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Companies must be run for wider stakeholders, says new law

UPDATED: Company directors have a duty to run a company in the interests of a wide group of stakeholders and not just the company's owners, according to a new law which will come into force on 1st October.31 Aug 2007

Free OUT-LAW Breakfast Seminars, UK-wide. 1:The new regime for prize draws and competitions. 2:How to monitor staff legallyThe law will force directors to consider the interests of 'stakeholders' in a firm, such as employees, the environment and the local community. The changes are among the directors' duties listed in the Companies Act 2006. The relevant sections of the Act come into force in a few weeks' time.

"Effectively, the Companies Act introduces on to the statute book for the first time the concept of the 'stakeholder' – that is, someone other than a shareholder who has an indirect interest in what a company may be doing," said Martin Webster, an expert in company law at Pinsent Masons, the law firm behind OUT-LAW.COM. Webster is author of The Director's Handbook, whose second edition contains guides to the new Companies Act.

"The duty to promote the success of the company is not simply a codification of an old law, but the introduction of a new one," said Webster. "To fulfil this duty, the legislation says that directors must have regard to six factors [listed below] that demonstrate what BERR calls “responsible business behaviour” in reaching their decisions.

Webster said that the new law will be likely to change directors' attitudes, but does not alter the existing fundamental duty of directors to promote the success of the company.

"There is no requirement that any one factor is given precedence over another, that employees must be favoured over the environment, for example, or the community over customers," he said. "The final decision might ignore all six factors – but the board needs to be able to demonstrate that it has at least thought about them."

The codification of duties changes the basis of one of the most fundamental of directors' duties, adding a wider obligation to the old one of acting in the interests of the company itself.

"This is a new duty, a re-casting of the old law that imposed a duty to act in good faith in the best interests of the company as a whole," said Webster. "The language is now subtly different; a director of a company must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole."

Webster said that the new codification will not involve any change for many modern businesses. "For many companies the concept of enlightened shareholder value is nothing revolutionary; they have been thinking about these factors, or something like them, for years. The duty merely gives statutory force to something that responsible boards of directors should be doing anyway," he said.

Other provisions of the Act that come into force on 1st October will make it easier for shareholders to take action against the directors of a company. Previously, shareholders could only take action in the name of the company as a whole, except in some specific cases.

The new laws allow shareholders to take action against directors who breach their duties.

"This is enshrining an old common law procedure where a shareholder can take action in the company name where there's been a fraud on minority shareholders," said Emma Flower, a commercial litigation expert at Pinsent Masons, the law firm behind OUT-LAW.COM. "A minority shareholder couldn't take action in their own right."

The new law clarifies that process, broadens it beyond pure fraud and gives it a basis in legislation, said Flower.

"This is a new procedure which will allow a shareholder to pursue an action where there's been some kind of negligence, a breach of duty," she said. "Shareholders will ask the court to allow them to step into the shoes of the company and bring the acton on behalf of the company."

The process of seeking a court's permission to take an action will be the critical part of the legislation, said Flower. The courts will look to decide if the action is in the best interests of the company as a whole but will want to stop the law becoming a vehicle for activists, she said.

"It should be quite a high threshold because they want to try to weed out frivolous actions and activist shareholders using these actions as a litigation strategy," she said.

"We might see some interesting test cases, you can imagine an environmental activist group buying into a company to use it as a route because you don't need to have a long standing interest in the company to take an action."

Among other provisions on directors' duties, secton 172 of the Companies Act states:

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

(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.

Editor's note, 04/09/2007: This story has been updated since it first appeared. The first version implied that a Code of Directors' Duties was to be published. This is not the case: the new Act simply codifies certain duties. We apologise for any confusion.