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Company Law Reform Bill [HL]

The starting point is to recognise what we are trying to do in this important clause. We will come back to other aspects of it in later amendments. The strength of the position of the noble Lord, Lord Freeman, is that the common law has traditionally talked about directors having a duty to act,"““bona fide in what they consider . . . is in the interests of the company””," and that is the formulation to which he wants to return. It is a formula that can be used but the Government did not prefer it because the main purpose in codifying the general duties of directors is to make what is expected of directors clearer and to make the law more accessible to them and to others. The problem is that the traditional formulation of that duty does not achieve that. To say that directors must exercise their powers in the interests of the company is to give very imprecise guidance about what the law requires. It might be churlish to note that some of the questions put to me by noble Lords indicate that that is one of the problems with the current formulation. The Company Law Review recommended that this clause should answer the question, ””In whose interests should companies be run?””, and the Government accepted its recommendation. That led to an important debate, to which we will return in later amendments. The Company Law Review considered and consulted on two main options. The first was ““enlightened shareholder value”” under which a director must first act in the way that he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members. I shall come back to the question asked by the noble Lord, Lord Freeman, about what is meant by ““success””. Secondly, in doing so, he or she must take account, where relevant and so far as reasonably practicable, of other factors such as the impact of the company’s activities on the community and the environment. That is where one gets to in Clause 156(3). The alternative approach was the pluralist approach, which is strongly supported by some people. Under it, directors would be required to serve a range of wider interests—employees, suppliers, local communities and the environment—not subordinate to, but as a means of achieving, shareholder value. As noble Lords will know, the Company Law Review came down firmly on the side of enlightened shareholder value. The Government agree that this is the right approach. It resolves any confusion in the minds of directors as to what the interests of the company are, and prevents any inclination to identify those interests with their own. It also prevents confusion between the interests of those who depend on the company and those of the members. The Government believe that the greater clarity in the formulation that has been used, rather than that suggested by the noble Lord, Lord Freeman, and the other noble Lords who have added their names to the amendment, will be of great benefit to directors and to their advisers. A company is an artificial legal entity. As such, it is hard to understand what the ““interests of the company”” are. An appeal to the ““interests of the company”” does not resolve the issue, unless it is first decided whether the company is to be equated with its members or with other interests. That is why the preferred approach was to adopt this formulation, which has to be understood with subsection (2), that the starting point is for the director to act in a way that he considers in good faith to be most likely to promote the success of the company for the benefit of its members. Subsection (2) goes on to recognise that there are companies that have purposes other than the benefit of their members. This was the point raised by the noble Lord, Lord Sharman. I can imagine a company that has been set up for charitable purposes. Its members are there to support the activities, but the company is not being run for their benefit, but for charitable purposes. Then the duty would be somewhat different: to act in a way that he considers in good faith to be most likely to achieve those purposes. That helps me to explain the answers to the questions put to me. First, what is success? The starting point is that it is essentially for the members of the company to define the objectives that they wish to achieve. Success means what the members collectively want the company to achieve. For a commercial company, success will usually mean long-term increase in value. For certain companies, such as charities and community interest companies, it will mean the attainment of the objectives for which the company has been established. But one can be more refined than that. A company’s constitution and the decisions that a company makes can also go on to be more specific about what is the appropriate success model for the company. I have indicated that usually for a company it will be a long-term increase in value, but I can imagine commercial companies that would have a different objective as to their success. Success can ultimately be determined only on a company-by-company basis, and it is impossible that it may change over time. The noble Lord asked, pertinently, who decides in those circumstances whether the success is taking place. We go back to the basic duty that it is for the directors, by reference to those things that we are talking about—the objectives of the company—to judge and to form a good faith judgment about what is to be regarded as success for the benefit of the members as a whole. It will be for the directors to determine; it is their good faith judgment that will matter, and they will need to look to the company’s constitution, shareholder decisions and anything else that they consider relevant in helping them to reach that judgment. What is meant by ““members as a whole””? The duty is to promote the success for the benefit of the members as a whole—that is, for the members as a collective body—not only to benefit the majority shareholders, or any particular shareholder or section of shareholders, still less the interests of directors who might happen to be shareholders themselves. That is an important statement of the way in which the directors need to look at this judgment that they have to make. The noble Lord, Lord Hodgson, asked how a company that tends to expand takes into account the different factors referred to in Clause 156(3). We shall come to some specifics in relation to the duty, but it is one that applies so far as is reasonably practicable. If, for example, the directors need to consider what the interests or needs of its future business relationship with suppliers will be. I am sorry, is that my phone making that noise? I think it is—I must turn it off.