The first stage of fundamental reform in the United Kingdom ended in 2001. Legal scholars point out that company law in the United Kingdom requires simplification for the promotion of business creation and growth, changes in corporate governance and the duties of the directors, and the institutional framework to provide regulation. The Company Act 2006 was formulated to ensure that company law statutes were responsive to the needs of the United Kingdom in promoting competitiveness, growth, and accountability of British companies.
Justification for the Company Act 2006
By the end of the 19th century, legal commentators had observed the continuing decline in the utilization of the chartering authority of the state in imposing significant regulations on activities of corporations. The legal commentators then postulated that corporations as aggregations of private individuals required minimum regulation to effectively protect the interests of shareholders from restrictions impeding their property rights. The aggregation theory advanced the idea that corporations were naturally created by private initiatives and market forces, replacing the notion of corporations as artificial bodies. This view led to the interpretation of the aggregate theory to develop the idea that corporations were natural and legal entities. The aggregation theory, therefore, led to the legitimization of the emerging concept of big business in the early 20th century.
The Strategic Framework of 1999, the consultation paper that provided the foundation for the drafting of Company Act 2006, outlined various challenges that the existing legislation did not address. Such challenges included the needs of small businesses. This led to the ‘think small first’ principle that sought to optimize the law so that it responded to the large proportion of small and medium-sized businesses that the law affected.
The Company Act 2006 provided for a statutory statement of the duties of directors. Legal scholars noted that the general duties of directors were often established in case law rather than in statute. The outcome was that there was a possibility that individuals could become company directors and lack understanding of their legal obligations. Furthermore, the legal obligations of the directors may not be understood by various stakeholders in a company on whose behalf the directors are acting. Thus, there was a need to create consistency in the understanding and practice of law relating to directors’ duties so that such laws were readily available and comprehensible.
The involvement of the government in modernizing the United Kingdom’s company law was critical. The court system in the UK had failed in developing fundamental principles of company law, including the need for directors’ duties to be updated with changing business practices. Additionally, the laissez-faire principles dominating the UK markets since the middle 1850s favored minimal involvement of the government in facilitating the development of systematic and novel corporate rules, such as those that emerged in other modern legal systems (Tomasic 2011). Thus, there was a need for the UK to move beyond traditional models of command and control and emphasis on self-regulation to an increased, flexible, and comprehensive system of regulating corporations.
A majority of company law principles before the Company Act 2006 were 19th-century case-laws. However, the courts in the United Kingdom preferred judicial self-restraint and showed significant reluctance in creating broader company law principles of directors’ duties, as well as more general trends in business. The courts waited for the legislature to create laws solving the wider challenges that company law presented. For instance, in Re City Equitable, the courts only restated the 19th-century company law principles that guided the duties of directors. The principles remained in force until the enactment of the Company Act 2006. However, the adoption of the provisions on wrongful trading introduced in Section 214 of the Insolvency Act 1986 and the United Kingdom Companies Directors Disqualification Act provided a foundation for establishing directors’ duty of care and led the courts to raise their expectations of standard of directors’ conduct. The aggregation theory posited that corporations are also judicial entities independent from their shareholders with rights and responsibilities imposed on them. The courts rejected the argument that directors could escape liability due to the delegation of duty to subordinates. However, legal scholars noted that the courts in the late 1980s and early 90s did not reflect an essential change in company law principles, but an approach of the courts in approaching company law changed with the courts applying the common law doctrines of company law in a modern text. The Company Act 2006, thus, clarified the uncertainties remaining in company law through the enactment of Section 174 explicitly imposing a considerably objective duty-of-care for directors.
The United Kingdom courts practiced judicial self-restraint, despite the other Commonwealth courts adopting an activist approach and developing theories in business administration, such as the stakeholder theory. However, the UK courts had recognized that companies owed a duty to their creditors, particularly when in financial difficulties or when the company nears insolvency as established in Kinsela v Russell Kinsela Pty Ltd. The protection of creditors’ interests is alluded to in Section 172(3) of the Company Act 2006. Judicial self-restraint in company law was informed by a lack of a robust tradition of corporate litigation due to the perception of chancery judges of directors as being akin to trustees who could be relied on to undertake the management of companies without significant judicial scrutiny.
Reform Committees and Proposals for the Company Act 2006
Under the aggregate theory, relevant contracts are those entered between a corporation and its shareholders. However, the challenge of the perspective of the theory is that it fails to articulate the shareholder interests that should matter.
The Gower Investor Protection Report authored in the late 1980s proposed the regulation of the financial services industry of the United Kingdom, leading to the establishment of the Securities Investment Board. The Gower Report followed a period of highly publicized scandals in the 1970s and 1980s hitting the United Kingdom’s financial services sector, which led to a shift from reliance on self-regulation to statutory regulation. The report culminated in the Financial Services Act of 1986 that established the Securities Investment Board (Pimlott 1985, p. 144).
The Cohen Report offered various recommendations, including that shareholders should maintain a considerable degree of control over company directors. The report further proposed that Board of Trade should be empowered to undertake litigation on behalf of shareholders. Finally, it recommended the abolition of the ultra vires rule providing companies the status of ordinary persons (Company Law Amendment Committee & Cohen 1945).
The Company Act 2006 sought to shift the perspectives of British companies so that they make their decisions taking into account a long-term view of their operations and sustainability rather than focusing on immediate returns. The law, thus, embedded in statute the notion of the Enlightened Shareholder Value. The law provided that directors must seek the objectives of their companies for the benefit of their shareholders by balancing the short-term and long-term perspectives, as well as employees, suppliers, customers, and taking into account the impact of their operations on the environment (Ferran 2001, p. 17). In taking this stance, the Company Act 2006 reformed the notion of aggregate theory that as a collection of common interests of shareholders, the corporation was justified to pursue the interests of shareholders, chiefly profit maximization, as the most important objective even at the expense of societal needs. The Company Act 2006 sought to capture the expectations of society by advocating directors to take an inclusive, a broader and long-term view of their role (Edmonds 2006, p. 38).
The Strategic Framework also acknowledged consideration of the notion that a company should encompass more than its shareholders. This perception would require that the directors should consider a broader range of interests, which are not subordinate to shareholder interests or pursued as a means of attaining shareholder interest. However, the Strategic Framework shunned the pluralist approach because it would significantly upset English company law by requiring reform of the law relating to duties of directors to allow directors to further the non-shareholder interests, even when it is detrimental to the shareholders (Hopt 2000, p. 13).
The Strategic Framework also noted that the pluralist approach could be pursued through altering board composition requiring mandatory broader representation. However, such a measure would mark a drastic change from the corporate culture of the British and would face enormous difficulties in finding widespread support. The Strategic Framework contended that a regime of enlightened shareholder value, when utilized together with improvements in the flow of information and greater disclosure, would make the company more accountable to wider interests (Company Law Review Steering Group 1999a, p. 61).
The challenge with widening groups to which a company owes duty is that it leads to challenges on holding a company accountable. The Company Act, therefore, settled on undertaking improvements on the regime of enlightened shareholder value by making the duties of directors explicit and through improvements in information flow (Edmonds 2006, p. 26).
In other consultative papers, there were deliberations on the sort of improvements that could be undertaken on the requirements for Annual General Meetings to allow such meetings to serve their objective of enhancing the accountability of directors to shareholders. Berle and Means refuted Corporate Realism Model that posited a company to be separate from its shareholders. The model further noted that as a separate entity, the managers of a company were at liberty to define the objectives of the company by practicing neutral management. However, such a perspective was defeated because of the lack of managerial accountability. Berle and Means suggested that shareholders should have greater transparency through granting voting rights to shareholders so that they can hold managers accountable. Advocating shareholder rights would lead to a reduction in the gap between ownership and control.
The consultative paper deliberated whether there were other ways of ensuring that directors would be held accountable to the shareholders to allow AGMs to be abolished for public companies. The document recognized that despite the potential effectiveness of general meetings in providing quasi-democratic control of directors of a company, the necessary conditions are rarely satisfied.
The conditions for effectiveness of general meetings are that most of the votes should be held by members other than directors or those under their control. Moreover, most shareholders should be willing to participate actively in meetings. In small companies, their shareholders and the directors are one and the same while in public companies, shareholders are many and spread across regions (Company Law Review Steering Group 1999b, p. 64). Additionally, most of the shareholders tend to be financial institutions whose representatives rarely attend company general meetings. The Company Act 2006 maintained that public companies are required to hold AGMs, but unanimous shareholders’ decision would allow a public company to dispense such a requirement.
Another consultative paper concerned with company formation and maintenance provided for the abolition of the memorandum of association, but there would be a new registration form for providing information required for the public register. The Company Act 2006 further abolished the distinction in authorized share capital and issued share capital. Furthermore, the Act provided for the abolition of the notion of par values for shares in private companies (Department of Trade and Industry 2005, p. 72). For small companies, the Strategic Framework recognized the need to codify and extend the ‘unanimous consent rule’, which was existing under common law. The outcome would be that any decision a company could make was valid even when all the required legal formalities were not observed, provided all company members consented to the decision (Company Law Review Steering Group 1999a, p. 57). The Company Act 2006 further abolished the need for written resolutions at private companies to solicit unanimous endorsement. The Act provided that the standard thresholds required for special and ordinary resolutions would also apply to written resolutions, allowing small companies to make faster decisions without the obligation of holding general meetings (Company Law Review Steering Group 2000a, p. 42).
The Act preferred the promotion of alternative dispute resolution for the settlement of disputes between shareholders as an ideal alternative to the court system. (Company Law Review Steering Group 1999b, p. 45). The Company Act 2006 provides for the resolution of members of a company to be circulated free of charge with the AGM papers removing the potential cost-barrier to the participation of members. Institutional investors would need to disclose the manner in which they have exercised their member rights if they are managing funds on behalf of other shareholders (Company Law Review Steering Group 2000b, p. 47). Companies are also required to disclose their primary relationships with financial institutions in their annual reports.
Despite the principal objective of the Company Act being the creation of a framework that would allow effective and efficient decision making, the Act fails in the discussion of the law relating to minority shareholders. Notably, the Act entrenches majority rule in most of its provisions. The Company Act 2006 seeks to ensure the integrity of the governance mechanism available for companies rather than advocating direct government intervention (Company Law Review Steering Group 2000b).
Thus, the Company Act seeks to strengthen and encourage the role that shareholders play. This attitude was reflected in the Directors’ Remuneration Report Regulation, where the Strategic Framework paper provided a mandatory advisory vote for members of a company rather than recommend the direct intervention of the government over the remuneration awarded to the directors. Legal scholars are concerned with the recommendation of the Strategic Framework paper that institutional investors should provide public disclosure on how they voted their shares is meant to influence the voting behavior of institutional shareholders, as the public disclosure may affect the perception of share ownership (Goddard 2003, p. 408).
The Act further provides that companies of economic significance should publish an Operating and Financial Review (OFR) that outlines a company’s activities, including all related information about its plans, risks, and opportunities. The OFR paper will require companies to describe information relating to its relationship with employees and the impact of its activities of the company on the environment. The hope of the government is that the information will assist shareholders to hold directors accountable. The government also hopes that the information will help wider interests among stakeholders (Goddard 2003, p. 415). The new requirement that companies should report on significant environmental issues will contribute to advancing a firm’s sense of corporate social responsibility and the initiatives aimed at ensuring sustainable development.
The government had for a long time promoted corporate social responsibility and sustainable development as matters that made business sense. However, it is critical to note that the OFR does not require companies to engage in socially responsible behavior. It requires that companies should disclose their policies related to social responsibility. However, legal scholars are critical of the Strategic Framework paper for its failure to mention the need for corporate social responsibility among small and medium sized businesses. Scholars point out that failing to perceive the relevance of CSR to small and medium-sized enterprises reflects the perception of the government on the role of company law in relating to CSR (Goddard 2003, p. 419).
The Company Act 2006 was a response to the need to modernize the United Kingdom to ensure that British companies experience growth, they become more competitive, and they have an increased sense of accountability. It sought to provide a simplification of the complexity of the prior legislation and provide a flexible mechanism for regulation that encourages effectiveness and efficiency for companies, while ensuring that it captured the need for wider interests to be treated fairly.
List of References
Company Law Amendment Committee & Cohen, LL 1945, Report of the committee on company law amendment, HM Stationery Office, Web.
Company Law Review Steering Group 1999a, Modern company law for a competitive economy: The strategic framework: a consultative document, Department of Trade and Industry.
Company Law Review Steering Group 1999b, Modern company law for a competitive economy, Company Formation and Capital Maintenance, DTI
Company Law Review Steering Group 2000a, Modern company law for a competitive economy: completing the structure: a consultation document, Department of Trade and Industry.
Company Law Review Steering Group 2000b, Modern company law for a competitive economy: Company general meetings and shareholder communication. Department of Trade and Industry, Web.
Department of Trade and Industry 2005, Company law reform- white paper, Web.
Edmonds, T., The company law reform bill: Bill 190 2005-2006, House of Commons Library, Web.
Ferran, E 2001, ‘Company law reform in the UK’, Sing. J. Int’l & Comp. L., vol. 5, p. 516, Web.
Goddard, R 2003, ‘Modernising company law: The government’s white paper’, The Modern Law Review, vol. 66, no. 3, pp. 402-424.
Hopt, K 2000, ‘Modern company law problems: a European perspective’, Company Law Reform in OECD Countries: A Comparative Outlook of Current Trends, Web.
Pimlott, GF, ‘Reform of investor protection in the UK–An examination of the proposals of the Gower report and the UK government’s white paper of January, 1985’, The. J. Comp. Bus. & Cap. Market L., vol. 7, no. 141, Web.
Tomasic, R 2011, ‘Company law modernisation and corporate governance in the UK-Some recent issues and debates’, DICTUM-Victoria L. Sch. J., vol. 1, no. 43, Web.