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Chapter Four - Directors' duties
A director ... of a corporation must exercise their powers and
discharge their duties with ... care and diligence.[142]
4.1
Term of reference (c) for this inquiry requires the committee
to consider 'the extent to which the current legal framework governing
directors' duties encourages or discourages them from having regard for the
interests of stakeholders other than shareholders'. In this chapter the committee
examines the duties currently imposed on directors by the Corporations Act 2001 (Corporations Act), and considers whether
those duties have any impact on corporate responsibility. Other social and
environmental laws require corporations to attend to key social and
environmental matters. Directors' duties as presently described already require
directors and corporations to observe these laws, however corporations are not
necessarily disclosing compliance. During the inquiry, submissions and
witnesses proposed several options for changes to directors' duties. The final
part of this chapter examines some of those proposals for change. The general
view of the committee is that a change to directors' duties is not the best way
to encourage corporate responsibility among Australian companies.
The current legislative framework
4.2
Subsection 180(1) of the Corporations Act 2001
sets out an objective standard for the performance of directors' duties in the
following terms:
A director or other officer of a corporation must exercise their
powers and discharge their duties with the degree of care and diligence that a
reasonable person would exercise if they:
- were a director or
officer of a corporation in the corporation's circumstances; and
- occupied the office
held by, and had the same responsibilities within the corporation as, the
director or other officer.
4.3
In ASIC v Adler, Santow
J of the NSW Supreme Court reviewed the
authorities and set out a number of principles which flow from this subsection.
Prominent among these are the following:
- Directors owe a duty of care and skill, but this
duty is not properly a fiduciary duty; and
- By becoming a director, a person implies that he
or she has the skills of a reasonably competent person in his or her category
of appointment and that he or she will act with reasonable care, diligence and
skill; and
- A director should take reasonable steps to place
themselves in a position to guide and monitor the management of the company.[143]
4.4
These provisions are sensible provisions which allow
investors to invest in a company on the understanding that the company
directors will manage the company in the interests of its shareholders. When a
shareholder invests in a company, they are in one sense investing in the
capacity of the directors and managers to operate the company. Consequently
they must have confidence that the directors are using their invested funds for
the benefit of the company, and not for other purposes. In his submission, Mr
Bill Beerworth
states:
Investors entrust their savings to corporate managers on the
implicit promise that they will be increased in value through a mixture of
earnings and capital gains.
All new capital raisings and every element of the securities
industry are predicated on this core investor promise. If investors did not
believe in this promise, they would invest elsewhere or they would not invest
at all. [144]
4.5
Section 181 of the Corporations
Act 2001 adds to this a requirement of good faith. It states:
- A director or
other officer of a corporation must exercise their power and discharge their
duties:
- in good faith in
the best interests of the corporation; and
- for a proper
purpose.
4.6
It should be noted that section 181 requires the duty
of good faith in the best interests of the corporation,
not in the best interests of the shareholders. These two will often be
contiguous. However, there are cases where directors acting in the best
interests of the corporation, will be acting in a manner contrary to the best
interests of at least some shareholders. For instance, if directors make a
decision which is in the long term interests of the company, benefiting long
term and future shareholders, but which results in a short term loss (and a
short term decline in share value for current shareholders), then this decision
will be in the interests of the company, but will be unwelcome news for
shareholders who have taken a short term, perhaps speculative position.
The business judgment rule
4.7
Subsection 180(2) of the Corporations Act 2001 sets out what is commonly known as the 'business
judgment rule'. The business judgment rule is essentially a process by which a
director may argue that they have met the duty of care and skill required of
them under subsection (1). A director can rely on the business judgment rule if
they set out, in relation to the judgment in question, that they:
- make the judgment
in good faith for a proper purpose; and
- do not have a
material personal interest in the subject matter of the judgment; and
- inform themselves
about the subject matter of the judgment to the extent they reasonably believe
to be appropriate; and
- rationally
believe that the judgment is in the best interests of the corporation.[145]
4.8
Again, it can be seen that paragraph (d) relates to the
best interests of the corporation, not the best interests of the shareholders.
4.9
In their submission, Freehills Lawyers commented on the
court's application of the business judgment rule as follows. Their focus was
particularly on corporate philanthropy
rather than corporate responsibility, but the analysis remains useful:
Courts are generally reluctant to interfere in matters that
involve the exercise of a commercial judgment, especially where a range of
decisions could have been made by a director in a particular circumstance. This
is likely to be the approach taken by a court if a reasonable corporate
donation was ever challenged in Australia.
Charitable donations by their nature often accrue intangible benefits to a
company, making the reward for the company difficult to measure. For example,
the result of philanthropy may be increased goodwill to the business, improved
reputation or a long-term shift in the well-being of the community where the
business operates. If a decision has been made to donate to a charity for these
reasons, courts will be cautious in second guessing the business decision of
the directors.[146]
4.10
On 7 April
2006, the Parliamentary Secretary to the Treasurer, the Hon Mr Chris
Pearce MP, released a consultation paper
entitled Corporate and Financial Services
Regulation Review. The consultation paper canvasses a possible extension to
the business judgment rule which would allow a general protection for
directors, excusing them from liability under the Corporations Act provided
they act:
- in a
bona fide manner;
- within
the scope of the corporation's business;
- reasonably
and incidentally to the corporation's business; and
- for the
corporation's benefit.[147]
Impact of the current legislative framework
4.11
One of the more significant items of contention before
the committee was the impact which the current directors' duties have on
corporate philanthropy and corporate responsibility. Various interpretations of
what the existing legal framework allows have been put forward, and these can
be classified into four groups, which the committee will describe as follows:
- the directors'
restrictive interpretation, under which directors claim that they are unable
to undertake activities based on corporate responsibility, because such activities
may not be directly 'in the best interests of the corporation';
-
the shareholders'
restrictive interpretation, which objects to corporations providing
philanthropic funds or acting with deliberate corporate responsibility, because
those funds could be invested in wealth generation (and thus returns to the
shareholders);
-
the short
term interests interpretation, which allows that investment in corporate
responsibility may be appropriate, but only if it can be justified on the basis
of annual return on investment (competing with other possible investments); and
-
the enlightened
self-interest interpretation, which holds that careful and appropriate
corporate responsibility is almost always in the interests of the corporation,
and thus falls well within the behaviours permitted to directors under current
duties.
Directors' restrictive
interpretation
4.12
The 'directors' restrictive interpretation' begins with
a fairly narrow view of what a company is, and applies to this a very narrow
view of what the directors' duties allow. For proponents of this view, a
corporation is an entity which exists purely for the purpose of profit
generation, by any lawful means. A corporation is not a participant in the
community, and has no obligations to the community which sustains it except
those prescribed by law (and in particular by contract law). Consequently, any 'corporate
responsibility' undertaken by these directors will either be incidental to
profit generation, or incidental to the discharge of other legal obligations.
4.13
The Chamber of Commerce and Industry of Western
Australia described this perspective (without endorsing it) in the following
terms:
Under this shareholder-oriented model ... no more is expected of
businesses than that they obey the rules as they go about their core function
of generating profits. [...] Positive advocates of the shareholder-oriented firm
assert that maximising profit within a framework of laws is both the most ethically
appropriate behaviour of business managers and the most socially desirable,
because it leads to the best economic and social outcomes. This view has been
stated by Milton Friedman,
who argued 40 years ago that “...there is one and only one social responsibility
of business – to use its resources and engage in activities designed to
increase its profits to long as it stays within the rules of the game.
The negative view of shareholder orientation presumes that
corporate ethics is an oxymoron. In this view nothing better than greed can be
expected of business operators and pursuit of owners' interests will be at the
expense of the wider community, so a system of laws and regulations is
necessary to force corporations to behave according to the community interest. An
oft-quoted observation from the 18th century British jurist Edward
Thurlow sums up this view summarising the
hopelessness of expecting unselfish behaviour from business: “Did you ever
expect a corporation to have a conscience, when it has no soul to be damned,
and no body to be kicked?[148]
4.14
An example of this approach in practice, commonly
referred to in evidence before the committee, was the decision of the James
Hardie Group to restructure its corporate affairs so as to quarantine itself
from liability for the health effects of its asbestos products. Such a decision
was clearly in the interests of the shareholders at the time it was made (as it
was calculated to assist them in avoiding significant financial liability) but
it was clearly contrary to the interests of external stakeholders: employees
and others affected by asbestos-related diseases as a result of their contact
with James Hardie
products. James Hardie
Chairwoman, Ms
Meredith Hellicar
has stated publicly that the company had taken a 'hard nosed' approach to its
responsibilities at least in part because of concern by the Directors that the
law required them to circumvent
liability if this was in the clear interests of the company. In the Australian Financial Review, Ms
Hellicar stated:
I think protection [for Directors seeking to act in the
interests of stakeholders other than shareholders] would be beneficial because
there is no doubt that the threat of a shareholder suit – even if we get
majority shareholder support – a minority shareholder can still say, we don't
agree, so some protection would help ... it certainly might make us feel more
comfortable.[149]
4.15
James Hardie
did not make a submission to the inquiry, and hence were not called as
witnesses. However during this inquiry the company's actions in restructuring
to avoid liability became the key example of corporations advancing the
interests of shareholders at all costs. The company's activities were discussed
on a number of occasions. One significant analysis was given by Professor Nowak
of the Governance and Corporate Social Responsibility Research Unit at the Curtin
Business School
who stated:
If you take Meredith Hellicar's argument that one of the things
that was in the minds of the directors was that they needed to do this
restructure to protect shareholder value as they saw it at that time, then I
think that gave them a rather lopsided view of the way in which they should be
making their decision. I would argue that that lopsided view needs to be
corrected.[150]
4.16
Another example raised during the inquiry was an issue
regarding Tasmanian vegetable growers who have been dramatically affected by a
series of 'ad hoc, unilateral' decisions by companies with major
purchasing power, to purchase their produce from overseas.[151] The growers cast the issue in terms
of corporate responsibility, as follows:
The 'boom and bust' cycles attached to much of Australia's
commodity based industries, such as vegetable processing, means that
decision-making based on short term cost competitiveness is not necessarily in
the long term interests of the industry sector, nor the regional communities
that support them. This is because the ultimate cost competitiveness of these
sectors is likely to be based on a range of pertinent long-term issues, beyond
immediate cost advantages: climate, soil, diversity in product line and
innovation in business models. This is an issue of sustainability, not
necessarily taken into account when decisions are made on short-term, cost
competitiveness.[152]
4.17
The committee agrees that the decisions of the companies
involved in this example were regrettable. They appear to be driven by a
restrictive interpretation of directors' duties and with a sole view to
maximising short-term profits with insufficient regard for the longer-term
implications for both the company or the surrounding communities. The companies
have suffered reputational damage as a result of their decisions, which have clearly
had a major impact on growers and their communities. The companies have also neglected
the concerns of local communities, which is both its customer base, and also a
potential future supplier of produce.
Committee view
4.18
The committee considers that directors who take this 'restrictive
interpretation' approach to the current law are misinterpreting the law. The
current directors' duties were intended to provide protection for shareholders,
not to create a safe harbour for corporate irresponsibility. However, the committee
also came to the view that this interpretation is relatively uncommon in
corporate Australia.
Most directors appear ready to accept that the current directors' duties allow
them some leeway for corporate responsibility and philanthropy. The question
for them is under what circumstances they should put corporate responsibility
ahead of immediate profit generation. The answer for each company will depend
on which of the final three interpretations discussed in this section are
adopted, and on the competitive pressures, strategic position and community
expectations of each individual company.
Shareholders' restrictive
interpretation
4.19
The shareholders' restrictive interpretation reaches a
similar position to the directors' restrictive interpretation, but via a
different route. Proponents of this position are usually shareholders or
shareholder advocates. Their view is that money invested in or generated by a
company is in fact the property of the shareholders. Consequently, instead of
the company investing in corporate responsibility or distributing corporate
philanthropy, the company should distribute its funds to shareholders, and
allow them to choose whether to
reinvest the money, use it for consumption, or apply it to philanthropic
causes. For the proponents of this view, then, any director who distributes
corporate philanthropy or who deliberately chooses corporate responsibility
over immediate profit, is acting outside the requirements of directors' duties.
4.20
The submission from Beerworth & Partners discussed
this position as follows:
Many shareholders to whom I speak are suspicious of corporate
philanthropy. Many take the strong view that, rather than play the corporate
Medici with funds that really belong to the shareholders, philanthropically
minded Chairmen and CEOs should distribute them as dividends so that each
shareholder can decide if she wishes to make the relevant donation.[153]
I have noticed at a number of AGMs that some shareholders
protest strongly against political or even significant charitable donations. The
Directors may have not only acted in what they regarded as good faith, in the
best interests of the corporation and for what they regarded as a proper
purpose, but different minds have different views on these subjects. I am not
at all confident that the extent under case law to which directors and officers
may take into account stakeholder interests other than of shareholders is clear
or easily discoverable.[154]
4.21
The committee notes that it remains open to
corporations and an option for resolving any dilemma directors may feel in
their particular circumstances, to put the Board policy to a shareholder vote
(for example on philanthropic spending).
Committee view
4.22
In the committee's view, this interpretation is supported
by a relatively small group of shareholders. Most shareholders are likely to
understand that investment in corporate responsibility is likely to result in
both short term and long term gains for the company, based on one of the two
interpretations considered below.
4.23
In addition, the committee observed the substantial and
growing group of investors who invest in 'ethical investment' structures,
taking a deliberate decision to invest their money in companies with an
appropriate ethical profile. These investors not only agree that directors
should pursue corporate responsibility, they demand it as a precondition for
their investment.
Short term interests interpretation
4.24
Directors who hold this interpretation have no
particular objection to investing in corporate responsibility, but such
investments must meet the same rigorous requirements as purely financial
investments. Various means can be used to measure the performance of
investments, but 'return-on-investment' is perhaps the most common.
4.25
Directors following this interpretation are usually
prepared to consider responsible investments, but only if they can meet the
required return-on-investment. So an exercise in corporate philanthropy will be
considered in terms of how much goodwill (and, consequently, what increase in
market share or sales) will be the result. It will not be measured in terms of how many underprivileged children are
fed, or how many young students get scholarships, or how many youth football
teams get jerseys. An investment in energy efficiency will be measured in terms
of cost savings from the energy bill, not in terms of the tonnes of greenhouse
gas emissions saved. An investment in workplace safety will be measured in
terms of reductions in insurance premiums, not in terms of worker injuries
saved.
4.26
An example of this form of interpretation can be found
in the submission of the BT Governance Advisory Service (BTGAS), which stated:
On energy efficiency, research repeatedly shows capital spending
on energy efficiency, such as whole-building upgrades, are sound financial
investments. A study conducted in the US
assessed the financial risk and return from fourteen whole-building energy
efficiency upgrade projects. The internal rate of return of the investment was
calculated using a ten year project lifetime and the investment risk was
measured as the variability in the expected investment return — the risk that
it would produce more or less than the expected return on investment. The
average return was more than 20%.[155]
Committee view
4.27
The committee is of the view that directors should not
be constrained only to activities which are profitable or capable of tangible
measurement. On the other hand, it is clear that there are still vast
improvements to be made in corporate responsibility in areas which do generate profits. Australian
companies, by pursuing increased water and energy efficiency, can decrease
waste and decrease costs (at the same time reducing the load on essential
social infrastructure). By increasing the availability of paid maternity leave,
they can increase their profitability by continuing to access the talents of
women who return to the workforce after having children. By contributing to
scholarships, for instance, the Australian mining sector has sought to
establish a steady stream of talented graduates who will ensure its continuing
profitability in years to come.
4.28
The committee also notes a practical difficulty with
this interpretation. In evidence Treasury officials noted that while the costs
of undertaking corporate responsibility are reasonably quantifiable, the
benefits, which are often intangibles such as improved reputation, are
difficult to measure. This may reduce the likelihood of corporate
responsibility activities being adopted because their benefits are
underestimated. This point is discussed further in chapter 8.
4.29
Almost any Australian company could find ways to
increase its profitability by looking for ways to increase its corporate
responsibility. While the committee does not consider that directors' duties
are limited to corporate
responsibility which turns a short term profit, the committee is strongly of
the view that Australian companies should at least seek to undertake those
investments in corporate responsibility which generate profit and competitive
advantage (while at the same time generating a wider community benefit).
'Shareholders first' interpretation
4.30
A further interpretation may be discerned, though it is
perhaps a variation on both the shareholders' restrictive interpretation and
the short term interests interpretation. Under this interpretation, there is no
particular objection to directors considering the interests of stakeholders
other than shareholders, but the interests of shareholders must be the clear
priority. Dr Forsyth
and his colleagues from the Department of Business Law and Taxation at Monash
University appear to take this
interpretation:
The basic legal position is quite straightforward: the duty of
directors to act in good faith and in the best interests of the company ...
requires directors to treat shareholders'
interests as paramount. The interests of employees, or other stakeholders, can be considered in performing these duties
– but only where this would be in the company's (ie the shareholders')
interests.[156]
Committee view
4.31
The committee considers that this interpretation, like
the shareholders' restrictive interpretation and the short term interests
interpretation, is too constrained. In addition, as noted above, the committee
does not agree that acting in the best interests of the corporation and acting in the best interests of the shareholders inevitably amounts to the
same thing. Consequently, the committee is not attracted to this
interpretation.
Enlightened self-interest
interpretation
4.32
The enlightened self-interest interpretation of
directors' duties acknowledges that investments in corporate responsibility and
corporate philanthropy can contribute to the long term viability of a company
even where they do not generate immediate profit. Under this interpretation
directors may consider and act upon the legitimate interests of stakeholders to
the extent that these interests are relevant to the corporation. Chapter 3 of
this report included discussion of the factors that drive corporate
responsibility, and some of these factors in particular clearly show how
corporate responsibility can be in the interests of companies (and therefore
well within the bounds of directors' duties). These driving factors demonstrate
how forward thinking directors, motivated by an enlightened approach to the
company's self-interest, can undertake activities which contribute to social
wellbeing and environmental protection, and which are clearly in the best
interests of the company from a commercial perspective. The key driving factors
to note are:
4.33
Community
license to operate: The concept of a 'community' or 'social' 'license to
operate' by companies was raised in several submissions. By effectively
engaging with the communities in which they operate, companies gain tacit
permission to continue in operation.
4.34
Reputational
factors: Enlightened self-interest takes into account reputational factors
well beyond mere community license to operate. Appropriate corporate
responsibility can lead to positive corporate reputations which can in
themselves have value for the company (particularly in terms of intangibles
such as goodwill).
4.35
Avoidance of
regulation: Corporate responsibility serves enlightened self-interest
because by taking voluntary action to improve corporate performance,
corporations may forestall regulatory measures to control their conduct.
4.36
Attraction and
retention of staff: A number of submitters and witnesses stated that an
enlightened approach to corporate responsibility assisted them in their efforts
to recruit and retain high quality staff, particularly in the currently-tight
skilled labour market.
4.37
Attraction of
investment from ethical investment funds: The growth of ethical investment
funds has been a key feature of the corporate responsibility environment in
recent years, both in Australia
and overseas. While these funds currently administer a relatively small
proportion of the market, evidence before the committee was that their size is
growing.[157]
Committee view
4.38
The committee has considered the various
interpretations of directors' duties given above. In the committee's view, the
restrictive interpretations overstate the impact of sections 180 and 181 of the
Corporations Act 2001. While some
directors have used these interpretations to defend irresponsible activities,
many other directors have led their companies towards increased corporate
responsibility, without facing the shareholder revolts imagined by those
holding a restrictive view.
4.39
The committee considers that the most appropriate
perspective for directors to take is that of enlightened self-interest. Corporations
and their directors should act in a socially and environmentally responsible
manner at least in part because such conduct is likely to lead to the long term
growth of their enterprise.
Options for legislative change
4.40
While the committee has stated above that in its
view there is nothing in the current legislation to inhibit directors from
taking account of stakeholders other than shareholders, the committee is still
open to consider the various proposals for reform which were given in
submissions and evidence. There were four
common proposals put forward. Those were as follows:
-
a directive view that the legislation in
its current form is far too weak and should be amended in order to make
corporate responsibility compulsory;
-
a permissive view that the legislation in
its current form probably allows for corporate responsibility but should be
clarified in order to provide directors with additional protection;
-
the status quo view that the legislation in
its current form is sufficient to allow enlightened self-interest to operate,
and need not be changed; and
-
the whole-of-law view suggesting that the
Corporations Act should not be looked at in isolation, as corporations are
regulated by many other pieces of state and Commonwealth legislation that cover
economic, social and environmental matters.
4.41
In
addition, the committee noted the interesting proposals that the Corporations
Act include an 'ethical judgment rule' or an additional replaceable rule. Each
of these will be dealt with in turn.
The directive view
4.42
A
number of submissions argued that the Corporations Act should direct
corporations, and in particular directors of corporations, and to take account
of the interest of stakeholders other than shareholders. For example, the
Department of Business Law and Taxation at Monash University stated:
The approach of mandating directors to take into account social,
environmental and other stakeholder interests is not a radical step, as
progressive corporations are already prepared to promote themselves as socially
responsible in accordance with various voluntary CSR strategies. However, the
absence of mandatory decision making criteria on these matters at the corporate
level often allows social and environmental considerations to either escape
notice, or be deliberately ignored. Arguments that shareholder interests are
threatened by new obligations of this kind may be largely illusory. The growth
of institutional shareholders and the likelihood that most shareholders will
have diverse holdings across many corporations and industry sectors (either
directly or through superannuation funds), means that there is now a much
greater commonality of interest between shareholders and the broader community.[158]
4.43
A
number of these submissions took as a model proposed British legislation entitled
the Company Law Reform Bill 2005. This Bill is an extensive reform of virtually all
aspects of corporate law in the United Kingdom. Part 10 Chapter 2 of the Bill sets out the proposed duties of Directors. Clause
156 sets out the duties relevant to this inquiry, and represents the UK government's attempt to balance duties to
shareholders with duties to other stakeholders. The provision states:
156 Duty to promote the success of the company
- 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.
- Where or to the extent that the purposes of the company consist of or include
purposes other than the benefit of its members, his duty is to act in the way
he considers, in good faith, would be most likely to achieve those purposes.
- In fulfilling the duty imposed by this section a director must (so far as
reasonably practicable) have regard to—
- the likely consequences of any decision in the long term,
- the interests of the company's employees,
- the need to foster the company's business relationships with suppliers,
customers and others,
- the impact of the company's operations on the community and the environment,
- the desirability of the company maintaining a reputation for high standards of
business conduct, and
- the need to act fairly as between members of the company.[159]
4.44
Several
submissions noted that this bill represents an attempt to codify and make
compulsory the 'enlightened self interest' approach discussed above. This
approach was endorsed by the Australian Network of Environmental Defenders'
Offices:
It should be noted that the language of the Bill
is prescriptive not merely permissive, and in effect, it would amend directors'
duties to enable an enlightened shareholder value approach to decision-making.
The introduction of similar legislation in Australia
should be actively considered as it would address several of the concerns
raised in this submission regarding the inadequate manner in which
organisational decision-makers currently take into account non-shareholder
interests.[160]
4.45
Some
submissions however, felt that merely endorsing enlightened self interest did
not go far enough. The Australian Conservation Foundation stated:
The difficulty with this bill is that it treats the interests of
corporate constituencies as means to the end of shareholder profits, rather
than legitimate interests in themselves. In effect, the bill provides no
greater consideration for communities or the environment, and no safe harbour
for directors, beyond that contained in a simple unadorned statement of
shareholder profit maximisation.[161]
Committee view
4.46
The committee
does not support the British approach, which appears to introduce great
uncertainty into the legal expression of directors' duties. For instance, there
is no way to forecast those circumstances under which a court might decide that
a company's purposes 'consisted of or included purposes other than the benefit
of its members.' And what might a court determine those purposes to be? Until
such a determination was made with respect to a particular company, directors
may not even be sufficiently equipped with basic knowledge about those to whom
they owed a duty. Subclause (3) requires directors to have regard to a menu of
non-shareholder interests, but gives no guidance as to what form this 'regard'
should take, and therefore gives no guidance to directors on what they must do
in order to comply.
4.47
As a matter of general principle, the committee
considers that a law which imposes duties should give those upon whom the duty
is imposed clear guidance as to whom the duty is owed, and how it is to be
discharged. A law which does not is bad law, and at the very least magnifies
the uncertainties faced by directors.
4.48
Furthermore, it has been noted in relation to many
different legislative schemes that directive legislation breeds a culture of
compliance. Within corporations, once legislation is imposed, it is likely that
compliance managers will take the lead and that the corporation's response will
be driven by a those compliance managers' desire to meet the requirements of
the legislation. Such activity is unlikely to satisfy those who advocate on
behalf of social or environmental causes, leading to inevitable calls for
legislation to become more stringent, prosecutors to become more aggressive,
and penalties to become more severe. Chartered Secretaries Australia (CSA), for
instance, stated:
CSA also believes that
performance pressures will encourage companies to have regard for the interests
of stakeholders other than shareholders and that this does not need to be
legislated. Indeed, if it were to be mandated, having regard for stakeholder
interests other than shareholders would likely become a compliance-driven,
box-ticking exercise, rather than an innovative, value-creating opportunity to
improve performance.[162]
4.49
For the
reasons expressed above, the committee is opposed to directive provisions in
the Corporations Act.
A permissive provision
4.50
One
approach in use overseas, particularly in the United States, is a permissive provision to make it clear
that directors are entitled to make decisions which reflect the interests of
stakeholders other than shareholders. The argument in this case, essentially,
is that directors (following the directors restrictive interpretation) have
been unnecessarily timid in approaching corporate responsibility, concerned
that where efforts to improve corporate responsibility result in diminished
short-term performance, there will be a backlash from shareholders or from the
stock market. Mr Kerr set out one view of the United States experience:
Some commentators feel that U.S.
constituency statutes are “red herrings” and have done little to advance the
interests of non-shareholders under U.S.
corporate law. While these statutes represent a statutory variation of the
directors' duty to act in the best interests of the company, the laws do not
oblige directors to act in a socially responsible fashion. Of the 32 constituency
statutes in place, all but one are permissive in nature. In other words, the
directors may take the interests of non-shareholders into account, but are not
obliged to do so. As a consequence, constituency groups do not have enforceable
rights should their interests be ignored.[163]
4.51
This
approach had limited support from witnesses and submitters before this inquiry.
Some, such as the Department of Business Law and Taxation from Monash University, were prepared to support a permissive
provision as a less preferred option, but most stakeholders, from both sides of
the debate, saw it as a poor alternative.
4.52
Some submitters
saw a permissive provision as an easy way out, unlikely to result in increased
corporate responsibility. The Public Interest Law Clearing House stated:
Such an approach [a permissive provision] is, however, likely to
be deficient for two key reasons.
First, experience suggests that compliance with voluntary or
permissive legislation or codes of conduct is likely to be limited,
particularly where compliance may occasion some form of financial detriment
(regardless of social or environmental outcomes) and among reticent
corporations. Permissive legislation tends to work best for already
well-intentioned actors.
Second, where a director may be permitted, but is not required,
to consider the interests of a stakeholder other than a shareholder, it is
unclear whether, how and by whom such consideration could be assured or
enforced.[164]
4.53
Other
submitters were concerned that a permissive provision may end up as a de facto mandatory provision. Mr Mnchenberg from the Business Council of
Australia noted in evidence that:
A large part of our
concern is that ... [courts] assume, perhaps from naivety, that the parliament
does not do things without good reason. They infer what those reasons might be.
[...]They then construct interpretation around what that may mean. The thing that
worries us is that we do not know what bizarre circumstances may one day arise
about which a court has to take regard to this provision. Were we solving a
particular key problem we may be prepared to take the risk, but, if there is no
major problem, why take the risk?[165]
4.54
Mr Mnchenberg
then agreed with Senator Brandis' proposition that 'there are some Federal
Court judges who ... say may means ought'.[166]
Committee view
4.55
The
committee is concerned that such a permissive provision may in effect amount to
shifting the goalposts rather than dealing with the problem. Directors who
currently feel constrained by the Corporations Act may, after the enactment of
such a provision, find themselves constrained instead by whatever definition of
corporate responsibility is built into the Act. If a history had emerged of
court judgments taking a narrow view of directors' duties, interpreting the law
in such a way as to suggest that corporate responsibility did involve risk to
directors, then the committee would consider a permissive provision. In the
current inquiry, no submitter has been able to point to court judgments which
suggested a judicial misinterpretation of current provisions. Under such
circumstances, and given the clear lack of support from all parties, a permissive
provision appears to be unjustified.
Arguments favouring the status quo
4.56
A
substantial number of submissions argued that the current legislative scheme is
not the problem: that it is sufficiently open to allow companies to pursue a
strategy of corporate responsibility, and that many corporations are actively
doing so. The Group of 100, for instance, argued that:
...mandating change is unnecessary in view of the current
Corporations Law and other requirements. In many of these areas, as evidenced
in the Business Council of Australia findings, the imperative is to remove
regulatory duplication and contradictions rather than to impose another layer
of requirements which may inhibit progressive behaviour on the part of
companies and directors. The best encouragement for entities is to create an
environment in which experimentation with reporting in this evolving area is
able to flourish. In a competitive environment the priorities and reporting of
leading companies will induce improved reporting by other companies in response
to changes in community expectations. This is unlikely to occur under a
mandatory regime.[167]
4.57
ASIC expressed the view that to change the law in
relation to directors' duties would create problems for ASIC in effectively
performing its role as the enforcement regulator:
...as an enforcement regulator on the one hand and a disclosure
regulator on the hand we can see great problems in opening up very well settled
law as to what the duties of directors are. If it were felt absolutely
necessary by the government—and this is a government decision—to have some
change to the system, we would prefer a tightly focused disclosure solution
rather than opening up the whole question of directors' duties. The upset to
the business of actually changing the law would be too great: 'What are we
supposed to do? Who are these stakeholders? How to we rank the priority of one
stakeholder against the other?' There would be all those questions. We see
problems there. With our enforcement hats on, we see that if we are not careful
that might build areas into which directors who had done something wrong could
go and sit and say, 'Actually, the reason we did this was because of these new
stakeholder rules.'[168]
Committee view
4.58
The committee
is of the view that no compelling case for change has been presented during this
inquiry. Directors' duties as they currently stand have a focus on increasing
shareholder value. This is important, because the provision is first and
foremost intended to protect those investors who trust company directors with
their savings and other investment funds. Directors' duties enable such
investors to have some confidence that their funds will be used to in order to
increase the income and value of the company they part-own.
4.59
In many
cases, it will be clear that corporate responsibility enhances shareholder
value. At the very least, it is clear that rampant corporate irresponsibility
certainly decreases shareholder value. Public allegations that the James Hardie
Group had demonstrated corporate irresponsibility had dramatic and public
consequences for the company over the past year. The more recent alleged irresponsibility
of AWB Ltd has led to the resignation of its managing director and the
commencement of a commission of inquiry under the Royal Commissions Act. Progressive,
innovative directors, in seeking to add value for their shareholders, will
engage with and take account of the interests of stakeholders other than
shareholders.
Other legislation
4.60
Term of
reference (d) for this inquiry specifically asks the committee to have regard
to obligations that exist in laws other than Corporations Act. A number of
submissions to the inquiry made the point that modern corporations are in fact
bound by any number of statutes and regulations, arising from Commonwealth,
state and territory laws. Environmental law, in particular, has been the scene
of much activity in recent years. Simply in order to stay in business,
corporations are required by various laws to take account of their
environmental and social impacts. For instance, they are required to seek
environmental approval before proceeding with certain projects, they are held
to account for their pollution, and they are required to meet guidelines of
safety for communities and for the workforce. In evidence, officers from
Chartered Secretaries Australia stated:
It is our view that a
legislative and regulatory framework relating to the individual components of
corporate responsibility is already in place. This body of existing federal and
state law covers the environment, financial services, human rights, equal
opportunity, industrial relations and occupational health and safety et cetera.
Much of this legislation requires directors and other officers to take account
of interests other than shareholders'.[169]
4.61
Several submitters recognised the legitimate role for governments
to regulate in certain areas of corporate performance. For instance
GlaxoSmithKline stated:
Few would seriously question the role of government in
regulating some aspects of business behaviour. Competition and consumer laws
are essential to combat unscrupulous conduct and protect more vulnerable
members of the community. Securities and investment laws are necessary to
maintain confidence in a functioning business sector. Workplace relations and
occupational health and safety laws are vital to address imbalances of power
between employees and their employers. And environmental regulations have
proven an effective mechanism for combating market externalities.[170]
Committee view
4.62
In the
committee's view, this network of legislation shows that the social and
environmental performance of corporations is already regulated in a number of
areas. The existence of such substantial and specific legislation provides
further argument against the need for any amendment of Corporations Act.
An ethical judgment rule
4.63
The St
James Ethics Centre proposed an 'ethical judgment rule' which could be included
in the Corporations Act and which would have similar status to the business
judgment rule currently used to assess the performance of directors. The proposal
was put in this form:
we would recommend an
amendment to the Corporations Act, similar to the provisions relating to the 'business
judgement rule', allowing company directors to make decisions based on bona
fide ethical considerations (including but not limited to the interests of
stakeholders other than shareholders) – and protecting them from liability for
doing so when a reasonable person would judge those considerations to be well
founded. This protection should be afforded in all cases – including when the decision
may have some detrimental effect on the financial interests of the company as a
whole, its shareholders or some group of them. As such, directors relying on
the 'ethical judgement rule' as a defence, would be required to produce
documents demonstrating the quality of the reasoning employed in reaching their
decision. Courts would only be entitled to review the substance of any decision
if the quality of the decision-making process was first found to be inadequate.[171]
4.64
The
committee does not support this proposal. However it was one of the most
innovative and interesting proposals for legislative change put forward during
this inquiry. Consequently, the committee wishes to be clear about its reasons
for not supporting such a role.
4.65
First
and foremost, as noted above, the need for an amendment to the Corporations Act
has yet to be shown. Before considering the value of amendment such as an
ethical judgment rule, the committee would need to be convinced that any amendment
to the Act was required. In the committee's view, the Act in its current form
is sufficient.
4.66
Second,
the committee is concerned that an ethical judgment rule, rather than enabling
decision-making based on court responsibility, would become a defence against
allegations that the business judgment rule had been broached. Directors
accused of failing to exercise proper business judgment might instead point to
the ethical judgment rule as a justification for their actions. The committee
notes the view put in evidence by Dr Longstaff that this objection is not insurmountable:
It is possible to
develop principles. I would be happy to rely on the fact that, if somebody was
just trying it on and saying, 'We made a hopeless decision but we are going to
pretend it was an ethical decision,' they would be exposed. One of the things
you would want to do is ensure that they were not retrospectively trying to
justify it. If such a provision was introduced into law to afford this kind of
protection, it would have to be for decisions made at the time, where you could
see the process of decision making going on as the decision was being made, and
not something which is introduced after the event.[172]
4.67
The committee notes that there is an argument that with
the various corporate governance rules that already apply to corporations, the
business judgement rule already requires (implicitly at least) an ethical
judgement.
4.68
However,
ultimately, the committee remains concerned that in an appropriate court case,
even as a defence of last resort, the ethical judgment would be called upon by
directors who had failed in their duties.
A replaceable rule
4.69
The Corporations Act 2001 contains a series
of provisions (listed in tabular form in section 141) which are known as replaceable rules. Under subsection
135(2) of the Act, a replaceable rule has effect on a company as though it were
part of the company's constitution. However the rule 'can be displaced or
modified by a company's constitution.'[173]
In other words, the replaceable rule provides a default provision, but any
company may, by resolution, opt out of the rule. CSA initially proposed a
replaceable rule to cover corporate responsibility:
A clause can be
included in a company's constitution permitting directors to take account of
the interests of stakeholders other than shareholders, for example, 'for any
purpose that the board sees fit'. CSA believes there is merit in the Corporations
Act including such a provision as a replaceable rule. Shareholders would
decide whether they wanted it, or a revised version of it, as an object in the
constitution.[174]
4.70
This
idea has some initial appeal, because it would make a subtle but profound
change to the dynamics of decision making on corporate responsibility. Corporate
responsibility proponents would no longer be required to try to convince
companies to take greater account of stakeholders other than shareholders;
rather, any corporation which so wished could make a deliberate decision to
exclude such considerations. The reputational implications of doing so may, of
course, be significant.
4.71
Perhaps
for this reason CSA moved, in oral evidence, towards recanting its support for
a replaceable rule:
I think it is important
for the record that technically we are not calling for this. I think that is an
important point to make. We definitely have included it in our submission—and
we chose our words carefully—as a notion that has some merit. But we are firmly
of the view that the Corporations Act is adequate. We are not calling for an
enabling section or anything like that. In honesty, I guess that if we were
pressed then this would be something that we think has merit [...]For the record,
we are not calling for it.[175]
4.72
Other
witnesses expressed reservations about a replaceable rule. A witness from the
Australian Institute of Company Directors stated:
I would say to somebody
who came to me, 'Are you in fact, by another route, trying to limit your
directors rather than making them more free?' At the end of the day, I think
that is what that does.[176]
4.73
Mr Honan from the Group of 100 brought consideration of a replaceable rule back
to the concept of enlightened self-interest:
I do not believe that
is necessary, because the directors need to act in the best interests of the
company and, if they ignore the interests of the community or other
stakeholders, they are not acting in the best interests of the company.[177]
4.74
Professor Redmond raised perhaps the most cogent argument against a replaceable rule when
he noted that such a rule would effectively give shareholders the right to
withdraw from directors the capacity to consider stakeholders other than
shareholders. Where a company's shareholders have removed the replaceable rule,
it seems to follow that directors would consider themselves under instructions
to refrain from considering the interests of other stakeholders. Professor Redmond stated:
This is not a matter of
shareholder autonomy; this is a matter in which I think you are legitimately
protecting directors against shareholders to a certain extent. You are enabling
them to give effect to either ethical considerations or their own sense of
where the company's long-term benefit lies, against all the market pressures of
short-term impacts. I think there is a public interest in granting that licence
and doing it in a way that does not allow shareholders the autonomy of
withdrawing it.[178]
Committee view
4.75
The committee
remains of the view that a replaceable rule is an interesting approach to the
issue of corporate responsibility. In view of the Chartered Secretaries'
clarification of their position, and the rebuttals expressed by other
witnesses, the committee does not recommend that a replaceable rule be
implemented.
Conclusions
4.76
The committee
considers that an interpretation of the current legislation based on
enlightened self-interest is the best way forward for Australian corporations. There
is nothing in the current legislation which genuinely constrains directors who
wish to contribute to the long term development of their corporations by taking
account of the interests of stakeholders other than shareholders. An effective director
will realise that the wellbeing of the corporation comes from strategic
interaction with outside stakeholders in order to attract the advantages
described earlier in this chapter.
4.77
The committee
considers that more corporations, and more directors, should focus their
attention on stakeholder engagement and corporate responsibility. However it is
clear from this chapter that any hesitation on the part of corporate Australia does not arise from legal constraints found
in the Corporations Act. As the problem is not legislative in nature, the
solution is unlikely to be legislative in nature. Elsewhere in this report, the
committee gives long consideration to other, non-legislative ways in which
Government might encourage greater corporate responsibility. However, the
conclusion of this chapter is that amendment to the Corporations Act, and in
particular to the provisions setting out directors' duties, is not required.
Recommendation 1
4.78
The committee finds that the Corporations Act 2001 permits directors to have regard for the
interests of stakeholders other than shareholders, and recommends that
amendment to the directors' duties provisions within the Corporations Act is
not required.
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