Skip to content
Journal

Revisiting the legal basis of shareholder primacy

  • To what extent is the shareholder primacy norm still relevant in Australian company law in 2019?
  • Recent case law recognises that the interests of shareholders are distinct from the interests of the company, and that these interests will often overlap, but that does not make them the same.
  • Is law reform needed to address rising community concerns about the standard of corporate conduct in Australia?

The duties and responsibilities of company officers have been highly topical in recent times, with a number of corporate scandals and seemingly widespread contraventions of financial laws that have outraged the community, the media and our politicians and called into question whether companies and their boards are putting profits above all else, even the law.

Indeed, a variety of events have contributed to an ongoing battle over the direction of corporate cultures inside Australian companies.1 The APRA report into the Commonwealth Bank has, rightly, generated considerable debate within Australia’s boardrooms about the risks of devoting too much attention to achieving financial goals and managing financial risk at the expense of stakeholder management and managing non-financial risks.2

The Final Report of the Banking and Financial Services Royal Commission has highlighted seemingly widespread conduct, from both large and small businesses, that has fallen well below community expectations. The commission’s final report, released on 1 February 2019, puts much of the blame on greed, both at the individual and institutional level.3 Many of the companies involved have been consistently successful in generating high returns for shareholders and have performed strongly on the stock market over a long period. Greed, it seems, is no longer good, or at least not good enough.4 Making consistently high returns for shareholders is no longer enough, if indeed that ever was enough, to satisfy directors’ legal duties owed to their companies.

These developments raise legitimate questions about what role the law can, and should, play in regulating conduct inside corporate boardrooms. The contours of the debate focus on the continuing relevance of the ‘shareholder primacy norm’, which refers to the idea that corporate directors and managers should focus their efforts on generating returns for shareholders. The debate concerning shareholder primacy has a long history in corporate law, dating back at least to the Great Depression. The frequently cited debate between American professors Adolf Berle and Merrick Dodd has provided the basic framework for the debate since the 1930s. Both leading corporate law professors were concerned with the rise of large companies and their effect on society, but they differed in what they considered to be the best way to address those concerns. In 1931, Professor Berle published an article in the Harvard Law Review,5 where he argued that directors were to exercise powers ‘only for the ratable benefit of all the shareholders as their interest appears.’6 Professor Dodd responded to this article the following year,7 and wrote:8

‘it is undesirable…to give increased emphasis at the present time to the view that business corporations exist for the sole purpose of making profits for their stockholders… public opinion, which ultimately makes law, has made and is today making substantial strides in the direction of a view of the business corporation as an economic institution which has a social service as well as a profit-making function, that this view has already had some effect upon legal theory, and that it is likely to have a greatly increased effect upon the latter in the near future’

Berle’s response, in the same year, was to argue that moving away from shareholder primacy to broader constituencies would result in a dilution of the system of accountability for directors and their management teams.9 Dodd drew support for this view from quotes from a number of leading business leaders who spoke of the need for business to serve community interests.10 Dodd also argued that management was becoming increasingly professional and, as such, this would generate an inherent sense of public duty and public benefit, even if such goals were aligned with long-term shareholder wealth in helping to minimise the potential for more restrictive regulation.11 Berle later came to concede that Dodd’s view had seemingly prevailed (at least up until that time in the 1950s),12 and went on to advocate for management to focus on the social responsibilities of corporations as social and political forces in the community.13

Professor Berle’s early view of the directors’ duties was reinforced by the rise of law and economics in the 1970s. The widely discussed article in the New York Times Magazine in 1970 by economist Milton Friedman’s declared that the only responsibility of corporate managers was ‘to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom’.14 This was justified on the basis that the corporate managers were agents of the owners of those corporations (that is, the shareholders). In Friedman’s view, corporate social responsibility involved spending shareholders’ money to support some general social interest.

The central question that this article considers is, to what extent is the shareholder primacy norm still relevant in Australian company law in 2019, and what might the future hold for the continued use of the norm in our law?

Legal recognition of shareholder primacy

The legal duties of company directors are derived from both general law and under statute.15 The most relevant duty for present purposes is the equitable duty to act ‘bona fide in the interests of the company’. There are a number of slight variations on this wording of the duty that can be found in judicial statements, such as ‘for the benefit of the company’, ‘for the best interests of the company’ and for ‘the company as a whole’.

The classic statement of the duty was given in Re Smith & Fawcett Ltd [1942] Ch 304 at 306, where Lord Greene MR explained that when directors exercise discretionary powers given to them under the company’s articles, they must:16

‘exercise their discretion bona fide in what they consider — not what a court may consider — is in the interests of the company, and not for any collateral purpose.’

The High Court of Australia had earlier held that the decision by directors to exercise a discretionary power was to be ‘bona fide in what they believed to be the interests of the company.’17

This duty is also found in the statute in s 181(1)(a) of the Corporations Act 2001, which states:

(1) A director or other officer of a corporation must exercise their powers and discharge their duties:

(a) in good faith in the best interests of the corporation; and

(b) for a proper purpose.

Although there are different lines of authority as to whether this provision involves one overarching duty or two separate duties (good faith and proper purpose), there is majority support for the latter view.18 The focus of this article is therefore on the scope of s 181(1)(a), and in particular the meaning of the phrase ‘the best interests of the corporation’.

There appears to be considerable authority, both under statutory and at general law to support shareholder primacy in Australian company law. However, it is argued that the Greenhalgh test gives an incomplete picture of the contours of Australian directors’ duties.

The phrase ‘the interests of the company’ is not defined in the Corporations Act 2001 (Corporations Act). The most frequently cited authority on the meaning of the phrase is the decision in Greenhalgh v Arderne Cinema [1951] Ch 286, which concerned a company whose constitution required shares to be sold to existing members if any such members were willing to purchase them. The managing director (who, together with his associates, held a majority ordinary shares) convened an extraordinary members meeting to change the constitution to require directors to transfer shares to an outsider where the members passed a resolution and named the transferee in the resolution. After the constitution was changed by passing a special resolution, a resolution was then immediately passed to allow the sale from the majority shareholder of a large parcel of shares to an outsider. A minority shareholder challenged the resolutions approving the sale. Evershed MR then stated (at 291):

‘Certain principles, I think, can be safely stated as emerging from those authorities. In the first place, I think it is now plain that ‘bona fide for the benefit of the company as a whole’means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase, ‘the company as a whole’, does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is, in the honest opinion of those who voted in its favour, for that person’s benefit.’

The court held that there was no evidence of any bad faith in passing the resolution as it did not unfairly discriminate between shareholders, any of whom could have sold their shares as part of the transaction. The resolutions were therefore upheld.

The statement of principle from Greenhalgh’s case was applied by the High Court of Australia in Ngurli v McCann.19 It has been broadly accepted that when Evershed MR spoke of the ‘corporators’, his Honour was referring to the shareholders of the company.20

There is further Australian authority for the view that the meaning of the term ‘the interests of the company as a whole’ refers specifically to the interests of shareholders as a whole.21 Indeed, in one case the very suggestion of any distinction between the interests of the company and the interests of the members was rejected as being a fundamentally flawed argument.22 It has even been held that ‘the consideration as to whether directors have complied with their duties involves a determination of whether the conduct diverged from the interests of the company’s shareholders’.23

The imperative to act in the interests of the members as a whole is also found in various statutory provisions in the Corporations Act, such as:

  • s 232(d) (dealing with rights of minority members);
  • s 207 (dealing with the purpose of the related party transaction provisions in Ch 2E);
  • s 254T (protecting the interests of the ‘shareholders as a whole’ when deciding whether dividends could be paid); and
  • s 256B (protecting the interests of the ‘shareholders as a whole’ in authorised capital reductions).

There appears to be considerable authority, both under statutory and at general law to support shareholder primacy in Australian company law. However, it is argued that the Greenhalgh test gives an incomplete picture of the contours of Australian directors’ duties.

Critique of the Greenhalgh test

Sir Douglas Menzies, writing extra-judicially in the aftermath of the Greenhalgh decision, in one of the first detailed articles on the Australian law of directors’ duties, noted that company directors and their legal advisers may have some difficulty in following Greenhalgh.24 A conceptual difficulty was expressed by the learned author as follows:25

‘it may appear to be something of a contradiction to say on the one hand the directors owe no duty whatever to the shareholders but only to the company, and then to say that in considering the exercise of their powers they must consider the interests of shareholders, that is, those to whom they owe no duty.’

The learned author also expressed concern about the practicality of identifying and applying what could be considered to be the interests of the general body of shareholders.26 The interests of actual shareholders are simply not homogeneous but will vary greatly between long and short term investors and between different groups of investors such as between institutional and retail shareholders.

Prior to Greenhalgh, it had been held that the interests of the company as a whole meant the company as a separate trading entity, regardless of who the shareholders happen to be.27 This is consistent with the reasoning in the seminal decision of Salomon v A. Salomon & Co Ltd [1897] AC 22. The principal effect of the ruling in Salomon’s case is that the separate legal status of a properly registered company is not to be diminished by the identity of the controlling shareholders. Put simply, the validity and legal consequences of the company’s decisions (such as whether to incur debts) does not depend on who the actual shareholders are. As was stated by the English Court of Appeal in Fulham Football Club Ltd v Cabra Estates plc [1992] BCC 863 at 876, ‘[t]he duties owed by the directors are to the company and the company is more than just the sum total of its members’.

Greenhalgh’s case was considered in detail by Owen J in Bell Group Ltd (in liq) v Westpac Banking Corp (No 9) [2008] WASC 239; (2008) 70 ACSR 1 at [4393] and [4395], who explained that Evershed MR’s statement (quoted above):

‘does not mean that the general body of shareholders is always and for all purposes the embodiment of ‘the company as a whole’. It will depend on the context, including the type of company and the nature of the impugned activity or decision. And it may also depend on whether the company is a thriving ongoing entity or whether its continued existence is problematic. In my view the interests of shareholders and the interests of the company may be seen as correlative not because the shareholders are the company but, rather, because the interests of the company and the interests of the shareholders intersect …

It is, in my view, incorrect to read the phrases ‘acting in the best interests of the company’ and ‘acting in the best interests of the shareholders’ as if they meant exactly the same thing. To do so is to misconceive the true nature of the fiduciary relationship between a director and the company. And it ignores the range of other interests that might (again, depending on the circumstances of the company and the nature of the power to be exercised) legitimately be considered. On the other hand, it is almost axiomatic to say that the content of the duty may (and usually will) include a consideration of the interests of shareholders. But it does not follow that in determining the content of the duty to act in the interests of the company, the concerns of shareholders are the only ones to which attention need be directed or that the legitimate interests of other groups can safely be ignored.’

This passage was not specifically discussed on appeal.28 There is support for this view in the High Court of Australia’s decision in Pilmer v Duke Group (in liq) (2001) 207 CLR 165,29 where it was stated by McHugh, Gummow, Hayne, Callinan JJ (at [18]) that it:

‘may be readily accepted that directors and other officers of a company must act in the interests of the company as a whole and that this will usually require those persons to have close regard to how their actions will affect shareholders.’

This recognises that the interests of shareholders are distinct from the interests of the company, and that these interests will often overlap, but that does not make them the same. Recently in in United Petroleum Australia Pty Ltd v Herbert Smith Freehills (2018) 128 ACSR 324 at [748]-[749], the court raised doubts as to whether Greenhalgh still represented the law, stating: ‘In more recent times, the view has been expressed that the general body of shareholders does not always, and for all purposes, embody “the company as a whole”.’

These cases clearly envisage that the interests of the company can be more than the interests of the shareholder.

Shareholder primacy is not seriously under threat by these changing times, because it has only ever been one part of the story.

Taking broader interests into account

The question of whether directors can take non-shareholder interests into account while still complying with their duty to act in good faith in the interests of the company is largely settled. In Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 rejected the test of assessing whether the directors’ power was exercised for the benefit of the company as a whole as being sufficient on its own. The Privy Council (at 836-837) approved of the reasoning in Teck Corp Ltd v Millar (1972) 33 DLR (3d) 288, where Berger J held (at [107]) that directors were entitled to exercise their managerial discretion to balance a range of interests (shareholders, employees and the community):

‘if they (the directors) observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company’

Justice Berger went on (at [109]) to confirm that directors could consider the potential consequences of a successful takeover for the company. The reasoning in the Teck case was explicitly approved by Wilson J in Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 at 305, and is consistent with the decision in Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483 at 493:

‘Directors in whom are vested the right and the duty of deciding where the company’s interests lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts’.

When exercising management decision-making power, company directors are permitted to take into account a range of considerations, as long as such considerations are not tainted by bad faith or some collateral purpose, that is, a purpose other than seeking to benefit the interests of the company.30 The company’s interest may often overlap with the actual (or hypothesised) interests of shareholders, but (to apply Owen J’s statement from Bell, quoted above) those interests remain distinct. The board may keep shareholder interests front of mind, because to fail to do so may result in them losing their board positions through a membership vote, or may encourage an activist investor campaign, but it is not because the law demands that that must be the only focus of their attention.

Is legislative change required?

Over the past 30 years, there has been a movement to give greater scope for corporate boards to take into account stakeholder interests, through the introduction of constituency statutes, which involve legislative provisions that specifically permit directors to consider non-shareholder interests. These are found in over 40 states in the United States (where corporate law is state-based), although not in the leading corporate law state of Delaware.31 More recently, the UK introduced the ‘enlightened shareholder model’ in the Companies Act 2006 (UK) s172, which provides:32

s 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.

This provision specifically endorses non-shareholder considerations to be considered by directors and does so in a non-exclusive manner so that interests which do not fall on the list in s 172(1) could still be considered by the directors. The determination of what matters should be considered for particular decisions before the board will involve the directors’ exercise of their business judgment, acting in accordance with their duty of care.33 The learned authors of Buckley on the Companies Acts argue that the ‘success of the company’ should equate to ‘long-term shareholder value’.34 This provision clearly does not reject shareholder primacy, because the wording of s 172(1) makes it clear that the ‘promotion of the success of the company’ is ‘for the benefit of the members as a whole’. Furthermore, while a range of stakeholder interests are recognised, there are no specific enforcement mechanisms provided to non-shareholder stakeholders. It is arguable that the provision adds value in better educating directors of their legal entitlement to consider a broad range of interests in promoting the success of the company.35

Shareholder primacy is not being seriously challenged by such legislative reform, at least in so far as requiring directors to balance competing stakeholder interests. While constituency statutes appear to give directors greater flexibility in decision-making, this flexibility is already available under existing law. This is one of the main reasons why government inquiries into corporate social responsibility have previously rejected the need to introduce constituency statutes into Australian company law.36

Conclusion

Is the shareholder primacy norm under threat from the seemingly rising community concerns about the standard of corporate conduct in Australia? Is law reform needed to address these concerns? In the author’s view, the answer to both questions is no.

This article has argued that while concerns about whether the shareholder primacy norm prevails over stakeholder theory continue to give rise to active debate (with vociferous and keenly entrenched positions on both sides). In the author’s view, that debate may well be intractable, but it is not one that should seriously concern Australian corporate boards, at least in terms of worrying about whether they have complied with their legal directors’ duties. While there are a number of cases that seek to assimilate the interests of the company with the interests of the shareholders, there are an equally weighty line of legal precedents that recognise that directors can and should take into account a variety of factors when making decisions.

The law should not seek to unduly constrain board decision making by mandating that particular considerations be taken into account. Offering a smorgasbord of options for consideration won’t lead to decisions that are more socially desirable. That is because company law has long allowed directors to take into account broad considerations, while holding them accountable by discouraging and constraining self-dealing and improper exercises of power done in bad faith. It is for the board to consider what the best interests of the company are, not the courts, and preferably not the legislature either.

When board members make decisions, they include a variety of considerations. They do so not simply because the law directs them to, but because of the commercial benefit in doing so. Shareholder primacy is not seriously under threat by these changing times, because it has only ever been one part of the story.

Notes
  1. See Jason Harris, ‘Corporate Cultures under Scrutiny’ (2018) 92(11) Australian Law Journal 882.
  2. APRA, Prudential Inquiry into the Commonwealth Bank of Australia by APRA (April 2018), available from www.apra.gov.au.
  3. Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Final Report, 1 February 2019, p138.
  4. Apologies to Gordon Gecko (played by Michael Douglas) in ‘Wall Street’ (1987, Oliver Stone, 20th Century Fox).
  5. Adolf Berle, ‘Corporate powers as powers in trust’ (1931) 44 Harvard Law Review 1049.
  6. Ibid, at 1049.
  7. Merrick Dodd, ‘For Whom are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review 1145.
  8. Ibid, at 1147-1148.
  9. Adolf Berle, ‘For whom corporate managers are trustees; a note’ (1932) 45 Harvard Law Review 1365 at 1167-1168.
  10. Merrick Dodd, ‘For Whom are Corporate Managers Trustees?’ (1932) 45 Harvard Law Review 1145 at 1154.
  11. Ibid, at 1153-1154.
  12. Adolf Berle, The 20th Century Capitalist Revolution, Harcourt Brace, 1954, at p169.
  13. See the detailed summary in Harwell Wells, ‘The Cycles of Corporate Social Responsibility: An Historical Retrospective for the Twenty-first Century’ (2002) 51 Kansas Law Review 77.
  14. Milton Friedman, ‘The Social Responsibility of Business is to Increase its Profits’, The New York Times Magazine, 13 September 1970. The full text of the article is available from http://umich.edu/~thecore/doc/Friedman.pdf
  15. Corporations Act 2001 ss 180-185. See further, Robert Austin, Harold Ford and Ian Ramsay, Company Directors: Principles of Law and Corporate Governance, LexisNexis Butterworths, 2005, Part B.
  16. Cited with approval in Abrahams v Federal Commissioner of Taxation (1944) 70 CLR 23. A similar statement was made by Latham CJ in Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 481.
  17. Australian Metropolitan Life Assurance Company Ltd v Ure (1923) 33 CLR 199.
  18. See Robert Austin and Ian Ramsay, Ford Austin and Ramsay’s Principles of Corporations Law, Lexis Advance Pacific, at [8.065].
  19. See also Reid v Bagot Well Pastoral Co Pty Ltd (1993) 12 ACSR 197 at 206.
  20. United Petroleum Australia Pty Ltd v Herbert Smith Freehills [2018] VSC 347 at 748.
  21. Australian Metropolitan Life Assurance Company Ltd v Ure (1923) 33 CLR 199 per Isaacs J (powers given to directors must be exercised honestly in the interest of the shareholders as a whole); Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 512 per Dixon J.
  22. Japan Abrasive Materials Pty Ltd v Australian Fused Materials Pty Ltd (1998) 16 ACLC 1172 (based in the High Court’s acceptance of Greenhalgh in Ngurli).
  23. International Swimwear Logistics Ltd v Australian Swimwear Company Pty Ltd [2011] NSWSC 488 at 102 per Ward J (as her Honour then was).
  24. Douglas Menzies, ‘Company Directors’ (1959) 33 Australian Law Journal 156 at 168. Professor Ford also described the decision as ‘difficult to accept’ : Harold Ford, Principles of Company Law, Butterworths, 2nd ed, 978 at [1704].
  25. Douglas Menzies, ‘Company Directors’ (1959) 33 Australian Law Journal 156 at 168.
  26. Ibid.
  27. Douglas Menzies, ‘Company Directors’ (1959) 33 Australian Law Journal 156 at 168. LCB Gower, Principles of Modern Company Law, Stevens and Sons Ltd, 2nd ed 1957, pp 474-475 (discussing the famous Savoy Hotel report). See also Geary v Melrose [1930] NZLR 768.
  28. Westpac Banking Corp v Bell Group (in liq) (No 3) [2012] WASCA 239; 39 WAR 1. See however, BCI Finances Pty Ltd (in liq) v Binetter (No 4) (2016) 117 ACSR 18, which also discussed the balancing exercise.
  29. This was applied in Hart Security Australia Pty Ltd v Boucousis [2016] NSWCA 307; (2016) 117 ACSR 408 at [117].
  30. Dyson Heydon, ‘Directors’ Duties and the Company’s Interests’ in Paul Finn (ed), Equity and Commercial Relationships, Law Book Company 1987, Ch 5 at pp 134-135.
  31. See Caroline Flammer and Aleksandra Kacperczyk, ‘The Impact of Stakeholder Orientation on Innovation: Evidence from a Natural Experiment’ (2016) 62 Management Science 1982.
  32. See further, Andrew Keay, The Enlightened Shareholder Value Principle and Corporate Governance, Routledge, 2012; Shuangge Wen, Shareholder Primacy and Corporate Governance Legal Aspects, Practices and Future Directions, Routledge, 2013; Richard Williams, ‘Enlightened shareholder value in UK company law (2012) 35 University of New South Wales Law Journal 360.
  33. LexisNexis, Buckley on the Companies Acts, (Lexis Advance Pacific) at [924].
  34. Ibid at [923].
  35. This is the central thesis of Shuangge Wen, Shareholder Primacy and Corporate Governance Legal Aspects, Practices and Future Directions, Routledge, 2013.
  36. Corporations and Markets Advisory Committee, The social responsibility of corporations (December 2006); Parliamentary Joint Committee on Corporations and Financial Services, Corporate responsibility: Managing risk and creating value (June 2006). See also the empirical study of directors’ attitudes to stakeholders in Shelley Marshall and Ian Ramsay, ‘Stakeholders and Directors’ Duties: Law, Theory and Evidence’ (2012) 35 University of New South Wales Law Journal 291, which showed majority support for stakeholder consideration by directors.

This article is based on a paper presented at the 2018 NSW Supreme Court Corporate Law Conference, held in conjunction with Sydney Law School and the NSW Law Society. The author thanks the organisers, particularly Dr Bob Austin, and the conference attendees for their comments and suggestions. All errors and omissions remain the sole responsibility of the author.

Jason Harris can be contacted on (02) 8627 8157 or by email at jason.harris@sydney.edu.au.

Material published in Governance Directions is copyright and may not be reproduced without permission. The views expressed therein are those of the author and not of Governance Institute of Australia. All views and opinions are provided as general commentary only and should not be relied upon in place of specific accounting, legal or other professional advice

Interview — Human Rights Commissioner, Edward Santow — AI and human rights: A double-edged sword

Next article