The Directors Duties Member's Bill – another distraction from real climate action?
The impacts of climate change are accelerating rapidly and visibly and the sense of urgency from society to take action is mounting. It is clear that a sustainable future for humans requires immediate and large-scale emissions reductions and that corporations must play a pivotal role in transitioning to a low-emissions economy. This has led to increasing societal pressure on businesses to act in a responsible manner and reduce their emissions.
Unfortunately, the business sector has been slow to take responsibility for reducing its emissions. Corporations often assert that such action is the remit of the public sector with their directors citing duties to shareholders as a barrier to transitioning to low-emissions business models and technologies. Such claims are often based on the widely held assumption that directors have a duty to maximise (short term) profits for shareholders. This assumption and the associated behaviours at board level pose significant challenges to corporate action against climate change. As a result, there has been increasing debate in the international legal community about the true nature of directors' duties, to whom those duties are (or should be) owed and whether they are a legitimate excuse for inaction on climate change.
Proposed Directors' Duty "Reform" in New Zealand
This debate has been heating up in New Zealand recently, in large part catalysed by the Supreme Court's obiter statements in Debut Homes and the Institute of Directors' call to action through its paper, Stakeholder Governance. Both touched on the basic duty of directors to act in the best interests of the company in the context of competing theories of governance about the meaning of "the best interests of the company". In particular:
the "traditional" theory of shareholder primacy, under which the company's interests are treated as the interests of the shareholders as a whole; and
stakeholder theory, where directors must take into account the interests of shareholders as well as a broader range of stakeholders, such as creditors, employees and the community and environment in which the company operates.
It is against this backdrop that the Companies (Directors Duties) Amendment Bill (the Bill) was introduced to Parliament last month. The Bill seeks to amend section 131 of the Companies Act 1993 (Companies Act) – the statutory duty to act in good faith and what the director believes to be the best interests of the company. The intention of the Bill is to clarify that directors may take into account a broader range of matters than the economic interests of shareholders in determining the best interests of the company. Given the debate leading up to the introduction of the Bill, many may now be wondering what exactly is the effect of the Bill if passed, and in particular, whether it will really empower boards to take the climate action so desperately needed to secure a sustainable future.
The explanatory note of the Bill states that the Bill "makes clear that a director, in acting as the mind and will of the company, can take actions which take into account wider matters other than the financial bottom-line. This accords with modern corporate governance theory that recognises that corporations are connected with communities, wider society, and the environment and need to measure their performance not only in financial terms, but also against wider measures including social, and environmental matters." For those that support action on climate change this certainly seems promising. However, on closer inspection, we see that the Bill is not proposing to reform the law, but rather clarify a relatively minor misconception.
As introduced, the Bill would insert a new subsection into s 131 as follows:
To avoid doubt, a director of a company may, when determining the best interests of the company, take into account recognised environmental, social and governance factors, such as:
(a) recognising the principles of the Treaty of Waitangi (Te Tiriti o Waitangi):
(b) reducing adverse environmental impacts:
(c) upholding high standards of ethical behaviour:
(d) following fair and equitable employment practices:
(e) recognising the interests of the wider community.
The introducing Member of Parliament has been clear that his intention was simply to clarify that profits need not be the only factor considered by directors (the catalyst for the Bill's introduction was a debate in Parliament about whether it was proper for Air New Zealand's shareholding Minister to divert attention away from profit maximisation with expectations about environmental impact), but for what purpose? Will such a clarification have any impact on decision making in the board room? Will this empower or even encourage directors to take bold action to become responsible corporate citizens, for example, by reducing emissions? Unfortunately, the answer is almost certainly no.
Does the Bill clarify legal uncertainty?
The Bill expressly empowers directors to consider a company's negative impact on the environment when determining the best interests of the company, but without any clarity on "best interests" this is little more than a token gesture. At common law (and this position likely remains under the Companies Act), the interests of the company were generally interpreted as the interests of the shareholders as a whole. In the absence of a contrary intention in the company's constitution, it was assumed that directors should pursue the company's purposes in a way that promoted shareholders' financial position. Does this mean that a company can take action to reduce its negative environmental impact only to the extent that this improves (or at least doesn't negatively impact) the company's bottom line? If so, over what time frame should directors consider any impact to the company's bottom line? If we want to see meaningful changes in the way corporates operate in society then we need to provide guidance not on what directors may take into account, but on how considerations such as environmental impact may interact with consideration of shareholder profit in decision making.
In fact, directors have very wide discretion to determine the best interests of the company. The duty under section 131 requires a subjective assessment of what the director believes to be in the best interest of the company (noting that this belief must be reasonably held) and the courts have taken the position that it is not their place to judicially review business decisions. Where we accept that the interests of the company are synonymous with the interests of shareholders as a whole, this still does not mean that directors have a duty to choose the path that will maximise profits for shareholders.
The real area of legal uncertainty is whether a company can prioritise reducing its negative impacts on the environment over the economic interests of shareholders. Although this is arguably a moot point as it seems increasingly unrealistic to claim that reducing emissions is inconsistent with the interests (economic or otherwise) of shareholders. The writing is on the wall for carbon intensive businesses and they both can and should be taking a longer-term view of what is in the best interests of the company. Perhaps the most useful clarification the Bill can make is to expressly require directors to act in the long-term interests of shareholders to remove any scope for argument that a focus on short-term profits is a legitimate excuse for irresponsible corporate behaviour.
Or is it a well-meaning distraction?
So, if the law provides a wide discretion for directors to consider and act on reducing its carbon footprint, then why has the business sector been so slow to move its focus away from short-term profits? Misunderstanding (or perhaps more accurately an outdated understanding that has not shifted with the context in which business operates) of what is required of directors under their duties has undoubtably played a role. However, directors' duties are probably not the primary driver of behaviour in the board room. To date, directors have faced very limited challenge in the form of action for breach of duties outside of insolvency proceedings. This is probably due to the fact that directors owe their duties to the company – who then will hold them to account when the directors themselves represent the mind and will of the company? Even if we were to require directors to consider the company's negative impact on the environment when determining the best interests of the company, the impact of such a requirement would be dulled by their wide discretion in making this determination and limited accountability.
The more immediate and obvious threat to directors is the threat of being removed from office by shareholders. This means that regardless of the legal position on duties, shareholder interests are likely to be front of mind in the decision-making process. This incentive structure (reinforced by directors often being shareholders themselves and significant shareholdings being controlled by institutional investors who themselves have short-term profit targets) and a tendency to favour established governance practices (which are not necessarily suited to dealing with the threat of climate change) are likely to be stronger drivers of corporate behaviour than the current legal duties. If we want to see bold action by companies to reduce emissions, we need to adapt governance practices and introduce clear legal obligations to reduce environmental impacts as well as efficient mechanisms to enforce them. While the Bill is well-intentioned, it risks being a distraction from the more significant adaptation of the legal and governance frameworks needed to effectively transition to a low-emissions economy.
This article was authored by Emma Geard as member of and in collaboration with LCANZI’s Corporate Governance and Director’s Duties Sub-committee.