Corporate social responsibility is by no means a new concept for directors of companies in the food and drink sector. In fact, it is a concept which many have been grappling with for some time now as part of day-to-day management. However, following the recent codification of directors’ duties, it is no longer a factor they ‘might’ like to consider, it is a factor they ‘must’ consider as part of their duties as a director.
Substantial parts of the Companies Act 2006 (the Act) are now in force, including four of the seven codified directors’ general duties which came into force on 1 October 2007; the other three codified duties are due to come into force later this year. The new set of directors’ duties is the first time that such duties have been recorded in statute codifying a myriad of well-trodden case law. Notably, the Act has now established a clear link between the duties that directors owe to a company and matters of corporate social responsibility, many of which are highly relevant to the food and drink sector, such as ethical trading and environmental best practice.
Something old, something new
For the last 300 years, the law governing directors’ duties has largely been derived from common law rules and equitable principles which have developed through the courts on a case-by-case basis. The law on directors’ duties has therefore not always been readily accessible to those who need it most, directors. It was therefore a key objective of the new legislation to make the law more accessible by codifying the general duties of directors so that they reflect the existing law and provide greater clarity on what is expected of directors. This sentiment is to be applauded and the Act now includes seven general duties that seek to reflect the existing law, as follows:
- To promote the success of the company
- To exercise reasonable care, skill and diligence
- To exercise independent judgement
- To act within the powers of the company
- To avoid conflicts of interest
- Not to accept benefits from third parties
- To declare any interest in proposed transactions or arrangements with the company
There is of course little that is controversial in the broad formulation of these duties. For example, few could doubt that directors should act within their powers and exercise reasonable care, skill and diligence. However, the simplicity of codification brings its own issues to the table, not least the fact that it is rarely possible to set out in statutory form the detailed principles on which the underlying cases have been decided. The Act provides that the new codified duties are to be based on the ‘existing duties’ and that regard should be had to the ‘corresponding’ existing duties when interpreting the new ones. What this means in practice is that the existing law is almost superseded, but not quite. Effectively, this approach avoids the necessity for detailed codification of complex principles underlying each of the new duties, whilst suggesting that the courts should be reluctant to move away from the existing law underpinning each of the duties.
Until this relationship is tried and tested in the courts, the interaction between existing case law and the new duties will provide scope for uncertainty and judicial development – in particular, it will be interesting to see if the courts decide that the language used in the Act compels them to follow old precedents or affords them with an opportunity to look at issues afresh.
Duty to promote the success of the company
One of the new codified duties is to ‘promote the success of the company’. Lord Goldsmith, the government spokesman, has reportedly said that success for a commercial company will usually mean a ‘long-term increase in value’. The Act provides that a director of a company must act in a way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so shall have regard (amongst other matters) to:
- The likely consequences of any decision in the long term (e.g. cutting a company’s research and development budget)
- The interests of the company’s employees (e.g. moving a manufacturing process abroad, thus leading to redundancies among existing staff)
- The need to foster the company’s business relationships with suppliers, customers and others (e.g tightening of supplier terms of trade in order to improve cash flow)
- The impact of the company’s operations on the community and the environment (e.g. the impact of new manufacturing processes on a company’s carbon footprint)
- The desirability of the company maintaining a reputation for high standards of business conduct (e.g. reputational risk of using private information relating to competitors)
- The need to act fairly as between members of the company (e.g. ensuring that private shareholders are not disadvantaged by corporate transactions or share issues).
The introduction of these ‘enlightened shareholder values’ (the CSR Factors) has been criticised for creating an additional burden on directors, although most competent directors have long had regard to these factors. Their statutory formulation will arguably just make directors think harder about them.
This is particularly so in the food and drink sector where directors are likely to have already considered a number of the CSR Factors as a matter of course whilst undertaking risk management exercises – one such example is packaging and waste. Directors no doubt have to weigh up product sales (success) on the one hand (often driven by presentation as much as taste), against the adverse consequences that non-recyclable packaging has on the environment. This is particularly so with landfill space in the UK rapidly declining and the consumer market becoming more and more socially and environmentally-minded.
Although directors now have an overriding duty to promote the success of a company, it is now mandatory that directors also consider the CSR Factors when making decisions. It will not be sufficient for directors simply to ‘pay lip service’ to these factors. Proper consideration will need to be given to each factor and its potential relevance to the matter in hand (the legislation does not dictate what weight should be given to each of them) and directors should maintain a written record of having given regard to the relevant CSR Factors. This is particularly important in an increasingly litigious environment and against the backdrop of an increased risk of claims being brought against directors personally.
The changes to directors’ duties, some of which have been described above, are certainly capable of creating uncertainty, at least until the courts have had an opportunity to rule on questions of construction and the interaction of the new laws with the old. While the codification of duties has arguably helped to clarify directors’ legal duties and obligations, this clarification has also served to create clearer grounds upon which directors might be sued personally for breaching such duties. This is all the more significant given the parallel changes in the scope of the shareholder action – otherwise known as a ‘derivative claim’.
If a wrong is done to a company, the correct entity to seek redress is the company itself. However, wrongs committed against a company are sometimes attributable to the directors who will have the power to prevent the company from bringing a claim. This is said to be tantamount to a ‘fraud’ against the minority shareholders with the result that, under the existing law, the minority are allowed to bring an action against the wrongdoers in the name of and for the benefit of the company. Although derivative claims are possible under existing law, they are complex and limited in scope. The Act has made two important changes to the existing law in respect of derivative claims, which are:
- it will no longer be possible for a simple majority of shareholders to ratify the conduct of directors, thereby leading to an absolute bar on a derivative claim. The votes of a director and of anyone connected with the director will be disregarded for these purposes. This represents a significant qualification to the general principle of majority control which is a cornerstone for a number of English company law principles; and
- it is now clear that any breach of duty, even negligence, can be the subject of a derivative claim – there was some uncertainty about this point under existing law.
One of the consequences of allowing negligence to form the basis of a derivative claim is the likelihood of a disgruntled shareholder being able to present a credible argument that a specific decision was made negligently because the directors failed to have regard for, or placed too much (or too little) weight on certain factors. Arguably, this is more likely than ever now that directors have a specific list of factors (the CSR Factors) to which they must have regard in seeking to promote the success of the company.
The potential for claims to be brought against directors would therefore seem to have been increased and early evidence of this is in circulation. For example, the Corporate Responsibility Coalition (CORE) has produced a guide on how its members can use the Act to bring companies to account for their social and environmental impact as well as financial performance.
The legislators were, however, aware of the sleepless nights these changes may cause a conscientious director to endure. The Act introduces a number of safeguards to limit unwarranted or frivolous claims being brought in abuse of the court process. A shareholder will be required to seek the permission of the court to bring an action in the name of the company and the courts will have a largely unqualified discretion as to whether or not to allow a shareholder action to continue. In particular, one of the grounds to be taken into account by the court is whether the application is being made in ‘good faith’. This is an important protection for directors and it is likely to guard against, for example, a situation where a campaigner or interest group purchases a share solely for the purpose of being able to bring a shareholder action. It is likely that the court will treat such action as a claim brought in bad faith and designed to further a different objective, rather than shareholder protection.
The main concern with the new rules is that they will lead to uncertainty and the prospect that almost every decision could be challenged with greater ease than under the existing rules. With no cast-iron rules, a shareholder will be able to apply to court and attempt to persuade the court to allow a derivative claim to proceed. This will inevitably lead to some cases where this is a positive development leading to greater accountability on the part of directors, but there must be a risk that it creates a climate in which shareholders are encouraged to raise arguments in order to explore an issue publicly or to apply pressure on the directors.
Many companies within the food and drink sector are already publicly demonstrating their ‘regard’ for the CSR Factors by publishing their policies on a wide range of corporate responsibility matters such as responsible drinking, food labelling and marketing to children, local sourcing and supplier relationships, all of which are potentially useful defensive measures to ward off derivative claims. But the reforms are still likely to create an environment in which challenges are made to actions and decisions of directors. In the context of broader shareholder activism and, let’s not forget, the uncertainty currently surrounding the world economy, there is a real prospect of increased litigation. One can only hope that the courts apply a sensible approach so as to minimise the scope for tactical action and other unnecessary claims.
The introduction of the new codified duties and an increased risk of directors’ decisions being challenged, particularly by way of shareholder actions, means some directors may find themselves faced with a new era of decision-making and a few sleepless nights lay ahead; for others, it will be business as usual. In order to acclimatise to this new era, it is recommended that:
- If relevant, directors are careful to ensure that each of the six CSR Factors are considered, bearing in mind they are not exhaustive. In many situations it will be necessary to have regard to other factors.
- Minutes do not necessarily need to give detail on how each relevant factor was considered if supporting board papers provide the relevant information. (A system of checking by the chairman or secretary before any paper is finally included in the board pack should be introduced, to ensure that all relevant factors are adequately covered).
- Directors use independent advisers such as environmental and health service consultancies to help to establish the potential impact of business decisions before they are implemented.
- The directors’ obligations in relation to their codified duties, in particular, the CSR Factors, should be brought to the attention of all directors on appointment.
- The Institute of Chartered Secretaries and Administrators has recently published a guidance note on directors’ general duties under the Act and it is well worth a read; it may even help to avoid the unwanted attention of a derivative claim