors to take account of the interests of groups other than shareholders when making corporate decisions.

Pearce has asked CAMAC to consider and report on the following matters:

• Should the Corporations Act be revised to clarify the extent to which directors may take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?
• Should the Corporations Act be revised to require directors to take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?
• Should Australian companies be encouraged to adopt socially and environmentally responsible business practices and if so, how?
• Should the Corporations Act require certain types of companies to report on the social and environmental impact on their activities?

The CAMAC inquiry is part of the Government's response to the corporate law issues raised by the James Hardie Special Commission of Inquiry.

The referral to CAMAC raises a fundamental question - for whom do directors of companies govern? Is it shareholders or is it a broader range of stakeholders?

As my co-authors and I state in a new book (Company Directors-Principles of Law and Corporate Governance, LexisNexis Butterworth, 2005, co-authored with Justice Robert Austin and Professor Harold Ford) this is not an abstract question.

Section 181 of the Corporations Act requires directors to exercise their powers and discharge their duties in good faith in the best interests of the company.

What is meant by "interests" of the company? Possibilities include:

• existing shareholders;
• future shareholders;
• creditors; and
• employees, customers, suppliers, the environment and the community in which the company operates.

Courts have generally interpreted the interests of the company to mean the interests of existing shareholders.

This is not the first time these issues have been considered in Australia. In 1989 the Senate Standing Committee on Legal and Constitutional Affairs in its report titled "Company Directors' Duties: Report on the Social and Fiduciary Duties and Obligations of Company Directors" recommended that while the companies legislation should be amended to make it clear that the interests of a company's employees may be taken into account by directors in administering the company, matters such as the interests of consumers and environmental protection should be dealt with not in the companies legislation but in other legislation dealing specifically with these matters.

Other countries are considering these issues.

On 17 March 2005 the UK Secretary of State for Trade and Industry presented to the UK Parliament a White Paper on Company Law Reform together with a draft Company Law Reform Bill. The Bill proposes changes to the UK law of directors' duties so as to incorporate into directors' duties the concept of "enlightened shareholder value".

The Bill proposes that directors must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. In fulfilling this duty, directors must take account (where relevant and so far as reasonably practical) of:

• the likely consequences of any decision in both the long and the short term;
• any need of the company: (i) to have regard to the interests of its employees, (ii) to foster its business relationships with suppliers, customers and others, (iii) to consider the impact of its operations on the community and the environment, and (iv) to maintain a reputation for high standards of business conduct; and
• the need to act fairly as between members of the company who have different interests.

The noteworthy feature of the UK Bill is that the primary duty of directors is still to shareholders but directors may take account, where appropriate, of the interests of other stakeholders.

The UK Government states that the proposed new formulation of directors' duties reflects wider expectations of responsible business behaviour and, in the opinion of the Government, is most likely to drive long term company performance and maximise overall competitiveness and wealth and welfare for society.

The proposed UK reforms are based on an earlier report of the Company Law Review Steering Group (CLR). In its final report, the CLR rejected what it termed the "pluralist" approach to directors' duties whereby directors would be empowered, or obliged, to set the interests of other stakeholders above those of shareholders. The reasons why the CLR rejected this approach included that it would:

• confer a broad policy discretion on directors, funded by the company's resources, that could lead to directors being less accountable;
• constitute an attempt to achieve external benefits which are often better secured by specific legislation which bears on business activity as a whole, such as employment, environmental, planning and fair trading and competition law; and
• allow directors to more easily frustrate takeover bids against the wishes of shareholders.

The CLR also raised a number of what it termed more technical difficulties with allowing or requiring directors to place the interests of other stakeholders above those of shareholders. For example, the CLR pointed out an inconsistency between the pluralist approach to directors' duties and yet leaving untouched the many rights shareholders have such as appointing and dismissing directors.

There are other potential difficulties. To change the duties owed by directors so that the interests of other stakeholders are elevated above those of shareholders would presumably vest additional discretions dealing with matters of business judgment in ASIC (when it investigates whether there has been a breach of duty by directors) and the courts (when they are called upon to decide whether there has been a breach of duty).

Whether ASIC and the courts would want these additional discretions, whether they are qualified to exercise them, and whether it is an appropriate role for them, are matters requiring detailed consideration.

The existing law does provide for an effective review of the actions of directors. If the law is changed so that directors have direct duties to a broad range of stakeholders, the irony is that this may result in directors being less accountable.

We should be careful about law reform that responds to one set of circumstances (in this case, the actions of James Hardie) but which may adversely affect many companies.

Our existing law of directors' duties has served us well. Australian courts have successfully applied directors' duties to different circumstances and adapted the law where appropriate (for example, gradually increasing the standard of care and diligence expected of directors as community expectations have increased).

Importantly, the existing law allows directors to consider the interests of stakeholders other than shareholders. As my co-authors and I state in our new book on directors' duties, the management of a company may be justifiably concerned to ensure that the company is a good corporate citizen. An extreme view, namely that a company should make only those expenditures that are directly related to the pursuit of profit for the benefit of members, would restrict management.

A fundamentally important issue is how directors balance the interests of various stakeholders in the company and the role of the law in this process.

The critical question for CAMAC is whether the law of directors' duties should be amended in the way proposed in the UK, or whether this balancing of interests is best left to the business judgment of directors and possible reform of specific laws that deal, for example, with employees' interests, protection of the environment, etc.

At the very least, as the UK debate tells us, we should be cautious about reform of directors' duties that elevates the interests of other stakeholders above the interests of shareholders.

* Professor Ian Ramsay is director of the Centre for Corporate Law and Securities Regulation at the University of Melbourne. He is a member of CAMAC and is the co-author of a new book on directors' duties.

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