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Law for Business

Knowhow - guidance - precedents

24 SEP 2013

Improving directors' behaviour:

Is an erosion of the principle of shareholder primacy the solution?


Nigel Banerjee

When the common law duty of loyalty owed by a director to his company was being codified, the key policy question with which the Company Law Review Steering Group, and then the government, had to grapple was whether shareholders' interests should reign supreme.  In the event, of course, the decision was taken that they should;  under section 172, a director is obliged to take into account various external factors - such as the impact of the company's operations on the environment - but only for the purpose of assessing whether the act in question would benefit the shareholders.

This summer, the Department for Business, Innovation & Skills' discussion paper on transparency and trust raised the question of the appropriateness of the shareholder primacy approach once more, seeking views as to whether, in the wake of financial crisis, directors of banks should be subject to a "primary duty to promote financial stability over the interests of shareholders".

The discussion paper also considered various measures to address the problem of improving the behaviour of directors generally - changes to the rules on disqualifying directors, for example - and it was right to do so.  Whilst there is scope to reform the law in this area, an erosion of a principle which is as fundamental to our system of company law as that of shareholder primacy is not the solution.

The discussion paper

The discussion paper, which was published in July 2013, was entitled "Transparency & trust: enhancing the transparency of UK company ownership and increasing trust in UK business".

In relation to enhancing transparency, the key matter upon which it sought views was the government's plan to require all companies to identify the beneficial owners of their shares, but it also made a number of other proposals, including the radical suggestion that companies should no longer be able to act as directors of other companies.

In relation to increasing trust, the most eye-catching question which it raised was whether directors of companies operating in the banking sector should be subject to a new, overriding duty to ensure the stability of the company.  It also outlined proposals affecting directors generally, in the shape of reforms to the rules governing directors' disqualification and reforms designed to make it easier for claims to be brought against directors under the fraudulent and wrongful trading provisions of the Insolvency Act 1986.

A new duty for directors?

The duty of loyalty is, at present, expressed in statutory form in section 172(1) of the Companies Act 2006, which provides that a director "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 list of factors including the interests of employees, the company's reputation and the impact of the company's activities on the community and the environment.

In June 2013, the Parliamentary Commission on Banking Standards, which was established in 2012 to review the banking sector's professional standards and culture, had recommended in its final report that the government should consult on amending section 172 so as "to remove shareholder primacy in respect of banks, requiring directors of banks to ensure the financial safety and soundness of the company ahead of the interests of its members".

Although the discussion paper duly asked for views on the introduction of a duty to that effect, a careful reading of the relevant passages suggests that BIS was not itself convinced of the merits of this approach.  Whilst accepting that the behaviour of bank directors needs to improve, it identified a number of reasons why a new duty might not achieve the desired result.  Of particular interest, it noted that:

  • shareholdersmay be so focused on short-term gains that, in practice, they would be unlikely to enforce the new duty


  • if shareholders' interests are expressly subordinated to the need to ensure the bank's stability, investors may be less inclined to invest in shares in banks.

Naturally, the discussion paper did not express a final view on this point, but it went so far as to conclude its discussion with the observation that there may be more effective ways to influence directors' behaviour.

Alternatives to a new duty

The discussion paper outlined several possible reforms designed to ensure that directors who misbehave (or, indeed, are incompetent) are held to account.

Many of the proposals concerned the Company Directors Disqualification Act 1986.  For example, the discussion paper asked whether the list of factors to which the court must have regard when deciding whether a person is unfit to be involved in the management of a company (see Schedule 1, CDDA 1986) should be expanded to include the following:

  • whether sector-specific regulations (for example, regulations applicable to the financial services sector) have been breached


  • the wider social impact of the director's actions


  • the impact of the director's actions on "vulnerable creditors"


  • whether the director has been involved in previous failed companies, even where those past failures may have been attributable merely to "honest incompetence" rather than deliberate misconduct.

More radically, the discussion paper also suggested that the courts could be given the power to make a compensatory award against a director who is being disqualified.  The details of such an innovation would need to be worked out in due course - in particular, the question arises as to who should benefit from the award - and the discussion paper noted that the risk of being made subject to an award might deter directors from giving disqualification undertakings, but the proposal would address the criticism that the disqualification regime may offer creditors and the public at large protection from future misbehaviour, but does not provide a remedy for those who have already suffered as a result of a director's misconduct.

Another measure designed to provide redress for existing creditors was a proposal that the liquidator should be permitted to sell the right to bring a claim against a director under the wrongful trading provision in section 214 of the Insolvency Act 1986.  At present, a significant problem with section 214 as a means of holding directors to account concerns the funding of claims under that provision.  On the one hand, the liquidator may be disinclined to risk using the insolvent company's remaining assets to bring legal proceedings.  On the other hand, the fact that any contribution which a director may be ordered to make under section 214 goes towards paying off the unsecured creditors as a body means that it may be difficult to obtain funding from individual creditors:  a secured creditor has no incentive to fund a claim since he will not benefit from it, and even an unsecured creditor may feel that it is not worth funding a claim which, if successful, would benefit the unsecured creditors collectively, rather than himself alone.  The proposal in the discussion paper that the liquidator should be permitted to sell the claim to a creditor or a third party is not free from difficulties, but it may go some way towards improving the position of existing creditors.  Not only would it give individual creditors the option of pursuing the director directly, but the proceeds of the sale of an action would increase the assets of the company available for distribution to the creditors generally.  (Looking at the proposal from a wider perspective, it might also be the case that an increase in the number of section 214 cases being brought would encourage directors to behave more responsibly in the first place.)

An initial government response

The discussion paper set a deadline for submissions of 16 September 2013, and noted that a government response would be issued once the submissions had been analysed.

Although the official response has not yet been published, it already seems clear that action of some sort will be forthcoming.  On the deadline date itself, Vince Cable announced at the Liberal Democrats' autumn conference and in a BIS press release that he will take action to strengthen the disqualification rules.  Although it is not clear exactly what reforms he intends to introduce (and no doubt that is a matter upon which he will be guided by the responses to the discussion paper), it is interesting to note that neither in his speech to the autumn conference nor in the press release did Mr Cable refer expressly to the possibility of altering section 172.


Some may feel that the current regime satisfies the policy objectives of encouraging directors to behave properly and ensuring that those who fail to do so are punished.  After all, a director who is guilty of misconduct is subject to a variety of possible sanctions, ranging from removal from his office by disgruntled shareholders to disqualification proceedings, an action for breach of duty, wrongful or fraudulent trading proceedings under the Insolvency Act 1986 or even criminal proceedings under the Companies Act 2006.  On the whole, though, there does seem to be scope to improve the current regime.  For example, the disqualification rules may be used quite widely, and may have the effect of controlling the future activities of an unfit director, but, as noted above, they do not address the concerns of those who have already suffered at the director's hands.  Given the importance of maintaining confidence in the regime, it is also a cause for concern that there seems to be a widespread perception that directors who preside over the failure of large companies are not punished sufficiently.

Assuming, then, that action is required, the question arises as to whether the measures outlined in the discussion paper would have the desired effect.

  • A new statutory duty


The principle of shareholder primacy is one of the foundations upon which the English company law framework is built, and it should not be eroded without good reason.  The arguments in favour of a pluralist approach were found to be wanting during the review which led to the introduction of section 172 of the Companies Act 2006, and the suggestion that the stability of the company should be set above shareholders' interests if the company happens to be a bank should similarly be resisted.  On the one hand, a new duty might result in little or no change in the behaviour of bank directors, since shareholders may not, in practice, be inclined to enforce it.  On the other hand, if it does lead to a change in behaviour, that change may be unwelcome, in that directors could become so wedded to the idea of safeguarding the bank's stability that they adopt an unduly risk-averse approach, rejecting sound opportunities for growth on the ground that they pose a relatively minor risk to the bank's financial position.


The government has made a separate commitment to introduce criminal sanctions for reckless misconduct in the management of a bank (see the government's July 2013 response to the PCBS's final report), and that innovation will no doubt act as a powerful incentive to bank directors to act responsibly.  If, as the government suggested in its response, the aim of any amendment to section 172 would be essentially to supplement the new offence by reminding directors of the importance of ensuring that the company's finances are sound, a better option would be to amend the wording of the mandatory factor in section 172(1)(a), such that it reads:  "the likely consequences of any decision in the long term, including its impact on the company's financial stability".  An amendment along these lines would serve to focus directors' attention on the importance of maintaining the company's stability without threatening the principle of shareholder primacy, and indeed could apply to all companies, rather than to banks alone.


  • Redress for existing creditors

               As the flow of Insolvency Service press releases announcing new disqualifications testifies, the disqualification regime is already fairly robust.  In fact, the discussion paper points out that about 1,200 directors are disqualified every year.  If enacted, the proposed measures to expand the list of factors to which the court must have regard when considering the fitness of a director would give the courts even more freedom to make disqualification orders, and that is no bad thing.  They would not, however, address the plight of those who have already suffered as a result of the misconduct of the director in question, and BIS is right to consider options for improving the position of existing creditors.

               Liquidators currently have the power to initiate proceedings for breach of duty or wrongful trading (or, indeed, fraudulent trading), but the difficulties associated with funding a section 214 claim seem to have rendered that tool, in particular, a less effective means of holding directors to account than might be expected.  The suggestions in the discussion paper that the court should have the power to make a compensatory award when it disqualifies a director, and that the liquidator should have the power to sell a section 214 claim, are sensible.  They would give the disqualification regime and section 214 real bite, and would go some way towards reassuring those who feel that directors of failed companies often go largely unpunished.

               The introduction of a power to sell section 214 claims might give rise to concerns about opening the floodgates to frivolous or speculative actions.  Such concerns deserve serious consideration, but they should not be overstated; the courts have shown themselves to be alert to the danger of imposing an unduly high standard of behaviour on directors when assessing, for the purposes of section 214(2)(b), whether a director should have realised that the company was going to fail (see, for example, the comments of the court on this point in Burke v Morrison, Re Idessa (UK) Ltd (In Liquidation) [2011] EWHC 804 (Ch) and Ward v Perks, Re Hawkes Hill Publishing Company Ltd (In Liquidation) [2007] BCC 937).

  • Training for directors

               One of the questions in the discussion paper which has so far not been touched upon in this article was whether disqualified directors should be offered training in an effort to improve their conduct in future.  This is an interesting idea, but it is perhaps lacking in ambition.  It is a peculiarity of the company law regime that a director is not required to have any formal qualifications, and the apparent assumption in the discussion paper that a less relaxed approach would be a threat to enterprise is not convincing.  Certainly, it would not be unreasonable to expect a career director who works in the listed company sector to be subject to an obligation to undertake regular training on legal and financial matters, and even shareholder-directors of the smallest companies may well feel that the time and expense involved in meeting a training obligation is a price worth paying for the benefit of limited liability.  If the government's aim is to encourage directors to behave properly, the logical first step would seem to be to ensure that all directors are aware of precisely what is expected of them.


Care needs to be taken when considering changes to the law governing directors' behaviour, for directors must not be made scapegoats for company failures for which they are not to blame.  It is, however, vital that directors meet high standards of conduct, and the discussion paper certainly succeeded in re-igniting the debate as to whether the current regime is fit for purpose.  Although the suggestion that bank directors should be required to give the stability of the company priority over shareholders' interests is flawed, some of the other proposals in the discussion paper are much more promising.  If, in due course, they are introduced, they may well help to ensure that directors meet the expectations both of shareholders and of society at large.

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