Proposed amendments to the director’s basic duty of loyalty – The Companies (Director Duties) Amendment Bill

At the end of last month a Labour MP announced that he had a Bill drawn from the ballot that has, as its aim, clarifying that a director can take actions which take into account wider matters other than the financial bottom-line.

This, the explanatory note for the Bill says, accords with modern corporate governance theory that recognises that corporations are connected with communities, wider society, and the environment and need to measure their performance not only in financial terms, but also against wider measures including social, and environmental matters.

The Bill takes the shape of an amendment to section 131 of the Companies Act 1993.  Section 131 specifies the (basic) duty of a director – to act in good faith and in best interests of company.  Specifically, the Bill proposes to amend section 131 by providing that, when determining what is in the best interests of a company, a director may take into account “recognised environmental, social and governance factors”.

Examples of these factors are listed as include:

• recognising the principles of the Treaty of Waitangi;
• reducing adverse environmental impacts;
• upholding high standards of ethical behaviour;
• following fair and equitable employment practices; and
• recognising the interests of the wider community.

Drivers for change

At first glance, the change proposed by the Bill may seem quite wide-sweeping.  The Law Commission report that drove the present Companies Act specifically rejected the idea that directors should have some sort of (enforceable) duty to wider stakeholder interests.  Instead, the Law Commission noted that such a primary obligation could be legislated elsewhere (it gave the example of employment law).

But, the Bill is proposing a “for the avoidance of doubt” provision.  And it says that directors “may” take such ESG factors into account.  

The architect of the Bill seeks to clarify the point that directors can take into account wider range of matters than the financial bottom-line.  Despite this, there already exists a body of opinion that a wider range of factors (for example those related to mitigating the environmental impact of the company’s business) must be considered as part of any consideration of the company’s economic performance.

Is there a problem that needs fixing?

Of course, a company can already identify wider, social good type objects in the constitution.  One of the benefits of doing so is that gives notice to all the worlds, and particularly those people with whom it is dealing, of those objects. 

And, in the case of listed companies, the NZX Corporate Governance Code contains recommendations on ESG matters – with NZX listed companies having “comply or explain obligations” in relation to those matters.

It must be considered unlikely that an expansion of the factors that directors may take into account when determining the best interests of the company will (of itself) lead to changes in corporate behaviour.  And it is difficult to know, because the Bill does not tell us, what problems it is seeking to fix.  To the extent that companies (or directors) may be accused of ‘short-termism’ or self-interested behaviour, this does not seem to be a direct route to the try line.  If a direct route is needed – in the face of a range of (societal) factors that are clearly driving many of the most successful companies, and their directors, to have regard to wider and longer-term factors wide identifying the meaning of what are the “best interests”.  Couple this with a body of governance practice that is better suited to flex with the size and shape of the business, and the communities of interest within which it operates, leaves the interested spectator wondering what the author of the Bill is trying to achieve – and whether the drafting of the Bill is the best means for doing so. 

The Bill also follows the recent IOD ‘white paper’ on the need to review directors’ duties.  Some of the points in the white paper seem to be well made.  Particularly the need for reform of sections 135 and 136.  Others are difficult to follow and do not make a good case for reform – and have been criticised as representing woolly thinking.

UK example

A 5-year old change to the Companies Act 2006 (UK) provides an example of how not to lead law reform.  It provides that 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 [shareholders] as a whole, and in doing so have regard a finite list of factors.

The result has been the creation of a new industry designed to provide directors with the appropriate paper trail.

Some commentators have suggested that it has led to precisely the opposite outcome to that proposed by its designers.  As a result, there have been efforts on law reform (largely to redefine what “success” looks like).

In short, let’s not go there.

Comments

The Bill will be subject to the usual Select Committee process.  It needs to do so for a variety of reasons – including inadequate problem definition and the need to clarify a laundry list of questions.  What, for example are “recognised factors” and will they change over time, by sector, or by region?  How does the proposed change interact with the balance of section 131 of the Companies Act?  And how does the architect of the Bill expect that the clarification might be back-stopped – should directors be said to have not met any new test for their behaviours?

Further information

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