Introduction
This essay examines the subjective and objective standards underpinning Section 172 of the Companies Act 2006 (CA 2006), a pivotal provision in UK company law that imposes a duty on directors to promote the success of the company. Enacted to codify directors’ duties, Section 172 requires directors to act in a way they consider, in good faith, would most likely promote the company’s success for the benefit of its members, while having regard to various stakeholders and long-term considerations. The dual subjective and objective tests within this duty raise critical questions about how directors’ decision-making is assessed. This essay will explore the nature of these standards, analyse their application through legal principles and case law, and evaluate their implications for corporate governance. By doing so, it aims to provide a sound understanding of how Section 172 balances directors’ discretion with accountability.
The Nature of Subjective and Objective Standards in Section 172
Section 172(1) of the CA 2006 explicitly incorporates a subjective test by stating that a director must act in a way they “consider, in good faith,” would promote the success of the company. This subjective element focuses on the director’s personal belief and intentions at the time of decision-making, rather than the outcome of their actions. As Davies and Worthington (2016) note, the subjective test grants directors significant discretion, reflecting the principle that courts should not second-guess business decisions made honestly. For instance, if a director genuinely believes a risky investment aligns with the company’s long-term success, they may be protected under this test even if the decision ultimately fails.
However, the subjective standard is not absolute. Section 172 must be read in conjunction with the objective test implied in broader directors’ duties under CA 2006 and common law precedents. The objective test, as highlighted in case law such as Re Smith & Fawcett Ltd [1942] Ch 304, requires directors to act with the degree of care, skill, and diligence that would be exercised by a reasonably competent director. This ensures that while directors’ good faith is a starting point, their decisions are not entirely immune from scrutiny if they fall below an acceptable standard of reasonableness (Sealy and Worthington, 2013). The interplay between these standards thus creates a framework where subjective intent is balanced against objective accountability.
Application and Challenges in Practice
The application of subjective and objective standards under Section 172 is not without challenges, particularly in determining how courts assess “good faith.” In *Regentcrest plc v Cohen* [2001] BCC 494, the court affirmed that the subjective test hinges on the director’s state of mind, making it difficult to challenge decisions unless there is clear evidence of bad faith or irrationality. This approach, while protecting directors from undue interference, arguably risks leniency if directors claim good faith without sufficient scrutiny of their competence (Hannigan, 2018).
Moreover, the objective test introduces complexity when evaluating whether a director’s actions meet the requisite standard of care. For example, in cases involving stakeholder interests—such as employees or the environment—under Section 172, a court might question whether a director reasonably considered these factors, even if acting in good faith. This dual scrutiny ensures accountability but can create uncertainty for directors navigating complex decisions. Indeed, the lack of definitive guidance on balancing stakeholder interests often leaves room for interpretive ambiguity, as noted by Davies and Worthington (2016).
Conclusion
In conclusion, Section 172 of the Companies Act 2006 encapsulates a nuanced blend of subjective and objective standards that govern directors’ duties to promote company success. The subjective test prioritises directors’ good faith, granting them discretion in decision-making, while the objective test imposes a baseline of reasonableness to prevent abuse or incompetence. Although this dual framework aims to balance flexibility with accountability, challenges remain in its practical application, particularly in assessing subjective intent and balancing stakeholder interests. These tensions highlight the need for clearer judicial guidance or legislative refinement to ensure consistency. Ultimately, Section 172 remains a cornerstone of UK corporate governance, shaping how directors navigate their responsibilities in an increasingly complex business landscape. Its implications underscore the ongoing debate about the extent to which courts should intervene in business decisions, a matter that warrants further exploration in both academia and practice.
References
- Davies, P. L. and Worthington, S. (2016) Gower and Davies’ Principles of Modern Company Law. 10th edn. London: Sweet & Maxwell.
- Hannigan, B. (2018) Company Law. 5th edn. Oxford: Oxford University Press.
- Sealy, L. and Worthington, S. (2013) Sealy & Worthington’s Cases and Materials in Company Law. 10th edn. Oxford: Oxford University Press.
