the director duties debate

  • Date:01 Sep 2005
  • Type:CompanyDirectorMagazine

 

The director duties debate


There is ongoing discussion on director duties and how far they should extend.
Bill Beerworth* puts a new twist on an old debate

 

Generations of lawyers have been taught that directors must discharge their duties in the interests of the corporation. This in turn is normally interpreted as in the interests of the shareholders.
Corporate finance theory and business schools translate this duty more pointedly into the mantra that the role of management is to maximise shareholder wealth.
   During the past 10 or 15 years, one debate about corporate activity has been the extent to which the controllers of corporations should have regard to the interests of stakeholders other than shareholders.
This discussion is now worldwide as a sub-set of the globalisation debate.
   The proposal that corporations should disclose their attitudes and actions towards society, the environment and economic sustainability has already provided the notion of triple bottom line reporting (TBL). This concept is now widely accepted.
Another global movement gives us the concept of corporate social responsibility (CSR), this does not have the same degree of acceptability, partly because there is considerable debate about what it means and what its proponents really want.
There was a time when all forms of business were widely perceived as rapacious and perhaps anti-social because they exploited labour and public resources to achieve the highest possible profits at the lowest cost.
But that Marxist vision of business ruthlessly acting in an entirely self-interested manner has been attenuated over this century by a raft of specific statutes which establish a legislative environment of requirements and standards, including for what economists call the externalities of business operations – the costs imposed on society by the carrying on of business enterprises.
The Simpsons’ Monty Burns could once have kept smoke stacks which belched toxic fumes and nuclear reactors which leaked radiation creating three-eyed fish in Springfield’s polluted rivers.
But a series of familiar statutes now impose strict requirements and standards about pollution and the environment; employment conditions; workers compensation; work place safety; trade practices and consumer protection; land use; equal opportunity and discrimination; and so on.
A key feature of this legislative business environment is that it applies equally to all forms of business including individuals, partnerships and corporations.
The Corporations Act does not itself deal with these issues. It deals merely with incorporation, the organs of the entity, and how the organisation is to be governed in various circumstances.
Those who wish to impose particular social obligations on corporations must justify why the same obligations should not be imposed equally on all other business organisations, including individuals, unions, partnerships and governments.
Perhaps any justifiable clamour should not be for CSR but for organisational social responsibility

TERMINOLOGY
Terminology in this debate is confusing rather than clarifying.
The term “stakeholder” is itself vague and suggests that anyone identifiable as such has an interest worthy of protection.
Similarly, the phrase “corporate social responsibility” implies that corporations are not socially responsible and that they must be forced to become socially responsible.
   In considering how to deal with the CSR movement, the starting point must be to ponder the role of the corporation in society.
A corporation is merely a particular form of organisation of individuals.
Through legislation, society allows a group of individuals to establish an invisible construct with a separate juridical status, perpetual life, the ability to do what an individual can do, and limitation of liability for the subscribers. Since a corporation is merely a form of organisation of individuals, there is no reason why greater or lesser social obligations should be imposed on it than on individuals, partnerships or other business organisations.
After all, individuals and partnerships are as equally moved by Adam Smith’s invisible hand to maximise their financial gain.
The corporate form arose simply because it was difficult and complex to arrange and regulate the affairs of a large number of individuals prepared to risk their capital in major projects.
Moreover, the corporation fulfils certain critical and socially desirable functions which have enabled the massive growth of free market economies.
There are a series of ongoing debates about various features of the corporation. One of these is corporate governance which deals with the way a corporation is structured internally to ensure that disinterested and effective decisions are made on behalf of the enterprise without unduly rewarding its controllers.
Because they provide the capital, it is normally considered that the enterprise should be governed for the benefit of the shareholders. This model is called the shareholder primacy model and it is generally accepted as the appropriate model in Australia. It tends to presuppose an agency relationship between managers and shareholders with a board elected to ensure that management effectively fulfils its stewardship role on behalf of the shareholders.

CURRENT CSR INQUIRIES
It is notable that two public inquiries are underway on CSR at the same time – one by the Parliamentary Joint Committee on Corporations and Securities and the other by CAMAC. (The AICD is making submissions to both inquiries)
Their terms of reference are slightly different, but the essence of each is similar:
•  the current extent to which directors may have regard to stakeholders other than shareholders
• whether the law should be clarified about the extent to which directors may take specific account of stakeholder interests
• whether the law should require directors to take such account
• whether there are other ways to encourage appropriate social behaviour
• whether some form of reporting would assist an assumed objective to make companies more socially responsible.
The CSR debate partly relates to the duties of directors and officers under s.181 of the Corporations Act to exercise their power and discharge their duties:
• in good faith in the best interests of the corporation; and
• for a proper purpose.
In simplistic terms, the issue is whether directors properly discharge these duties if they take action for social purposes which may not maximise shareholder wealth. This could include taking stakeholder interests into account. Bear in mind that, if they breach their duties, they may be civilly liable, or even criminally liable in extreme cases.
Many learned legal commentators take the view that there is already sufficient flexibility in the case law to permit directors and officers to have regard to stakeholder interests. They argue that activity designed to build the reputation and brand of the company is protected even if it cannot be shown to provide an identifiable financial return.
In an age of anti-globalisation rhetoric, many in society are vaguely opposed to commercial corporate activity and wish to ensure that corporations use a proportion of their assets and profits for activities which would normally be underwritten by taxpayers generally.
I was involved in a television current affairs debate a few months ago in which a bishop said that most corporate executives were animals who should be caged. When I protested, he hissed that I was also probably a corporate criminal.
We must therefore accept we live in a society in which even highly educated people of goodwill who have not been obliged to study law or finance often have passionately negative views about the role of corporations and those who control them.
I have noticed at a number of AGMs that some shareholders protest strongly against political or even significant charitable donations. The directors may have not only acted in what they regarded as good faith, in the best interests of the corporation and for what they regarded as a proper purpose, but different minds have different views on these subjects.
I am not at all confident that the extent to which directors and officers may take into account stakeholder interests other than of shareholders is usefully clear.
Few citizens subscribe to the law reports, particularly law reports of the 19th century.
Moreover, the outcome in a particular case may depend on the predilections of the particular judge hearing the case.
The two inquiries into CSR will need to determine what approach, if any, should be taken.
If they agree with me that visible clarification of the existing law might be useful, a new provision might be included in the Corporations Act.
Some resist this on the basis that it is not necessary. But if it is already the law, why not say so plainly and clearly in the statute itself? After all, most of the duties provisions are already a codification of the existing common law. Why should we resile now from adding yet a further clarification or codification if we are confident that it is the existing law?
The next issue is whether any CSR provision should merely give permission to directors to take stakeholder interests into account. If so, the provision might be regarded as a shield to immunise directors from shareholder or regulatory action.
A quite different sort of provision would require directors to take stakeholder interests into account. This approach would upend 150 years of economic and corporate theory and I do not envy the draftsman her role of defining stakeholder interests and the extent to which regard is to be given to them. This sword approach would presuppose a view of social experimentation which will need to be carefully articulated and tested.
Finally, as hinted by the terms of reference of both inquiries, a possibility might be to require boards to report how and the extent to which they take into account social and community issues and how they accommodate the usual expectation of shareholders that the board will seek to maximise the value of their investment.
Some who propound CSR assume that taking account of stakeholder interests other than of shareholders is the equivalent of ethical corporate behaviour. Many shareholders, particularly those dependent on dividends for their retirement and livelihood, take the opposite view that ethical corporate behaviour lies in maximising shareholder wealth.
This raises the whole issue of what are called community service obligations (CSO).
There is a vague public perception that, the larger the corporation, the more appropriate that it should have some CSO. By this is meant that the corporation should voluntarily provide some products or services free or at a subsidised rate to some members of society.
There was a time when Telstra was a public utility. However, if it becomes wholly privatised, I have difficulty understanding, except perhaps on a transitional basis, why it should be required to provide free or subsidised services to any segment of society including farmers and those who live in remote areas.
If society wishes to subsidise communications, it should do so explicitly by a payment from taxpayers generally. It seems to me that any such subsidy should be a visible and quantified transfer payment from tax payers rather than a hidden and unquantified subsidy provided by a private corporation at the expense of its shareholders.
Requiring a corporation to provide free or subsidised products or services is no different from requiring a butcher to provide free or subsidised meat to some customers. The mere size of the corporation or the complexity of its activities cannot hide the essential element that a demand for free or subsidised products or services is really a demand that the shareholders should provide those products or services at their own expense.
If it is decided that change is necessary, the identity of the relevant statute will need to be determined.
A new provision could be added to the Corporations Act.
But if it is considered desirable that businesses should make some free or subsidised contribution to the community, I would argue that the source should be a specific and separate statute called the “Social Contributions Act” which would have equal application to individuals, unions, partnerships, corporations and perhaps even governments and local governments.
   Of course, we already have a statute designed to provide funding for social and community objectives. It is called the Income Tax Assessment Act.
If neither clarification, shield nor sword is chosen as the way forward, it would certainly be possible to require directors to report how and in what fashion they take account of stakeholder interests. I imagine that would really be a mandatory TBL requirement.
In this context, it is of interest that ASX Corporate Governance Principle 10 recommends that companies should establish and disclose a code of conduct to guide compliance with legal and other obligations to legitimate stakeholders.
My own view is that the extent to which directors may take into account stakeholder interests other than shareholder interests is not visibly clear, and it is particularly unclear to non-lawyers.
I would strongly resist a provision which required a corporation to have regard to interests other than of the shareholders.
But if directors wanted to have regard to a relevant range of stakeholders, I would be happy to provide a shield for them.
In this context, it is noteworthy that the 1999 CLERP Bill which provided the present section 181(1) of the Corporations Act originally stated that a director must exercise her powers “in good faith in what she believes to be in the best interests of the corporation and for a proper purpose”.
The Labor Opposition wanted an objective test, so the words “in what she believes to be” were omitted.
Having regard to the evolution of two lines of case law at the time, there were rational reasons for the Opposition’s position.
My colleagues who believe that the Corporations Act is already clear will disagree, but I am a believer in providing a form of business judgment rule (BJR), not only for all duties and obligations in the Corporations Act, but in all other statutes.
When introducing the original BJR to qualify the care and diligence provision of the Corporations Act (s.180), the Treasurer Peter Costello, said that, if the BJR for s.180 was a success, the Government would consider introducing it generally.
My proposal is that a new provision be added to the Corporations Act to provide a BJR for a director or officer who undertakes an activity:
• bona fide
• within the scope of the corporation’s business
• reasonably and incidentally to the corporation’s business
• for the corporation’s benefit
This is, after all, the common law test and has been since the 19th century.
It would permit directors and officers to have appropriate regard to stakeholder interests without fear of being held in breach of their duties.
Since this test is from the 19th century, perhaps there is, after all, nothing new under the corporate sun or, as the French have it: Plus ‡a change; plus ‡a la mˆme chose.

* This is an edited version of a paper presented at a seminar arranged by Melbourne University Centre for Corporate Law and Securities Regulation and CAMAC. Bill Beerworth is managing director of Beerworth & Partners, a corporate advisory firm specialising in mergers and acquisitions. He has spent much of his career in securities regulation as a lawyer, merchant banker and commentator. He was a member of the Wallis Committee on the Australian Financial System