The Gender Representation on Public Boards (Scotland) Bill 2017

Although women make up over 51% of the population in Scotland,[1] they are under-represented in political, civic and public life, and in senior decision making positions in the public and private sector.  Women hold only 35% of positions in the Scottish Parliament, 31% of the House of Commons, 29% of local government councillors in Scotland, and 24% of public board chairs.[2] To address this issue, on 15 June 2017 the Cabinet Secretary for Communities, Social Security and Equalities introduced the Gender Representation on Public Boards (Scotland) Bill to the Scottish Parliament. The Bill aims to redress the gender imbalance on the boards of public bodies by setting a gender representation objective of 50% for the non-executive members, and requiring positive action to encourage non-executive board applications by women.

The Bill is not the first effort of the Scottish Government to redress the gender imbalance in public authorities. In September 2008, the Commissioner for Public Appointments in Scotland issued an equal opportunities strategy for ministerial public appointments.[3] The strategy’s main aim was to raise public awareness about the importance of diversity in public bodies, and to reach out to a diverse pool of potential candidates for public appointments, with a particular focus on under-represented groups such as women, people from a minority ethnic background, LGBT people and disabled people. It urged public authorities to promote gender equality in their appointments, and to monitor the gender profile (among other characteristics) of their applicants.  Several years later, in April 2014, the Scottish Government launched a public consultation on the introduction of mandatory quotas of 40% of women representation on public boards.[4] The consultation also asked whether gender diversity quotas should be extended to company boards. This initiative did not lead to legal reform, as at that time the Scottish Parliament lacked the legislative powers to address this issue. The 2017 Bill was made possible by the Scotland Act 2016, which transferred competence to the Scottish Parliament to legislate on equal opportunities in relation to non-executive director appointments to the boards of Scottish public authorities.[5]

The Bill is a key commitment of the Scottish Government under its 2016-17 Programme.[6] It sits alongside the ‘Partnership for Change Pledge – 50:50 by 2020’ campaign announced in the 2014-15 Government Programme[7] and launched in June 2015. The campaign encourages public, private and third sector organisations to sign up to the Partnership for Change pledge and to set a voluntary commitment for board gender balance of 50:50 by 2020. The campaign has proven very successful so far, with over 90% of public bodies having taken the pledge.[8] The same Government Programme introduced the Scottish Business Pledge, an invitation to Scottish businesses to commit to fair and progressive business practices.[9] Signatories to the Business Pledge undertake, among other commitments, to make progress on gender diversity by putting in place progressive policies and practices. Businesses are encouraged to assess how their organisational culture supports diversity in the workforce, by using the Think Business, Think Equality self-assessment tool.[10] As at 2 June 2017, 371 businesses (representing a meagre 0.2% of the Scotland’s registered business base) had signed up to the Business Pledge.[11]

If the Bill passes, it will become part of a broader legal framework relevant to public sector board diversity. Under the Equality Act 2010, a public authority must, in the exercise of its functions, have due regard to the need to eliminate discrimination, to advance equality of opportunity and to foster good relations between people who share a protected characteristic and those who do not (the ‘public sector equality duty’).[12] The Equality Act 2010 (Specific Duties) (Scotland) Regulations 2012, as amended in 2015 and 2016, require Scottish Ministers to gather information on the relevant protected characteristics of board members of a listed authority, and to provide this information to the listed authority in question. The listed authority must use this information to better perform the public sector equality duty.[13] Moreover, listed authorities must publish every two years a mainstreaming report including details on the steps they plan to take across all relevant protected characteristics to promote diversity in their members.[14] Diversity provisions exist also with regard to appointment and succession of public sector board members. As regards appointments, the Commissioner for Ethical Standards in Public Life in Scotland issued in October 2013 a revised Code of Practice for Ministerial Appointments to Public Bodies in Scotland.[15] The revised Code stipulates three core principles underpinning public appointments in Scotland: merit, integrity, and diversity & equality. The latter principle requires that public appointments be advertised in a way that will attract a strong and diverse field of suitable candidates. As regards board succession, in January 2017, the Scottish Government issued a set of guidelines on succession planning for public body boards.[16] The guidance highlights diversity in relation to board members’ protected characteristics as a key issue central to a board’s approach to succession planning.

The content of the Bill

The Bill sets a board gender representation objective of 50% women non-executive directors to be achieved by 31 December 2022.[17] To attain this goal, the relevant appointing person must give preference to a woman candidate when there are two or more equally qualified candidates.[18] Exceptionally, when multiple equally qualified applicants exist, the appointing person may give preference to a candidate who is not female, if this is justified on the basis of a characteristic or situation particular to that candidate.[19] In addition to the tie-breaker provision, the Bill imposes on the appointing person or public authority several duties regarding the appointment process. First, they must take appropriate steps to encourage women to apply for non-executive board positions.[20] Second, whenever the gender representation objective is not achieved, they must take other appropriate steps with a view to achieving it by the 2022 deadline.[21] Third, certain public authorities must publish reports on their progress towards the objective, as instructed by regulations to be adopted by the relevant Scottish Ministers.[22]

The gender representation objective covers non-executive board members only. A ‘non-executive member’ is defined as a person who is not an employee of the public authority. Schedule 1 also specifies other members of the relevant public authority who are excluded from the Bill (for example, because they are elected rather than appointed to the board). The ‘appointing person’ envisaged by the Bill refers to a person who has the authority to appoint a non-executive member of a public board. In most cases, such person is the relevant Scottish Minister, deciding on the basis of recommendations from an appointing panel.[23] Examples of other appointing persons include the Lord President, for the Judicial Appointments Board for Scotland, or the Scottish Parliamentary Corporate Body, deciding for the Standards Commission for Scotland.[24] The ‘public authorities’ covered by the Bill are listed in Schedule 1. They include entities such as a college of further education (within the meaning of the Further and Higher Education (Scotland) Act 1992), a health board constituted under section 2(1)(a) of the National Health Service (Scotland) Act 1978, a regional transport partnership created under section 1(1) of the Transport (Scotland) Act 2005, the Scottish Social Services Council, the National Library of Scotland, the Board of Trustees for the National Galleries of Scotland, the Board of Trustees of the Royal Botanic Garden of Edinburgh, and Revenue Scotland. In addition, Schedule 2 of the Bill sets out special provisions for the Judicial Appointments Board for Scotland, the Regional Board for Glasgow Colleges, regional colleges, and the Scottish Criminal Cases Review Commission.

Reactions to the draft Bill

The initial draft version of the Bill was published on 5 January 2017. Between January and March 2017, the Scottish Government held a public consultation, seeking views on the content and application of the Bill.[25]

One of the main issues flagged up by the respondents was the binary definition of gender used in the draft Bill. In its initial version, section 1 defined the gender representation objective as achieving a board having ‘50% of non-executive members who are female or who identify as female’ and ‘50% of non-executive members who are male or who identify as male’. Respondents commented that the language in this section was not inclusive of people who do not identify as either a man or woman. Women 50:50, for example, suggested that a more inclusive gender representation objective would be 50% of females/persons who identify as female, and 50% of males/persons who identify as males or do no identify within a gender binary. The Scottish Legal Complaints Commission pointed out that the gender binary definition of the objective could force public authorities to categorise applicants as either male or female, in order to apply the tie-breaker provision. To avoid this, Stonewall Scotland suggested that the Bill clarify that where a non-binary person is equally qualified as other candidates, they may be appointed under the ‘exceptional circumstances’ clause. A binary definition of the gender objective may also be inconsistent with the Scottish Government’s commitment to consult on reforming the Gender Recognition Act 2004, with a view to bring in it line with best international practice.[26] Other respondents observed that the ‘male/identify as male’ and ‘female/identify as female’ may not be sufficiently inclusive of trans people. Close the Gap pointed out that, since ‘female’ and ‘male’ are used to describe biological sex, rather than gender identity, it would be more inclusive of trans persons to use ‘woman’ and ‘man’ throughout the Bill. Stonewall Scotland commented that female (male)/identify as female (male) creates an unnecessary distinction between cis and trans persons, which could have a detrimental impact on persons who share the protected characteristic of gender reassignment. As a result of these views, the Government amended the draft Bill by removing the male/female terms and redefining the objective as ‘50% of non-executive members who are women’.

Another common suggestion was that the appointment and outreach provisions of the Bill must make greater consideration of intersectionality. The Coalition for Racial Equality and Rights observed that a narrow focus on gender may potentially inhibit diversity as a whole, rather than improve it. A narrow approach may result in candidates with disabilities or belonging to a minority ethnic group not being offered a position in order to achieve a 50/50 gender objective. Similarly, Queen Margaret University commented that the emphasis on gender and the highly prescriptive requirements of the draft Bill may have the unintended consequence of discriminating against candidates with other protected characteristics. Although the Scottish Government did not amend the draft Bill to cover other protected characteristics, it stated in the Impact Assessment review that it is ‘prioritising work’ to address the under-representation of other groups in public sector boards.[27] It also observed that the promotion of women gives public authorities the opportunity to test their board recruitment processes and make them more inclusive of all potential candidates, irrespective of their protected characteristics.[28]

Finally, respondents highlighted the need for including reporting duties. Women 50:50 called for an obligation of public authorities to disclose their strategy to reach gender parity, including timescales and individual responsibilities. Furthermore, the Bill should provide for a Government duty to monitor the overall progress towards the objective and report to the Scottish Parliament. Close the Gap argued for reporting obligations aligned with existing reporting regulations and timescales under the public sector equality duty. Another respondent noted that the list of bodies covered by the draft Bill and those subject to the Equality Act Regulations do not overlap completely, and suggested reporting obligations covering only institutions not already subject to the public sector equality duty. In response, the Bill was amended to include a reporting duty the details of which are to be determined under regulations adopted by the Scottish Ministers.

Concluding remarks

The public debate that followed the publication of the draft Bill highlights the complex issues arising when the need to design effective boards intersects the need to advance equality of opportunity for people sharing a protected characteristic. The focus of the board diversity debate appears to have moved away from the desirability of board diversity to the need to reconcile promotion of gender diversity and intersectionality. The main arguments in support of gender diversity, such as the need to recruit from the widest possible talent pool, the need to have a greater understanding of all relevant stakeholders, or the superior board decision-making process, are ultimately arguments for diversity in its widest sense. At the same time, insights form corporate governance and strategic management show that boards of directors function better when they are relatively small and have a certain degree of cohesion that facilitates development of trust and celerity. The real challenge in making board diversity work resides perhaps not so much in achieving a fair representation of the diverse stakeholders relevant to a particular organisation, as in identifying and implementing decision-making processes that would allow a diverse board to function efficiently.

[1] National Records of Scotland, “Mid-Year Population Estimates Scotland, Mid-2016” (27 April 2017), available here.

[2] Scottish Government, “Gender Representation on Public Boards (Scotland) Bill EQIA Results Template” (June 2017) pp 3-4, available here.

[3] Office of the Commissioner for Public Appointments in Scotland, “Diversity Delivers: A strategy for Enhancing Equality of Opportunity in Scotland’s Ministerial Public Appointments Process” (September 2008), available here.

[4] Available here.

[5] 2016 c. 11. S 37(3) of the Act transfers competence to the Scottish Parliament to legislate on equal

opportunities “so far as relating to the inclusion of persons with protected characteristics in non-executive posts on boards of Scottish public authorities with mixed functions or no reserved functions.” The protected characteristics under the Equality Act 2010 are: age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion or belief, sex, sexual orientation (2010 c.15 s.4).

[6] Scottish Government, “A Plan for Scotland: The Government’s Programme for Scotland 2016-17” p. 12, available here.

[7] Scottish Government, “One Scotland: The Government’s Programme for Scotland 2014-15” p. 28, available here.

[8] Scottish Government, “Gender Representation on Public Boards (Scotland) Bill EQIA Results Template” p. 4.

[9] Available here.

[10] Available here. This online self-assessment test is developed by Close the Gap, a charity funded by the Scottish Government.

[11] Scottish Business Pledge, “Statistical Overview June 2017”, available here.

[12] Equality Act 2010, 2010 c.15 s 149.

[13] The Equality Act 2010 (Specific Duties) (Scotland) Regulations 2012, regulation 6A.

[14] Ibid. regulations 3 and 6A.

[15] Available here.

[16] Available here.

[17] S1 and s6.

[18] S 4(3).

[19] S 4(4).

[20] S 5.

[21] S 6.

[22] S 7.

[23] SCG 9.

[24] SCG 9.

[25] The published responses are available here.

[26] Scottish Government, “A Plan for Scotland: The Government’s Programme for Scotland 2016-17” p. 77.

[27] Scottish Government, “Gender Representation on Public Boards (Scotland) Bill EQIA Results Template” p. 5.

[28] Ibid.

Posted in Uncategorized | Leave a comment

STRATEGIZING BOARDROOM GENDER DIVERSITY

We continue our series of guest contributions from our postgraduate community with an entry by Anindita Jaiswal. Anindita is a PhD student at our Law School. Her doctoral project, entitled “Female Directors on the Board: Viability from an Indian Perspective” is a critical assessment of the viability of the recently legislated quota, mandating one female director on the board of Indian public companies.

“Diversity” generally connotes variety, difference and mixed population. Historically perceived as a potential threat to social cohesion, it has evolved to become a necessary end of social justice.[1]  Regardless of what meaning and form it takes, diversity has carved out a permanent space for itself not only in social subjects but also across all disciplines, with corporate governance being no exception to it.[2]  More specifically in the context of board composition, the form of diversity that has assumed the maximum prevalence across countries is gender diversity,[3] i.e., female representation in corporate leadership.

Conflict of Rationales

To start with, a conflict of rationales – social justice versus the business case – emerged on a recurring basis, as regards which of the two better justifies diversity in the boardroom. While proponents of the former demanded gender balanced boards for reasons of gender equality, distribution of power, fairness and democracy,[4]  the latter was based on commercial utility, i.e., the idea that diversity adds value to board performance, corporate profits, and the business.[5]  Over the course of arguments, it was realised that the choice of rationale had no practical significance insofar as justifying boardroom diversity. Drawing a demarcation between the two rationales had no concrete relevance,[6] as such demarcation was seldom called for by the industry.

Thus, with some positive and some mixed-bag results, the debate was settled with a general industry wide acknowledgement of gender diversity as being a good governance practice.[7]  Accordingly, the debate has now shifted from “whether diversity or not” to “how to manage diversity”.[8]  In other words, the question whether or not the board should be diverse seems to have become obsolete, as the focus has now shifted to the next level, i.e., determining how such diversity can be optimally implemented.

How to determine the legal strategy?

To this end, countries have adopted strategies ranging from quotas of various kinds (incremental or fixed numbers, at individual company or industry levels, absolute or procedural), targets, disclosure requirements, to industry-led charters or agreements.[9]  Well-illustrated by Norway and United Kingdom (which converge upon a common goal of increasing female participation in corporate leadership, but via two contrasting pathways), all of such strategies can be located within the scale of mandatory regulation/hard law approach on one hand and voluntary regulation/soft law approach on the other hand.

What are the causes for the differences in strategies and policy approaches to board gender diversity?

A review of the two jurisdictions reveals that, while Norway primarily constructs its case on justifications of equality and social justice (with an ultimate diversity twist to ensure wider acceptance or least resistance from the business community),[10] UK is firm on its business motives (where equality has an under-tone influence so as not to overlap or trample upon business autonomy).[11] Such predominance of one rationale over another is what justifies why Norway (advocating fairer and egalitarian social norms) chose quota or hard law,[12] as against voluntary means or soft law adopted by the UK (motivated by business value addition).[13] Similar correlation can be observed in the context of France and Sweden. While France has legislated quota steered by prominent reasons of gender equality,[14] Sweden has resisted State intervention in business autonomy and rejected a quota proposal.[15] Thus, while the choice of rationale may not be significant to establish a case for boardroom diversity, the predominance of one over the other assumes relevance when determining the strategy to implement such diversity.

Further, an approach of hard law most often equates to rule-based governance,[16] as against principle-based governance, which aims at more flexible and value oriented behavioural change conforming to standards or norms, akin to soft law.[17]  In other words, an approach of hard law normally works well when it functions in rule-based style of governance (for instance, the Norwegian quota was built upon a legacy of such mandatory governance),[18] where both share a common aim seeking compliance. On a parallel note, soft law finds optimum prevalence in a principle-based governance system,[19] premised on standards and norms, as in the UK.[20]

Having said that, considering the unique mix/interplay of social and business concerns that is intrinsic to boardroom gender diversity, a more preferred approach could be an optimum balance of both- hard law and soft law.  Accordingly, an optimum strategy could be one that seeks to amalgamate the two approaches into a fine balance. Countries have sought to achieve such balance through a single hybrid strategy (like comply-or- explain, flexible quota, procedural quota), and/or through a mix of strategies (as witnessed in the Swedish context),[21] targeted at the overall board level or specific to non-executive roles only.

Does the same strategy work for executive and non-executive directors alike?

As mentioned above, countries have mostly promulgated a single overarching strategy for the overall board, or specific strategy for non-executive roles while exonerating executive positions altogether or subjecting the latter to the same strategy but with lesser stringent rules. For instance, as can be observed in the proposed EU Directive, the strategy is to impose an obligation for listed companies to undertake individual commitments regarding gender balance in executive director positions.[22] Likewise, in the UK’s Hampton-Alexander Review of 2016,[23] the strategy remains that of being voluntary targets, as is applicable to other board positions. Also, quota forms the dominant strategy for France and Norway (including the executive directors in the former case, and excluding them in the latter).

Adoption of different strategies for the two sub-sets of the board is uncommon at national level. It is here that a divergence is suggested from the regular course commonly adopted by countries. To explain further, it is suggested that a balance of hard and soft law approach, which is desired in the context of corporate governance (and more specifically, for boardroom gender diversity) keeping in view its dynamic and complex character,[24] can be attained through differential strategies adopted for executive and non-executive roles, i.e., one strategy for non-executive positions, and another for executive ones. Considering the established variances in the objectives, roles and responsibilities, and eligibility conditions, within which the two sub-sets of the board function,[25] a “one size fits all” approach is less likely to work for the entire board.  This is more so, as the executive appointments are more individualistic and function-oriented, rather than being representative roles.[26]

What could be the strategy befitting each of the two sub-sets of the board?

While what could be a good strategy for the executive and the non-executive roles depends much upon the political, economic and cultural conditions[27] specific to the country where it is sought to be implemented,[28] a good starting point can be (i) mandatory quota for non-executive directors, alongside (ii) comply-or-explain targets for executive positions.

A review of Norway and UK reveals that, while there is no substantial lack of talent (both in terms of qualifications and board exposure) at the overall board level (inclusive of non-executive positions),[29] a gap exists in the executive pipeline. Most of it can be attributed to filtering-out or mid-level attrition resulting in poor female presence in the line or direct to executive positions of the corporate hierarchy, which serve as the preparatory or feeding ground for potential senior management recruits.[30]  In such a situation, imposing a mandatory quota would either result in large scale non-compliance, or recruitment of directors not suitable for the functions for which they are responsible.  This can have dangerous implications on the business, considering that the executive directors are the ones responsible for day-to-day management, decision-making and revenue generation.  Hence, mandatory quota is definitely not the way forward for executive positions.[31]

Rather, female participation in the executive positions ought to be driven by soft law approach,[32] aiming at generating an adequate pipeline through systemic reforms.  While voluntary targets may be an option, a more preferred strategy may be setting up targets on a comply-or-explain basis, i.e., companies would be directed by a minimum threshold of say 30% (acknowledging the critical mass) female executive directors, but not as a mandatory obligation.  If the company falls short of it, the reasons for such non-conformity must be disclosed. Thus, under this strategy, companies would be inspired to undertake systemic reforms while retaining the leverage to decide conformity based on their individual business specific conditions.  Any breach, i.e., omission to explain a non-conformity, would then be subject to regulatory intervention (thereby infusing some element of layered binding regulation).[33]

Considering that the pipeline for non-executive roles is more broad-based with potential candidates from within and outside the corporate domain, including professionals, academicians, representatives from the non-profit sectors, and industry experts,[34] mandatory quota could work well for such positions.  This is more so, as non-executive directors are not directly engaged in active revenue generating or management decisions, but are mostly responsible for monitoring or supervising the executive functions.  Hence, imposing a quota for this sub-set of the board (while the executive pipeline is developed) can be good way to start the diversity movement. Aside to enhancing the board experience or exposure among female directors, it would also increase the visibility of female role models which is likely to trigger greater interests among female board aspirants down the corporate ladder.  Such quota can be a great step to get the ball rolling, for an enduring movement of boardroom gender diversity that still has a long way to go.

 

[1] PH Schuck, ‘The Perceived Values of Diversity, Then and Now’ (2000-01) 22 Cardozo Law Review 1915.

[2] SA Ramirez, ‘A General Theory of Cultural Diversity’ (2001) 7 Michigan Journal of Race & Law 33. See also, RF Burch, ‘Worldview Diversity in the Boardroom: A Law and Social Equality Rationale’ (2010-11) 42 Loyola University Chicago Law Journal 585.

[3] ‘Beyond Independent Directors: A Functional Approach to Board Independence’ (2005-06) 119 Harvard Law Review 1553.

[4] LM Fairfax, ‘The Bottom Line on Board Diversity: A Cost-Benefit Analysis of the Business Rationales for Diversity on Corporate Boards’ (2005) 795 Wisconsin Law Review 798.

[5] DB Wilkins, ‘From ‘Separate is Inherently Unequal’ to ‘Diversity is Good for Business’: The Rise of Market-Based Diversity Arguments and the Fate of the Black Corporate Bar’ (2004) 117 Harvard Law Review 1548.

[6] M Huse & M Brogi, ‘Introduction’ in S Machold, M Huse, K Hansen & M Brogi (eds), Getting Women onto Corporate Boards: A Snowball starting in Norway (Edward Elgar Publishing Ltd 2013) 3.

[7] DC Langevoort, ‘Overcoming Resistance to Diversity in the Executive Suite: Grease, Grit and the Corporate Promotion Tournament’ (2004) 61 Wash & Lee Law Review 1615.

[8] AG King & JW Hawpe, ‘Gratz v Grutter: Lessons for Pursuing Diversity in the Workplace’ (2004) 29 Oklahoma City University Law Review 41.

[9] K Hansen & S Machold, ‘Concluding Remarks to Part V’ in S Machold, M Huse, K Hansen & M Brogi (eds), Getting Women onto Corporate Boards: A Snowball starting in Norway (Edward Elgar Publishing Ltd 2013) chapter 30, 211.

[10] M Teigen, ‘Gender Quotas for Corporate Boards in Norway’ (European University Institute, Department of Law, 2015) 8.

[11] Lord Davies, ‘Women on Boards’ (UK: The Department for Business, Innovation & Skills, February 2011) 8.

[12] Proposition 97 (Norwegian Ministry of Children and Family 2002-03).

[13] ‘UK Response to the European Commission Consultation on Gender Imbalance in Corporate Boards in the EU’ (The Government Equalities Office, department for Business Innovation and Skills, May 2012).

[14] A Masselot & A Maymont, ‘Balanced Representation between Men and Women in Business Law: The French ‘Quota’ System to the Test of EU Legislation’ (2014) 3(2) Centre for European Law and Legal Studies Online Paper Series (University of Leeds).

[15] ‘Sweden Rejects Quotas for Women on Boards of Listed Companies’ (The Guardian, 12 January 2017) < https://www.theguardian.com/world/2017/jan/12/sweden-rejects-quotas-women-boardroom-listed-companies> accessed 2 April 2017.

[16] AA Dhir, ‘Contextualizing the Content Analysis Results: Norms, Expressive Law, and Reform Possibilities’ in AA Dhir, Challenging Boardroom Homogeneity – Corporate Law, Governance, and Diversity (Cambridge University Press 2015) Chapter 7, 240.

[17] AL Dempsey, Evolutions in Corporate Governance: Towards an Ethical Framework for Business Conduct (Greenleaf Publishing 2013) 83.

[18] M Teigen (n 10) 12.

[19] J Casson, ‘A Review of the Ethical Aspects of Corporate Governance Regulation and Guidance in the EU’ (Institute of Business Ethics Occasional Paper 8, June 2013) 13, 41.

[20] R Tomasic & F Akinbami, ‘Towards a new corporate governance after the global financial crisis’ (2011) 22(8) International Company and Commercial Law Review 237.

[21] Annual Accounts Act of 1995, chap 5, section 18. Section 4.1 of the Swedish Corporate Governance Code (Swedish Corporate Governance Board, 1 December 2016).

[22] Proposal for a Directive of the European Parliament and of the Council on ‘Improving the Gender Balance among Non-Executive Directors of Companies Listed on Stock Exchanges and Related Measures’ – COM(2012) 614 Final 2012/0299 (COD) (The European Commission, Brussels, 14 November 2012). See also, ‘Improving the gender balance in company boardrooms’ (European Commission June 2014).

[23] ‘Hampton-Alexander Review- FTSE Women Leaders, Improving gender balance in FTSE Leadership’ (KPMG November 2016).

[24] R Tomasic & F Akinbami (n 20).

[25] D Higgs, Report on Review of the Role and Effectiveness of Non-Executive Directors (UK: The Department of Trade and Industry January 2003); and ‘A review of corporate governance in UK banks and other financial industry entities’ (November 2009) (“Walker Review”).

[26] H Bjørkhaug & S Øyslebø Sørensen, ‘Feminism Without Gender? Arguments for Gender Quotas on Corporate Boards in Norway’ in F Engelstad & M Teigen (eds), Firms, Boards and Gender Quotas: Comparative Perspectives (Emerald 2012) Chapter 6, 201.

[27] S Machold & K Hansen, ‘Policy Approaches to Gender Diversity on Boards: An Introduction to Characteristics and Determinants’ in S Machold, M Huse, K Hansen & M Brogi (eds), Getting Women onto Corporate Boards: A Snowball starting in Norway (Edward Elgar Publishing Ltd. 2013) chapter 24, 168-169.  See also, A Klettner, ‘Corporate Governance Codes and Gender Diversity: Management-based Regulation in Action’ (2016) 39(2) UNSW Law Journal 715; and EE Clark, ‘Reflecting Inward and Looking Outward’ (2013) 2 Global Journal of Comparative Law 115.

[28] S Machold & K Hansen (n 27) 173.

[29] ‘Board representatives, by gender, age groups, level of education, size groups and economic activity’ (Statistics Norway, 1 January 2016); T Løyning, ‘Business Elites and power: board networks during the period from 2008-2013’ in M Teigen (ed), Gender Balance on Company Boards (Institute for Social Research Report 2015) 38. See also, ‘Improving the Gender Balance on British Boards- Women on Boards Review: Five Year Summary’ (KPMG, Cranfield University October 2015) 22, 23; ‘Patterns and Trends in UK Higher Education 2015’ (Higher Education Statistics Agency 2015) 23.

[30] S Halrynjo, M Teigen & M Nadim, ‘Women and Men in Senior Management. Ripple effects of Laws Requiring Gender Balance on Company Boards’ in M Teigen (ed), Gender Balance on Company Boards (Institute for Social Research Report 2015) 20. See also, Lord Davies (n 11) 16; ‘Gender Diversity in the Boardroom: Reach for the Top’ (CIPD Survey Report, February 2015) 13; and ‘Empowering Productivity: Harnessing the Talents of Women in Financial Services’ (HM Treasury, March 2016) 28 (“Gadhia Review”).

[31] A Rafiq, Member of Parliament (Parliamentary Debate 2002)- H Bjørkhaug & S Øyslebø Sørensen, ‘Feminism Without Gender? Arguments for Gender Quotas on Corporate Boards in Norway’ in F Engelstad & M Teigen (eds), Firms, Boards and Gender Quotas: Comparative Perspectives (Emerald 2012) Chapter 6, 185, 201.

[32] A Klettner, ‘Corporate Governance Regulation: Assessing the Effectiveness of Soft Law in relation to the Contemporary Role of the Board of Directors’ (University of Technology – Sydney 2014) 7.

[33] C Parker, ‘Meta-regulation: Legal Accountability for Corporate Social Responsibility’ in D McBarnet, A Voiculescu & T Campbell (eds), The New Corporate Accountability: Corporate Social Responsibility and the Law (Cambridge University Press 2007) 208.

[34] ‘Improving the Gender Balance on British Boards- Women on Boards Review: Five Year Summary’ (n 29) 20.

Posted in Uncategorized | Leave a comment

The Legacy of B Lab: Italy’s Società Benefit

This blog entry is written by Joseph Liptrap, LLM by Research student at University of Edinburgh. It is the first post in a series of guest contributions from our postgraduate students and alumni, researching in different areas of commercial and corporate law and governance.

In a 2010 TEDx Talk, Jay Coen Gilbert, a co-founder of B Lab, spoke about the range of businesses which B Lab certifies – called Certified B-Corps – and admonished the existing US corporate law for not prioritising social and ecological sustainability.[1] Since the 2010 TEDx Talk, B Lab has been hard at work on two fronts.

First, the organisation has privately certified over 2,000 businesses in fifty countries.[2] The businesses are assessed against a set of social and ecological benchmarks to determine if their social responsibility claims are, in both form and substance, truthful.[3] Second, B Lab has also managed to convince the legislatures of thirty US states and the District of Columbia[4] to pass benefit corporation statutes, which, in the words of Jay Gilbert, are meant to “change the rules of the game.”[5] The benefit corporation statutes are modelled on the Model Benefit Corporation Legislation (MBCL), a model statute drafted by Bill Clark, a Drinker, Biddle & Reath LLP attorney, who worked in conjunction with B Lab on the project.[6] The statutes create a distinct corporate form, different from both the label B Lab offers to businesses and the traditional for-profit corporation. Benefit corporation statutes expressly mandate directors to balance the interests of both shareholders and other relevant non-shareholder constituencies in setting the corporate agenda.

The benefit corporation movement has recently extended into Europe. On 15 December 2015, the Italian Parliament, through a diverse coalition, created its own version of the US benefit corporation, known as Società Benefit. Italy thus became the first country outside the US to provide a statutory form of benefit corporation. Much like the efforts of B Lab, Nativa, a B Lab country partner for Italy, began the lobbying process for the bill which later became the Legge di Stabilita 2016 (hereafter Stability Law 2016). Eric Ezechieli, a co-founder of Nativa, noted that “[w]e are sure this event will accelerate the adoption of similar, much needed legislation in Europe and worldwide.”[7]

This post analyses the new Società Benefit statute through a comparison with the US approach. It highlights the common aspects and where the two jurisdictions diverge.

The US Approach

The MBCL defines a benefit corporation as a distinct corporate form available to for-profit corporations. It has three fundamental characteristics: purpose, accountability and transparency.

A benefit corporation must have purposes which go beyond simply maximising the wealth of shareholders. A benefit corporation must blend the pursuit of profit with a general public benefit and at least one specific public benefit. Regarding the general public benefit, a benefit corporation must create an overall material and positive social and ecological impact.[8] In addition, a benefit corporation may choose one or more specific public benefit purposes which are laid down in the MBCL. They include, for example: providing financially at risk individuals or communities with products and services; promoting economic opportunity for individuals or communities beyond job-creation in the course of business; and protecting or restoring the environment.[9] However, this is not a closed list and a benefit corporation may elect to choose a specific public benefit that is not explicitly itemised in the MBCL.

A benefit corporation’s social and ecological performance in pursuing the stated purposes must be assessed against a third-party standard. The organisation which develops and administers the assessment must be independent of a benefit corporation. It must also enjoy the requisite level of expertise necessary to assess a benefit corporation’s alleged social and ecological impact. The third-party standard must satisfy the legal requirements: it should be comprehensive, independently developed and administered, allow for a benefit corporation’s non-shareholder constituencies to have input and be transparent.[10] This third-party standard is only a modest infringement on the authority of shareholders, since, to become a benefit corporation, a business’ shareholders must vote in favour of the change, and alter the articles of incorporation so that the pursuit of a general public benefit and one or more specific public benefits becomes compulsory.[11]

The directors of a benefit corporation, relative to their counterparts in a traditional for-profit corporation, have increased responsibilities and added protection when they take decisions which aim to safeguard or further the interests of non-shareholder constituencies. Directors must consider how a benefit corporation’s behaviour will affect the entire range of corporate stakeholders, not just shareholders. The list of stakeholders is quite broad. To illustrate, the MBCL requires directors to consider the interests of seven non-shareholder constituencies: (i) employees of a benefit corporation, its subsidiaries and its suppliers; (ii) consumers; (iii) the communities in which a benefit corporation, its subsidiaries and its suppliers are located; (iv) the local and global environment; (v) the short-term and long-term interests of a benefit corporation; and (vii) the ability of a benefit corporation to fulfil its general public benefit purpose and any specific public benefit purpose it identifies as relevant in the articles of incorporation.[12] Therefore it follows that shareholders cannot lodge a derivative suit against a director of a benefit corporation for balancing profit maximisation with the pursuit of non-financial objectives. However, the MBCL also shields directors from personal liability against third-party suits. Section 301(c) provides that “a director is not personally liable for monetary damages for: (1) any action or inaction in the course of performing the duties of a director [of a benefit corporation]…or (2) failure of the benefit corporation to pursue or create general public benefit or specific public benefit.”[13] Shareholders can only instigate a benefit enforcement proceeding in the event that a director of a benefit corporation fails to either publish an annual benefit report on its website or otherwise provide copies upon demand.[14]

Aside from Delaware, a benefit corporation in any other US state jurisdiction has an obligation to publish an annual benefit report. The report articulates the actions taken to pursue a general public benefit and one or more specific public benefits. The report must clearly show the extent to which public benefit was created and how overall social and ecological performance are measured.

The Italian Approach

The approach taken in Italy is not a carbon copy of the US benefit corporation. The Società Benefit is the product of a different legal, social and historical background. For example, in Italy, and most other civil law jurisdictions, directors are not as hamstringed in considering the interests of non-shareholder constituencies. This means that shareholder primacy is not as pronounced relative to the US position. As such, the creation of the Società Benefit was not underpinned primarily by a motivation to give directors more flexibility to look after the interests of non-shareholder constituencies.[15] Rather, the advent of the Società Benefit is treated as an innovation which was necessary to bring Italian conceptions of corporate law into the twenty-first century: “[t]he aim of the new legislation is to promote a new business model in Italy to achieve an effective and innovative way to achieve the dual goal of profit and not-for-profit entrepreneurship, drawing strength from the benefits that characterise both types of business. Within this paradigm, the social dimension is no longer marginal, but a key component of the value chain. The concept of value production is extended to pursue long-term sustainability with every tool, including collaboration, sharing and relationship with the community. This process can open new opportunities in terms of the corporation’s ability to renew both itself and the social and economic fabric.”[16]

But there are similarities between the two approaches. In a general way, the Italian law has implemented the three fundamental characteristics. The Stability Law 2016 describes a Società Benefit as available to for-profit and low-profit businesses.[17] Registering as a Società Benefit entails the pursuit of economic activity through a blending of profit maximisation with the realisation of one or more common benefits.[18] A common benefit is a positive effect or the reduction of a negative effect on one or more of the following categories: people, communities, territories, the environment, cultural heritage, social activities, public or private organisations or associations and other stakeholders.[19] In this way, the list seems to be non-exhaustive through the wording of “and other stakeholders.” A Società Benefit must also overall operate in a responsible, sustainable and transparent way.[20] Additionally, a Società Benefit must alter the corporate purpose provision(s) of its constitution to specifically include a list of the common benefits which will be pursued.[21] Equally, the directors of a Società Benefit have an obligation to consider non-shareholder constituencies’ interests. The Stability Law 2016 identifies relevant non-shareholder constituencies as: employees, customers, suppliers, lenders, creditors, government and society.[22] Like the requirements of the MBCL, a Società Benefit must draft an annual benefit report.[23]

Significant Differences between Approaches

 The US and Italian approaches diverge in three main areas.

First, the constitution of a Società Benefit must specify the chosen common benefit(s) and how the directors aim to achieve them.[24] The MBCL does not require a benefit corporation to explicitly list a specific public benefit purpose in the articles of association.[25] It is submitted that this might better combat corporate greenwashing, since a Società Benefit must both overall operate in a responsible, sustainable and transparent way and pursue one or more explicit common benefits. A Società Benefit which does not pursue the stated common benefit(s) is subject to the Italian Consumer Code rules on misleading advertising which are policed by the Competition Authority.[26] The MBCL does not include any such enforcement mechanism, aside for shareholders’ power to bring a benefit enforcement proceeding.[27] The available reporting data is clear that US benefit corporations’ pursuit of a specific public benefit purpose has thus far been unsatisfactory,[28] and shareholders remain the only constituency with a right of action against the directors of a benefit corporation if they fail to do so.[29] This might suggest that, in the US, the social purpose aspect of a benefit corporation is still only secondary to profit maximisation.

Second, directors’ responsibilities are, at least prima facie, considerably more onerous in a Società Benefit. The MBCL frees directors from personal liability for an act or a failure to act as it relates to the creation and realisation of a general public benefit or specific public benefit.[30] In a Società Benefit, directors must actively protect non-shareholder constituencies’ interests. A Società Benefit’s constitution must also identify an “impact director” responsible for the pursuit and realisation of the common benefits. In the annual report, the impact director responsible must describe the specific objectives, methods and actions taken to pursue the common benefits, as well as any circumstances which might have prevented completion.[31] The annual report also requires the impact director responsible to identify how the specific objectives will be pursued in the following year.[32] A contravention of any of these requirements would constitute a breach of fiduciary duty under the existing corporate law which otherwise governs traditional for-profit businesses in Italy; but it would also make a director personally liable under the already discussed Italian Consumer Code penalties provided for misleading commercial advertising.[33]

Third, it was stated above that the Stability Law 2016 allows for-profit and low-profit businesses to become a Società Benefit. Low-Profit businesses, which include, for example, cooperatives, limited companies and mutual companies, have boundaries on profit distribution to shareholders. In the US, only traditional for-profit corporations can register as a benefit corporation. Consequently, the US approach excludes hybrids and quasi-charitable businesses from becoming a benefit corporation. By virtue of this distinction, the required “SB” or “Società Benefit” designation next to a business’ name might better be understood as a species of legal status, rather than an entirely different corporate form like its US counterpart.[34]

Final Thoughts

This post analysed the new Società Benefit statute through a comparison of the US and Italian approaches, and underscored the common aspects and where the two jurisdictions diverge. Italy’s benefit corporation experience is still very much in a period of infancy. At the time of writing this post, there is no empirical data to examine with regard to its market reception, and it would make more sense to return to an in-depth analysis after a suitable period of continuing development. Said another way, an attempt could be made to make a few informed estimates in relation to the potential successes or problems associated with the Società Benefit, but they would remain only that, informed estimates.

In this respect, two points should be noted. First, the Società Benefit statute does not overtly recognise a difference between the annual report external evaluation standard found in the legislative provisions and the benchmarks utilised by B Lab to measure social and ecological impact in the creation of certified B-Corps.[35] A Società Benefit must report annually, but must also, and perhaps more importantly, measure the impact generated by its activities using an external evaluation standard which is independent, credible and transparent.[36] The external evaluation standard must take into account specific “evaluation areas” which include corporate governance, the treatment of workers, the treatment of all other stakeholders and the environment.[37] Even though the B Lab Impact Assessment is thought to be independent, credible and transparent, it remains to be seen whether the Italian Parliament will establish a Società Benefit regulator to administer the impact evaluation, or otherwise create its own detailed criteria to be used in measuring a Società Benefit’s social and ecological impact. This could lead to a reduction of B Lab’s market reach in Italy, and potentially in other European jurisdictions if and when the MBCL is exported elsewhere. Moreover, it seems to be the case that the Global Reporting Initiative Sustainability Reporting Guidelines are also widely recognised as an international standard for sustainable reporting. Failing formal regulation, it will be interesting to see whether one reporting standard is favoured over the other, or what the effects will be within and across jurisdictions vis-à-vis mixed usage of both standards concurrently.

Second, the arrival of the Società Benefit should be acknowledged as a departure from the traditional European conception of social enterprise. There has historically been a stark contrast between US and European approaches to social enterprise. This has created complications for those scholars interested in finding out whether there is space for cross-border communication and learning in this thread of comparative corporate law.[38] It can be said, generally, that the US has characterised the benefit corporation as a part of the “fourth sector” of the economy.[39] The fourth sector is an area of the US economy in which profit maximisation and the pursuit of social or ecological purposes are blended together.[40] Conversely, European jurisdictions treat social enterprise as an alternative to the traditional charity.[41] The Società Benefit statute departs from the historical European narrative and converges closely with the US approach. The implications of this are still unknown, but the Società Benefit movement will have at least three questions to answer which will determine its ongoing and future market reception. First, will the Società Benefit be an attractive vehicle to social entrepreneurs who are accustomed to the European cooperative model of social enterprise? Second, will more socially-minded investors, not so worried about profit maximisation, be interested in a blended value business model which does not feature a profit distribution restriction? Third, a notable aspect of the EU’s “Europe 2020” strategy involves an increased focus on social entrepreneurship to further Single Market integration.[42] Particularly, the European Commission (EC) has focused on the conceivable potential of social cooperatives to create more jobs.[43] To this end, the EC has proposed the creation of both a harmonised regulatory regime[44] and a network of regional investment funds to broaden the use of social cooperatives from the national level to the regional level.[45] If these policy suggestions are implemented, will the Italian experience and the MBCL proliferate among other EU jurisdictions, and if so, will the EU respond positively to this development by expanding the Europe 2020 strategy to account for benefit corporations? If all three questions are not answered in the positive, it might be the case that the benefit corporation could be relegated to an inconsequential area of the economy.

Joseph Liptrap

LLM by Research, Edinburgh Law School

 

[1] TEDx Talk, “TEDx Philly – Jay Coen Gilbert – On Better Businesses” YouTube, at 9:40-10:20 (1 December 2010), https://www.youtube.com/watch?v=mGnz-w9p5FU [hereafter TEDx Philly].

[2] B Lab, Benefit Corporation, https://www.bcorporation.net.

[3] J. Haskall Murray, “Choose Your Own Master: Social Enterprise, Certifications, and Benefit Corporation Statutes” American University Business Law Review (2012), 21.

[4] B Lab, “State by State Status of Legislation” Benefit Corporation, http://benefitcorp.net/policymakers/state-by-state-status.

[5] TEDx Philly, at 10:17-10:18.

[6] B Lab, “Model Benefit Corporation Legislation” Benefit Corporation (16 September 2016), http://benefitcorp.net/sites/default/files/Model%20Benefit%20Corp%20Legislation_9_16.pdf [hereafter MBCL].

[7] The B Corporation Blog, “Italian Parliament approves Benefit Corporation legal status” Benefit Corporation (22 December 2015), http://bcorporation.eu/blog/italian-parliament-approves-benefit-corporation-legal-status.

[8] MBCL, §102.

[9] Ibid.

[10] B Lab has created a non-exhaustive list of third-party standards that, at least prima facie, meet the legal requirements for use by a statutory benefit corporation. See B Lab, “Third Party Standards for Benefit Corporations” Benefit Corporation (6 March 2012), https://www.bcorporation.net/news-media/articles/third-party-standards-benefit-corporations.

[11] MBCL, §201.

[12] Ibid, §301(a)(1)(i)-(vii).

[13] Ibid, §301(c).

[14] Ibid, §305.

[15] A principal claim made by the drafters of the Model Benefit Corporation Legislation was that, under the existing corporate law which otherwise governs traditional for-profit corporations in the US, directors do not have the flexibility to consider the interests of shareholders and non-shareholder constituencies equally. In this way, the benefit corporation was a needed innovation. See generally William W. Clark, Jr. & Larry Vranka, “White Paper: The Need and Rationale for the Benefit Corporation” (2013),10 (emphasising that the legal uncertainty surrounding directors’ ability to consider non-financial aspects under the existing corporate law has made it problematic for directors to feel legally secure).

[16] European Social Enterprise Law Association, “Benefit Corporation – the new B Corporation and “doing business” in Italy Today – February 2016” (26 February 2016), http://esela.eu/news/benefit-corporation-seminar-new-b-corp-legislation-business-italy-today/.

[17] Gazzetta Ufficiale No. 302, Suppl. Ordinario No. 70 (30 December 2015), Law No. 208, Article 1, para 377. See also Italian Civil Code, Book V, Titles V, VI.

[18] Law No. 208, Article 1, para 380.

[19] Ibid, Article 1, paras 378(a), 376.

[20] Ibid, Article 1, para 376.

[21] Ibid, Article 1, paras 377, 379.

[22] Ibid, Article 1, para 378(b).

[23] Ibid, Article 1, para 382.

[24] Ibid, Article 1, para 379.

[25] MBCL, §201(b).

[26] Law No. 208, Article 1, para 384.

[27] MBCL, §305.

[28] See, for example, J. Haskall Murray, “An Early Report on Benefit Reports” 118 West Virginia Law Review (2015-2016), 25-56.

[29] Leo J. Strine, Jr., “Making it Easier for Directors to ‘Do the Right Thing’?” 4 Harvard Business Law Review (2014), 250-251.

[30] MBCL, §301.

[31] Law No. 208, Article, para 382(a).

[32] Ibid, Article 1, para 382(c).

[33] Ibid, Article 1, para 381.

[34] Ibid, Article 1, para 379.

[35] Ibid, Article 1, para 382(b).

[36] Ibid, Article 1, Annex 4.

[37] Ibid, Article 1, Annex 5.

[38] See generally, for example, Robert T. Esposito, “The Social Enterprise Revolution in Corporate Law: A Primer on Emerging Corporate Entities in Europe and the United States and the Case for the Benefit Corporation” 4 William & Mary Business Law Review (2012-2013) 639-714; Mystica M. Alexander, “A Comparative Look at International Approaches to Social Enterprise: Public Policy, Investment Structure, and Tax Incentives” 7 William & Mary Policy Review (2016) 1-34.

[39] Thomas Kelley, “Law and Choice of Entity on the Social Enterprise Frontier” 84 Tulane Law Review (2009), 358.

[40] Antony Bugg-Levine & Jed Emerson, Impact Investing: Transforming How We Make Money While Making a Difference (2011), 10-11 (the authors define blended value as “economic, social and environmental” returns that in “their natural integration, transform into a new, stronger and more nuanced organizational and capital structure.”).

[41] See generally Jacques Defourny & Marthe Nyssens, “Conceptions of Social Enterprise and Social Entrepreneurship in Europe and the United States: Converges and Divergences” 1 Journal of Social Entrepreneurship (2010) 32-53.

[42] Communication from the Commission, “Europe 2020: A Strategy for Smart, Sustainable and Inclusive Growth” COM (2010) 2020 (3 March 2010), 2, 14-15, http://ec.europa.eu/eu2020/pdf/COMPLET%20EN%20BARROSO%20%20%20007%20-%20Europe%202020%20-%20EN%20version.pdf.

[43] Ibid, 15 (see also footnote 49 of the Communication).

[44] Communication from the Commission to the European Parliament, the Council, the Economic and Social Committee and the Committee of Regions, “Social Business Initiative: Creating a Favourable Climate for Social Enterprises, Key Stakeholders in the Social Economy and Innovation” COM (2011) 682 (25 October 2011), 10, http://ec.europa.eu/internal_market/social_business/docs/COM2011_682_en.pdf.

[45] Ibid, 6-8.

Posted in Uncategorized | Leave a comment

Hard Brexit: company law and governance implications

In a previous post, I discussed the three main Brexit scenarios and their potential impact on the UK company law in general. This post will look in more detail at two corporate law and governance areas that are likely to be affected by a hard Brexit: corporate cross-border mobility and risk management.

The first step in the exit process is for the UK to notify the European Council of its intention to withdraw, as required by Article 50 of the Treaty on European Union (TEU).[1] An Article 50 notice is irrevocable and cannot be given conditionally, so the inevitable result of issuing it will be that the UK will leave the EU.[2] The EU Treaties will cease to apply to the UK from the date of entry into force of the withdrawal agreement or, failing that, two years after the UK submits its notification of intention to withdraw, unless the 27 remaining Member States unanimously decide to extend this period.

The impact of Brexit on the role of EU law in the UK is not entirely clear. On October 2, Prime Minister Theresa May announced plans to introduce a “Great Repeal Bill” in 2017. The proposed Bill will repeal the European Communities Act 1972, thus removing the supremacy of EU law over domestic law in case of conflict, as well as the binding force of the Court of Justice of the EU decisions. The Bill will incorporate into UK law the full body of EU law not already implemented. It is unclear, however, whether the Bill will transpose EU law into domestic law without amendments, or will include material changes that will come into force after Brexit. It is also unclear whether the transposed law will continue to be updated in line with the changes made in the EU, and whether the UK courts will continue to look to the CJEU for guidance on interpreting the transposed EU law.[3]

Until the completion of the Art 50 procedure, and irrespective of the Brexit model adopted, the UK will remain a Member State of the EU and will remain bound by EU law. The trajectory of the UK company law upon completion of the Article 50 procedure will depend on the negotiated terms. Although there is great uncertainty about the Brexit model and process, commentators seem to agree that a hard Brexit scenario, involving a complete split from the EU with limited or no participation in the single market, will have no significant effect on the UK corporate law in the short term, with a few exceptions. These exceptions include freedom of establishment and risk management and disclosure.

The freedom of establishment and corporate mobility

Art 54 of the Treaty for the Functioning of the European Union (TFEU) provides for the right of establishment for companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Union. Such companies or firms enjoy the same rights conferred to natural persons by Art. 49 TFEU. In practice, taking advantage of the freedom of establishment is rendered more difficult by the differing legal traditions of the Member States as regards the conflict of laws rules that determine the applicable company law. Most continental EU jurisdictions (e.g. France, Germany) adopt the real seat theory, which determines the applicable company law based on the location of the company’s center of management and control. Under the incorporation theory (adopted, for example, in Scotland, England or the Netherlands), the applicable company law is determined by the jurisdiction where the company is incorporated. The jurisprudence of the CJEU has contributed significantly to reconciling the two doctrines, thus safeguarding the corporate mobility within the single market.[4] In light of the latest judicial developments, a host member state has an obligation to recognise a company duly incorporated in another member state, irrespective of the conflict of law rule of the host state. The host state may apply its own law only to the extent that this is justified in order to protect imperative requirements in the public interest.

In a hard Brexit scenario, the UK will acquire a third country status, which means that UK companies may no longer enjoy the same freedom of establishment as the other companies incorporated in the EU. The corporate mobility of businesses incorporated in the UK and seeking to establish themselves in the rest of the EU will be determined by the relevant private international rules concerning the law applicable to foreign legal persons. Following Brexit, companies registered in one of the UK jurisdictions but having their central administration in a real seat country (such as Germany) risk to be regarded as unincorporated associations, resulting in the removal of the corporate veil and of the limited liability of shareholders. This is likely to affect a significant number of foreign businesses incorporated in the UK. Following Centros, the UK attracted numerous foreign businesses, driven by lower incorporation costs, less restrictive minimum capital requirements and a flexible company law. [5] Consequently, it seems that the safest option for companies incorporated in the UK for legal arbitrage purposes, which have their central administration in real seat countries, is to convert into a company form of another member state prior to the implementation of Brexit.[6] At the same time, if UK chooses a hard Brexit it will no longer be bound by the CJEU decisions on freedom of establishment, and may implement restrictions on corporate mobility aimed at discouraging companies from fleeing the UK. Such measures may prevent some companies from migrating, but at the same time may reduce the attractiveness of UK as a place of incorporation.

Risk management and disclosure obligations

A hard Brexit will also require UK companies that have significant business relations with the rest of the EU to reassess their risk management and oversight systems, and to communicate to their relevant stakeholders the nature and extent of the impact of Brexit on their business.

The UK Corporate Governance Code 2016, which is applicable to companies with a Premium Listing at the London Stock Exchange on a comply or explain basis, stipulates certain obligations with respect to risk management and oversight. Listed companies must establish “a framework of prudent and effective controls which enables risk to be assessed and managed”,[7] ensure that their “financial controls and systems of risk management are robust and defensible”,[8]  and carry out “a robust assessment of the principal risks […], including those that would threaten its business model, future performance, solvency or liquidity”.[9] Depending on the company’s size, field of activity and the extent of its trading relations with the EU, the impact of Brexit on companies’ risk profile may vary. All large companies, however, are likely to be affected in the medium or long term by issues such as market volatility and the fluctuation in value of the British pound (with consequences on exchange rates, import and export costs); cash flow risks resulting from decreased consumer spending, loss of international or EU-based customers, suppliers or investors; or other exposures in the supply chain, resulting from solvency risks of trading partners. [10] Moreover, companies seeking to raise new capital through issuance of new debt or equity securities will have to disclose in their prospectus any material business risks resulting from Brexit, and the mechanisms that the company has in place to manage them. Some companies may even consider establishing a dedicated Brexit response committee, in charge of coordinating the companies’ risk management oversight systems across all areas of business.[11]

[1] Art. 50 (2) of TEU states that the Member State which decides to withdraw “shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union.” Currently, the anticipated date of an Article 50 notice is March 2017. This date may be delayed by the pending Supreme Court litigation regarding the Government’s power to serve the notice without prior approval of the Parliament. The notice may also be deferred until after the French and the German elections of spring and autumn 2017, respectively.

[2] The irrevocable nature of an exit notification is subject of academic debate. It might be for the Court of Justice of the EU to decide whether Article 50 is revocable. See House of Commons Library, “Brexit Unknowns”, Briefing Paper No 7761, 9 November 2016, p. 6.

[3] House of Commons Library, “Brexit Unknowns”, Briefing Paper No. 7761, 9 November 2016, p 7.

[4] Daily Mail [1988] ECR 5483, Centros Ltd. v Erhvervs-og Selskabsstyrelsen, [1999] ECR I-1459, Überseering B.V v Nordic Construction Baumanagement GmbH [NCC], [2002] ECR I-9919, Inspire Art [2003] ECR I-10155, Cartesio [2008] ECR I-9641 and VALE Építési kft. [2012] EUECJ C-378/10.

[5] Marco Becht et al, “Where do Firms Incorporate? Deregulation and the Cost of Entry” (2008) 14 Journal of Corporate Finance 241.

[6] Such conversion may be achieved via a cross-border merger or through a cross-border conversion, in light of Cartesio and VALE. See Michael Schillig, “Corporate Law after Brexit”, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2846755

[7] Principle A.1

[8] Principle A.4

[9] Principle C.2

[10] For a more detailed review of these risks see “Slaughter and May, “Brexit Essentials: Navigating Uncharted Seas; A Practical Guide for Businesses” (2016)

[11] Ibid.

Posted in Uncategorized | Leave a comment

What would a hard Brexit mean for company law?

On June 23, the UK voted in favour of leaving the European Union. The Leave campaign won 51.9% of the votes across the UK, while Remain won 48.1% of the votes.[1] Many aspects relating to the exit procedures or the legal and economic consequences of Brexit are unclear or unknown. The impact of Brexit on the UK company law and on the future development of the EU company law is equally uncertain. Although the details of the UK’s future relationship with the EU are likely to remain uncertain for several years, three main scenarios have emerged as potential Brexit models.

The ‘Norwegian model’ has the least severe consequences for the continuation of the existing UK-EU relations. Under this model, the UK would leave the EU but join the European Free Trade Association (EFTA) and the European Economic Area (EEA). It would retain access to the single market, in exchange for accepting the principles of free movement of goods, services, capital and persons. The EU company law framework would continue to apply, as EU legislation having EEA relevance.[2] The main downsides of this model are UK’s loss of voice in the EU law making process, and a continuing obligation to contribute financially to EU’s budget.

The ‘Swiss model’ is a compromise between a soft and a hard Brexit. Under this model, the UK would leave the EU and join EFTA but not the EEA. The Swiss Model would allow access to the single market only in the sectors agreed upon with the EU. The UK would be required to comply with the EU-derived corporate laws and regulations only to the extent that such instruments are relevant to the limited areas of access to the single market. Similarly to the Norwegian model, the UK would lose its decision-making rights as regards EU law, and will have to contribute to the EU budget (albeit a smaller amount than under the Norwegian model).[3]

The more radical option, often referred to as a ‘hard’ or ‘clean’ Brexit, would involve a total exit from the EU and the single market. It is likely that, in the short term, the UK would continue to trade with the EU within the framework of the World Trade Organisation (WTO). In the longer term, it could seek a customs union (the ‘Turkish option’), or seek to negotiate a new, bespoke free trade agreement (the ‘Canadian option’). The hard Brexit model would allow the UK extensive freedom to adjust its company law regime in order to make it more attractive for foreign businesses, as compared to the EU regime. The UK could pursue a deregulatory agenda in areas often considered burdensome for business. A recent study by the British Chamber of Commerce found that among the EU instruments that impose the highest financial costs on businesses are the Working Time Directive, the Pollution Directive, the Data Protection Directive and the Directive on the Sale of Consumer Goods.[4] In corporate law, the UK could create a simplified, more attractive regime by derogating from legal provisions that it opposed or considered cumbersome.

For example, the UK could abolish the requirement for shares to have a nominal value, the minimum share capital for public companies, the prohibition on the giving of financial assistance by public companies, or the prospectus form and content requirements imposed by the Prospectus Directive. The UK would also be freed from the obligation to implement the proposed Directive for improving the gender balance in the boards of listed companies, which sets a quantitative objective of at least 40% representation for each gender among non-executive directors by 2020. In other areas where the UK has been supportive of EU developments, such as the Shareholder Rights Directive II, or the Fourth Money Laundering Directive, the UK and EU laws are likely to remain aligned. Such deregulatory measures will render the UK more attractive to businesses focused on the UK domestic market or on non-EU countries. Businesses trading with the EU would continue to be bound by EU requirements (for example in areas such as consumer protection, or for the purpose of  financial services passports) and thus may have to comply with two potentially divergent sets of rules.

The Norwegian and Swiss models have the least impact on the future trajectory of the UK and EU corporate law and governance. They are, however, the least likely to be adopted. On the UK side, restricting the freedom of movement of persons by controlling immigration was a key issue on the Leave agenda, and remains a priority for the new Government.[5] On the EU side, the leaders of the EU Member States have recently dismissed any prospect of the EU retaining access to the single market without also accepting free movement of persons.[6]

The impact of a hard Brexit on the future of the UK and EU company law and governance is difficult to predict. Two aspects that are likely to be affected by a hard Brexit are the freedom of establishment of companies and the companies’ obligation to oversee and disclose their risks associated with Brexit. Overall, commentators appear to agree that fundamental corporate law revisions are unlikely to be a political priority post Brexit. The UK company law has recently undergone an extensive update and recodification process, resulting in the Companies Act 2006. Moreover, the current law enjoys a positive international reputation for stability and effectiveness, which the UK will seek to maintain post-Brexit.

[1] The Electoral Commission, “EU referendum results

[2] See Article 77 and Annex XXII of the EEA Agreement.

[3] It is estimated that the UK’s contribution to the EU budget would fall by about 59% under the Swill Model and by around 17% under the Norwegian Model. See Gavin Thompson and Daniel Harari, “The Economic Impact of EU Membership on the UK”  House of Commons Library (2013) pp 25-26.

[4] British Chambers of Commerce, “The Burdens Barometer” (2010)

[5] In an official statement in the House of Commons, David Davies, Secretary of State for Exiting the European Union, declared that the UK aims to “create an immigration system that allows us to control numbers and encourage the brightest and the best to come to this country.” (“Exiting the European Union: Ministerial Statement”, 5 September 2016). Similarly, in her speech at the 2016 Conservative Party conference, the Prime Minister Theresa May stated: “But let me be clear. We are not leaving the European Union only to give up control of immigration again. And we are not leaving only to return to the jurisdiction of the European Court of Justice.” (Theresa May, “Britain after Brexit: A Vision of a Global Britain”, 2 October 2016).

[6] “In the future, we hope to have the UK as a close partner of the EU and we look forward to the UK stating its intentions in this respect. Any agreement, which will be concluded with the UK as a third country, will have to be based on a balance of rights and obligations. Access to the Single Market requires acceptance of all four freedoms.” (the European Council and the Council of the European Union, “Informal meeting at 27: Statement”, 29 June 2016).

Posted in Uncategorized | Leave a comment

Fiduciary duties as implied contractual terms: MacRoberts LLP v McCrindle Group Ltd

In MacRoberts LLP v McCrindle Group Ltd[1] the Inner House of the Court of Session examined the nature of a solicitor’s duty to avoid placing himself in a position of actual or potential conflict of interest. The central question was whether this duty was an implied term in the solicitor’s contract to provide professional services, or a fiduciary duty imposed by law on a contractual fiduciary relation. The qualification of the no-conflict duty as an implied contractual term was essential for the defenders’ case. Their argument was that, by placing themselves in a potential conflict of interest, the solicitors committed a material breach of contract which, under the principle of mutuality, exonerated the defenders from their contractual obligation to pay fees. The court ruled unanimously that, although the fiduciary relation was created by contract, the resulting fiduciary duties are not contractual. Fiduciary duties and contractual obligations are distinct concepts with distinct consequences. Consequently, the breach of the no-conflict duty by the solicitor was not regarded as a breach of an implied term in the contract for provision of legal services.

The facts

The pursuers, MacRoberts LLP (ML) acted as solicitors for the defenders, McCrindle Group Ltd (MGL), in relation to a dispute with MGL’s former solicitors, Maclay Murray & Spens (MMS). MMS represented MGL in a contractual dispute with Haden Young Ltd, which was referred to arbitration in 1992 and which was settled in 2004. MMS failed to advise MGL that the arbiter had no power to award interest for the period prior to the date of his decree arbitral, and failed to raise protective court proceedings to preserve MGL’s entitlement to the pre-award interest. In 2002, MGL hired ML to represent them in their claim against MMS for breach of contract and professional negligence, as well as to take over the representation of MGL in the Haden Young arbitration. The action against MMS was raised in 2005, but sisted until 2011.

Meanwhile, ML and MGL continued to negotiate with Haden Young. MGL’s instructions were given by William McCrindle, the managing director, and the ML partner responsible for carrying out those instructions was Richard Barrie. In May 2003, a series of discussions and negotiations took place with a view to achieving a settlement, but Haden Young’s offers were unacceptable to MGL. On 29 May 2003, the parties met for a further attempt to settle the arbitration. Mr McCrindle made it clear to Mr Barrie that he was not willing to settle without clarifying the issue of pre-award interest. He was concerned that a failure to address this point may have a negative impact on the MMS litigation. More specifically, he was concerned that MMS’s professional insurance company could argue that there had been an entitlement to interest which ought to have been taken into account in the settlement with Haden Young, and which could not therefore be recovered from MMS. The arbitration dispute continued and was ultimately settled in 2004.

In 2011, the sist in the MMS litigation was recalled. MMS admitted negligence and breach of contract, but denied MGL’s claim that their negligence caused MGL to obtain a less favourable settlement than that which it eventually achieved. Evidence of the negotiations on 29 May 2003 was critical for proving the sum that Mr McCrindle would have been prepared to accept. That evidence no longer existed, however, since ML had destroyed Mr Barrie’s notes without retaining scanned copies. Furthermore, written evidence existed that suggested that Mr Barrie might have been discussing settling the arbitration at an amount unacceptable to Mr McCrindle. The apparent lack of support by Mr Barrie for Mr McCrindle’s position, as well as the destruction by ML of the records of the 29 May meeting had the potential to affect negatively the credibility of Mr McCrindle’s evidence in the MMS litigation. ML advised McCrindle that there was a potential conflict of interest between ML’s interests and those of MGL, which could crystallise into an actual conflict of interest, and advised him to seek independent legal advice.

Mr McCrindle turned to another law firm, TLT LLP, who confirmed that there was a conflict of interest between ML and MGL in respect of the absence of the 29 May notes and Mr Barrie’s acting beyond the scope of his authority. TLT took over the action against MMS and was successful on all claims.[2]

In 2012, ML sued MGL for unpaid fees amounting to £104,065. MGL did not contest this amount, but contended that it was not due because ML were in material breach of their contract to provide professional services by placing themselves in a position of conflict of interest. Alternatively, MGL contended that they were entitled to set off the fees with the damages they incurred as a result of ML’s conflict of interest, consisting of expenses with the new firm of solicitors and fees paid to ML for work that would not have been required if the breach of contract had not occurred.

The court decisions

The action came before Lord Tyre, Lord Ordinary in the Outer House of the Court of Session. The Lord Ordinary found that ML were not in material breach of their contractual duties.[3] Without discussing the fiduciary or contractual nature of the no-conflict duty, the Lord Ordinary held that ML did not breach such duty either in connection with the destruction of Mr Barrie’s notebooks or as regards Mr Barrie’s authority to act for Mr McCrindle.[4] Consequently, ML were entitled to payment of their fees.[5]

MGL appealed. It argued that the Lord Ordinary erred in law in failing to hold that, by destroying the written evidence of the 29 May discussions, ML placed themselves in a position where there was a real and sensible possibility of conflict of interest, and thus materially breached their contract.[6] The careless destruction of the notes created an interest in ML to deny that there ever was a note of the meeting in question, which came into conflict with their core duty to represent their client forcefully.[7] Consequently, under the principle of mutuality, which holds that a non-performing party is disabled from insisting on the performance by the other party of the correlative obligation, ML were disabled from seeking to enforce the obligation to pay their fees.[8] ML responded that the no-conflict duty invoked by MGL, although referred to by the defenders as a contractual term, “has all the aspects of a fiduciary duty”.[9] Drawing on Bristol and West Building Society v Mothew,[10] the pursuers pointed out that, although the solicitor-client relation is fiduciary, not all breaches by a fiduciary are breaches of fiduciary duties. The failure to make scanned copies of the notes was a carless mistake that had no component of disloyalty or lack of fidelity, which are required for breach of fiduciary duty.[11]

Lord Brodie, writing the unanimous decision, sided with the pursuers. He noted that there was no disagreement with regard to the existence of a potential conflict of interest. ML raised this issue with MGL, and instructed them to seek independent advice.[12] MGL’s case depended on whether ML was under an obligation not to allow a conflict to arise, which could be implied in its contract with ML. Lord Brodie observed that MGL’s statements about the nature of the no-conflict duty were to some degree inconsistent  and “slipped between contractual obligation and fiduciary duty.”[13] The judge went to great lengths to highlight the differences between the two types of duties and the dangers of conflating them:

[The fact that] a solicitor has a particular duty arising from the fiduciary nature of his relationship with his client does not require the contract for the retainer to be analysed as containing an implied term not to breach the fiduciary duty. Such an analysis has no purpose. If a solicitor is under a duty by virtue of the fiduciary relationship, there is no need to re-impose it by the mechanism of contractual implication.[14]

The no-conflict fiduciary duty which arises from a fiduciary relation, Lord Brodie further observed, is different in content from the implied contractual duty alleged by the defenders. The fiduciary duty prevents a fiduciary from placing himself in a conflict situation, as opposed to the alleged implied contractual duty of not finding oneself in a position of conflict of interest.[15] The difference between the two is significant. The fiduciary duty is breached by deliberate action that carries with it an element of disloyalty or malice, whereas the alleged contractual duty would be breached by and inadvertent omission or carelessness.[16] If the view of the defenders were accepted, it would turn any negligent action that had potential to have adverse consequences on the client’s interests into a breach of the implied no-conflict duty, because the solicitor would be tempted to conceal or minimise the consequences of the relevant action. Such an interpretation is overly broad and inconsistent with the way in which the contract for the provision of a solicitor’s services is usually analysed.[17]

Comments

Are fiduciary duties contractual (voluntarily undertaken) or are they imposed by law and courts? This is an inveterate controversy in fiduciary law theory and there are strong arguments for both parts of the question. The answer to this question may have far-reaching implications in cases where the nature of the relation between two parties, or the scope of one party’s fiduciary duties, are called into question. In such cases, the courts may find that fiduciary duties have arisen from specific circumstances, even if not expressly contemplated by the parties, or that the fiduciary duties override express provisions of their bargain. In other words, if fiduciary duties are consensual, they are restricted to the perimeter of the parties’ express or implied wishes; if they are imposed, fiduciary law may override express or implied contractual terms in furtherance of other, higher-raking, interests.[18]

On the one side of the debate there is the contractarian view, which dominates the current law and economics view of fiduciary duties. Its key tenet is that, because fiduciary relations are created by contract, fiduciary duties must accommodate to the terms of the contract, rather than contradict it.[19] In the contractarian view, the purpose of the fiduciary duties is to fill in the broad gaps in the fiduciary agreement. Fiduciary obligations perform a gap-filling function, akin to contractual implied terms.[20] Courts fill in the contractual gaps by supplying the terms the parties themselves would have agreed had they negotiated about the unanticipated circumstance at the outset.[21] In other words, the fiduciary duty of loyalty is a generic rule against conflicts of interest or unauthorised profits, which morphs into contractual provisions when applied ex post by courts in specific scenarios. From this perspective, fiduciary duties are standard terms in contracts derived and enforced in the same way, as other contractual undertakings.[22]

On the other side, there are the anti-contractarians. The key insight of this set of theories is that the values underlying contracts and fiduciary relations are fundamentally different. In contracts parties are usually on equal footing and expected to further their own interest, within the limits of good faith, unconscionability and undue influence. Fiduciary relations, in contrast, have trust and confidence, vulnerability and dependency of one party to another, at their core.[23] Therefore, fiduciary duties and contractual obligations arise differently and differ in nature and purpose.

Although they diverge as regards the essential role and purpose of fiduciary duties, the contractarian and anti-contractarian views have important points in common. Both agree that fiduciary duties involve a voluntary undertaking from at least one party to the relation. Both agree that fiduciary duties require one party to abstain from conflicts of interest or unauthorised profits, unless there is express disclosure followed by informed consent. They disagree significantly, however, about why and to what extent, fiduciary duties should be imposed. Contractarians focus on the need to approximate the interests and expectations of both parties. Anti-contractarians tend to focus on one party to the relation. This is either the beneficiary of fiduciary duty, who is particularly vulnerable and in need of protection beyond that offered by the contractual tools, or the fiduciary, who undertook a position that is highly valuable for the society and must therefore be held to standards that are higher than the average commercial morality. Consequently, anti-contractarians reject the gap-filling methodology for determining the content of fiduciary duties. In their view, the content should be determined based on values such as trust or morality, rather than outcomes of a hypothetical bargaining between the parties to the fiduciary relation.[24]

The decision in MacRoberts makes a clear case against the contractarian view. Lord Brodie brought clear and convincing arguments against regarding fiduciary duties as mere implied contractual terms. His explanations, however, do not go far enough to provide support for anti-contractarians. The judge rejected the contractual nature of the fiduciary obligations, but did not go on to analyse the underlying objectives that these obligations serve in the solicitor-client fiduciary relation. Given the continuing controversy surrounding the anti-contractarian arguments, the decision is a missed opportunity to shed light on the reasons for the existence and strictness of the no-conflict fiduciary duty.

An emerging inter-disciplinary theory of fiduciary duties has the potential to bring new insights into the function of the strict proscriptive fiduciary duties and, potentially, to put the contractarian vs anti-contractarian debate to rest. Drawing on cognitive and behavioural research, the new theory argues that the strict no-conflict fiduciary duty plays an essential role in maintaining the reliability of fiduciary’s exercise of judgment.[25] Recent interdisciplinary research shows that conflicts of interest have the potential to affect the reliability of a decision-maker’s judgment in unpredictable ways, and despite the decision-maker’s good faith and honest efforts to keep them aside.[26] Fiduciary conflict of interest situations are reprehensible because they create a risk of error in fiduciary’s judgment, thus the rendering his exercise of discretion less reliable.

The emerging theory points out that the strict no-conflict rules are needed to protect the fiduciary’s exercise of judgment. Disloyalty, in this sense, means primarily unreliable judgment rather than selfish motivations. The court’s statement in MacRoberts that the no-conflict duty requires an element of disloyalty, infidelity[27] or malice[28] are problematic. While in many cases a disloyal fiduciary seeks to pursue his own interests at the expense of the beneficiary, this may not always be the case. In fact, one of the hallmarks of the fiduciary no-conflict and no-profit duties is that they are unusually strict. Liability for breach of these proscriptive duties does not depend on the fiduciary’s good faith or actual motives, on the fact that the beneficiary suffered no loss or obtained a benefit following the conflicted transaction, or on the fact that the opportunity that the fiduciary took for himself was no longer available to the beneficiary.[29] Consequently, something other than deterring infidel or malicious fiduciaries must the principal purpose of the strict rules against conflict of interest and unauthorised benefits. The emerging inter-disciplinary theory of fiduciary duties makes a compelling case for regarding the proper and reliable exercise of fiduciary judgment as the principal concern of this area of law.

Conclusion

Lord Brodie’s succinct analysis of the fiduciary no-conflict duty in MacRoberts is valuable for making a strong case against the contractarian approach to fiduciary duties. The persuasiveness of his views, however, is diminished somewhat by the absence of a clear explanation of the purpose of the strict no-conflict fiduciary duty.

[1] [2016] CSIH 27, 2016 Scot (D) 9/5

[2] [2013] CSOH 72.

[3] 2015 S.C.L.R. 67.

[4] Ibid. at 84.

[5] Ibid.

[6] [2016] CSIH 27 at [35].

[7] Ibid at [37].

[8] [2016] CSIH 27 at [35]-[36].

[9] Ibid at [40].

[10] [1998] Ch 1.

[11] [2016] CSIH 27 at [40].

[12] Ibid. at [43].

[13] Ibid. at [45].

[14] Ibid. at [50].

[15] Ibid. at [51], emphasis added.

[16] Ibid.

[17] Ibid. at [52].

[18] See Anthony Duggan, “Contracts, Fiduciaries and the Primacy of the Deal” in Exploring Private Law (Cambridge: Cambridge University Press, 2010) 275.

[19] The prevailing contractarian model is founded on the principal-agent problem and the ensuing agency costs. The works of Cooter and Freedman, Easterbrook and Fischel Langbein and Sitkoff have played a decisive role in shaping the law and economics understanding of the fiduciary conflict of interest and of its economic and legal consequences. See Robert Cooter and Bradely Freeman, “The Fiduciary Relationshop: Its Economic Character and Legal Consequences” (1991) 66 New York University Law Review 1045; Frank H. Easterbrook and Daniel R. Fischel “Contract and Fiduciary Duty” (1993) 36 Journal of Law and Economics 425; John H. Langbein, “The Contractarian Basis of the Law of Trusts” (1995) 105 Yale Law Journal 625; Robert Sitkoff, “An Economic Theory of Fiduciary Law” in Andrew Gold and Paul Miller, eds., Philosophical Foundations of Fiduciary Law (Oxford: OUP, 2014) Ch. 9.

[20] Duggan, supra note 18 at 278.

[21] Kelli Alces, “The Fiduciary Gap” (2015) 40 Journal of Corporation Law 351 at 365.

[22] Easterbrook and Firshel, supra note 19 at 427.

[23] See e.g. Victor Brudney, “Contract and Fiduciary Duty in Corporate Law” (1997) 38 Boston College Law Review 595 at 597; Deborah A. DeMott, “Beyond Metaphor: An Analysis of Fiduciary Obligation” (1988) 5 Duke Law Journal 879 at 891-892; Tamar Frankel, “Fiduciary Law” (2011) 71 California Law Review 795 at 799-802.

[24] Alces, supra note 21 at 353-354.

[25] See Remus Valsan, “Fiduciary Duties, Conflict of Interest, and Proper Exercise of Judgment” (2016) 62:1 McGill Law Journal 1 (forthcoming); Lionel Smith, “Fiduciary Relationships: Ensuring the Loyal Exercise of Judgment on Behalf of Another” (2014) 130 Law Quarterly Review 608.

[26] Wayne Norman and Chris MacDonald, “Conflicts of Interest” in George Brenkert and Tom Beauchamp, eds., The Oxford Handbook of Business Ethics (Oxford: Oxford University Press, 2010) 441; Michael Davis, “Conflict of Interest” in Ruth Chadwick, ed., Encyclopedia of Applied Ethics, vol. 1 (London: Academic Press, 1998) 589; Don A. Moore and George Loewenstein, “Self-Interest, Automaticity, and the Psychology of Conflict of Interest” (2004) 17 Social Justice Research 189; Don A. Moore, Lloyd Tanlu and Max H. Bazerman “Conflict of Interest and the Intrusion of Bias” (2010) 5 Judgment and Decision Making 37.

[27] [2016] CSIH 27 at [48].

[28] Ibid. at [53].

[29] Aberdeen Railway Co v Blaikie Brothers (1854) 1 Macq 461, at 471-472; Bray v Ford [1896] AC 44 at 51; Parker v McKenna (1874) LR 10 Ch App 96 at 124-125; Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 at 144.

Posted in Uncategorized | Leave a comment

Cultural values and corporate governance

What is the role of cultural values in understanding the mechanisms and processes that influence the way in which corporations are governed and controlled? There are two facets to this question. The first one is external culture: the social and cultural norms characteristic to the country where the company carries on its business. The second one is internal culture: the internal set of corporate values that underpin the relations among corporate constituencies. Both aspects of corporate culture have become prominent topics in the corporate governance literature.

External culture as driver of corporate governance

Scholars approaching corporate governance from a socio-cultural perspective argue that informal rules, such as social and cultural norms are at least as relevant as law, politics or economics in influencing corporate governance structures and models. Geert Hofstede is one of the pioneer researches on the interplay between national cultural beliefs and workplace values embedded in corporate governance policies. In his extensive research, Hofstede identified four national cultural dimensions that underpin the diverse corporate governance models around the world: the power distance index, individualism versus collectivism, masculinity versus femininity, uncertainty avoidance index, long term versus short term normative orientation, and indulgence versus restraint.[1] Two of these factors are especially thought-provoking and deserve a closer examination: the power distance index, and masculinity versus femininity index.

The power distance element refers to commonly held beliefs and attitudes about inequality of power in organisations and institutions. This index is useful in understanding the role of national cultural values in shaping the dynamics between employees working at different levels on the corporate ladder. It casts light on the widely diverging expectations and attitudes that exist worldwide as regards acceptance of unequal powers and rights, styles of management and leadership, power-dependency relations, and employee obedience and loyalty. Members of organisations from societies exhibiting a high power distance index (PDI) are likely to be more accepting of a strict hierarchical order. China is one of the countries with a very high PDI index. Inequalities among people and the power of formal authority tend to be broadly accepted in this country. Employees are generally not encouraged to have aspirations beyond their rank, and there are very few defences against power abuses in the superior-subordinate work relationships. Russia is another example of a very high PDI index. The gap between powerful and dependent people is high, which leads to a great significance of status symbols and roles in business interactions inside and between organisations. Other countries with a high DPI include France, Brazil and India. At the opposite end of the spectrum, countries with a low DPI are characterised by a decentralised organisational structure, high value placed on egalitarianism, close relations between managers and team members, consultations of employees, and straightforward communication channels. Countries falling in this category include Austria, Canada Finland, Norway and the United Kingdom.

The masculinity versus femininity (MAS) index is another driver of differences in national corporate governance and organisational values. Societies that embrace stereotypical masculine values such as competitiveness, assertiveness, and material rewards for success tend to favour managerial decisiveness and a focus on financial returns. Switzerland, the United Kingdom  and the United States are examples of high MAS index countries. Prominent masculine corporate values include a ‘live in order to work’ philosophy, decisive management, and a strong emphasis on competition and financial performance. Scandinavian countries, in contrast, are feminine societies with a low MAS index. Translated into corporate culture, feminine values underpin organisations that prioritise participatory decision making procedures, consensus, solidarity, equality, and conflict resolution though compromise and negotiation. Sweden is the most feminine society according to Hofstede’s rankings, followed by Norway and Denmark.

Hofstede’ path-breaking research provides a unique insight into the correlation between national cultural values and the internal structures and values of organisations. Although his work has been criticised on both theoretical and empirical and grounds, Hofstede’s ideas highlight the essential role of national culture as a driver of corporate governance structures and processes.

A renewed focus on internal corporate culture

The role of the internal corporate culture in promoting high quality corporate governance is the focus of a special report by the UK Financial Reporting Council published last month. The report, entitled ‘Corporate Culture and the Role of Boards’ examines how boards and executive management establish and promote a corporate culture capable of delivering long-term business and economic success. More specifically, the Report draws on interviews with FTSE chairpersons and CEOs to determine the values, attitudes and behaviours that companies apply in their relations with shareholders, employees, customers, suppliers and the wider community. The key observations and suggestions of the Report include:

  • the responsibility of the board to evaluate the company’s internal set of cultural values, to consider how to report on it, and to ensure that the company’s purpose, strategy and business model are aligned with its internal values
  • the responsibility of senior managers to embody the desired culture and oversee its implementation at all levels and in every aspect of the business
  • increased transparency and accountability regarding the way in which the company’s business respects the wide range of stakeholder interests

The Financial and Reporting Council aims to use this Report and the feedback it generates to update its 2011 ‘Guidance on Board Effectiveness’.

[1] Geert Hofstede, Gert Jan Hofstede and Michael Minkov, Cultures and Organizations: Software of the Mind, 3rd ed (New York: McGraw-Hill USA, 2010), originally published in 1991; Geert Hofstede, Culture’s Consequences: Comparing Values, Behaviors, Institutions and Organizations Across Nations, 2nd ed (Thousand Oaks, Calif: Sage Publications, 2001), originally published in 1984.

 

Posted in Uncategorized | Leave a comment

Recent developments in corporate board diversity

The Hampton-Alexander Review of women on FTSE 350 boards

Earlier this year, the Department for Business, Innovation and Skills announced the formation of a new independent review on increasing the representation of women in corporate leadership positions. The review is led by Sir Philip Hampton, Non-Executive Chairman of GlaxoSmithKline (chair of the review) and Dame Helen Alexander, Chair of UBM (deputy chair of the review). The new body continues on from the Davies Review, which pushed the representation of women on FTSE 100 boards from 12.5% in 2010 to 26.1% in October 2015. A new target for female board representation is set at 33% of FTSE 350 by 2020. The Hampton-Alexander Review also extends the focus below the board, to the executive senior layers of FTSE 350 companies. It aims to consider options, make recommendations and work with the business community to improve the representation of women in corporate leadership. The review is expected to present recommendations by the end of 2016.

Viewed against the latest trends and figures, the objectives of the Hampton-Alexander Review appear optimistic. The most recent FTSE 350 statistics show that, overall, women hold 22% of the board seats. Only 60 companies (17%) have 33% or more women directors, and 16 companies have no female directors at all. More worryingly, the pace of progress has slowed significantly after October 2015, when the final Davies Report was released. According to the latest Female FTSE Board Report released by Cranfield University, City University London and Queen Mary University London, there has been no increase in the female representation on FTSE 100 boards after the Davies Review ended. Moreover, only 24.7% of the new board appointments after September 2015 went to female directors, the lowest rate in five years.

Progress is slow in the executive ranks as well. Only 7% of executive directors in FTSE 350 are women, dropping to 5.6% in FTSE 250. A recent study led by KPMG finds evidence of a ‘career bottleneck’ for senior female executives at executive committee level in FTSE 100 companies, where there was no significant increase in female representation over the past two years. The report cautions that, based on this pace of change, it is impossible to predict when, or if, women will acquire the 30% critical mass in executive committees of large UK businesses.

Cracking the lavender ceiling

The glass ceiling metaphor has become a popular representation of the informal barriers that prevent women from ascending to the highest levels in an organisation.[1] The glass ceiling is the most noted and debated form of systematic discrimination, but is not the only obstacle to diversity in leadership. Racial and ethnic stereotypes often portray qualified persons in a light that is unfavourable to leadership, thus preventing them from reaching board seats. African Americans are sometimes stereotyped as antagonistic and lacking competence, Hispanics as uneducated and unambitious, while Asian Americans are pigeonholed as quiet and unassertive.[2] Lesbian, gay, bisexuals and transgender (LGBT) employees are likely to face discrimination in male-dominated contexts, a phenomenon sometimes labelled as the ‘lavender ceiling’.[3] The lavender ceiling undermines the access of LGBT employees to leadership positions, as well as their acceptance as ethical leaders and role models.[4]

In the EU, the latest Eurobarometer survey shows that LGBT people face a high risk of discrimination. A majority of respondents believe that discrimination on the basis of sexual orientation (58%) and gender identity (56%) is widespread in their country. In the UK, 19% of LGB employees have experienced verbal bullying from colleagues, customers or service users because of their sexual orientation in the last five years. Almost a third of them have been bullied by their manager and more than half by people in their own team. Approximately 42% of transgender people are not living permanently in their preferred gender role because they fear it might threaten their employment status.

The effects of the lavender ceiling are clearly visible in large corporations around the world. A recent study by the Human Rights Campaign Foundation shows that 91% of Fortune 500 companies have policies against discrimination based on sexual orientation and 61% against gender identity. In practice, however, these LGBT-inclusive policies have significant limitations. Over half of the surveyed LGBT employees hide who they are in the workplace and 23% of them remain closeted for fear of not being considered for advancement or development opportunities.

Two recent market-led initiatives promise to crack the lavender ceiling in large US corporations. The first one is the Quorum Initiative, a project aiming to connect companies with qualified, experienced LGBT corporate executives and potential board candidates. The project was launched in 2015 by Out Leadership, a New York-based advisory firm dedicated to the promotion of the business case for LGBT inclusion in executive leadership.

According to Out Leadership, there are currently fewer than ten open LGBT directors on Fortune 500 companies, amounting to a dismal 0.03%. To address this lack of diversity, Out Leadership is building the world’s most comprehensive database of top LGBT executives around the world, with a particular focus on candidates who are women or people of colour. At the same time, it works on developing the companies’ internal pipeline of LGBT future business leaders, via the OutNEXT project. OutNEXT pairs outstanding openly LGBT employees identified and selected by member companies, with networking and leadership development opportunities offered by top experts such as EY or McKinsey & Co.

The second market initiative comes from institutional investors. A recent joint statement issued by public officials who are fiduciaries of 14 US public pension funds, notes that “straight directors predominate in corporate boardrooms” and calls on their portfolio companies to “include nominees who are diverse in terms of race, gender, and LGBT status.” The joint statement emphasises the corporate governance benefits of diversity, which include better financial performance, enhanced firm reputation, increased innovation and group performance. Another recent report by CalPERS, California’s largest public pension fund and one of the leading institutional investors worldwide, provides further support for the business case of LGBT diversity. The report finds evidence that companies with an open and inclusive LGBT environment outperform the market by 1.7 – 3.3% annually.

It is hoped that these recent market-driven initiatives and reports will increase awareness of the benefits of diversity in corporate leadership and will accelerate the efforts toward removing the glass and lavender ceilings from the corporate hierarchy.

[1] The origins this metaphor are not altogether clear. It is usually attributed to Carol Hymowitz and Timothy Schellhardt, whose 1986 Wall Street Journal article made this phrase popular. See Carol Hymowitz and Timothy Schellhardt, “The Glass Ceiling: Why women can’t seem to break the invisible barrier that blocks them from the top jobs” The Wall Street Journal, 24 March 1986.

[2] Ronit Kark and Alice H. Eagly, “Gender and Leadership: Negotiating the Labyrinth” in Joan Chrisler and Donald McCreary, eds, Handbook of Gender Research in Psychology, vol. 2 (New York; London: Springer, 2010) 443 at 449.

[3] Annette Friskopp and Sharon Silverstein, Straight Jobs, Gay Lives: Gay and Lesbian Professionals, the Harvard Business School, and the American Workplace (New York: Touchstone, 1995) 108.

[4] Kark and Eagerly, supra note 2 at 449.

 

Posted in Uncategorized | Leave a comment

Filling the void: the Brexit effect on employment law

by David Cabrelli

Having been cast as unnecessary “red tape”, a burden on business, inflexible, uncompetitive and inefficient, it is widely assumed that a sizeable number of domestic employment laws derived from European Law will be in the firing line in the event of a Brexit. In a well-publicised written opinion produced for the TUC, the leading labour law barrister, Michael Ford QC, has provided some support for this assumption. He noted the vulnerability of these EU-derived employment rights and labour laws, and divided and categorised them according to whether a future UK government would be likely to repeal, dilute or preserve them. In this blog, I will probe what might fill any void created by the removal of employment rights rooted in EU law. Surprisingly, the common law would appear to have as significant a role to play as domestic legislation in this context. The potential involvement of the common law is somewhat paradoxical, particularly in light of its perceived ‘undemocratic’ credentials, it being a source of law crafted incrementally by unelected judges.

Turning to the legislation listed in the ‘repeal’ camp, the understanding is that statutory rights to information and consultation on collective redundancies are liable to removal. These rights afford trade union or employee representatives the right to be informed and consulted about managerial proposals to effect redundancies of more than 20 employees in any period of 90 days or less. The effect of any repeal of these provisions is likely to be partial, which can be ascribed to the domestic ‘unfair redundancy’ protections provided to employees on an individual basis pursuant to Part XI of the Employment Rights Act 1996 (ERA). These pre-date the accession of the UK to the European Economic Community in the early 1970s. It is a fundamental part of any fair and proper pre-redundancy process that the employer engages in consultation with employees provisionally earmarked for redundancy on an individual basis: a failure to do so will very likely render any dismissal for the reason of redundancy unfair under Part XI of the ERA, enabling an employee to secure compensation. As such, the notion that employees will no longer have any entitlement to be consulted about proposed redundancies is inaccurate, since domestic law will step into the breach.

Another piece of legislation that Michael Ford QC identifies as ripe for repeal is the Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246) (TUPE). This is rooted in the European Acquired Rights Directive 2001, which is designed to protect employees from dismissal or variations of their contractual terms in the event of a change of identity of their employer, e.g. on a sale of the business and assets of the employer to a third party, or an outsourcing situation. I am slightly more sceptical about the prospect of a UK Government repealing TUPE than some other commentators, despite the lack of enthusiasm of employers and the Government for such provisions. It is more likely that particular provisions will be cherry-picked and done away with.

Although it is probable that the right of transferring employees to be collectively consulted on a proposed transfer of their employer’s business will be removed, as will the right not to have the terms of their contract varied, it is likely that other domestic legislation and the common law will adapt to confer some protection, albeit admittedly not entirely equivalent to that removed. For example, the domestic protections on dismissals and redundancies conferred under Parts X and XI of the ERA will continue to impose an obligation on the employer to consult with an employee pre-dismissal about any proposed dismissal or redundancy. Likewise, the common law of the contract of employment regulating the variation and implied terms of that contract will function to ensure that some measure of control over the behaviour of the employer is imposed if the latter attempts to foist contractual amendments on transferring employees without their consent.

The common law will also be relevant in the event that the EU-derived rights to annual leave/holiday pay and maximum weekly limits on working hours in the Working Time Regulations 1998 (SI 1998/1833) are removed. For example, the implied terms of the employment contract place limits on the power of employers to exercise contractual options to extend the working hours of employees (Johnstone v Bloombsury Health Authority 1991) and it is likely that similar common law protections would be adapted to afford employees a range of rights to annual leave as a means of ensuring that employers exercise reasonable care for the physical and psychiatric well-being of their employees.

Finally, Michael Ford QC also pinpoints the protections for agency workers, part-time workers and fixed-term workers as targets for future repeal, each of which are grounded in EU law. These measures ensure parity of treatment with permanent, full-time workers directly employed by the employer. Whilst any repeal would be a regressive development for workers’ rights, in light of the statistical evidence that the majority of such atypical workers are female, domestic anti-discrimination legislation arguably could fill the gap to offer them redress if they were treated less favourably than permanent, full-time workers colleagues who are directly employed by the employer. This would be based on the statutory tort of indirect sex discrimination, since such unequal treatment would be in contravention of section 19 of the Equality Act 2010.

Of course there are deficiencies in the domestic legislation and the common law that could or would operate to plug any spaces left by the repeal of UK legislation based on EU labour laws. For example, the common law underwrites the ability of employers to dictate contractual terms, imposes implied terms designed to ensure the subordination of the employee to the employer, and confers unrestricted powers in favour of employers to dismiss and re-engage employees with few legal sanctions. However, I would argue that once EU laws are removed, domestic statute and the common law could well reach out and expand to occupy the field. The regenerative capacity of the common law and its ability to reinvigorate workers’ rights ‘in the gaps’ created by repealed labour legislation should not be underestimated.

As explicitly recognised in recent judgments, the judiciary are fully aware of movements in underlying social and economic conditions that are prejudicial to the cause of workers’ rights, and are not afraid to use them as a justification for common law expansion. In this way, they have shown themselves to be just as prepared to apply the accelerator on progressive common law developments as they are to hit the brake. The end result is that any post-Brexit legislation that is passed to strip back labour laws may not necessarily have the effect that is intended.

This entry was originally published on http://blog.oup.com/

Posted in Uncategorized | Leave a comment

Brexit and employment law: a bonfire of red tape?

by David Cabrelli

If you’ve been following the Brexit debate in the media, you no doubt will have noticed how European employment laws are frequently bandied around as the sort of laws that Britain could do without, thank you very much. As welcome as a giant cheesecake at the Weight Watchers Annual Convention, the European Working Time Directive is never far away from the lips of Brexiters, and is routinely cited as the one of the worst kinds of “red tape” laws coming out of Brussels. But have you ever stopped to think about the assumption that underpins such statements? That is the notion that all employment laws, including those that are designed to protect workers from excessive working hours, are in fact a barrier to economic growth. Cast as drivers of inefficient intrusions into management time, such employment protection measures are deemed to be unnecessary pieces of social regulation, which must be stripped back. By doing so, employers would be rendered free to co-ordinate their labour force as they see fit, thus retaining flexibility in their internal labour markets, and increasing employment rates and overall economic growth.

In this blog, I aim to probe the received notion that employment laws are inefficient. A slew of justifications for this claim will be examined, before moving on to focus on the counterclaims made by economists who argue instead that employment laws promote economic efficiency. Ultimately, as lawyers, and not economists, this is not an issue for us to resolve, but a flavour of the economic arguments in favour of and against the introduction and preservation of employment laws in a countries’ legal order is a useful thing to understand. Whenever proposals for reform of employment law are suggested by government, it is particularly eyebrow-raising how frequently some of the claims and counterclaims we are about to examine are in fact versed as part of the relevant debate.

Turning first to the claim that employment laws are inefficient, it is contended that countries with policies encouraging flexible labour markets and less rigid employment laws will have companies that generate higher stock market returns: since the likelihood of being fired is greater in the absence of job security protections such as unfair dismissal laws, employees will invest greater effort to succeed. They will do so in order to minimise the scope for them to be discharged, and as such, will achieve greater satisfaction in their jobs. This increased satisfaction rate translates into higher firm productivity and stock market prices. For the same reason, there is evidence to suggest that one consequence of increased employment protection legislation is a reduction in worker effort in their jobs, together with higher staff absences in comparison with workers with more limited employment protection laws, such as casual workers, temporary workers, and other atypical workers. In essence, countries who choose to introduce rigid employment laws are acting as surrogate regulators of the terms and conditions of the contracts of employment of employees and employers in their jurisdiction. By over-riding the independent judgments of workers and employers in favour of the collective and social interests of certain sections of society, efficiency is reduced. Although equity in the workplace might be increased via redistributive employment laws – although this point is not conceded by adherents of this view – efficiency is clearly impeded.

This view is countered by those who support employment laws. The principal rejoinder is that such laws act as positive factors contributing to an increase in the productive output of workers. The suggestion being made here is that an alignment between equity and efficiency is not impossible. For example, those in favour of employment laws will point towards the evidence that suggests protective employment laws do not have any negative effects on equality, productivity or unemployment, and that they may have a positive impact on innovation and productivity. The positive impacts suggested here may be attributable to the “efficiency wage” theory. This is the idea that better-paid and happier employees enjoying higher contractual benefits and treated well and appreciated by their employers in the workplace equates to higher productivity and firm value.

This entry was originally published on http://blog.oup.com/

Posted in Uncategorized | Leave a comment