Authored By: Selina Bagiyeva
City University of London
Abstract:
This legal article will determine whether section 172 of the Companies Act ascertains that directors act in good faith and in the best interest of the company. It provides a simplified and academically appropriate analysis of the Companies Act 20061, recent developments in corporate governance, whether the real-life situations align with the Companies Act and also some real world corporate failures. On the one hand, provisions outlined under s 172 of the Companies Act 2006 seek to promote overall accomplishment of the companies; it is a very important legal step towards responsible corporate governance which holds companies and directors accountable for the consequences of their actions and negative impacts of their actions on stakeholders. There are still some doubts about its effectiveness. The written nature of this act – the existence of this act on paper – – demonstrated some protections; however, when put into practice, its effectiveness can actually become limited. The idea of acting in good faith amounts to a quite subjective nature – since different directors may interpret the idea of good faith distinctively – undermining clarity and resulting in commercial/corporate uncertainty. This article includes a variety of case law, policy reforms, and recent developments which imply – suggest that more improvements have to be made, and section 172 should encourage even more accountable and responsible behaviour – thus suggesting directors’ duties have to be strengthened even more.
Introduction:
Directors play a crucial role in running a corporation, representing shareholder interests, managing and ensuring the company’s compliance and solvency. Decisions made by directors have an impact not only on shareholders but also on other stakeholders such as employees, creditors, consumers, and the wider community. To put this into practice and transform it into a tangible legal framework, the Companies Act 2006 was introduced, which codified directors’ duties, with Section 172 becoming one of the most influential and debated provisions.
The main aim of section 172 of the Companies Act 2006 is to make it mandatory and compulsory for the directors to act in good faith to promote the company’s success for its members as a whole – but most significantly by taking into consideration a broader range of stakeholder interests beyond just shareholders, including employees, suppliers, customers, the environment, and the wider community, as mentioned earlier – fostering a long-lasting, accountable approach to business.
The legal question of whether section 172 of the Companies Act 2006 ensures that directors act in good faith and promote the success of the company for its members as a whole has been a subject of debate for years, and it also remains a subject of significant debate in today’s corporate environment.
The collapse of Carillion in 20182 serves as a prominent example, illustrating the strong connection between the legal question and its wider context in which it operates. This event left thousands unemployed and significant public contracts unfulfilled, placing a lot of individuals in a vulnerable position. This event also touched on the question of whether directors gave proper consideration to long-term consequences and stakeholder interests. In this instance, the Carillion company and its directors were criticised for focusing on short-term profits, dividends and bonuses instead of the company’s long-term survival, sustainable business and obligations to employees/pensioners – which fails to satisfy provisions outlined under s 172 of the Companies Act 2007.
Stakeholders were disregarded by the company’s pension deficits, and supplier problems were handled without taking into account the act’s mandated consideration of the impact on the larger community and economy. The 2024 UK Corporate Governance Code3 amendments, investor activism, ESG demands, and the Company Directors Duties Bill 2024-26 all show how corporate responsibility is still changing.
This legal article examines whether section 172 truly achieves its goal. It contends that although the fact that all the requirements and the idea of acting in good faith are transformed into a tangible piece of legislation with the establishment/introduction of the Companies Act 2006 section 172 and contributed to a certain level of improved awareness, culture, and transparency, its impact remains limited due to weak enforcement, subjective judicial interpretation, and structural dominance and prioritisation of shareholders in real commercial life.
Research Methodology:
An analytical and theological approach is taken in this work. Lawsuits, actions, and legislation are only a few of the significant sources I used to support my claims. The Companies Act 2006, specifically Section 172, and a few cases and their rulings, such as Re Smith & Fawcett Ltd4., Regentcrest plc v. Cohen,5 Item Software (UK) Ltd v. Fassihi6, and BTI 2014 LLC v. Sequana SA7, are the most well-known sources cited in this article. The UK Corporate Governance Code, government research on the opinions of 172 directors, and parliamentary reports—most notably the Carillion probe—have all been used to assess the practical impact.
Academic opinion8, expert advice, and policy discussions are examples of secondary sources that are enhanced by recent advancements like new legislation and governance improvements. These resources collectively serve as the foundation for a critical assessment of the efficacy of s. 172.
Legal framework: understanding s 172
section 172 rquires:
A director of a company must act in the way that he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In doing so, the director is required to take into account the likely long-term consequences of any decisions, the interests of the company’s employees, and the need to foster positive business relationships with suppliers, customers, and others. The director must also consider the impact of the company’s operations on the community and the environment, the importance of maintaining a strong reputation for high standards of business conduct, and the need to act fairly between members of the company. Where the purposes of the company include objectives beyond benefiting its members, the duty applies as if the requirement to promote the success of the company referred instead to achieving those wider purposes. In addition, this duty operates alongside any legal rule requiring directors, in certain circumstances, to consider or act in the interests of the company’s creditors.
This reflects the UK’s “enlightened shareholder value” approach: shareholders remain central, but stakeholder considerations form part of responsible, long-term success, maintaining a striking balance between shareholder and stakeholder interests when promoting the success of the company.
Previous case law remained relevant, as section 172 further provides that section 170(4) does not interfere with any common law obligation. It has two co-existing ones, one being of appropriate purposes (section 171) and the other of reasonable care, skill and diligence (section 174). To ensure transparency, big businesses must also submit Section 172(1) statements detailing their stakeholder considerations. The aim of Section 172 is to encourage behaviour by companies which is consistent with ethical and responsible governance. It is designed to align with the UK Corporate Governance Code, which stresses culture, accountability, and long-term sustainable advantage. modern law essay help.
Judicial Interpretation:
The principle of good faith and company success is also illustrated in different cases, the judgements of which make it clear what is meant by it.
Re Smith is considered to be one of the cases in which good faith and directors’ duties are mirrored. The case involved a company called Smith & Fawcett Ltd. The company’s rules (articles of association) allowed its directors to decide whether or not to approve the transfer of shares. When one of the directors, Mr Fawcett, passed away, his executors wanted to transfer his shares to someone else. The remaining director, Mr Smith, refused to approve the transfer, using his discretion under the company’s rules. The executors argued that Mr Smith’s refusal was unfair and not made in good faith.
The most important thing to think about when judging whether directors are acting in good faith when making decisions for a company is whether they truly believe that their actions will help the company succeed for the benefit of all its members. The Companies Act 2006, section 172(1), makes it clear that directors must act in good faith and take into account a number of factors, such as the long-term effects of their decisions, the interests of employees, building business relationships, the effects on the community and the environment, keeping high standards of business conduct, and treating all members fairly.
The test for good faith is subjective, which means that the court will look at how the director was feeling and whether they really thought their actions were in the best interests of the company. But good faith isn’t enough if the directors do something that isn’t in their powers or for a different reason.
Regentcrest plc v. Cohen [2001] 2 BCLC 80 confirmed this subjective approach even more. It said that the question is not whether others would agree, but whether the director honestly thought the decision was in the company’s best interest.
The case of Regentcrest plc v. Cohen 2 BCLC 80 was about a disagreement over the responsibilities of directors to act in the best interests of the company. The case came about because people said that the directors of Regentcrest plc had broken their fiduciary duties by signing a settlement agreement that was said to not be in the best interests of the company. The court had to decide if the directors had acted in good faith for the company’s sake. This is a subjective test that looks at the directors’ state of mind when they made the decision. The court said that the important question was whether the directors truly thought that what they did was best for the company, not whether the decision was objectively best for the company. The court made it clear that the duty to act in the company’s best interests is subjective, and the directors’ honest belief is the most important thing, even if their decision ended up hurting the company.
Section 172, on the other hand, adds more things to think about, like the need to think about the long-term effects of decisions, the needs of employees, and the effects on the community and the environment, among other things. These factors indicate that although the duty is subjective, directors are still required to prove that they have thoughtfully considered these issues in good faith. The subjective test from Regentcrest plc v Cohen gives us a way to figure out if directors have done their job under section 172. However, it doesn’t mean that directors will always act in good faith or work to make the company successful. Section 172 may or may not be able to make sure that these duties are followed, depending on the evidence used to question the directors’ belief and the court’s assessment of their state of mind.
This case illustrates the advantages and disadvantages of the statutory obligation to act in good faith to further the company’s success in relation to section 172 of the Companies Act 2006. The subjective test is in line with the idea that directors should be able to make decisions based on their own judgement and knowledge, without too much interference from the courts. This backs up the claim that section 172 makes sure directors act in good faith, since it acknowledges how important it is for them to honestly believe that their actions will help the company succeed.
On the other hand, the fact that the test is subjective can make it hard to question directors’ choices, even if those choices seem to have hurt the company. Because the director’s state of mind is so important, proving a breach of duty often requires proof of dishonesty or bad motives, which can be hard to get. This part of the judgement may make section 172 less effective at holding directors accountable because it puts a lot of weight on their own beliefs instead of objective results or the reasonableness of their actions.
The case also makes us think more broadly about how to strike a balance between giving directors freedom and holding them accountable. The courts don’t want to get involved in business decisions, but this can sometimes protect directors from being looked at too closely, especially when their choices have hurt the company. Regentcrest shows how hard it is to balance the need to respect directors’ business judgement with the need to make sure they really are acting in the best interests of the company.
But courts have also recognised limits. The Court of Appeal stressed loyalty and honesty in Item Software (UK) Ltd v. Fassihi [2004] EWCA Civ 1244. They said that a director can break their duties even if no money is lost if they don’t act honestly in the best interests of the company. BTI 2014 LLC v. Sequana SA [2022] UKSC 25 made it clear that directors must think about the interests of creditors when a company is likely to go bankrupt. This means that Section 172 changes depending on the company’s financial situation.
Recent appellate opinions have also suggested a small change to a completely subjective criterion. These opinions show that there is a growing tendency to see dishonesty and bad behaviour as incompatible with good faith. However, the courts’ continued reluctance to get involved with business decisions shows a basic idea of “business judgement”.
However, section 172 also introduces additional considerations, such as the need to have regard to the long-term consequences of decisions, the interests of employees, and the impact on the community and environment, among others. These factors suggest that while the duty is
subjective, directors must still demonstrate that they have considered these matters in good faith. The subjective test established in Regentcrest plc v Cohen provides a framework for assessing whether directors have fulfilled their duty under section 172, but it does not guarantee that directors will always act in good faith or promote the success of the company. The effectiveness of section 172 in ensuring compliance with these duties may depend on the evidence presented to challenge the directors’ belief and the court’s evaluation of their state of mind.
When linked to section 172 of the Companies Act 2006, this case highlights both the strengths and limitations of the statutory duty to act in good faith to promote the success of the company. On one hand, the subjective test aligns with the principle that directors are entrusted with the responsibility to make decisions based on their own judgement and expertise, without undue interference from the courts. This supports the argument that section 172 effectively ensures directors act in good faith, as it recognises the importance of their honest belief in promoting the company’s success.
On the other hand, the subjective nature of the test can make it difficult to challenge directors’ decisions, even if those decisions appear to have caused harm to the company. The reliance on the director’s state of mind means that proving a breach of duty often requires evidence of dishonesty or improper motives, which can be challenging to establish. This aspect of the judgement arguably undermines the effectiveness of section 172 in holding directors accountable, as it places significant weight on their internal belief rather than objective outcomes or the reasonableness of their actions.
Evaluation of Section 172: Does It Apply in Practice?
What are the positive aspects?
The advantages accruable to Section 172 are many. It has made the legal duties of company directors easier to comprehend. It supports long-term thinking and integrity, aligned with what the current society requires from corporations. Although currently many boards prominently consider the subject of sustainability and stakeholders in their company operations, the influence of investors and the Corporate Governance Code has changed the business environment brought about by Section 172. Corporate governance codes should consider adapting business practices according to current society needs.
Limitations
Nevertheless, there are certain major issues left.
Enforcement is the most important aspect. It is the responsibility of the company, not the stakeholders. Employees, suppliers, and communities lack the right to Section 172 enforcement. Shareholder derivative actions are also unusual, costly, and subject to judicial review. As a consequence, stakeholder protection is more of a figure of speech.
Secondly, boards are highly shielded by the subjectivity of good faith. It is extremely difficult for judges to challenge boards’ decisions if they actually believed they would win. Though this approach undermines accountability, it is rational from a commercial point of view.
Third, business failures reveal a gap between the law and reality. Although there has been Section 172, the failure of Carillion highlighted a lack of risk management and failure to address stakeholders. There was an implication that the duty of governance was not fully addressed by Parliament.
The third option available would be “box-ticking”. There would be Section 172 claims which would require repeating ambiguous promises without necessarily expressing the slightest interest.
Recent Developments and the Present Circumstances
Section 172 is a contentious part of public and policy debates.
The aim of the Company Directors (Duties) Bill 2024-269 is to modify Section 172 to better indicate a balance between shareholders and the environment/employees. It is clear that individuals are seeking better protection for stakeholders despite it not being codified into law.
Conversely, the 2024 amendments to the UK Corporate Governance Code place greater emphasis on the role of internal controls and accountability. Pressure from investors and regulators is mounting on the board to think about risk culture, executive payoffs, and ESG issues. This changes the definition of the word “success”. The general public and the press will keep the pressure on for changes after a scandal like Carillion.
Despite the potential weakness of Section 172 on its own, these changes show that the environment as a whole is starting to move towards increased accountability and regulation.
Concepts and Forthcoming Actions
In a bid to remedy the situation, the following changes would need to be implemented:
The introduction of certain stakeholders’ standing or derivative actions can thereby facilitate enforcement.
- Improving reporting quality—moving away from box-ticking and towards evidence-based reporting;
- Strengthening regulation—the need to give regulators enhanced powers of inquiry and sanctioning of governance failings;
- Judicial development—the ongoing shift towards a balanced, partially objective assessment of good faith;
- Setting expectations—the need to provide clear legal advice on what constitutes genuine consideration of stakeholders;
Through these measures, Section 172 would become a more effective tool for holding people responsible than it is now, containing more than just advisories.
Bibliography
Legislation
Companies Act 2006
UK Corporate Governance Code 2024 (Financial Reporting Council)
Cases
BTI 2014 LLC v Sequana SA [2022] UKSC 25
Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244
Regentcrest plc v Cohen [2001] 2 BCLC 80
Re Smith & Fawcett Ltd [1942] Ch 304
Parliamentary / Government / Regulatory Sources
Carillion: Second Joint Report of the Business, Energy and Industrial Strategy and Work and Pensions Committees, HC 769 (2018)
Department for Business, Energy and Industrial Strategy, Director Perceptions of Section 172 Financial Reporting Council, UK Corporate Governance Code (2024)
Financial Reporting Council, Guidance on Internal Controls (2024)
UK Parliament, Company Directors (Duties) Bill 2024–26
Books
Hannigan B, Company Law (OUP)
Sealy L and Worthington S, Sealy and Worthington’s Cases and Materials in Company Law (OUP)
Academic Commentary
Odusanya TO, ‘Directors’ Duties: Section 172 of the UK Companies Act 2006’ Underwood T, ‘Shareholder Primacy and the Corporation While Rome Burns’ (2023)
1 Companies Act 2006, s172
2 House of Commons, Carillion: Second Joint Report of the Business, Energy and Industrial Strategy and Work Pensions Committees
3 Financial Reporting Council, UK Corporate Governance Code 2024
4 Re Smith & Fawcett Ltd [1942] Ch 304 (CA)
5 Regentcrest plc v Cohen [2001] 2 BCLC 80 (Ch).
6 Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244.
7 BTI 2014 LLC v Sequana SA [2022] UKSC 25.
8 Odusanya TO, ‘Directors’ Duties: Section 172 of the UK Companies Act 2006’ (Academic Commentary).
9 UK Parliament, Company Directors (Duties) Bill 2024–26.
