1 September 2022 - This blog is the second in a series from CISL Fellow, Professor Richard Calland. It builds on the over-arching argument about why boards matter and why boards must lead, by exploring the emerging corporate law and governance terrain. It concludes by laying the gauntlet for directors to start focusing on how they lead and how they govern through the much clearer multi-focal lens of direction, oversight and accountability, in direct service of organizational purpose.
Corporate law and governance is a dynamic space at the moment, as it seeks to catch up with systemic pressures and trends that threaten people, nature and climate, changes in regulatory norms and market forces, as well as powerful new frontiers of public interest litigation and social activism.
Both the hard and soft law governance environment is evolving fast. This has significant implications for board leadership – both in terms of legal and fiduciary duties on the one hand, and corporate governance more broadly on the other.
Directors are going to have to be alert to the consequences for their own governance arrangements and decision-making and, as a previous, ‘foundational’ blog argued, the role of directors is rightly attracting far greater scrutiny and so now is the right time for boards to reset their mission and rewire their approach to leadership, so as to fundamentally rethink the role of business in society and the economy.
This blog builds on this over-arching argument about why boards matter and why boards must lead, by exploring the emerging corporate law and governance terrain, influenced as it is by important new developments in international standard-setting and reporting regimes.
It grapples with the distinction between the hard and soft law dimensions, and argues that one way of thinking about the relationship between them is to think of the hard law duties as giving effect to a wider and even deeper strategic imperative that transcends national legal regimes, potentially binding boards of directors to a new global set of principles on corporate leadership and governance.
The shift towards hard law duties
In thinking about this new emerging landscape, it is important to make a distinction between the ‘hard’ legal responsibilities (mainly statutory, and generally national level) and the ‘soft’ governance rules that are emerging from global organisations such as the International Standards Organisation (ISO), as well as with the implementation of new information disclosure norms such as those that accompany implementation of the Task Force on Climate-related Financial Disclosures (TCFD) and, now, the the emerging Taskforce on Nature-related Financial Disclosures Framework (TNFD).
While both are important, after the initial focus on voluntary, soft governance responsibilities there is now a discernible shift towards hard(er) law duties. Yet, along this spectrum from hard law duties at one end – that require mandatory compliance – to purely voluntary soft governance principles or guidance at the other end, there are myriad other forms of norms and standards that need to be kept in sight and, often, heeded. For example, some regulatory or even industry bodies are adopting standards that they expect companies to respect; often such expectations can lead to more specific mechanisms as new norms gain traction.
The board is the governing body – comprising the group of people who have ultimate accountability for the whole organization. So on all of these issues the buck stops with the directors.
The specific legal and fiduciary duties of a company and, therefore, its board will clearly depend on the precise legal regime of the jurisdiction in which the company operates. Different jurisdictions have different legal approaches. As the Commonwealth Climate and Law Initiative states: in the UK, directors’ duties “are largely contained in the Companies Act 2006 and in common law fiduciary duties. Similar (but different) duties exist in other legal systems all around the world - in some jurisdictions they are on a statutory footing, in others they are based on fiduciary duty and common law principles.”
Yet, even allowing for jurisdictional differences, they tend to gravitate towards a three-handed set of duties (although the precise definitions, wording and implications for compliance will vary from place to place), namely: to act in the interests of the company; to exercise due diligence or reasonable care; and to act in good faith. In addition, there is a fast-growing duty to comply with disclosure requirements in relation to material information.
But as legal opinions in Singapore, Australia, New Zealand and Canada argue, traditional approaches to legal and fiduciary duty, which focus on out-dated concepts such as “control” and serving only shareholder interests, are now being extended to new layers of potential liability that pivot towards responsible and timely responses to external threats and harm.
As experienced Danish board member, former investment banker and now activist for board leadership, Maria Hjorth, puts it: “Control and shareholder interests are still key responsibilities for the boards. The new layers of liability which are being referred to are add on’s meaning that the “old” framework is still in place but is no longer enough. The responsibility of the boards has widened and has increased in complexity as a consequence.”
In recognising the duty to be responsive to myriad other interests and risks, corporate law and governance is shifting towards capturing the notion that the company has a far deeper responsibility to the needs of society and the protection of the environment.
The changing role of the director – from shareholder agent to stakeholder engagement
The anachronistic definition emanated from what is now an outdated understanding of the role of the director as simply the agent of the shareholder. Now, that is not enough. Hence, the concept of what is in the ‘interests’ of the company stretches far beyond what is in the interest of the shareholder – although it should take this into account; the shareholder is a stakeholder, but one amongst many that includes, consumers/customers, unions, civil society organisations, the current and future members of society, biodiversity (‘ecological infrastructure’), governments and so on - all of which may be positively or negatively impacted by the actions of companies.
This is why ‘stakeholder engagement’ is now such an important part of corporate leadership and, increasingly recognized to be vital - although why and how precisely to engage stakeholders is far from resolved.
It is also why context matters so much. No director can ‘govern’ the company on whose board he or she sits without a full and deep appreciation of the external environment. Directors that are found through litigation or information disclosure, to have failed to consider and weigh in the balance the relationship between the company and those external system-level trends and threats, opens themselves up for a finding of culpable liability.
A future blog will take this argument further, exploring how a new frontier of climate and other forms of ‘sustainability’ public interest litigation is impacting on both the risk environment and the potential legal liability of directors.
But to settle on where we seem to be at in terms of the evolution of corporate law duties on directors, there is a valuable quote from the Singapore legal opinion referred to above:
…in view of the well-established physical, transition and liability risks associated with climate change, and in light of the measures taken by the Singapore government and regulators to address these risks, directors of companies are required under Singapore law to take into account climate-related risks in their decision-making process, failing which they will be liable for breaching the duty to act in good faith in the best interests of the company and the duty to exercise reasonable diligence. Further, this paper shows that failing to disclose climate-related risks may amount to a breach of the Singapore Exchange’s continuous disclosure requirements and the rules on sustainable reporting guide. Importantly, this paper also considers how the directors’ duties can be enforced using the techniques of derivative action and oppression.
This neatly captures the trend: first, the scope of what is “in the best interests of the company” is expanding; second, failure to recognise this and to act accordingly will likely amount to a breach of the duty to exercise reasonable diligence; third, in many jurisdictions there are important related new duties in terms of relevant information disclosure; and, lastly, fail to respect these duties will likely lead to enforcement and/or litigation.
In other words, as the duties are widening and deepening, so the risks associated with non-compliance are rising. As legal liability sharpens and deepens, it is worth also thinking of this in terms of leadership and what I call a ‘thick’ governance concept, and one that escapes a narrow, and ‘thin’, notion of board leadership that is largely technical and concerned with compliance and risk management, towards one that is about setting high, long-term strategic sights.
In other words, visionary leadership that is focused on creating long-term financial value while helping to fix a world that is breaking at its ecological, social and economic seams. Hjorth points to this as “a positive commercial opportunity that the emerging new understanding of corporate governance and leadership can generate and serve, which will enable boards to have real impact in the future”.
Corporate governance – what does it mean and what is its purpose?
Here the work of ISO 37000 provides a valuable foundation stone. It burrows deep into the entrails of what an over-used and often misunderstood term – ‘governance’ – actually means. And, importantly, it does so by first anchoring governance in the ‘why’. What is the point of ‘governance? The answer lies in ‘purpose’, in two senses of the word: the purpose of governance to ensure that the organization can deliver on its purpose.
What does this translate to? Again, ISO 370000 provides a helpful answer that can potentially transcend different jurisdictional approaches to a narrower form of legal duty. It defines ‘governance’ as “a human-based system by which an organization (3.1.3) is directed, overseen and held accountable for achieving its defined purpose”.
It is worth pausing to reflect on the meaning of these words and to transpose them into the corporate boardroom. They represent a subtle but significantly different definitions of corporate governance that tended to focus on ‘control’ more than anything, in the context of delivering value for one set of stakeholders – the shareholder.
Ownership and accountability
The debate about what exactly a shareholder actually owns, other than the shares, is for another day. Save to say that Earth on Board founder, and CISL Fellow, Philippe Joubert argues forcefully that “the only thing that the shareholder owns is the share; they do not own the company”. Since there are several different categories of shareholder, there will be differences of view on this point; founder-owners, for example, who are sole or even majority shareholders, will often take the view that it is “their” company and they are in control and/or that the directors must dance to their tune.
Whether, in law, the shareholder is the ‘owner’ of the company or not, what matters more is who has the authority to direct, oversee and be accountable for the company: the board. This should be the focus. So, all of the difficult decisions about strategy and purpose – and especially purpose – and the resolution of tricky dilemmas in determining the future business model of the company, have to be resolved by the directors (and then executed by the executive and management of the company).
Hence, the legal duties, and potential legal liabilities, relate to how, in effect, the board may be held accountable for what the company does and does not do – acts of omission and commission. So, if the board say “X’ (‘direct’) and then fail to ensure it happens (‘oversee’), it may subsequently be held accountable for that failure and found liable for the consequences – a breach of its legal duties. So they are liable both if ‘x’ turns about to be a bad thing to do (‘commission’), and if they don’t deliver on ‘x’, where x is a good thing (‘omission’), although ‘defence’ provided by the ‘business judgement rule’ may apply where directors can adduce sufficient evidence that the decisions were taken in good faith.
And, since getting the governance right is so important, it is foreseeable that liability might extend to a situation where the decision-making process is inadequate, for example by not setting appropriate policy parameters relating to risks and values – the how and the when, as well as the what and the why.
Conclusion
The wheels of legal change are turning – ever faster it would seem, as pressure grows through public interest litigation, activist-minded judges and bolder regulatory bodies. Boards of directors will have to adjust to those widening and deepening national-level legal duties. But regardless of this pace of legal change, directors can now start to focus on how they lead and how they govern through the much clearer multi-focal lens of direction, oversight and accountability, in direct service of organizational purpose, as ISO3700 so forcefully proposes.
Clearly, this is a dynamic arena; the jurisprudence and the legislative landscape is changing fast, which is why the trends in corporate governance and sustaina governance and practice are to be explored in a new, two-year collaboration between the University of Cambridge Institute for Sustainability Leadership (CISL) and law firm, DLA Piper.
But to return to the starting point of this blog and the question it posed about the relationship between (hard) law duties and (soft) governance norms and standards, the most compelling and useful way to think about it is that the hard law duties are the institutional infrastructure to accompany and deliver on the leadership and governance mandate that the board has.
Power dynamics within an organization and its board will impact on this, as well as cultural norms. A future blog will explore these ‘political economy’ considerations. The next blog in this series, however, will focus on the kinds of questions that a well-run, organised and informed board will be asking itself and the executive of the company as it rises to the new challenge of the age – to direct, oversee and be accountable for a company that contributes positively to socio-economic transformation so as to protect people, nature and climate, to ensure that there is a thriving economy for future generations.
This is both the future of the board and the board of the future.
For 27 years, The Prince of Wales’s Business & Sustainability Programme (BSP) has helped over 3,300 senior executives translate complex sustainability trends into strategic business decisions, supporting individual leadership, business strategy and systemic change. Every year, we deliver the BSP in key parts of the world. CISL has a long history of welcoming delegates from across Asia to the Cambridge seminar, 2022 provides an exciting opportunity for the inaugural Singapore programme. The programme will look at the global challenges facing business, government and finance and will also be tailored to the regional context. We are working closely with our Steering Committee, Network Ambassadors and resident experts to ensure the content is shaped to the lived experience of senior delegates in an incredibly unique cultural, political and geographic context. Find out more here.
