The principal duty for directors exercising their decision-making power is to act in good faith for the benefit of the company as a whole. When it comes to making business decisions in complex situations, applying this duty can be difficult and lead to misunderstanding and disagreement between directors and shareholders.
COVID-19 has exemplified the challenges directors face in complex situations. Directors are considering whether to retrench staff, reduce salaries or require no pay leave, whether to renegotiate contracts with customers and suppliers and overall, what impact the decision has on the company’s survival, profitability and long-term success. Outside of the COVID-19 situation, there is growing pressure from shareholders, governments and other stakeholders for companies to take proactive measures on environmental and social matters. In these complex situations, what framework do directors have to assess whether a decision is in the best interests of the company?
1. Decision-Making Theories Cause Differences of Opinion
Two main theories of board decision making have dominated discussion – the ‘shareholder primary’ model and the ‘stakeholder’ model. The shareholder primary model correlates the company’s best interests only with its shareholders. Alternatively, the ‘stakeholder’ model stresses the company’s relationships with its customers, suppliers, employees, shareholders, communities and others who have a stake in the organisation.
The UK adopted a form of stakeholder model for directors’ duties in the Companies Act 2006. With the introduction of the UK Companies (Miscellaneous Reporting) Regulations 2018, listed and large private UK companies must prepare a strategic report which includes a statement which describes how the directors have had regard to stakeholders when performing their duties. Directors are encouraged to take a holistic approach and ensure the factors are embedded into everything they do as a director.
Beyond these two models, new forms and theories of decision-making and organisations structures continue to evolve. New organisational theories provide opportunities for organisations to develop innovative decision-making, corporate governance and organisational structures to address their complex business and social challenges beyond the shareholder and stakeholder models.
2. Hong Kong Companies have Some Flexibility to Define their Principles
Each organisation’s shareholders and directors will have different attitudes and preferences when it comes to decision-making principles, whether they fall within the shareholder model, stakeholder model or some other model.
During the 2008 consultation process for the Hong Kong Companies Ordinance (Cap 622), it was considered whether the duty to act for the benefit of the company as a whole, should be codified. Responses were highly divided. Concerns were raised that doing so would reduce flexibility and may not fit with the beliefs of some companies. The Standing Committee on Company Law Reform concluded that it was premature at that time to codify this duty. This leaves both uncertainty, as shareholders and directors may have different views on how to exercise this duty, and flexibility, for shareholders and directors to define decision making principles within the overall broad framework.
3. Beyond the Shareholder Versus Stakeholder Debate
In the meantime, organisations are starting to go deep into stakeholder concepts and how to drive long-term profitability and sustainability. This is on the back of a number of recent statements by leading local and international players which illustrate the shift towards more complex and community orientated company decision-making:
- expanded Environmental, Social and Governance (“ESG”) reporting requirements of companies listed on the Stock Exchange of Hong Kong;
- US Business Roundtable statement from 181 CEOs from leading US companies supporting the stakeholder model;
- World Economic Forum’s Davos Manifesto 2020: the Universal Purpose of a Company in the Fourth Industrial Revolution which focuses on the importance of purpose and stakeholders and the role of companies within the community;
- CEO of Blackrock calls for companies to embrace purpose and serve all stakeholders; and
- legislation in the US and other countries creating new forms of for-profit companies which include a positive impact on society and community as part of their fundamental objectives.
4. Why does this Matter to a HK Lawyer?
The impact of COVID-19 has resulted in many organisations refocusing on how they operate internally and how they operate within their communities. With this growing focus on stakeholders and sustainability, external and in-house lawyers can be at the forefront of enabling organisations to achieve these efforts by advising on how those goals and principles intertwine with legal and governance documents and obligations. Defining decision-making principles can add significant clarity and promote the success of the organisation.
Advising in this area comes with the challenge of understanding the latest local and international organisational structuring, governance and sustainability trends. Nevertheless, it provides an opportunity for lawyers in Hong Kong to be a key element in how this area develops in Hong Kong and across Asia-Pacific.
– Michael Horman,
Director of Corporate Finance & Legal,
NISI (HK) Limited
Editorial Note: This is a summary of the article “COVID-19 Opens New Opportunities for Corporate Governance and Sustainability” which was circulated via Hong Kong Lawyer eNewsletter and posted on Hong Kong Lawyer website in June 2020.