American businessman Bert Lance is credited with popularising the phrase, ‘If it ain’t broke, don’t fix it.’ Lee served as director of the Office of Management and Budget under President Jimmy Carter. He would have scratched his head at Labour back-bencher Duncan Webb’s Companies (Directors Duties) Amendment Bill.
The Bill proposes an amendment to section 131 of the Companies Act 1993 dealing with the duty of directors to act in the best interests of the company.
The operative clause of the Bill reads “To avoid doubt, a director of a company may, when determining the best interests of the company, take into account recognised environmental, social and governance factors.” The factors listed include reducing adverse environmental impacts, fair and equitable employment practices, the Treaty of Waitangi, and so on.
Well-meaning though the Bill undoubtedly is, it is misguided. It is also harmful – though perhaps not as harmful as it might have been.
The Bill is misguided because there has never been any doubt under New Zealand law that, when considering the best interests of a company, directors are permitted to take account of factors that go beyond the interests of shareholders in maximising short-term profits.
It is true that the framework of the Companies Act means shareholders’ interests are paramount. Shareholders appoint directors. They can amend a company’s constitution, including its objectives. They can pass special resolutions controlling almost any aspect of a company’s affairs. And just as shareholders bring a company into existence, they can also bring it to an end by liquidation.
But to suggest shareholder primacy means directors must ignore issues like the environmental impact of their activities, treating employees reasonably, or recognising the other stakeholder interests listed in the Bill is just plain wrong.
You only need to imagine the consequences for a company’s profitability if, for example, it adopted unfair and inequitable employment practices. Try winning the war for talent – which is a precondition for any business’s long-term success – if you don’t treat employees well.
To the extent some directors might sometimes have been too short-sighted, in the 21st century few directors are likely to ignore concepts like ‘social licence to operate.’ Today, directors can be under no doubt that having regard for shareholders’ long-term interests requires a holistic approach.
And in case anyone thinks that this obvious business reality might conflict with decisions from the courts, the drafters of the Bill will not be able to point to a single New Zealand – or Commonwealth – case to the contrary.
Indeed, the courts have consistently held that they will not consider whether directors have put stakeholder interests ahead of profits when deciding the company’s best interests.
To be fair, the Bill does at least give a nod toward the argument that there is no gap in the law that needs filling. It does this by proposing changes that operate only ‘for the avoidance of doubt.’
But legally, there is no doubt. And that’s why the Bill is harmful. It leaves a future court in the invidious position of asking itself, “If there really was no doubt, why did Parliament think a law change was needed?”
The courts have enough difficulty interpreting the Companies Act 1993 without adding any more uncertainty.
And on the issue of uncertainty, the Bill’s reference to “the principles of the Treaty of Waitangi” as one of the factors directors can consider is particularly problematic. Important though the principles of the Treaty of Waitangi are – especially when it comes to the public law duties of the Crown – a future court will have little guidance on why they have been tucked into a Bill dealing with the private law obligations of company directors. And, therefore, what legal meaning they should be given. The reference to Treaty principles smacks of tokenism – or virtue signalling. And it will create legal uncertainty and consequently harm.
Yet, the Bill is not as bad as it could have been.
Recent calls overseas and in New Zealand (including in last year’s Institute of Directors, Stakeholder Governance discussion document) suggest the shareholder primacy model requires ‘reconsideration.’
Those calling for change would impose duties requiring directors to balance the interests of shareholders with the interests of other stakeholders.
But there are many reasons why this duties-to-multiple-stakeholders approach would be a mistake.
The immediate objection is that directors are managing the shareholders’ money. If shareholders’ interests cease to have primacy under New Zealand company law, why would any shareholder invest in a New Zealand company? Despite the success of the corporate model over several centuries, such a change would bring about its demise, as investors channelled their capital into alternative business models like partnerships and trading trusts – or simply took their capital to more investor-friendly jurisdictions.
But even aside from the economic consequences, the duties-to-multiple-stakeholders idea is legally incoherent.
Against what standard would directors balance the interests of shareholders, employees and wider society? What chance is there of the competing groups being satisfied with any board’s decision on the inevitable trade-offs? And, when challenged, how would a court adjudicate among competing claimants?
In the words of New Zealand’s leading company law expert, Professor Peter Watts QC, such an approach would create ‘a Pandora’s box of misery.’
The reality is that the current model of shareholder primacy does not need ‘fixing.’ Under it, directors are already able to take a broad view of what is in a company’s best interests.
Satisfying customers. Treating staff fairly. Repaying creditors. Meeting environmental obligations. Acting ethically. These are all interests the modern company – and its directors – must take into account. If they do not do so, they will quickly find their critical stakeholders jumping ship – including their customers, employees and even shareholders.
Are all companies perfect? Of course not. Some break the laws. Some exploit loopholes in the law. And some simply sail too close to the wind.
But the corporate model has contributed to an enormous flourishing in human prosperity since its invention two centuries ago.
The solution to bad corporate activity is not to throw out a model that is working well. It is better accountability through better law enforcement, better laws that close obvious loopholes, and effective shareholder and societal activism.
Parliament fiddles with fixing something that is not broken at society’s peril.
Roger Partridge is chair of the New Zealand Initiative. This column is based on his comments at the Institute of Directors’ Leadership Conference on Monday, 2 May 2022