Corporate governance reporting under Section 172 of the Companies Act 2006

As of June 2018, pending legislation will require companies meeting certain criteria to report on their compliance with Section 172 of The Companies Act 2006.

Section 172 is a part of the section of the Act which defines the duties of a company director, and concerns the “duty to promote the success of the company”.

What is noteworthy about Section 172 is the diverse range of stakeholders whose interests are said to feature in the “success of the company” – shareholders, employees, suppliers and local communities affected by company activities are all included.

Subject to Parliamentary approval, the new requirements will apply to company reporting on financial years starting on or after 1 January 2019. The first actual reporting under the new regulations will therefore start in 2020.

Section 172 in detail

Here is the full wording of Section 172:

Section 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, and in doing so have regard (amongst other matters) to —

(a) the likely consequences of any decision in the long term,

(b) the interests of the company’s employees,

(c) the need to foster the company’s business relationships with suppliers, customers and others,

(d) the impact of the company’s operations on the community and the environment,

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company.

(2) Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.

(3) The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.

Which companies will have to report compliance with Section 172?

Companies required to report on their compliance with Section 172 will be those already required to produce a Strategic Report. These companies will therefore meet two of the following three criteria:

• Turnover above £36mn
• Balance sheet assets above £18mn
• More than 250 employees

These criteria suggest that small companies are always exempt from Section 172. This is not always the case – companies active in several sectors (especially regulated financial services) cannot exercise Small Company exemptions from reporting, regardless of size. For more information see the UK Government’s Legislation website.

The new reporting requirements do not apply to businesses not constituted as companies – such as LLPs and charities.

How is compliance with Section 172 to be reported?

• Qualifying companies will be required to include a Section 172 statement within their annual Strategic Report. The Statement must be clearly identifiable and separate from the main report body.
• The Section 172 statement must be available online. Quoted companies are already required to post their annual report online, but unquoted companies which currently do not publish their annual report will have make provision for making their Section 172 statement accessible on the web.
• The Section 172 statement should include an “appropriate” level of detail sufficient to show which stakeholders featured in the board’s decision making, and how the interests of those stakeholders were treated during board deliberations. (This is the demonstrating “regard” part).
• Companies with more than 250 UK employees will be required to include a statement as part of their directors’ report summarising how the directors have engaged with employees, how they have had regard to employee interests and the effect of that regard, including on the principal decisions taken by the company in the financial year.

Corporate governance issues relating to Section 172

During the passage of the Companies Act 2006, Section 172 was one of its most intensely debated elements, and remains the focus of discussion in corporate governance and legal circles.

Previous legislation and common law already demanded that company directors be ‘fit and proper’ persons and conduct their business activities fairly. A superficial reading would suggest that Section 172 just adds more detail – but there are two key issues:

Having ‘regard’ for stakeholders

Section 172 defines company success as promoting the interests of shareholders while taking account of a diverse group of stakeholders. From this arises the challenge for a company director to demonstrate regard for stakeholder interests which may conflict with what might be best for shareholders. A simple illustration – A company board concludes that it is in the long term interest of the business to close a production site with 1,000 redundancies. Certainly such a decision may make sense for shareholders, but the 1,000 employees affected will not feel their interests have been served.

Enforcement

The Companies Act 2006 did not change the fact that company directors are (provided they commit no outright criminal act) solely accountable to the company and its members or shareholders.  Provided a board can demonstrate that the concerns of various stakeholders are considered as part of a board decision, a class of stakeholders adversely affected by a decision has little recourse against the directors if it cannot secure the support of company members/shareholders.

IoD Professional Development and corporate governance

The IoD is committed to the principle that company directors trained in proper corporate governance make better decisions which build long-term value for their companies and stakeholders.

Section 172 features in the IoD Professional Development course The Role of the Director and the Board, which is open to both IoD members and non-members.

The legal obligations of UK companies can be discussed with the IoD Directors Advisory Service.

Specific questions on UK company law can be answered by the IoD Directors Law Express helpline.

The Business Information Service, Directors Advisory Service and Directors Law Express are all IoD membership benefits and are exclusively for IoD members.

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