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Law for Business

Knowhow - guidance - precedents

20 APR 2015

PART 2: Section 172 of the Companies Act 2006 - A critical examination

PART 2: Section 172 of the Companies Act 2006 - A critical examination
Anna Hadjimarkou

Is s. 172 in need of change? Should the increase in commercial competition globally and the role of UK companies in creating economic growth lead to a reform? The answer is: No.

Section 172 constitutes the subject of various fierce debates which concentrate on the question of reform. This article aims to cover both sides of arguments and to take into account the different perspectives following a critical approach. Firstly, it must be stressed that UK companies constitute one of the most important vehicles for creating a flourishing economy and in consequence, prosperity, wealth, and economic growth for the country in the long-run. As a result, company law must incorporate a flexible mechanism within which companies are facilitated in achieving their objectives and at the same time the interests of the country’s economy are protected - whether this is translated as protection from outside competition or from internal mismanagement of companies.

To begin with, Professor Keay submits that one of the biggest problems of s.172 is the lack of enforcement by stakeholders of the company who are non-shareholders.1 It is suggested that this provision resembles s.309 of the Companies Act 1985 which was often characterised as a “lame duck”.2 It is suggested that shareholders will only bring a derivate claim3 on behalf of the company when their own self-interests - in their capacity as shareholders or in any other additional capacity - are harmed.4 It is extremely unlikely to find shareholders who are willing to bring such expensive, time-consuming and often exceptionally difficult to establish claims, in order to support an environmental or communal cause without having a personal interest. Consequently, it is reasonable to say that “a right without a remedy is worthless”5 and as a result, s.172 does not effectively take into account the interests of stakeholders.

Nonetheless, the above arguments do not necessarily lead to the conclusion that s.172 is in need of reform. Even if various stakeholders are unable to enforce their rights under this section, their interests are protected in many different ways. Firstly, s.417 requires directors to prepare a business review which its “purpose…is to inform members of the company and help them assess how the directors have performed their duty under section 172”.6 By evaluating and analysing their actions, directors would be obliged to take into account the provisions of s.172 as well as - why not - to think about the different roles of the various constituencies and their importance towards the long-term success of the company.7 In this way, as Lynch suggests, “the provisions of s.172 are unlikely to be ignored”. Furthermore, environmental, labour, and planning law, all can be used to protect and reinforce the rights of the company’s stakeholders.8 These can be supplemented by various other legal regulations and statutes, e.g. Human Rights Act 1998.

Moreover, it is argued that s.172 should adopt a pluralist approach and abandon the Enlightened Shareholder Value (ESV) concept which prioritises the shareholder interests. Stallworthy talks about the vitality of “wider stakeholder engagement” for a better sustainable future and “long-termist economic frameworks”9 which will benefit the society as whole. However, it is convincingly supported by Odenius, and I tend to agree with him, that a pluralist approach will lead to inefficiencies and greater burdens on directors which will ultimately fall on shareholders through increased “agency costs”;10 something which will completely destroy the core aims of company law. This argument is reinforced by the case of R. (on the application of People & Planet) v HM Treasury which supports that company law is not the right mechanism for promoting and protecting environmental and human rights issues.11 Additionally, the subjective test of good faith adopted by the section12 enhances this idea of rejecting a pluralist approach, by acknowledging that the internal management of the company and the decision-making process should be left to those who have the greatest knowledge, experience and awareness of the business sector. Courts have followed a non-interventionist approach which implies their acceptance of directors’ discretion as to what they should consider in making their managerial decisions.

In conclusion, company law has specific objectives, purposes and targets which will definitely be distorted if the government introduces reforms which will oblige directors to protect and promote the interests of the company’s different stakeholders. Therefore, by considering the role of UK companies and the competitive environment in which they operate, s.172 “establishes a happy medium between the extremes” and constitutes “a positive addition to decision making in the wider scheme of corporate governance”.13 In consequence, it is advised that according to the general UK company law framework, this section should not be reformed.

1Keay, “Section 172(1) of the Companies Act 2006: an interpretation and assessment” Comp. Law. 2007, 28(4), 106-110, p.6-7.
2Above fn.1, p.6.
3Section 260 Companies Act 2006.
4Above fn.1, p.7.
5McDaniel, “Bondholders and Stockholders” (1988) 13 Journal of Corporation Law 205, p.309.
6Section 417(2) Companies Act 2006.
7Lynch, “Section 172: a ground-breaking reform of director's duties, or the emperor's new clothes?” Comp. Law. 2012, 33(7), 196-203, p.6.
8Above fn.7, p.8 and see Schall, Miles and Goulding, “Promoting an Inclusive Approach on the Part of Directors: the UK and German positions” (2006) 6 J. Corp. L. Stud.299, 302.
9Stallworthy, “Sustainability, the environment and the role of UK corporations” I.C.C.L.R. 2006, 17(6), 155-165, p.10.
10Odenius, “Germany’s Corporate Governance Reforms: Has the System Become Flexible Enough?” (IMF Working Paper, 2008), p.4.
11Copp, “S.172 of the Companies Act 2006 fails people and planet?” Comp. Law. 2010, 31(12), 406-408.
12Keay, “Good faith and directors' duty to promote the success of their company” Comp. Law. 2011, 32(5), 138-143, p.3.
13Gopal, “A Critical Examination of the Impact of Section 172 of the Companies Act 2006”, (2012) The Student Journal of Law, Issue 4, p.4.
Gore-Browne on Companies

Gore-Browne on Companies

The pre-eminent source for interpreting and applying company legislation

More Info £1,393.00
Available in Company Law Online
Alcock, Birds and Gale on The Companies Act 2006

Alcock, Birds and Gale on The Companies Act 2006

Explains what stage the implementation process has now reached.

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