Standen, Mark --- "The Corporation in Society: Time to Revise Its Role?" [2005] ALRCRefJl 21; (2005) 87 Australian Law Reform Commission Reform Journal 12

---

Reform Issue 87 Summer 2005/06

This article appeared on pages 12 – 16 of the original journal.

The corporation in society: Time to revise its role?

By Mark Standen *

The publication of the Jackson Report in September 2004 and the issue by the Australian Shareholders’ Association in January 2005 of a press release expressing disapproval at corporate philanthropy regarding the Boxing Day tsunami disaster provoked lively debate on the role of the corporation in Australian society.

Mark Standen writes that much of the discussion focused on the extent to which companies should be able or required to take into account the interests of stakeholders other than shareholders.

James Hardie and CAMAC

In 2001, James Hardie Industries Ltd established the Medical Research and Compensation Foundation (MRCF) to administer future asbestos-related claims against two former James Hardie subsidiaries.

In 2004, David Jackson QC was commissioned to inquire into the financial position of the MRCF and to determine:

• if the MRCF was likely to meet its asbestos related liabilities; and

• whether the circumstances in which it was separated from the James Hardie Group affected its ability to meet its current and future asbestos-related liabilities.

In September 2004, Mr Jackson QC’s findings were published in a report which stated, among other things, that:

• James Hardie had knowingly underfunded the MRCF and had seriously misled the public in relation to the sufficiency of those funds; and

• in regard to the separation of the MRCF from the James Hardie Group, the current concept of limited liability in relation to a holding company’s responsibility for the torts of its subsidiary meant that James Hardie was not legally obliged to fund the liabilities of its former subsidiaries.

According to the Jackson Report, the estimated $1.5 billion shortfall in compensation exposed ‘significant deficiencies in Australian corporate law’.

In response to the findings of the Jackson Report and the enormous public concern over the plight of asbestos victims, Parliamentary Secretary to the Treasurer, the Hon Chris Pearce MP referred to the Companies and Markets Advisory Committee (CAMAC) in March 2005 a number of questions concerning directors’ duties and corporate social responsibility.

Given the broad economic and environmental impact of activities conducted by corporate entities in modern society, the reference stated that:

‘there is an understandable interest in the legal framework in which corporations make decisions. A question which has been raised from time to time is whether the current legal framework allows corporate decision makers to take appropriate account of the interests of persons other than shareholders’.

The following questions were referred to CAMAC:

• Should the Corporations Act be revised to clarify the extent to which directors may take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?

• Should the Corporations Act be revised to require directors to take into account the interests of specific classes of stakeholders or the broader community when making corporate decisions?

• Should Australian companies be encouraged to adopt socially and environmentally responsible business practices and if so, how?

• Should the Corporations Act require certain types of companies to report on the social and environmental impact of their activities?

A range of views

The traditional view under the Corporations Act 2001 and at common law is that a director’s duty to act in the best interests of the corporation requires a director to govern solely in the interests of shareholders, and that this involves the maximisation of shareholder wealth. Directors are not required to consider social or environmental issues in the discharge of their duty. Only in limited circumstances will directors be required to consider the interests of parties other than existing members, and this usually only extends to considering the interests of creditors when the company is insolvent or near insolvent.

One commentator recently made the ‘modest proposal’ that directors should be entitled to a defence to a complaint that they had acted improperly in circumstances where the directors consider the interests of stakeholders in their decision making. He argues this would be a minor amendment to current Australian corporations laws as it does not impose a new duty on directors, nor does it prevent optimisation of shareholder wealth since optimisation often presupposes due regard to stakeholder interests.¹

Other commentators disagree. In response to the ‘modest proposal’, one writer believes that such reform is inconsistent with the fundamental duty imposed on directors to act in the best interests of their company and that, if directors were required to consider the interests of stakeholders, the ever-changing assessment of community expectations would mean that they:

‘will, inevitably, find themselves beholden in the conduct of their company’s business not to the company and its shareholders...but to the state and its politicians and bureaucrats’.²

Ralph Evans, Chief Executive Officer of the Australian Institute of Company Directors, believes that any alterations to the fundamental concepts of Australian corporate law should be approached with great caution as such reforms could have significant adverse consequences for thousands of companies and should not be introduced merely in response to the unique situation of James Hardie.³ In his view, if directors had to ‘constantly balance the interests of shareholders with those of other stakeholders, it would often be impossible for them to reconcile their duties’.⁴

The duty to act in the best interests of the corporation does not require that the directors act to maximise shareholder wealth at the expense of the interests of other stakeholders. Indeed it will often be in the interests of the corporation that appropriate recognition is given to the interests of such groups as employees, customers, contractors and the community. That is, the existing law already provides a significant degree of flexibility which facilitates due consideration of the interests of such stakeholders as part of the broader consideration of what is in the best interests of the corporation as a whole.

An extension of the existing duties of directors to take into account the interests of specific classes of stakeholders is likely to raise further questions in such areas as:

• the extent to which other stakeholders should be entitled to seek remedies in the courts if they believe there has been a breach of duty;

• the extent to which the shareholders in the corporation will be entitled to ratify breaches of the extended duties by directors;

• how directors would balance competing interests between stakeholders, for example if environmental and employees interests point in different directions; and

• would there be an effective lessening of the content of directors’ duties through the ability of directors to consider the interests of a much wider group?

Even if there is an extension of the law to permit, rather than to oblige, directors to take account of the interests of various stakeholders, there will be interesting and potentially complex questions as to when the directors ought to take those interests into account.

Overseas

The corporations laws of a number of countries including the USA, Japan, Germany, England and Canada recognise, to varying extents, a director’s duty to take into account non-shareholder corporate stakeholders in decision making.

Several American states have adopted this concept. The majority of them authorise directors to consider the interests of non-shareholder stakeholders. However, the Connecticut constituency statute requires directors to consider the interests of non-shareholder stakeholders, stating that:

‘a director... shall consider, in determining what he reasonably believes to be in the best interests of the corporation... the interests of the corporation’s employees, customers, creditors and suppliers, and... community and societal considerations...’⁵

The recognition of non-shareholder interests has not been adopted by Delaware statute. In Delaware—where 50% of US public companies and more than 60% of the Fortune 500 companies are incorporated⁶—directors are still required to owe an ‘unyielding’ duty to the corporation and its shareholders.⁷

In March 2005, the UK Government published a further White Paper entitled ‘Company Law Reform’ which sets out proposals for comprehensive reform to the UK company law framework. The reform proposals reflect a possible movement away from the common law expressed, for example, in the 1962 case Parke v The Daily News Ltd,⁸ in which Plowman J stated:

‘The view that directors, in having regard to the question what is in the best interests of their company, are entitled to take into account the interests of the employees, irrespective of any consequential benefit to the company, is one which may be widely held... But no authority to support that proposition as a proposition of law was cited to me; I know of none, and in my judgment such is not the law’.

Clause 156 of the Company Law Reform Bill introduced into the House of Lords in November 2005 required that directors must (to the extent reasonably practicable) consider the interests of non-shareholder stakeholders. In fulfilling the duty to ‘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’ a director would be obliged to:

‘(so far as reasonably practicable) have regard 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, and
(f) the need to act fairly as between members of the company’.

PJCCFS inquiry

Sitting alongside the CAMAC inquiry is the inquiry of the Parliamentary Joint Committee on Corporations and Financial Services (PJCCFS) into corporate social responsibility, which was announced on 23 June 2005. The PJCCFS inquiry Terms of Reference include inquiring into corporate responsibility and ‘triple bottom line’ reporting for incorporated entities in Australia, with particular reference to:

• the extent to which organisational decision makers have and should have an existing regard for the interests of stakeholders other than shareholders, and the broader community;

• the extent to which the current legal framework governing directors’ duties encourages or discourages them from having regard to the interests of stakeholders other than shareholders, and the broader community;

• whether revisions to the legal framework, particularly to the Corporations Act, are required to enable or encourage incorporated entities or directors to have regard for the interests of stakeholders other than shareholders, and the broader community;

• any alternative mechanisms, including voluntary measures that may enhance consideration of stakeholder interests by incorporated entities and/or their directors;

• the appropriateness of reporting requirements associated with these issues; and

• whether regulatory, legislative or other policy approaches in other countries could be adopted or adapted for Australia.

The PJCCFS inquiry received 124 individual submissions and 31 standard letter submissions from corporates, trade unions, law firms, community and human rights groups and academics.

Some, such as the Corporate Research Group, do not support any reform proposals and consider the existing framework of directors’ duties under the Corporations Act ‘accommodates directors taking into account, and indeed embracing, the interests of non-shareholder stakeholders—so long as a commercial justification for this benevolence can be articulated’.

Corporates such as BHP Billiton and Coles Myer warn against prescriptive legislation and reporting standards and consider corporate social responsibility integral to how a company conducts business.

In contrast, the Australian Human Rights Centre at the Faculty of Law, University of New South Wales (for example) considers:

‘mandating the disclosure of social and environmental issues is a necessary step in integrating corporate responsibility issues as part of a company’s core business strategies. Clear guidance must be provided to companies on what and when such issues should be disclosed or triple bottom line reporting runs the risk of engendering a movement that merely encourages the production of token reports that lack consistency, comparability and credibility’.

Philanthropy Australia is one of a few charitable organisations that considers proposed regulation of corporate social responsibility inappropriate. It states, ‘legislation and regulation are not the tools by which the Government will encourage and enhance continued growth and evolution in the social partnership between Australian corporations and community’.

The PJCCFS is not the first time that a parliamentary inquiry has considered the wider social responsibilities of company directors in Australia. In 1989, the Senate Standing Committee on Legal and Constitutional Affairs (Cooney Committee) considered the social and fiduciary duties and responsibilities of company directors.

The Cooney Committee saw inadequacies with potential approaches requiring or permitting directors to consider the interests of non-shareholders when making decisions. Although recommending (unsuccessfully) that companies legislation be amended to make it clear that the interests of a company’s employees may be taken into account by directors in administering the company, the Cooney Committee concluded that:

‘requirements aimed at securing responsible corporate behaviour are...best provided in other than company law’.⁹

Corporate philanthropy

The public debate concerning corporate social responsibility ignited by the Jackson Report received new impetus in response to corporate donations relating to the Boxing Day tsunami tragedy.

The ‘non-strategic’ nature of some of these corporate donations provoked a degree of criticism by the Australian Shareholders’ Association (ASA). The ASA expressed disapproval of companies pledging relief on the basis that they have no shareholder approval for their philanthropy. An ASA spokesperson was cited as saying:

‘firms should not generally give without expecting something in return... in most circumstances, donations should only be made in situations that are likely to benefit the company through greater market exposure’.¹⁰

Subsequent community criticism caused the ASA to release a statement to the effect that the ASA is not opposed to corporations making donations to assist the tsunami victims, but made the point that since the donations are a distribution of shareholder funds, ‘the companies should publicly disclose the amount and recipients so shareholders are kept informed’.¹¹

The community seemed to favour the significant donations given by corporations to the extent that some corporations were criticised for not donating enough.¹²

The current Australian position which requires the pursuit of shareholder wealth in order to act in the best interests of the company limits the discretion directors have to make social contributions on behalf of the company. Accordingly, directors may breach their duty if they exercise corporate philanthropy in a manner which might impact on profits. The exercise of corporate social responsibility can only be justified where a clear financial benefit to shareholders can be shown.

Mahoney JA explains this concept in Woolworths v Kelly:

‘A company may decide to be generous with those with whom it deals. But... it may be generous to do more than it need do if, essentially, it be for the benefit of or for the purposes of the company that it do such. It may be felt appropriate that the company require a reputation of being such.’¹³

This type of corporate social responsibility may be regarded as ‘strategic’ because the ultimate goal of such behaviour is to achieve a benefit for the company rather than to promote social or environmental values. ‘Strategic’ corporate social responsibility is unlikely to offend the legal duties of directors because it is really a self-interested attempt to improve the company’s reputation in accordance with the policy of profit maximisation.

However, behaviour that involves voluntary sacrificing of profits for the benefit of society (to achieve a purpose other than to maximise shareholder wealth) may not be regarded as being in the best interests of the company unless the company’s success is based on consumer approval.

Corporations that benefit from consumer approval and a positive social reputation, such as banks, or corporations which conduct business in socially or environmentally sensitive industries, can justify potentially ‘non-strategic’ profit sacrificing philanthropy on the basis that they will benefit from an improved social reputation.

* Mark Standen is a partner at MinterEllison, advising on corporations law and corporate governance issues.

Endnotes

1. B Beerworth ‘A modest proposal: recognise the existence of stakeholders’, Company Director, December/January 2004–2005,13.

2. T Bostock, ‘Is Beerworth’s proposal really so modest’, Company Director, December/January 2004–2005, 16.

3. R Evans, ‘CEO Report’, Company Director, December/January 2004–2005, 4.

4. Ibid.

5. Conn. Gen. Stat 33-756; J Fisch, Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy (2004), 17.

6. K Greenfield, ‘Democracy and the Dominance of Delaware in Corporate Law’, (2004) 67 Boston College Law School Faculty Papers, 101.

7. Smith v Van Gorkom 488 A.2d 858, 872 (Del. 1985) cited in K Greenfield, ‘Democracy and the Dominance of Delaware in Corporate Law’, (2004) 67 Boston College Law School Faculty Papers, 105.

8. Parke v The Daily News Ltd (1962) 2 All ER 929.

9. Australian Parliament—Senate Standing Committee on Legal and Constitutional Affairs, Company directors’ duties (1989), [6.51].

10. ABC News Online, <www.abc.net.au/news/newsitems/200501/s1278005.htm> at 7 January 2005; see also T Wilson, ‘The ‘Best Interests of the Company’ and Corporate Social Responsibility’ (Paper presented at CLTA conference, 7 February 2005), 1.

11. ASA Media Release, ‘ASA supports Tsunami Donations’, posted 7 January 2005 at <www.asa.asn.au>.

12. T Wilson, ‘The ‘Best Interests of the Company’ and Corporate Social Responsibility’ (Paper presented at CLTA conference, 7 February 2005), 9.

13. Woolworths v Kelly (1990) 4 ACSR 431.