COVID-19 has not only resulted in a major decline in economic activity as large parts of society began to enter lockdowns, but has also caused companies to focus on making challenging decisions about how to best allocate financial resources during the crisis. Many companies have been concerned about the effect of the pandemic on their workforce, suppliers and customers. Many have offered financial support for their customers, creditors and employees through measures such as shortening payment of invoices to provide cashflow or making financial accommodations on debt outstanding. Some companies have also decided to reduce or defer dividends and other capital returns to shareholders.
These measures raise the question of whether such decisions may be criticised as overriding the interests of shareholders — particularly decreasing short-term returns to shareholders — in favour of other stakeholders, and whether this will raise any liability concerns for directors of boards.
The duties of directors to act in good faith and in the best interests of the company under Australian corporate law are similar to those in other comparable common law countries such as Canada, Hong Kong, New Zealand, Singapore, the United Kingdom and the United States. Case law decisions demonstrate that directors have considerable discretion under the law when exercising managerial power. This discretion is not constrained to purely act in the short-term interests of shareholders, nor are directors legally required to make shareholder interests paramount (the so-called “shareholder primacy norm”). The determination of what interests are relevant to promoting the success of the company, and how those are to be balanced, is to be made by the directors and not by the courts reviewing good faith business decisions.
What does this mean in Australia?
The best interests duty is found in s181(1)(a) of the Corporations Act 2001 (Cth). The statutory duty operates in parallel with the general law duty.
The courts have adopted a variety of formulations over the years:
- “Bona fide in the interests of the company”
- “For the benefit of the company”
- “For the best interests of the company”
- For “the company as a whole”.
The courts have clearly and repeatedly stated that the determination of what lies within the company’s best interests is a matter for the board. It is not for the courts to determine where the best interests of the company lie.
While the courts have recognised that “directors must act in the interests of the company as a whole and that this will usually require those persons to have close regard to how their actions will affect shareholders”, there is also case law that supports the “general principle that a director’s fiduciary duties are owed to the company and not to shareholders”.
This is consistent with the general principle that the board has management discretion and shareholders cannot usurp that by directing the board by a majority resolution.
In summary, directors are not required to focus only on shareholder returns when discharging their duties and making decisions in the best interests of the company. It is not a breach of directors’ duties to exercise management power to consider the interests
of employees, customers and creditors, even where the current shareholders might have different views.
United Kingdom In the UK, the best interests duties of company directors are stated in s172(1) of the Companies Act 2006 (UK). That section requires the directors to act to promote the interests of the company, and in so doing to have regard to a variety of stakeholder interests (such as employees, creditors and customers).
The requirement to promote the best interests of the company is stated to be “for the benefit of its members as a whole”, but the decision as to how to balance these stakeholder interests is left to the board to determine.
New Zealand The best interests duty is found in s131 of the Companies Act 1993 (NZ).
New Zealand company law requires directors to act in what they consider to be the best interests of the company. As to how the stakeholder interests should be balanced, this is left to the board to determine so long as it is focused on benefiting the company and not acting under a conflict of interest.
Singapore In Singapore, the duties of company directors are stated in broad terms in s157(1) of the Companies Act 1967 (SG). Singaporean company law does not require that directors only act in the interests of shareholders, or that the interests of the company be equated only with the interests of shareholders.
Hong Kong The best interests duty in Hong Kong is derived from the general law and remains uncodified. Hong Kong courts have largely followed UK law on this duty, so that the duty is subjectively assessed on what the directors believe is in the best interests and not merely what the court may believe is in the best interests.
Canada The best interests duty is found in the Canada Business Corporations Act 1985 (Can) s122(1)(a) and in the Business Corporations Act 1990 (Ont) s134(1)(a).
Both of these provisions state the duty as requiring directors to “act honestly and in good faith with a view to the best interests of the corporation”. The federal statute was recently amended to allow directors to take into account broader constituencies (including employees, retirees, pensioners , creditors, consumers and governments) — s122(1.1) — but these are merely permissive and not mandatory. This change was introduced to codify the recognition that Canadian courts have shown over many years in allowing directors the flexibility to balance the interests of different stakeholders.
United States Corporate law in the US differs from state to state, although Delaware is the most influential corporate law jurisdiction. Many states have adopted some or all of the American Bar Association’s Model Business Corporation Law (MBCL). The MBCL requires “directors to act in good faith and in a manner the director reasonably believes to be in the best interests of the corporation”.
In Delaware, the Delaware General Corporate Law does not provide a detailed
code on directors’ duties, but the courts have strongly endorsed shareholder primacy.
In the leading decision in Revlon Inc v MacAndrews & Forbes Holdings Inc (1986) 506 A2d 173, the court said, “Although… considerations of non-stockholder corporate constituencies and interests may be permissible, there are fundamental limitations upon that prerogative. A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders.”
US law also clarifies that directors may take into account stakeholder interest through the use of constituency statutes. These are found in more than 40 states in the US where corporate law is state-based, although not in Delaware.
The review of common law countries reveals a consistent approach to the best interests duty of company directors. This is that the duty is owed to the company, and gives the board discretion as to which stakeholder interests are considered and how they are to be addressed by making decisions to promote the long-term success and sustainability of the company. Outside of Delaware in the US, the shareholder primacy norm is not a guiding principle of directors’ duties under corporate law.
Jason Harris is professor of corporate law at Sydney Law School. Grace Borsellino is a lecturer at Western Sydney University School of Law.