"Section 172 of the Companies Act 2006 is an interesting innovation in that it provides, for the first time, a legislative mandate as to for whose interests directors are to act in their management of the affairs of companies. However, there does not seem to be any framework in place to ensure that directors are held accountable for their decision-making process. " Discuss. The Companies Act 2006 was largely a piece of legislation which amalgamated pre-existing common law and statutes. As such, the interpretation of much of the act depends on an understanding of the original common law and equitable principles.
This is particularly so for Chapter 2 of Part 10 of the act, in which section 172 is located1. It will be important to bear this in mind as we analyse the provisions in the statute for the purposes of establishing the extent to which directors are held accountable for their decision-making process. The structure of the essay is relatively simple: firstly I will explain the essence of section 172 as whole before analysing each subsection, raising questions regarding the accountability of directors and attempting to arrive at solutions in each case.
This will be followed by a short conclusion. Section 172 of the Companies Act 2006 is entitled 'Duty to promote the success of the company'. As the name suggests, it is somewhat ambiguous. Nevertheless it is a bold attempt by the legislators to firstly ensure that directors are acting in the interests of the company and secondly to provide some detail on the factors which directors ought to take into account.
Subsection 1 in particular is based on the notion of 'enlightened shareholder value', which is a middle ground between those who believe companies should be run purely for unadulterated capitalist purposes, and those who argue that companies should be directed with consideration for a variety of external issues such as the environment and the local community. The wording of subsection 1 is clearly based on existing common law. Lord Greene MR in the case of Re Smith & Fawcett Ltd  Ch 304 said that '…
Directors must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company'. This view was bolstered in Dorchester Finance v Stebbing  BCLC 498 in which Foster J stated '… (a) director must exercise any power vested in him as such, honestly, in good faith and in the interests of the company… ". Subsection 1 provides a number of requirements: the director must act in good faith, in the way he considers would most likely promote the success of the company for the benefit of its members as a whole.
He must do this with regard to various factors (listed (a)-(f) under subsection 1) – 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. In the preceding line of the statute it is indicated that this is a non-exhaustive list.
Subsections 2 and 3 state that, in certain circumstances, directors must have regard to types of success other than mere financial success if financial success is not the company's sole purpose(2), and creditors(3) (generally relevant when companies are becoming insolvent). This may be condensed into the following areas which will now be analysed in detail: the meaning of 'the company', the meaning of 'good faith', the meaning of 'success', the relevance of paragraphs (a)-(f) of subsection 1 and the effects of subsections (2) and (3).
The meaning of 'the company' is not particularly complicated but it is nevertheless important – it is necessary to have an accurate and clear description of what the company is if directors are to be held fully accountable for the decisions regarding the company. Assistance in this matter is provided by Megarry J in the case of Gaiman v Association for Mental Health  Ch 317 who accepted that the company included the interests of both 'present and future members of the company as a whole'.
He believed this was a helpful expression of a 'human equivalent' (as necessitated by the Salomon principle the companies have their own legal personalities). Defining the company should not cause too much of an issue in most cases. Slightly more complex is the issue of good faith. Directors are required to act in good faith at all times. So what does this mean? Again, case law provides the answers. It can be observed that there is both a subjective element and an objective element to the test of good faith.
In Regentcrest plc v Cohen  2 BCLC 80, Jonathan Parker J presented this view, highlighting the important aspect as being what the director 'honestly thought was in the interests of the company'. A similar view can be found in Extrasure Travel Insurances Ltd v Scattergood  All ER (D) 307. However, there is also an objective test which was propounded by Lord Pennycuick in Charterbridge Corporation Ltd v Lloyd's Bank Ltd  Ch 62.
This test is like a 'reasonable man' test which can be found in various areas of criminal and tort law and essentially it asks whether the 'intelligent and honest man in the position of a director of the company' would have seen the transactions as beneficial to the company. As I have suggested above, it is neither unusual nor difficult for the law to simultaneously incorporate both subjective and objective tests for the same issue. I think a combination of both tests would provide a perfectly adequate framework for holding directors who have not acted in good faith accountable. The 'success' of a company is a fairly vague term.
However, assuming that company law is ultimately based on the principle of gaining capital it is reasonable to assume that the term 'success' should be regarded in financial terms. The wording as a whole, subsection 1 says "success of the company for the benefit of its members as a whole… " seems to bolster this view, and it would seem that subsection 2 becomes relevant where the objectives of the company are not purely financially motivated. Ultimately this is unlikely to be an obstacle when it comes to holding directors accountable for their decisions because the emphasis is so clearly on capital.
So far, the effects of the first part of S. 172(1) have been looked at and considered with regard to their effects on directorial accountability. So far, it seems, so good with the only possible problem as I see it being the potential conflict between the subjective/objective test for good faith. However, paragraphs (a)-(f) of the subsection pose an entirely new problem. As the title question proclaims, there has never been a legislated list of factors into which directors must take account when making decisions.
This inevitably complicates the application of the latter part of subsection 1. This is further confused by the indication that the list is non-exclusive: "A director of a company must… have regard (amongst other matters) to-"2. A number of questions arise at this point: firstly, what are the other factors and who decides what they are? Secondly, what weight is to be given to each of the factors listed? Thirdly, what weight is to be given to unlisted factors in comparison to those listed? Fourthly, how much "regard" must a director pay to such factors and how is this to be evidenced?