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Corporate governance reform: a focus on directors’ duties under section 172 Companies Act 2006

14 November 2017

This article is taken from November's public matters newsletter. Click here to view more articles from this issue.

There has been considerable activity in the recent months in the proposed reform of the UK’s corporate governance framework. Around 8 weeks ago, the government published its response to the report made by the BIS House of Commons Select Committee following its inquiry into corporate governance of public and private companies which addressed, among other things, the duties of company directors. Any changes to directors’ duties would clearly impact on the directors of the ever growing number of public sector owned companies.

Directors’ duties are enshrined in the Companies Act 2006 (Act) which provides for, in summary, the following seven general duties:

  1. to act within powers;
  2. to promote the success of the company;
  3. to exercise independent judgment;
  4. to exercise reasonable care, skill and diligence;
  5. to avoid conflicts of interest;
  6. not to accept benefits from third parties; and
  7. to declare an interest in a proposed transaction or arrangement.

Under the Act, most companies must prepare a stand-alone strategic report (in addition to their directors’ report). This is to inform the members of the company and help them assess how the directors have performed their duty under section 172 of the Act (i.e. to promote the success of the company).

As part of the UK corporate governance reform, the government is intending to make it a formal, legal requirement for all (private and public) companies of significant size (which is, at this stage, thought to mean companies with over 1,000 employees) to explain how their directors have had regard to the employee and other non-shareholder interests set out in section 172. A draft statutory instrument is due to be published later in 2017 in respect of this.

In carrying out their duty to act in the way he or she considers, in good faith, would promote the success of the company for the benefit of its members as a whole directors must have regard (among other matters) to the following factors:

  • the likely consequences of any decision in the long-term;
  • the interests of the company’s employees;
  • the need to foster the company’s business relationships with suppliers, customers and others;
  • the impact of the company’s operations on the community and the environment;
  • the desirability of the company maintaining a reputation for high standards of business conduct; and
  • the need to act fairly as between members of the company.

When considering their duties under section 172 of the Act and in particular when making strategic decisions, the directors may also wish to consider/refer to the guidance on board engagement with stakeholders (guidance) was recently published by Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association (IA). The Guidance sets out, among other things, ten core principles (set out below) which aims to help directors consider and weigh up the interests of their company’s key stakeholders when making strategic decisions:

  1. directors should identify, and keep under regular review, who they consider their key stakeholders to be and why;
  2. directors should determine which stakeholders they need to engage with directly, as opposed to relying solely on information from management;
  3. when evaluating their composition and effectiveness, directors should identify what stakeholder expertise is needed in the boardroom and decide whether they have, or would benefit from,directors with directly relevant experience or understanding;
  4. when recruiting any director, the nomination committee should take the stakeholder perspective into account when deciding on the recruitment process and the selection criteria;
  5. the chair (supported by the company secretary, if applicable) should keep under review the adequacy of the training received by all directors on stakeholder-related matters, and the induction received by new directors, particularly those without previous board experience;
  6. the chair (supported by the board, management and the company secretary, if applicable) should determine how best to ensure that the board’s decision-making processes give sufficient consideration to key stakeholders;
  7. directors should ensure that appropriate engagement with key stakeholders is taking place and that this is kept under regular review;
  8. in designing engagement mechanisms, companies should consider what would be most effective and convenient for the stakeholders, not just the company;
  9. directors should report to its shareholders on how it has taken the impact on key stakeholders into account when making decisions; and
  10. directors should provide feedback to those stakeholders with whom it has engaged, which should be tailored to the different stakeholder groups.

Although principally aimed at public and other large companies, the guidance is helpful for all company directors and may therefore be informative for companies owned by the public sector and their directors when determining how they should operate as regards all of their stakeholders.

The guidance describes stakeholders as those groups which are likely to be affected by the company’s actions, or whose actions can affect the company’s operation or business model and in considering the company’s long-term success, the appropriate treatment of stakeholders is a factor.

Key stakeholders will vary based on a company’s circumstances (e.g. size, industry and location) and there is no exhaustive list of such stakeholders. For private companies which are owned by public sector bodies (e.g. local authority trading companies), we would expect that their customers, the communities in which they operate and their workforce would be their key stakeholders along with their public sector shareholders.

It would be sensible for directors to decide which stakeholders or issues are of sufficient importance to the company’s long-term success that the directors should engage with them directly. The directors should also consider whether, and what, information they may require from the stakeholders, how extensively they need to engage with the stakeholders and the best way to do so. 

In terms of timing of the reform (which will cover various other areas including executive pay and stronger corporate governance framework for large, privately-held companies), the current intention is to bring the reforms into effect by June 2018 - to apply to company reporting years commencing on or after that date (although some of the proposals may be implemented more quickly than this). The Guidance is intended to also be updated in June 2018 and reviewed again in the second half of 2019 against company experience in applying the Guidance.

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The content on this page is provided for the purposes of general interest and information. It contains only brief summaries of aspects of the subject matter and does not provide comprehensive statements of the law. It does not constitute legal advice and does not provide a substitute for it.

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