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Published: Fri, 02 Feb 2018

Examination of the ESV approach as a positive modern approach

The enactment of S. 172 of the Companies Act 2006 represents Parliamentary endorsement of the enlightened shareholder value approach (ESV) in corporate governance. The essay will begin with an examination of the ESV approach as a positive modern approach underpinning directors’ duties in company law.

Subsequently in considering whether S.172 is a positive development, this essay will argue that S.172 is merely a codification of the ESV approach with no substantive legal development. However, there is no substantive changes is needed so long as it is an accurate codification of the ESV approach. It will also be argued that the normative effect provided by S.172’s codification should be recognized as a positive development in company law.

The approach underpinning S. 172

Keay, (2007) examined the development of S. 172 and he noted that in the course of modernizing company law, Parliament wanted to introduce a broad duty to guide directors’ duties in corporate governance. In doing so, the Company Law Review Steering Group (CLRSG), the committee tasked with overseeing the review, had to consider an important issue: in whose interest should companies’ affairs be conducted?

Keay explained that the CLRSG had considered the shareholder value and the pluralist approach as an answer to the question. He mentioned that the CLRSG had stated in its report that the present law reflects the fact that the shareholder value approach, as exemplified in Dodge v Ford Motor Co, is still predominant in the United Kingdom.

On the other hand, the stakeholder interest required ‘directors to conduct the affairs of the company for the benefit of all stakeholders.’ In other words, this approach rejects shareholder primacy and directors must balance all interests when running the company.

Ultimately, the CLRSG’s Final Report proposed the ‘enlightened shareholder value’ approach which essentially incorporates the main aspects of the two approaches mentioned above: directors are to run the company for the benefit of shareholder collectively, but to adopt a more inclusive approach to other stakeholders when discharging this duty. The CLRSG felt that the ESV approach would ‘better achieve wealth generation and competitiveness for the benefit of all’ and should therefore be the underpinning approach to the new Company Law 2006.

The ESV approach as a positive modern approach to directors’ duties in corporate governance was accepted by Parliament and was subsequently spelt out by S. 172 CA 2006.

In fact, the ESV is not an novel concept and was previously articulated by Bowen LJ in Hutton v West Cork Railway: ‘The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company’.

The issue is, to what extent did the enactment of S. 172 contribute substantively to company law?

S.172 – extent of development in the law

S.172(1) – an encapsulation of ESV and the current law

S. 172(1) introduced to the law for the first time, a ‘duty’ on the directors through the use of the word ‘must’. This is a move from the common law ‘permission’ to an ‘obligation’ as noted by Davies, which ‘disabuse directors…of unduly narrow interpretations of the duty previously held’. However, this is where the substantive development ends.

The subjective element of this duty is retained through the phrase: ‘in the way he considers, in good faith’. This is similar to the common law articulation by Lord Greene MR in Re Smith and Fawcett Ltd where it was said that the directors must act ‘bona fide in what they consider – not what a court may consider- is in the interests of the company’ [306].

Jonathan Parker J applied this in Regentcrest Plc v Cohen where he said that ‘The duty imposed on the directors to act bona fide in the interests of the company is a subjective one…the question is whether the director honestly believed that his act or omission was in the interests of the company’ [120].

This is similar to the American ‘business judgment rule’ where business decisions of directors who discharged their duties in good faith are not reviewed.

In assessing a director’s ‘good faith’, Item Software (UK) Ltd v Fassihi illustrated the court’s use of objective measure to determine whether the director could reasonably have taken that decision in good faith. Keay, (2007) suggested that S. 170(3) and (4) permits the use of common law and equitable principles in the application of S.172. Thus, Item Software continues to be relevant.

Turning to the central test in S. 172(1), ‘would most likely promote the success of the company for the benefit of its members as a whole’, the focus here is that members’ interest should come first. A recent case of R. (on the application of People & Planet) v HM Treasury confirms that stakeholder interests are considered in subordination to members’ interests. This dismisses the argument made by Kong, (2010) that ‘stakeholder management’ has been introduced by the backdoor. Indeed, the ESV retains members’ primacy in order to ‘overcome problems of balancing conflicting interests’.

Further, ‘as a whole’ is also a mere codification of the common law principle found in Mills v Mills that directors should try to act fairly for the interests of both majority and minority shareholders.

S. 172(1) introduces the list of factors to be considered through the phrase, ‘and in doing so have regard (amongst other matters) to –‘. This tells us that it is a non-exhaustive and non-ranked list. This would accommodate non-listed interests such as that in Charterbridge Crp v Lloyds Bank where it was held that directors of the subsidiary can consider the interest of the group. However, the ‘non-exhaustive’ element does not add anything substantial but merely allows previous, present or future interests that are not listed to be introduced where applicable.

As discussed, S. 172(1) encapsulates the ESV approach and codifies the law without major changes.

S. 172(1) – The ‘List’

The ‘list’ in S. 172(1) contains the ‘pluralist’ element of the ESV approach by spelling out the various subordinate interests which directors should consider.

S. 172(1)(a) mentioned that directors should have a view on the long-term implications of their decisions. The phrase ‘short- term’, which was used in the original Bill was removed to emphasize the point that directors, particularly in public listed companies, should have regard to what is down the line even though they are under pressure to be concerned about short-term profits and share prices. This subsection allows directors to justify taking a decision, which has long –term benefits that may not be profitable in the short-term.

Employee’s interests are codified in S.172(1)(b), the seed of which can be found in the now repealed S.309 Companies Act 1985 and S. 46 Companies Act 1980. Davies argues that the predecessor, S.309 CA 1985, is likely to be an ESV approach given that employees have found it difficult to use the section offensively and it was meant to ‘dilute directors’ accountability to shareholders rather than to strengthen their accountability to employees’. This was illustrated in Re Welfab Engineers Ltd where directors were not liable for choosing the lower bidder who promised to keep the employees.

It is therefore submitted that S.172(1)(b) would have the same effect as S. 309 and consequentially do not add to nor worsen an employees’ legal position.

Furthermore, the interests under subsections (1)(c) to (f) do not really have any substantial effects given that they are either mere codification of existing laws, or just broad-brush statements of good corporate practices.

S.172(3) – A deliberate silence on creditor’s interest

One particular concern is the absence of creditors’ interest in the ‘list’ under S.172(2). However, S.172(3) mentioned that creditors interests are considered subject to any ‘enactment’ such as S.214 Insolvency Act 1986. This imports the post-insolvency legal position into S.172, but the main difficulty is at what point before insolvency should creditors’ interests be considered?

Keay, (2002) examines the various remedies available to creditors on insolvency but acknowledges that there is ‘no plain statement as to when the duty to consider creditors’ interest is triggered’[408]. Davies expresses a similar view that ‘it seems likely that the courts will continue to experiment with different formulation of the trigger point’.

It is submitted that it was not intended for S.172 to decide on that issue. Rather, through the use of ‘rule of law’, it is deliberately silent in order for case law to develop obligations in borderline cases where appropriate. In addition, the width of ‘to consider or act in the interests of’ affirms the flexibility given to judicial consideration.

The above analysis shows that these interests under S. 172(1) and (3) are not substantive additions to the law. Instead, it is a codification in order to provide guidance to directors in the conduct of the company.


Even if there is a development, whether it is substantially relevant will be determined by the effectiveness of the enforcement mechanism. Indeed, ‘a right without a remedy is worthless’.

Firstly, stakeholders do not have locus standi in S. 172. The proper claimant is the company and only members are able to bring an action under a derivative claim. In fact, S. 417(2) Companies Act 2006 states clearly that directors are only required to provide a business review in their report to ‘inform members…and help them assess how the directors have performed their duty under section 172.’

Secondly, it is difficult for shareholders to challenge a decision where the board insists was taken in ‘good faith’. Therefore, it seems that S.172 has given directors a ‘shield’ against the shareholders without conferring a ‘sword’ onto the other stakeholders. Since both shareholders and stakeholders will find it hard to enforce any duty introduced by S. 172, it is submitted that even if there is a substantive right introduced by ‘the list’, it is of little value. Nonetheless, this arrangement is a crucial element of the ESV because it gives the board sufficient room to consider other interests without compromising on shareholders primacy.

In light of the above, S.172 represents a minor substantive development in the law. However, should there be major changes? It is submitted that the ESV approach is a fine balance between various competing interests and if the pre-S.172 legal position already recognizes the ESV approach to a substantial extent, then S.172 should not introduce anything that may tilt this delicate balance.

Promoting the ESV

Perhaps, the biggest contribution the enactment has brought to company law is in terms of its normative effect on corporate governance. Kong, (2010) has argued that although S. 172 does not ‘in reality change director’s practice substantively’, it’s codification effect has the ‘aim of bringing about a change in director’s behaviour by educating directors and providing them with greater certainty regarding what the law requires’.

Furthermore, He argues that S. 172 gives guidance for companies seeking to engage in Corporate Social Responsibility by providing that ‘so long as management can justify why they have come to a particular decision based on those statutory criteria…they have integrated social and environmental concerns in their operations’

In addition, Fisher, (2009) commented that even though ‘S. 172 poses little threat to directors intent on maximizing profits…[it] provides a strong normative element which, coupled with other forms of stakeholder pressure and prevailing business climate, will encourage boards to consider an increasing range of interests’ (parenthesis added).

Indeed, while S. 172 represents no substantive development of the current law, it encapsulates fully the essence of ESV. One cannot deny the importance of making the law and it’s underpinning policy clear to directors, who may not have received legal training, in discharging their duties. Furthermore, statutory support removes fear of shareholders’ backlash from the boardroom atmosphere and facilitates the implementation of these standards. Therefore, S. 172 has made a significant contribution to company law by providing clarity, guidance and certainty.


The CLRSG and Parliament considers the ESV to be the right direction for company law. By accurately codifying the ESV, S.172 should similarly be seen as a positive development in company law. This article has argued that despite S.172 bringing little substantive legal development, change is only necessary insofar as it better reflect the balance struck by the ESV approach. Moreover, its normative effects of promoting the ESV policy underlying corporate governance also count as a major contribution to the company law regime. Thus, S.172 is considered a positive development in company law.

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