Directors’ duties and creating a more accountable corporate culture
Responsible businesses don’t just materialise from nowhere. Fiona Gooch and Tom Wills, in the first of a series of blogs, look at how changing the legal responsibilities of company directors could create a more accountable corporate culture.
When we think about irresponsible business practices a few famous examples come to mind: from Trafigura dumping toxic waste near the Ivory Coast to Phillip Green heading off to spend more time with his yachts, leaving BHS with a pensions deficit of more than £500 million. Each time a scandal hits the headlines there is a flare-up of outrage around the lack of accountability and the individual features of the case at hand. There is rarely proper analysis of the common features of these cases: shortcomings in the ways that companies are structured.
There are signs that Theresa May’s government is aiming to move beyond this cycle of introspection and inaction, offering up some very strong messages about how businesses should act. Speaking to the World Economic Forum at the Prime Minister laid out her vision for British business:
“…businesses paying their fair share of tax, recognising their obligations and duties to their employees and supply chains, and trading in the right way; companies genuinely investing in – and becoming part of – the communities and nations in which they operate, and abiding by the responsibilities that implies; and all of us taking steps towards addressing executive pay and accountability to shareholders”
Traidcraft was established to demonstrate that business can be done differently – in a responsible, sustainable and ethical way – and we are certainly supportive of Mrs May’s rhetoric in this area. The government have published a Green Paper on Corporate Governance Reform, to which Traidcraft has contributed our ideas for improving the legal frameworks within which businesses operate.
This first blog looks at one fundamental underpinning of corporate culture: the duties of company directors. At present, an individual serving as director of a company takes on a set of duties that are laid out in the 2006 Companies Act.
A director of a company must act in the 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 have regard (amongst other matters) to—
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships with suppliers, customers and others,
(d) the impact of the company’s operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct, and
(f) the need to act fairly as between members of the company.
By codifying directors’ duties in this way, the Companies Act represented a big step forward. As a result of the legislation, many non-executive directors feel more comfortable bringing up issues such as environmental impact or supplier relationships in the boardroom. However, more than ten years on it is apparent that requiring directors to concentrate on the interests of shareholders (or ‘members’, as they are referred to here) above and beyond any other concern will not create the responsible business environment that Theresa May envisaged in her Davos speech. We need directors to take on new obligations, and to institute a system where director’s duties can be effectively enforced.
Several examples demonstrate the flaws in the current system.
Take the 2016 report into Tesco’s purchasing practices, compiled by the UK’s Groceries Code Adjudicator. The investigation found that the supermarket had been regularly delaying paying its suppliers, sometimes of sums exceeding £1 million and in some cases for longer than two years. Through such behaviour, directors could report artificially high quarterly financial figures – which was in the interest of shareholders – yet it damaged the company’s long-term standing, its supplier relationships and the sustainability of its supply chains.
Another example is Acacia Mining, a UK-registered company that carries out mining operations in Tanzania. In 2008, security providers employed by the corporation at the North Mara mine shot and killed members of the community. Directors in the UK were made aware of this when a civil court case began in the UK in 2013, but chose not to review the performance of their security provider. Since then, there have been further reports of violence, including beatings and shooting with live ammunition. The priority of the directorship since 2013 was, as per their legal responsibility, to ensure shareholder value. Longer term questions of company reputation, community relationships or ethical conduct clearly came in second.
Reworking the definition of director’s duties in the Companies Act to prioritise the success of the company rather just its ability to deliver shareholder dividends would help avoid these situations, and would support business to play a more responsible role in society.
However, simply rephrasing of the Companies Act would only be a partial solution. The laws surrounding corporate criminal liability must be reformed to incentivise directors to prevent harms rather than ignore them: this will be explored in a subsequent blog. Steps must also be taken to ensure that duties are more enforceable: there should be better mechanisms for sacking directors if they don’t carry out their duties, and there should be more regular and robust methods of investigating director failure.
At present, a director failing to exercise their duties properly is accountable in two places. The government is theoretically able to enforce director’s duties on publicly limited companies. However, ministers have never sanctioned an individual outside of a winding up order. The other way is for shareholders to question the performance of a director. This is rarely in the interest of the shareholder: it is preferable to divest oneself of shares and walk away rather than destabilise a share price by calling the performance of a director into question.
This lack of enforcement helps to create an unaccountable corporate culture. Directors who breach their duties must be subject to personal consequences, including disqualification in cases of criminal behaviour such as failing to prevent death or injury, or defrauding customers.
As well as the consultation on corporate governance, the government is running a consultation on corporate liability for economic crimes. This hopefully means that Theresa May’s administration is looking seriously at how better rules for companies can create a better society. Changing the duties of directors, and reviewing how these are enforced, would be a vital step in the right direction.
Our full submission to the government’s Green Paper on Corporate Governance Reform can be found here.