Shareholder Primacy and Corporate Purpose

In recent years, calls for companies to have a ‘corporate purpose’ and for business to contribute to sustainability have grown significantly. In the UK Corporate Governance Code (2020) it is stated that the board should establish the company’s purpose, alongside values and strategy, and satisfy itself that they are aligned with its culture (Principle B). The extent to which the legal framework should be adapted to mandate and regulate corporate purpose has, accordingly, engendered considerable academic debate. The issue arose recently in the case of  BTI 2014 LLC v Sequana SA & Ors [2022] UKSC 25 on the nature, scope and contents of directors’ duties with regards to creditors, when a company is nearing insolvency. In that context, the Supreme Court (of Appeal) considered the duty of directors to act, in good faith, for the benefit of the company and what that means. In other words, who are the ultimate beneficiaries of the duty to act in good faith? Even though this case focused primarily on the point in time when directors should consider the interests of creditors, which may be different from those of the shareholders, it also provides a confirmation by the Court of shareholder primacy. We focus, in this short note, on the implications of the case for corporate purpose provisions and strategies.

S172 and relevant interests

Referencing the common law, Lord Reed stated that the director’s fiduciary duty to act in good faith in the interests of the company means the interests of its members as a whole (paras 11,17 and 21). With respect to section 172 of the Companies Act, 2006 where this has now been codified the court held that since this duty is focused on promoting the success of the company ‘for the benefit of its members as a whole’, it is clear that, although the duty is owed to the company, the shareholders are the intended beneficiaries of that duty. The court did refer to the secondary importance of other considerations that directors need to take into account under s172 but held that the primary duty in s172 remains focused on promoting the success of the company for the benefit of its members (para 67). To that extent, ‘the common law approach of shareholder primacy is carried forward into the 2006 Act’ (para 65). It seems clear to us that the court’s approach confirmed shareholder primacy as the position under the common law but also under the codified s172(1).

Notwithstanding, shareholder primacy has been challenged by the emergence of sustainability as a key theme in corporate and financial law. Corporate governance and financial regulation have a role to play in the transition to a sustainable economic model, especially in a global context. This is already happening through voluntary action driven by global guidelines, policies and principles as well as national, self-regulatory codes of best practice. Some of these soft law recommendations are also starting to be framed as harder obligations mandating responsible behaviour from companies through, for example, reporting requirements. Various suggestions have therefore been made in the recent years on ways to ensure more sustainable companies.

These suggestions include a reform of s172 (see the Better Business Act initiative for example), or, as we have, previously suggested an ESG entity model, which does not propose reform of directors’ duties per se, but rather focuses on the internalisation of externalities and suggests various mechanisms that can be adopted by companies to enhance stakeholder engagement and participation such as board committees, procedural due diligence requirements and non-financial reporting. A central element of this debate has been corporate purpose.

S172 and purpose

A key question in this context is how does s172 link with corporate purpose? In principle, it seems correct to view purpose as setting the context for interpreting the meaning of the ‘success of the company’. We argued before that the key issues have been whether corporate purpose encompasses objectives other than profit maximization and whether, and if so how, interests other than those of shareholders can legitimately be considered in board decision-making. We argued that the default position in the UK is that it falls to the board of directors to determine corporate purpose in accordance with the standard process of majority decision-making. However, it has been observed that the emergence of a de facto norm of shareholder value maximization constrained any inclination on the part of boards to act in that way.

Alex Edmans in his book ‘Grow the Pie’ defines corporate purpose as ‘why a company exists – who it serves, its reason for being, and the role that it plays in the world’. He sees both the enlightened shareholder value (ESV) approach and his idea of ‘growing the pie’ as highlighting the interests of stakeholders but also stressing the importance of profits. However, while the ESV approach has profit making, over the long-term, as the ultimate goal, his approach focusses on creating value to society, which can, but will not necessarily, lead to profit maximisation. Colin Mayer argues that profit must be derivative from solving a problem (it should not create a problem) and that we need to ‘rethink corporate purpose’ by identifying or determining purpose and then implementing it, subject to board oversight. Paul Davies argues that s172 should not be seen as an obstacle when directors want to set policies as only policies with no benefit to shareholders, over the long term, are really ruled out. Section 172 gives a wide discretion to the board over the setting of policies. Even though s172 refers to the members, as ultimate beneficiaries, it does not restrict the setting of a corporate purpose that benefits stakeholders, other than just shareholders. It actually puts corporate purpose at the heart of directors’ duties.

It is clear that commentators are not always in agreement when it comes to (1) the potential for setting a corporate purpose encompassing broader, sustainable goals within the current legal framework; and (2) the interaction with the codified duty in s172. There are two related issues here. First, with s172 focused on shareholder primacy, which is in line with the judgment of the Supreme Court, it seems harder (at least de facto if not de jure) for directors to set a corporate purpose that will potentially benefit stakeholders at the expense of the shareholders collectively. Second, corporate purpose ultimately comes before duties, and it is really the purpose that shapes the duty; therefore, s172 is not an obstacle for setting a purpose that facilitates better stakeholder integration. The discretion available to directors under s172 and the potential to focus on long-term factors (such as eventual market pricing of externalities) make this even more possible.

The way forward?

While this judgment clarified the application of ESV and shareholder primacy, it is still unclear to what extent directors could set a corporate purpose, through strategy and policies, which has the potential to deviate from shareholder value. And with shareholder primacy being confirmed it would be interesting to see how far directors are willing to go to agree a sustainable corporate purpose that will add value to society, but not necessarily to the shareholders as a collective group. The issue may be amendable to resolution in the form of engagement with shareholders through stewardship and collective investor engagement, albeit that process in itself would represent an exercise in shareholder primacy. More ambitious moves by boards to set a more stakeholder focused form of corporate purpose seem less likely at this point in time. 

Irene-Marie Esser is a Professor of Corporate Law and Governance at the University of Glasgow and Extraordinary Professor at Stellenbosch University.

Iain MacNeil is the Alexander Stone Chair of Commercial Law at the University of Glasgow and Head of the Corporate & Financial Law Research Group.