The role of corporate law in corporate purpose: the British Academy Report

In 2018, in his book Prosperity, Colin Mayer promoted “an embarrassingly simple policy” aimed at inducing companies to pursue purposes defined more broadly than the shareholders’ interests. To be sure, shareholders would benefit from these broader purposes, but that benefit would flow from the attainment of the broader purposes, and not be the direct goal of corporate action. The book led to the establishment of a Future of the Corporation programme at the British Academy (BA), designed to analyse ways of taking this policy forward. Its final report, Policy & Practice for Purposeful Business, appeared in September 2021. The role proposed for corporate law was put as follows: “Corporate law should place purpose at the heart of the corporation and require directors to state their purposes and demonstrate commitment to them.” This policy is spelled out in a little more detail. “More specifically it is proposed that:

• Company law emphasises duties of directors to determine and implement company purposes. 

• Governments publish guidance on how companies can incorporate purpose in their legal form, for example in their articles of association.”

What is this likely to amount to for UK company law and other legal systems persuaded to go down the same path? The answer is probably “not very much”, though that “not much” is likely to be positive. Let’s look at the directors’ duties and company’s constitution proposals in turn.

Directors’ Duties

As is clear from the opening pages of Prosperity Colin Mayer was reacting against the view of Milton Friedman, which Mayer characterises as being that “the purpose of business is exclusively to make money for the owners of the business” (p 3). Whether this is actually what he said is contested by some. In any event, for a corporate lawyer, this seems a questionable starting point, since it is impossible to identify a corporate law system in any developed system of law which casts the duties of directors in such blunt and unqualified terms.

UK company law, as the BA Report states, “requires directors to promote the success of the company for the benefit of its shareholders, having due regard to the long term and the interests of other stakeholders.” This is surely clear enough: the directors are not under a duty to promote the interests of the shareholders directly but only by means of setting policies which promote the company’s success. When one adds in the words, which the Report omits, that the director “must act in the way he considers in good faith would be most likely” to promote the success of the company, it becomes clear that the section gives directors a wide range of discretion over the setting of company policies. Only policies which would confer no substantial benefit on the shareholders over any reasonable time-frame are ruled out – and Prosperity appears to rule them out also. 

One might cavil at the fact that the section gives shareholders’ interests priority over those of other stakeholders. In formal terms, this is so. In practice, it is doubtful whether this is a significant restriction on directors’ policy setting. The duty is subjective (and so it’s difficult to get a court to review a board’s decisions) and no time-frame is stipulated for the benefit to the members to emerge, except some encouragement to take a long-term view. So, giving stakeholder interests greater weight than is currently done is not likely to be problem for the well-advised board. If the directors of UK companies do in fact prioritise the interests of the shareholders and prioritise them over the short-term (also a contested proposition ), then the cause is more likely to lie in capital market pressures (limited protection of directors against removal, hostile takeovers and activist shareholders) than in the law of directors’ duties. If one wants to change company law to reduce the shareholder pressure on managers, then Law of directors’ duties is not the most useful place to begin.

The current formulation of the core duty of directors in UK law does put the formulation of company purposes at the heart of directors’ duties

In short, the current formulation of the core duty of directors in UK law does put the formulation of company purposes at the heart of directors’ duties. And those strategic choices and a whole raft of material relevant to ESG matters must then be revealed publicly in the company’s Strategic Report (if its shares are publicly traded). The BA Team may not like the purposes boards currently choose, but the law neither mandates that choice nor prevents the board from making a different set of choices. Perhaps some dim realisation of these points explains the ambiguity of the word “emphasises”: the use of the indicative rather than the subjunctive tense leaves it unclear whether reform of the law is suggested.

If the above analysis of UK law is correct, it is likely to be even more applicable to legal systems (probably the majority) which dodge the issue by stipulating that the directors promote the “interests of the company” and omit any formal reference to the shareholders, thus leaving the directors with even greater freedom of action.

Incorporating purposes into the company’s constitution

This is to be a voluntary matter, it appears. The government is to provide guidance on how to incorporate purpose commitments into the company’s constitution, but it is not proposed that companies be required to do this. This is a softening of what was proposed in Prosperity, where purpose statements in the articles were proposed to be mandatory. The voluntary approach follows that of the recent French reforms. 

This is a wise decision. We have been here before, of course – in the nineteenth century. The mandatory purpose statement was circumvented then and its modern-day counterpart is likely to be equally avoidable.

In the middle of the nineteenth century, fearing the consequences of the introduction of this new business organisation with limited liability, the legislature required companies to state the areas of business in which they were to operate and the powers they were to have. The courts in the UK (and other common law countries) then applied the “ultra vires” doctrine to this statement: transactions outside the declared purposes were of no legal effect and directors were potentially personally liable to the company for failing to conduct its affairs in accordance with the company’s constitution. Naturally, directors did not relish the prospect of personal liability, but neither did shareholders nor third parties contracting with the company like the ultra vires doctrine. The company might lose valuable business opportunities arising in adjacent areas of activity. (Originally, the statement of purpose was unalterable, so that a new company with fresh capital was needed to exploit non-covered activities, even though the company was well placed to exploit them itself.) Third parties did not welcome the risk of losing a transaction because the company, ex post, sought to argue opportunistically that the contract was beyond its powers, whilst companies lacked effective means to bond themselves in relation to this risk. As usual, only the lawyers benefitted, since an obvious response was to have the lawyers pore over the company’s constitution to see if the proposed transaction was within the company’s objects.

Today, commercial companies are not required to specify their objectives and, more important, the ultra vires rule has been removed.

A better response, however, which boards began to adopt was to take advantage of their drafting freedom and insert in the constitution prolix objects clauses, covering any future activity in which the company might conceivably wish to engage. In its fully developed form, the list would have final clauses which included anything “incidental or conducive” to the achievement of specified activities or even “any other trade or business whatever which in the opinion of the board of directors can be advantageously carried on by the company” in connection with the specified objects. Although this drafting effectively defeated the legislature’s objectives, the courts came to accept it, probably because of the doctrine’s disadvantages mention above. Today, commercial companies are not required to specify their objectives and, more important, the ultra vires rule has been removed.

What does this little piece of legal history tell us about the likely take-up of the facility to include purpose statements in the articles (or for boards to adopt purpose resolutions)? I suggest two things. First, both directors and shareholders will be reluctant to adopt purpose statements which significantly constrain the company’s commercial freedom. Second, both directors and shareholders will be reluctant to avail themselves of constraints which threaten stringent monetary sanctions against either the directors personally or the company.

One way to achieve both objectives would be again to use the lawyers’ drafting skills to produce purpose statements which have a high level of generality and imprecision. Breaches of such statements are difficult to establish. A quick look at the optional statements produced by companies under the recent French reforms suggests this is a likely pattern.   

Shareholders and directors might feel less incentivised to take this avoidance approach if the enforcement mechanism were constrained. Under conditions where breach of the purpose statement did not threaten the validity of corporate transactions, where enforcement lay exclusively in the hands of the shareholders (no third party and especially no civil society enforcement or public authority enforcement, the latter being hinted at in the “Regulation” section of the BA Report) and where the remedy was confined, at least as a first step, to a court order to the directors to observe the purpose statement, shareholders and directors might be willing to take up the option on a significant scale.

We are told that investors are increasingly willing to invest according to ESG criteria, but the breadth and depth of the shareholder taste for this style of investing is unclear

Indeed, this facility might prove an interesting test of shareholders’ ESG commitment. We are told that investors are increasingly willing to invest according to ESG criteria, but the breadth and depth of the shareholder taste for this style of investing is unclear, especially if there is a risk that the company’s financial performance will suffer from its ESG commitments. This proposal might provide an interesting event study.

Conclusion

The directors’ duty proposal arguably calls for no reform of current company law, and the proposal for inclusion of purpose statements in the constitution is avowedly to be implemented through guidance. Does this mean there are no new angles for corporate law in relation to corporate purposes? This would be too negative a conclusion. One might explore ways of making companies’ (voluntary) purpose commitments credible, whether or not they are embedded in the articles or ways of using corporate law to secure better levels of compliance with external regulation. These look like fruitful lines of enquiry, but, unfortunately, not simple ones.

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Paul Davies is Emeritus Fellow of Jesus College Oxford and ECGI Fellow. He was elected a Fellow of the British Academy in 2000, an honorary Queen's Counsel in 2006 and an honorary Bencher of Gray's Inn in 2007. He is a deputy chairman of the Central Arbitration Committee. 

This article reflects solely the views and opinions of the authors. The ECGI does not, consistent with its constitutional purpose, have a view or opinion. If you wish to respond to this article, you can submit a blog article or 'letter to the editor' by clicking here.