Directors' duties and corporate purpose re-examined: should directors be obliged to prioritise people and planet?

The recent (so far, unsuccessful) action brought by activist environmental charity ClientEarth against the directors of Shell highlights concerns around whether boards of UK companies are taking sufficient account of the wider environmental and social impacts of their decision-making and activities. In this article, we look at some of the arguments for and against changing UK law on directors' duties, in the context of a constantly evolving backdrop.

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Why look at changing directors' duties?

We have recently witnessed a high-profile attempt to hold directors to account for their company's approach to climate change, in the form of a derivative action brought under the Companies Act 2006 (the "CA 2006"). In ClientEarth v Shell plc [2023] EWHC 1137 (Ch), non-profit organisation ClientEarth sought permission to continue a derivative claim based on allegations that the directors of Shell plc had breached their statutory duties in relation to their management of the company's climate change risk. In particular, ClientEarth alleged that there had been breaches of sections 172 (the duty to promote the success of the company for the benefit of its members) and 174 (the duty to exercise reasonable care, skill and diligence) of the CA 2006. The claim was dismissed at the initial stage and the Court found that there was no clear case that Shell’s directors had in fact breached their legal duties and, in any event, the demanding hurdles that a claimant must overcome in order to bring a claim of this nature were not passed.

A similar derivative action claim was brought in McGaughey v Universities Superannuation Scheme Limited last year. The claimants in this case sought to argue that the directors had failed to form an adequate plan to deal with the financial risks involved in investments in fossil fuels, to the detriment of the Scheme. Again, the High Court ultimately dismissed the claim, finding that the claimants were unable to make out that the Scheme had suffered a loss and, in any event, the claimants did not have standing to bring the claim. The case was appealed, with the hearing being held in June (it is not clear when judgment is expected). For more on McGaughey, see our client note.

These judgments prompt a fresh look at directors' statutory duties and corporate purpose at a time when the Better Business Act campaign and increasing shareholder activism are trying to achieve greater emphasis on wider stakeholder interests, climate change considerations and other issues in relation to environmental, governance and social (ESG) issues.

Is the current law deficient?

Many argue that changes to the statutory framework (in particular, section 172 of the CA 2006) are now necessary in order to drive a change in behaviour and expressly require directors to consider people and the planet in their decision-making, as considered in our note below. Others, however, may question whether a change to the legal default position is required, given that UK company law already requires directors to have regard to wide-ranging matters (which could include transition risks and other environmental and stakeholder impacts) to the extent these are considered to be financially material, and provides discretion for companies to put purpose at the heart of their business. It is increasingly recognised that companies (both public or private) taking their environmental and social responsibilities seriously are more likely to prosper in the long term, and the statutory regime in the UK, as it currently stands, offers no impediment to that. In fact, as we explore below, a growing number of companies in the UK are already taking full advantage of this.

Section 172 revisited

Many will already be familiar with section 172 of the CA 2006 which sets out a director's duty "to promote the success of the company for the benefit of its members¹ as a whole". In carrying out this duty, directors are required to "have regard to" the interests of other stakeholders when making decisions – section 172 itself requires directors to have regard to a non-exhaustive list of matters, including:

interests of the company's employees;
the need to foster business relationships with suppliers, customers and others; and
the impact of the company's operations on the community and environment.

There is, therefore, an existing and well-trodden path to the consideration of wider stakeholder interests, which is, in fact, required by the legislation. However, such additional considerations are instrumental – directors are required to take them into account if, and only to the extent that, those interests affect shareholder value. Serving those interests is not, in itself, the object of their decisions, which is to pursue the success of the company for the benefit of the shareholders – so-called “enlightened shareholder value”.

S.172 "enlightened shareholder value" – useful flex or an obstacle to prioritising people and planet?

As noted above, section 172 requires directors to take non-shareholder interests into account if, and to the extent that, those interests affect shareholder value. The list of non-shareholder interests is non-exhaustive and there is no prescribed order of priority as between those interests. For some, this flexibility is to be applauded - directors, who know the business and its strategy best, will be best placed to identify and consider relevant shareholder interests, giving weight to those considerations as they deem necessary, applying a materiality lens and consideration of impact on longer term value. In short, it promotes a more holistic approach to decision-making without being overly prescriptive. For others, however, the ultimate yardstick of promoting shareholder value serves as an obstacle to giving proper weight to wider stakeholder interests.

The section 172 statement

Although section 172 itself has been embedded in statute for a long time now, it has had renewed focus over recent years as a result of the "section 172 statement" which is required in all public companies' and other large companies'² strategic reports and on their website. This statement will include the issues which the directors considered relevant when making decisions and the main methods of engagement with stakeholders. Although there is no change to the underlying section 172 duty, it has therefore become even more important for companies to focus on the way their key decisions are made and the involvement of the right stakeholders.

The section 172 ability to change purpose

It is also worth noting that section 172 expressly allows for the possibility of the company's purpose consisting of or including a purpose other than the benefit of members – something that is often overlooked. Indeed, as we explain further below, B Corporations (as well as charitable companies) already take advantage of this.

Section 172 (2): "Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) [of section 172] has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes."

The case for change

The prominence and importance of ESG are clear – in recent years, "ESG" as a topic has moved rapidly up the agenda for many boards who increasingly recognise the business imperative of performing well on ESG in order to mitigate risk and seize opportunity. Moreover, as the world and communities at large battle against the climate crisis and work to tackle the many social injustices, there is a growing expectation that corporates should play their part, and inevitably that brings with it a focus on the decision-making powers of boards of directors. It is perhaps unsurprising that there is a growing call for a legal framework on directors' duties in the UK that will hold corporate leaders to account for promoting and protecting people and planet, rather than placing sole emphasis on shareholder value. Some argue that the law on directors' duties needs to go further in this regard and that the default position should be that directors are no longer required to put shareholder value above all else.

The Better Business Act

The British Academy's Future of the Corporation project recommends that UK company law should be changed to "emphasise duties of directors to determine and implement corporate purpose". In its report, the British Academy specifically highlights one important initiative: the campaign for a Better Business Act ("BBA"), which seeks to change section 172 of the CA 2006 to clarify that – as well as making profit for shareholders – companies must also operate in a manner that benefits wider society and the environment and reduces harms that the company creates, thus bringing wider societal and environmental considerations on a par with shareholder value.

Through the Better Business Act campaign, we are aiming to change the law to make sure every single company in the UK, whether big or small, puts balancing people, profit and planet at the heart of their purpose and the responsibilities of their directors" (Douglas Lamont, current CEO of Tony's Chocoloney and Campaign Co-Chair)

Although section 172 currently allows companies to have a different purpose, it could be argued that this does not go far enough and a change in the law to alter the default position in this way could be the necessary catalyst to focus directors' minds and help drive behavioural change.

B Corps – an example of working within existing parameters

There is much to be said in favour of the flexibility that the law already provides for shareholders to amend the default corporate purpose so that wider stakeholder interests and ESG issues are put on an equal footing with shareholder value, or even that they take priority. We must not overlook the fact that there are good examples of companies embracing the existing flexibility afforded by the law, with many already taking steps to address wider stakeholder interests and environmental and social issues through voluntary measures, such as to define their purpose more broadly than shareholder value alone and certification as a B Corporation.

What are B Corps?

B Corporations or "B Corps" as they are often referred to, are companies that have voluntarily committed to meeting "the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose". There are now over 1,300 certified B Corps in the UK, across 58 different industries³, indicating a real momentum in this movement. The criteria that a business must satisfy in order to be certified as a B Corp are set by B Lab and there is an ongoing vetting process once a company has obtained certification. Crucially, the company must change its constitution, using the flexibility inherent in Section 172, to confirm its commitment to (i) stakeholder interests; and (ii) having a material positive impact on society and the environment.

By incentivising companies to voluntarily address wider stakeholder interests and environmental and social issues, the law can encourage best practice without imposing additional regulatory burdens on businesses and their boards. Household names such as World of Books, Gousto, Innocent Drinks, The Body Shop and FatFace, to name but a few, have committed to give stakeholders equal billing with shareholders in their company's corporate purpose, while also getting a certification from B Lab to confirm that they deliver on that promise. UK law offers no impediment to that. B Corps therefore represent not only an ethical way forward as an organisation, but also a means of working within the existing parameters of English law to modify the default position, with checks and balances including in-built accountability and external vetting by B Lab.

The Shell judgment – a cautionary tale

The Shell and McGaughey judgments offer a cautionary tale for activist claimants who seek to intervene with directors' decision-making powers and their existing ability to consider business strategy and what is or isn't material within the parameters of the law. Assuming that they are complying with their duty under section 174 to exercise reasonable care, skill and diligence, directors will almost certainly be best placed to make the right strategic decisions for the company with the full context of relevance, materiality and impact and the two judgments are a good illustration of how the law should not interfere with their discretion in that regard.

In Shell in particular, the High Court emphasised the need for flexibility in the law to allow companies to adapt to changing circumstances and make informed decisions about how to address environmental and other issues affecting their business. As we have seen above, the current statutory duties provide this flexibility by requiring directors to act in the best interests of the company, which includes taking into account a range of different factors, including environmental and social issues. The High Court is essentially deferring to directors as being best placed to make decisions on company strategy, given their understanding of the full business context and material issues at play.

The wider picture

There are also a number of wider factors to take into account when weighing up the merits of a change in the law in this area.

Lessons from a listed company perspective

In the listed company arena, the UK Corporate Governance Code provides that the board should establish the company’s purpose (albeit that purpose in this context is not necessarily the same as purpose under section 172), values and strategy, and satisfy itself that these and its culture are aligned. All directors must act with integrity, lead by example and promote the desired culture. Under recently proposed changes to the Code, remuneration outcomes should be clearly aligned to a company's performance, purpose and values, expressly including ESG objectives. Linking financial reward to ESG performance is something that is already demonstrated by many listed companies and is arguably a more convincing way of driving a change in behaviour and influencing decision-making.

Other existing pressures

We must not forget either that, for listed companies and large private companies (and to an increasing degree, smaller private companies) existing social pressures, not to mention increased regulation around disclosure of environmental and social impacts will play a part in shaping directors' decision-making and their judgement as to what is in the best interests of their business as a whole (including customers, suppliers and other stakeholders).

Increased reporting requirements

Reporting requirements are increasing at a rapid pace with all public companies and large private companies and LLPs already having to include a section 172 statement in their strategic report and on their website, and large organisations⁴ now also having to make climate-related financial disclosures in line with the recommendations of the Task Force on Climate-related Financial Disclosures ("TCFD").

From the European perspective, the EU's Corporate Sustainability Reporting Directive ("CSRD") will bring into focus not only the interests of the direct stakeholders of a business, but also sustainability concerns and responsible corporate behaviour across global value chains. There is no escaping the fact that from here on in, the businesses that take their sustainability performance and impact on people and planet seriously are the ones that will prosper in the longer term.

Shareholder activism

For listed companies, shareholder activism is also increasing, which is in turn forcing directors to think about the way in which they are making decisions and to what extent they are engaging with stakeholders. Whilst there have been no major legislative changes that have influenced the activism landscape, there is a consensus that the UK will continue to be an attractive market for activists, fuelled by a number of factors such as a weak pound and a regulatory regime which affords shareholders with significant rights. An increasing number of companies have been receiving proposals to table climate change resolutions (called "say on climate" resolutions) at their AGMs, in particular within energy/natural resources companies and the financial services industry. With the increasing amount of disclosure on ESG-related matters globally, there has been a marked increase in "trojan horse" activism, with some activists pulling levers likely to garner support from non-financial investors who may have, for example, ESG concerns, alongside financial underperformance issues. A recent example of this is Third Point's engagement with Shell, lobbying for a restructuring of the group based on climate related concerns.

A word of caution from the EU

Perhaps there are also lessons to be learnt from the recent failure of EU legislators to agree on the regulation of directors' duties proposed in Corporate Sustainability Due Diligence Directive ("CS3D"). It had been proposed (among other things) that, in exercising their duty to act in the best interests of the company, directors subject to the jurisdiction of CS3D would have to consider, where relevant, impact on the environment, climate change and human rights, including in the short, medium and long term. However, the Council and the European Parliament recently adopted their negotiating position on this, proposing the removal of these provisions and signalling that we are unlikely to see such broadening of the scope of directors' duties in other European jurisdictions anytime soon. There is a danger of reducing the appeal and competitiveness of UK companies by increasing regulatory burden and creating restrictions not faced by foreign competitors.

Conclusion

Using the flexibility that is currently baked into our legal framework on directors' duties, companies can, where shareholders are willing, already drive better performance in the interests of wider stakeholder groups and put purpose at the heart of business without interfering with those levers and discretions that are essential to the effective management and operation of a business. Directors frequently make trade-offs in their decision-making (for example, a decision on whether to increase prices in order to improve employee salaries will benefit employees at the detriment of customers) but how would directors decide on such trade-offs if the default legal position required equal consideration of all stakeholders? To say that directors must keep everyone happy or risk being sued by all, would not be particularly helpful in the context of business decision-making. Crucially, the current law strives to achieve a suitable degree of discretion and flexibility whilst also prescribing an ultimate yardstick of maximising longer term shareholder value. There may, of course, be differing views on what that yardstick should be, but for many, longer term shareholder value maximisation is the object that provides most benefit to the economy as a whole, creating strong companies that can serve the needs of their stakeholders. For companies that want to re-set that yardstick (for example B Corps) there is already the option of changing the company's purpose to do so.

We would argue also that maintaining the status quo as regards the statutory position does not equate to "no change" – far from it. Even without change to section 172 itself, the guidance and expectations surrounding it are constantly evolving in light of factors such as increased reporting requirements, growing social pressures and stakeholder expectations and the broader political and economic context. All these factors already play a part in shaping a new outlook on corporate purpose and success without having to create unintended complexity through statutory changes to directors' duties.

The bigger picture: using the threat of litigation to change behaviour

To return to where we started, with the ClientEarth v Shell case, there will sometimes be a case for changing the law so that fear of litigation acts as an additional incentive for businesses to be "good corporate citizens" and to deter "bad behaviour". But to date, the UK Government has generally been fairly cautious in its approach on that front. For example, although it has made it easier for collective actions to be brought in relation to breaches of competition law, it has not extended this to other areas such as consumer protection or data protection, where similar claims could be brought. It is therefore questionable in our view whether a change in the law on directors' duties or the enforcement mechanics to make it easier to sue them in relation to alleged failures to take account of environmental or social issues would be consistent with the Government's cautious approach elsewhere. Without such change, however, there are many other pressures on directors to increase the focus on transition risks and other ESG factors and, as activists continue to drive the agenda and push for novel ways to hold companies to account, some might say there is already a significant fear of litigation influencing behaviour.

Footnotes

[1] In the context of a company limited by shares, "members" means shareholders.

[2] A "large" company for the purposes of the CA 2006 is one which exceeds the thresholds for a medium-sized company, i.e. if in the last financial year it has:

(i) turnover of £36m or more;
(ii) balance sheet total of £18m or more ; and
(iii) more than 250 employees.
Note that certain companies are automatically treated as large even if they do not meet the above size criteria – this includes (i) public companies and (ii) companies that are part of an ineligible group, for example where there is a traded company in the group.

[3 ] Data taken from the B Corporation UK website as at July 2023.

[4] A "large organisation" for these purposes catches:

UK companies that

have more than 500 employees; and
either (i) have transferable securities admitted to trading on a UK regulated market or (ii) are banking companies or insurance companies;

UK AIM companies with more than 500 employees;
other UK companies (public or private) which have (a) more than 500 employees; and (b) a turnover of more than £500m;
LLPs (other than traded or banking LLPs) which have (a) more than 500 employees; and (b) a turnover of more than £500m; and
traded or banking LLPs which have more than 500 employees.

Spotlight on better regulation

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