Directors have a duty to act in good faith and in the best interests of the corporation. But there is much debate where decision-making discretion lies. A new legal opinion and practice statement from AICD provide greater clarity.
Acting in the best interests of the company means directors should focus on sustainable value creation over time, rather than short-term profit maximisation. While the interests of shareholders are central, directors can, and should, as a matter of practice, consider other stakeholders such as employees, customers and the environment when discharging their duty. Maintaining and advancing the organisation’s reputation and community standing are key considerations.
In Australia, the statutory duty of directors to act in good faith in the best interests of the company came under close scrutiny in the banking Royal Commission. Instances of corporate misconduct and governance failings have continued to raise concerns about whether this duty is being fulfilled in practice. The extent to which directors under Australian law can, and should, factor stakeholder interests into directors’ decision-making when fulfilling their duty to act in good faith in the best interests of the corporation, has also been subject to debate in legal and governance circles. To support directors in understanding and meeting the best interests duty, the AICD commissioned barristers Bret Walker AO SC and Gerald Ng MAICD to examine its current interpretation by Australian courts (Walker-Ng opinion).
Drawing on the view reached by the Walker-Ng opinion, the AICD’s practice statement provides guidance for directors on what it means to act in the best interests of a company in practice.
This is an edited extract of the AICD’s practice statement on the duty of directors to act in good faith in the best interests of the corporation.
Identify the company’s best interests
Directors have the discretion to use their judgement to identify the best interests of the company. Under Australian law, directors must exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose.
The courts have confirmed that directors have considerable discretion in identifying the best interests of a company and its shareholders/ members, and the courts will not second-guess business decisions (unless they are manifestly unreasonable).
Directors have discretion to determine:
- What the best interests of a company are
- Over what time horizon those interests are to be assessed
- The precise nature of interests that are to be advanced or protected — whether they be purely financial, reputational or otherwise.
Relevance of stakeholder interests
The duty requires directors to consider what is in the best interests of shareholders/members as a whole. However, the law does not assume that shareholder/member interests are best served by having no regard to other stakeholders, particularly over the longer term. Rather, employees, customers, suppliers, creditors, Traditional Owners, the environment and broader community are legitimate concerns of company directors, tied back to the long-term interests of the company, including its interest in avoiding reputational harm. Equally, this does not mean there is a duty owed specifically to stakeholders, as distinct from the company. Of course, for directors of a charity or NFP, the purposes of the organisation will necessarily be paramount in the application of the duty.
Directors find themselves in an era where shareholders/members as well as other stakeholders are demanding greater accountability from organisations and their boards than ever before. Whether that be demands for the organisation to prioritise the welfare of its workforce, reduce its environmental impact or address modern slavery risks in its supply chain — it is not difficult to see how the long-term interests of the company can readily intersect with employees, suppliers or, more broadly, the community.
Commissioner Hayne made similar observations in the final report of the banking Royal Commission. Notably, an assessment of what is in the best interests of a company “demands consideration of more than financial returns that will be available to shareholders in any particular period”.
Although there may be some shareholders focused on short-term financial return, there are often as many, if not more, investors who take a long-term view aimed at sustainable value creation.
Commissioner Hayne also stressed that pursuit of the best interests of a financial services entity is a more complicated task than a binary choice between the interests of shareholders and the interests of customers, and that over time, the interests of different stakeholders will converge.
“...The longer the period of reference, the more likely it is that the interests of shareholders, customers, employees and all associated with any corporation will be seen as converging on the corporation’s continued long-term financial advantage.” (Royal Commission final report, p403.)
Directors should also note that the law commonly imposes specific obligations on the company with respect to the interests of customers, employees, suppliers and the community, which may necessitate the prioritisation of those interests. For example, obligations relating to environmental protection or employee safety.
In these circumstances, directors are required to comply with those obligations in the course of decision-making, even if that jeopardises returns that might otherwise be enjoyed by shareholders/ members. In the context of a company’s potential insolvency, it is widely accepted that considering the best interests of the company and its shareholders/ members will closely align with the interests of its creditors. Put differently, a failure by directors to take into account the interests of creditors will have adverse consequences for the creditors and the company.
How Australia compares internationally
The AICD commissioned law firm Allens Linklaters to compare the best interests duty in Australia with the equivalent duty in comparative jurisdictions. This research shows that Australia’s approach to factoring stakeholder interests into decision- making is largely aligned in practice.
Some jurisdictions, such as Canada and the United Kingdom, have more expressly required under their equivalent legislation that stakeholder interests (such as employees, the environment and consumers) be considered when acting in the best interests of the company.
However, the lack of prescription under the Australian statutory duty does not appear to make a marked difference in the practical operation of the duty. The courts in Australia consider it reasonable for directors to factor the interests of a range of stakeholders into decision-making when acting in the best interests of the company, and directors are in the practice of doing so as a matter of good governance.
Long-term interests of the company
The AICD encourages directors to consider the long-term interests of the company. Boards operate in an increasingly complex environment and directors’ decisions can have a significant effect on a range of stakeholders beyond shareholders.
Heightened expectations of corporate behaviour with respect to issues such as the environment, data protection, Traditional Owners’ rights and workplace culture mean that the best interests of the company can rarely be isolated from the interests of its stakeholders. Rather, to build long-term value for organisations, it is critical the legitimate concerns of stakeholders are heard. The AICD publication Elevating Stakeholder Voices to the Board provides practical guidance on how such perspectives can be considered in decision-making.
It must be acknowledged that there will be times when the interests of shareholders and stakeholders will conflict, especially over the short term. Indeed, stakeholder views are rarely homogenous, and are sometimes irreconcilable with each other. The AICD endorses the position under Australian law that directors:
- Have considerable discretion in determining what is in the best interests of a company
- Are permitted to consider a range of stakeholders beyond shareholders in deciding what is in the best long-term interests of those.
In a practical sense, doing so is often necessary to protect an organisation’s reputation and ensure its sustainability over the longer term.
The Walker-Ng legal opinion should provide directors with comfort that stakeholder interests are a legitimate concern of directors, and that courts will not, except in egregious cases involving clear self-interest or acting contrary to the company’s interests, seek to question their judgement with hindsight. As a guiding principle, directors should take a long-term view of where the company’s interests lie, while seeking to maintain as respectful and transparent a relationship as possible with stakeholder groups.
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