CSR in a company law
context
Legal duties of directors
•
Content of obligations
• Enforcement
Some relevant questions
Key question: Does the pursuit of
stakeholders’ interests clash with
managerial duties under company law?
• What are the legal duties of
managers/directors under company law?
• Whose interests do these duties protect?
• How are these managerial duties enforced?
Content of managerial duties
Two main managerial duties
Duty of Care - requires “some level of
attentiveness, some process for (and actual)
acquisition or possession of relevant information,
some reasoned deliberation in performing
services, and exercise of some conscious (but
virtually unrestricted) judgment about acceptable
levels of return per unit of risk or other measure of
enhancing stockholder well-being.”
Duty of Loyalty - no self-dealing (self-interest of
directors), treating all shareholder fairly
Legal formulations of duties
UK: “we do not accept that there is anything in the
present law of directors’ duties which requires them
to take an unduly narrow or short-term view of their
functions... There is nevertheless considerable
evidence that the effect of the law is not well
recognised and understood.” (UK Company Law Review Steering Group)
Pay attention to:
• Whose interests (shareholders, company itself,
stakeholders)
• Short-term v. long-term perspective
OECD
‘Board members should act on a fully informed basis, in
good faith, with due diligence and care, and in the best
interest of the company and the shareholders.’ (Principles
of Corporate Governance 2004, (since 2014 under review -> 2015))
“Generating economic profit so as to enhance shareholder
value in the long term, by competing effectively, is the
primary objective of corporations in market economies.
Corporate governance must acknowledge this objective
while simultaneously fulfilling broader economic, social
and other national objectives. This multiplicity of
functions is complex but necessary to the perpetuation of
the corporation and the market system.” (Millstein Report)
UK
“(1) 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, and in doing so have regard
(amongst other matters) to (a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
(c) the need to foster the company’s business relationships
with suppliers, customers and others,
(d) the impact of the company’s operations on the
community and the environment,
(e) the desirability of the company maintaining a reputation
for high standards of business conduct...” (Art. 172, Companies Act 2006)
US
Director to act “in a manner [the director] reasonably
believes to be in the best interests of the corporation.”
(Model Business Corporation Act ann. (1996) para. 8.30(a).)
Directors have a general duty to act with care and in the
best interests of the corporation and its stockholders.
(Delaware law)
“‘The best interests of the corporation’ are generally
understood to coincide with the best long-term
interests of the shareholders.” (US author)
Germany
Two-tier board system: management board (senior executives) and supervisory
board (appoints, supervises and advises MB; 1/3 -1/2 worker reps).
Pre-2010 version of Code
• Management Board “is responsible for independently managing the enterprise. In
doing so, it is obliged to act in the enterprise’s best interests and undertakes to increase
the sustainable value of the enterprise.”
• Supervisory Board: “The representatives elected by the shareholders and the
representatives of the employees are equally obliged to act in the enterprise’s best
interests.” (Corporate Governance Code)
2010 Code
• Management Board “is responsible for independently managing the enterprise in the
interest of the enterprise, thus taking into account the interests of the shareholders, its
employees and other stakeholders, with the objective of sustainable creation of value.”
• Supervisory Board: as in pre-2010 Code.
The Code ‘clarifies the obligation of the Management Board and the Supervisory
Board to ensure the continued existence of the enterprise and its sustainable
creation of value in conformity with the principles of the social market economy
(interest of the enterprise).’
German Corporate Governance Code (2010)
http://www.ecgi.org/codes/documents/cg_code_germany_may2010_en.pdf
France
“In his business relations with other partners… the
manager may undertake all managerial decisions in the
interest of the company.” (Article 13, the 1966 Company Law)
The interest of the company “May be understood as the
over-riding claim of the company considered as a
separate economic agent, pursuing its own objectives
which are distinct from those of shareholders,
employees, creditors including the internal revenue
authorities, suppliers and customers.” (Vienot Report I, 1995)
“The common interest of all of these persons… is for the
company to remain in business and prosper; is not the
sum of conflicting interests.” (Vienot Report I, 1995)
Conclusion: Interests promoted by CL
Company laws re. the interests of shareholders:
• Qualifies them with varying terms (‘collective’,
‘long-term’ or ‘common’ interests of
shareholders);
• Replaces them by the ‘interest of the company’;
• Refers explicitly to the interests of
stakeholders (employees, creditors including
the internal revenue authorities, suppliers and
customers, the community and the
environment, even the market system).
Enforcement of managerial duties
Judicial enforcement of …
1. Duty of Care
Weak judicial enforcement due to the ‘business
judgment rule’ (BJR) – managers have to be
grossly negligent, not merely ordinarily negligent
2. Duty of Loyalty
Strong judicial enforcement – self-dealing not
allowed
Ford Model T
http://en.wikipedia.org/wiki/Ford_Model_T
http://www.youtube.com/watch?v=0k7YXc8G8-s
Dodge v. Ford Motor Co (1919) (1)
Ford’s decision: Limit dividends to 5%, but for what reason?
Henry Ford: future dividends would be limited to five
percent monthly while the remaining profits would be
used for business expansion, and also “to employ
still more men, to spread the benefits of this
industrial system to the greatest possible number, to
help them build up their lives and their homes.”
Minority shareholders complain and go to court
Dodge v. Ford Motor Co (2)
Court: “There should be no confusion ... of the duties
which Mr. Ford conceives that he and the
stockholders owe to the general public and the duties
which in law he and his codirectors owe to protesting,
minority stockholders. A business corporation is
organized and carried on primarily for the profit of
the stockholders. The powers of the directors are to
be employed for that end.
The discretion of directors is to be exercised in the
choice of means to attain that end and does not
extend to a change in the end itself, to the
reduction of profits or to the nondistribution of
profits among stockholders in order to devote
them to other purposes.”
Dodge v. Ford Motor Co (3)
HOWEVER, Ford wins: the court applies the business
judgement rule (BJR):
“We are not, however, persuaded that we should interfere
with the proposed expansion of the business of the Ford
Motor Company. In view of the fact that the selling price
of products may be increased at any time, the ultimate
results of the larger business cannot be certainly estimated.
The judges are not business experts. It is recognized that
plans must often be made for a long future, for expected
competition, for a continuing as well as an immediately
profitable venture.”
Wrigley Field, Chicago
Shlensky v. Wrigley (1968) (1)
Wrigley’s decision: refused to schedule baseball games
at night (as all other baseball clubs were doing)
Minority shareholders complain of lost business
opportunities (reduced profitability), and go to court.
They claim:
Wrigley has refused to install lights, not because of
interest in the welfare of the corporation but because of
his personal opinions that baseball is a ‘daytime sport’
and that the installation of lights and night baseball games
will have a deteriorating effect upon the surrounding
neighborhood.
Shlensky v. Wrigley (1968) (2)
Complaint of minority shareholders:
Directors were acting for a reason or reasons
contrary and wholly unrelated to the business
interests of the corporation; such arbitrary and
capricious acts constitute mismanagement and
waste of corporate assets, and the directors
have been negligent in failing to exercise
reasonable care and prudence in the
management of the corporate affairs.
Shlensky v. Wrigley (3)
HOWEVER, Wrigley wins: the court applies the
business judgement rule (BJR):
‘By these thoughts we do not mean to say that we have
decided that the decision of the directors was a correct
one. That is beyond our jurisdiction and ability.
We are merely saying that the decision is one properly
before directors and the motives alleged in the amended
complaint showed no fraud, illegality or conflict of
interest in their making of that decision.’
Business judgement rule (BJR)
Standard of review ref duty of care: only when managers
were grossly negligent, not merely ordinarily negligent
Stated explicitly in laws (‘business judgment rule’ BJR)
Implicitly, a matter of judicial self-restraint
BJR: A special standard of culpability (greater fault than ordinary
negligence)
• gross negligence standard
• The process-versus-substance distinction: judicial review of the
process of decision-making is tighter than the review of the
decision arrived at through that process
(American Law Institute’s Principles of Corporate Governance)
Judicial enforcement of Duty of Care
Bottom-line: When minority shareholders challenge top
management with breach of duty of care in pursuing the
profitability of the company, Courts are unwilling to secondguess management
Why: ‘The institutional incompetence of courts to pass upon the
wisdom of business decisions.’ BJR ‘protects from substantive
review for wisdom.’
Rationale: in a risky business environment, managers should be able
to take risky business decisions without constant fear of lawsuits
affecting their professional judgment. Business executives will not
be held liable simply for a bad business decision.
However, while protected by BJR the ’board members to act on a
fully informed basis’ –> review of process of internal control (2004
OECD Principles of corporate governance)
Company Law & Managerial discretion
Bottom-line on CL - “Directors have
fiduciary responsibilities to shareholders
which, while allowing directors to give
consideration to the interests of others,
compel them to find some reasonable
relationship to the long-term interests of
shareholders when so doing.”
(American Bar Association’s Committee on Corporate Laws)
CL & the managerial duty of care
Bottom-line
CL protects – through the BJR – the discretion
of management against overbearing
shareholders (-> opening for CSR)
CL cannot force managers – through litigation –
to exercise CSR (-> pointless to try to modify duties
of managers under CL to promote CSR)
Corporate governance system
Protection of shareholders’ interests through:
• Managerial duties and litigation
• Powers and rights of shareholders under CL
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elect directors
amend the constitutive of the company
approve the distribution of dividends
approve external auditors
approve annual accounts
approve new share issues
– approve extraordinary transactions (mergers, take-overs).
Transparency laws – material information for shareholders to understand the
performance and prospects of the company
Capital markets – impersonal valuations of company performance (markets
elevate “exit” over “voice”: shareholders sell and invest elsewhere)
Institutional shareholders – large size -> no easy ‘exit’ from market -> engage
and pressure the management (‘voice’)
‘Market for corporate control’ – ‘hostile takeovers’ (new owners sack top
management), especially in the 1980s.
Key points from legal formulations
OECD: ‘Board members should act on a fully informed
basis, in good faith, with due diligence and care, and
in the best interest of the company and the
shareholders.’ (Principles of Corporate Governance 2004)
UK: “we do not accept that there is anything in the
present law of directors’ duties which requires them
to take an unduly narrow or short-term view of their
functions... There is nevertheless considerable
evidence that the effect of the law is not well
recognised and understood.” (UK Company Law Review Steering Group)