Directors' Decisions and the Law

Promoting Success

Alice Belcher

• Publisher: Routledge
• Year: 2014
• eBook ISBN: 9781134445295
• Edition: 1
• Topic: Law
• Subtopic: Business Ethics
• Index: Law

Directors are key decision-makers in any organisation, whether it is in the public sector, a family business or a transnational company. The UK Companies Act 2006 codified directors' duties for the first time and describes the director as the 'most likely to promote the success of the company for the benefit of its members as a whole'.

This book addresses key tensions and problems involved in the duties and responsibilities of the director in promoting success, including corporate culture and credibility, trust, risk and uncertainty, collective responsibility, and the degree of control. The book considers directors' decision-making in both private and public sector organisations and explicitly examines aspects of decision-making during periods of financial distress. The book compares the legal contexts of director's decisions in the UK to those of the USA, Germany and Australia, and takes an interdisciplinary approach in its combination of management theory, economic theory and behavioural studies. In doing so the book addresses issues key to the understanding of corporate governance in light of recent financial crises.

Introduction¹

1.1 Introduction

Directors are key decision-makers. This is true for organisations in the private sector and the public sector, and whether a company is a family business or part of a transnational group. The UK Companies Act 2006 includes directors’ duties in a codified form for the first time. The title of this book is taken from one of the newly codified duties:

172 Duty to promote the success of the company

(1) A director of a company must 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 . . .²

It is a book about directors individually and collectively and about their organisations. It is a book rooted in the law, but willing to explore the basic issues involved in being a director in ways that go well beyond the law.³ In this opening chapter some of the key tensions and problems addressed in more detail later in the book are exposed for the first time. These include the distinction between human persons and other forms of person, in particular the legal person that is the company; the difficulty for a director posed by the multiple levels of responsibility that could attach to a single decision (individual, collective as a board, collective as the company itself); and the problem of the degree of control – this can be a real and a theoretical issue but comes down to whether company culture, strategy, etc. can be controlled or must be in some sense emergent. In order to introduce these topics in ways that go further than the superficial phrases just given, but without spoiling the reader’s pleasure in the later chapters, this introduction is presented as a set of vignettes showing the directors through a series of lenses. The aim is not to complete a picture, rather it is to tempt the reader into the rest of the book. The lenses are linked with and prefigure topics in the book, which is in three parts. Part I – Contexts – explores the settings for directors’ decisionmaking in chapters on the private sector; the public sector; and the organisation in (or close to) financial distress. Part II – Themes – approaches directors’ decisions via a set of themes that each prompt innovatory interdisciplinary investigations. However, each theme has a practical basis and came out of the author’s experience as a non-executive director of an NHS body in Scotland.⁴ For instance, the reason for exploring “trust in the boardroom” was the statement made to board members of public bodies in Scotland that “the effective board member . . . gains the trust and respect of other board members”. This felt odd when juxtaposed with case law in which courts have disqualified directors, in effect, for trusting their fellow directors too much. Other themes in Part II are risk and uncertainty, corporate culture, and credibility. Part III – Levels – is structured around levels of decision-making and responsibility. The chapters explore a director’s individual responsibility; the rhetoric of collective responsibility (of the board or its subcommittees); and finally governance between organisations. This last topic has a very practical application in the public sector where the use of protocols and memorandums of understanding abound and these often involve pseudo organisations that sit somewhere between organisations as constituted, but it could also apply to the exposure of private sector organisations to risk through joint venture agreements and agreements between companies and nation states. The vignettes included in this introduction are about the directors within Company Law, the directors within Corporate Strategy and the directors within Economics.

1.2 Directors through the lens of the company

The company is such a familiar thing that to view the directors through it seems an odd beginning, especially as this book also aims to study directors operating not only in the private sector but also in the public sector where organisations are mostly not constituted as companies. However, the company that is used for this vignette is Aron Salomon and Company Limited, the company that caused arguably the most significant case in all company law: Salomon v Salomon heard by the House of Lords in 1895.⁵ The persons involved in the drama of Salomon v Salomon are: A. Salomon & Co. Ltd, a company incorporated under the Companies Act 1862; the trade creditors of the business, those supplying raw materials on credit with no security; and the debenture-holders, those supplying a large loan to the company secured on its assets. We also meet Mr Salomon himself, wearing various hats; first Mr Salomon, the Victorian entrepreneur and self-made man; second Mr Salomon, the major shareholder of the Company; third Mr Salomon, a debenture-holder of the company; and finally Mr Salomon, the director of the company. One of the reasons for approaching directors’ decisions in the context of this case is to emphasise the importance of the formal legal constitution of an organisation. It also serves to point up first the tensions between substance and form; second the differences in possible attitudes to risk taking (from protecting risk takers from themselves to leaving them to face consequences); and third the difference between expecting individuals to obtain and understand information that is theoretically available to them and placing the onus on those with information to provide it.

What company law students remember about the case of Salomon v Salomon is that the House of Lords held the company to be a legal person separate from its shareholders. Mr Salomon, the director and business decision-maker, is not significant in the case; only Mr Salomon, the shareholder, and Mr Salomon, the secured creditor, are significant. It should also be noted that although Salomon v Salomon is also a case about corporate insolvency. Mr Salomon successfully managed his business; indeed, he promoted its success, and is praised by the House of Lords for doing so. However, the Mr Salomon who directed his company into insolvency is missing from the case. The principle that a company has an independent legal personality, separate from its shareholders, means that a veil (of incorporation) is drawn around the company, and that the company is capable of independent actions, as a legal person, such as suing, being sued, holding property, and having an insurable interest in property. In coming to its decision the House of Lords reversed the decisions of both Vaughan Williams J. and the Court of Appeal. These basics about the case will be well known to law students and later developments where the veil of incorporation has, and has not, been lifted have been written about extensively. The consequences of this decision have been played out in the context of very small companies where the veil can prevent the court from seeing an individual human being hiding behind the company, and in the context of very large corporate groups where the veil can prevent the court from seeing beyond the particular individual company to reach the assets of other companies within the group. In order to recognise the independent legal person that is the company, the courts have been obliged to also recognise its separation from other legal actors such as shareholders, other companies within a group structure, and the directors. Sometimes this separation has not been tolerated by the courts for instance where the human shareholder is an enemy alien at a time of war. Sometimes the result of the separation produces an apparent injustice – for instance, where industrial disease is the fault of one company in a group, the assets of the group as a whole are plentiful but held by group companies that cannot individually be held at fault, and the assets of the company at fault are small or non-existent. Faced with various scenarios of apparent injustice in the application of the decision in Salomon v Salomon, there are now a range of cases where the veil of incorporation has been lifted. These cases form the basis of an extensive academic literature that reveals the subsequent importance of the main principle laid down in 1896. The importance of the decision was not underestimated at the time, as shown by the fact that six judges sat in the House of Lords. While the consequences of the decision have been covered extensively, the background to the case has been less widely written about. The House of Lords judgment should perhaps be seen in its social, policy and legal context by focusing on the Victorian setting that covers a period of over 40 years from the first Limited Liability Act in 1855 to the reporting of the decision in 1897. It also allows a discussion on Victorian attitudes to information gathering, risk-taking and matters of substance rather than form – matters that appear again later in the book.

1.2.1 The facts

The case concerned a company formed in 1892 that by 1893 was in default on its debentures, resulting in an action being brought by Broderip, the main debenture-holder, on behalf of himself and all the other debenture-holders, including the appellant, Salomon. A debenture-holder is a secured creditor usually entitled to demand that the assets securing the loan are sold and the proceeds used to return the amount loaned plus accrued interest. If the assets used as security are vital to the running of the business, an action by debentureholders will lead to the liquidation of a company. By the time the case reached the House of Lords, Broderip had been paid off, but the company was in liquidation and the main practical consequence of the decision was to allow Salomon as the other debenture-holder to take the remainder of the company’s assets by ranking ahead of both the unsecured creditors and the shareholders. Salomon was, up to the incorporation, a sole trader operating on his own account with unlimited liability to his trade creditors. After incorporation the assets of the business were transferred to the company, the existing debts were paid off and a loan was raised using debentures coupled with a floating charge as security. At the time of the default the lender, Broderip, held the debentures and Salomon had a beneficial interest in their residual value. In his capacity as debenture-holder, Salomon would rank ahead of trade creditors and shareholders, including himself. The bargain he made when the company was incorporated was that the business assets that were his personally as a sole trader were transferred to the company in exchange for paid up shares and his interest in the debentures. In his capacity as shareholder Salomon held paidup shares. There was no further capital available to be called up and his liability was limited if the company was properly constituted as a limited liability company under the Companies Act 1862.

The crucial issue before the House of Lords became the interpretation of the provisions of that Act, which was itself consolidating legislation with the relevant provisions first appearing in the Limited Liability Act 1856 as amendments to the first Limited Liability Act dated 1855. This puts a gap of forty years between the passing of the relevant statutory provisions and the House of Lords’ interpretation in Salomon v Salomon. Other salient facts are that 20,001 of the company’s 20,007 shares were held by Salomon with the other 6 held one each by Salomon’s wife, a daughter and four sons, all the terms of sale of the business to the company being known to and approved by the shareholders. Salomon was also appointed director of the company.

1.2.2 Self-help and the “self-made man”

Although Salomon v Salomon can be seen as a case that turns on the i...

Table of contents

• Cover
• Half Title
• Series Title
• Title Page
• Copyright
• Table of Contents
• Acknowledgements
• Table of cases
• Table of statutes
• 1 Introduction
• PART I Contexts
• PART II Themes
• PART III Levels
• Index