Section 172, an elevator to better best practice

At the Subsidiary Governance Summit on Thursday, 10 December, the session on 'Section 172, an elevator to better best practice'

At the Subsidiary Governance Summit on Thursday, 10 December, the session on 'Section 172, an elevator to better best practice' looked at how for some companies it’s a tick-boxing exercise, whereas for others it’s an opportunity to examine and explain how long-term value is being created for material stakeholders. This, in turn, raises questions about how governance professionals can best ensure they gather the right information to demonstrate that directors of subsidiaries, not only the ultimate group board, are discharging their statutory duties to stakeholders. To examine this important issue, Stephen Page (Head of EMEA Board Engagement, Nasdaq Centre for Board Excellence) got together with Aviva’s Julian Baddeley (Deputy Group Company Secretary and Corporate Counsel, Aviva plc) and Karina Bye (Company Secretary Aviva Investors, UK Life & Pensions and UK General Insurance at Aviva, Aviva investors) to explore practices within Aviva.

All large UK companies are required to publish a section 172(1) statement on their website and in the Annual Report, which shows how directors have discharged their duty under section 172. Boards must demonstrate how, whilst acting in the way most likely to promote the success of the company for the benefit of members; the directors have had regard to the likely consequences of any decision in the long term; the interests of the company's employees; relationships with suppliers, customers and others; the impact of the company's operations on the community and the environment; the company's reputation; and the requirement to act fairly between members of the company. In particular, they have to report on how they have engaged with employees, which is a key focus of both the UK Corporate Governance Code 2018 and the Wates Corporate Governance Principles for Large Private Companies 2018. A board should also be able to demonstrate how a company has undertaken effective engagement with its material stakeholders. Examples of how the key factors in section 172 might be considered in decision-making are set out in our updated guidance.

It is important to note that directors will have obligations and responsibilities beyond the general statutory duties covered in this guidance. Directors must act in accordance with their company's constitution, and companies may, through their Articles of Association, go further than the general duties by placing additional requirements on their directors. These general duties are owed to the company, for the benefit of members as a whole; not directly to its shareholders. If directors breach their duties, they could face civil actions and, in some cases, criminal sanctions.

Julian, who looked at how Aviva were addressing section 172 at group level, said different stakeholders would have a lot to say in a challenging 2020 year impacted by the pandemic. In 2020, organisations have done a lot to survive, thought a lot about their employees and considered broader stakeholders. More so than ever before. The continuing challenge with section 172 for businesses is aligning it all to strategy, and the longer-term aims and goals. However, where previously companies might not have had an integrated programme for section 172 with their boards, the reaction to COVID-19 will, by default, have allowed them to have done so this year. Julian said the board at Aviva plc met 40 times this year meaning there is a lot to include in their section 172 statement. But having done test runs in 2018 and bringing together all stakeholders on section 172, they were able to build a framework to bring together all groups and subsidiaries. This framework allowed them to provide an overview of the approach to board decisions and engage with them. It also meant having disclosure on strategic decisions made during the year and how key stakeholder discussions aligns with those board decision. All this leads to what Julian describes as an insightful and enjoyable process. By not treating it as an afterthought, they were able to build a good base for full disclosure. The framework has allowed for integrated thinking as well as integrated reporting.

Karina, who works on UK Life & Pensions and UK General Insurance at Aviva, has a different company secretarial approach when it comes to section 172 reporting. She says there is a danger in leveraging off Aviva plc and tempting to consider at a group level, but subsidiaries have different services, stakeholders and subcultures. So they can’t take too formulaic an approach. Subsidiaries that are regulated entities have to demonstrate individuality, and for Karina, even customers in insurance are different from life businesses, so reporting has to be different. But the approach they use is similar to Julian, and following the tried and tested group framework helps them achieve this along with incorporating Wates Corporate Governance Principles.

Stephen alluded to a new FRC report ‘Review of Corporate Governance Reporting’ published in November 2020. In this report, the FRC expressed disappointment at the quality of some of the section 172 reporting, citing examples of good and bad practices, as well as including some helpful top tips to improve section 172 reporting. Will this influence Aviva’s process? Julian and Karina see the events of 2020 as a way of bringing together conversations about the future and planned actions, in particular, strategic changes and roles changes andy by better-using entity management systems and training boards on good business practices, this can be achieved.

Some key practical points to note on section 172 are:

  • Directors should not attempt to balance the interests of the company and those of other stakeholders. The six factors covered by section 172(1) (a) to (f) and any 'other matters' discussed above are matters to which directors must 'have regard' but, ultimately, directors should comply with the overriding duty to 'promote the success of the company for the benefit of the members as a whole'. For most commercial companies, success will often mean a long-term, sustainable increase in value but traditional considerations such as profitability, viability and the financial effects on the company and its shareholders, remain of critical importance. Of course, where the purpose of the company is not explicitly commercial, success may be otherwise defined.
  • To fulfil its duty to have regard to the six factors, the board must take into account the workforce, customers, suppliers, government and regulators, and wider stakeholders in each case where relevant.
  • In the decision-making process, there is generally no absolute wrong or right approach; the directors must make a judgement in good faith for the success of the company having regard to all the information and having taken advice when appropriate. It is important that consideration of the factors set out in section 172 are embedded within the culture and policies of the organisation, and taken into account in decision-making at all levels. Directors' general duties under the Companies Act 2006.
  • Papers written for the board, which are not merely information papers, need to include relevant details and refer to the six factors, and any other factors or stakeholders where they are applicable to the decision being made, but not in circumstances where any of those factors does not arise. In order to ensure that this happens, it is recommended that each person below board level responsible for writing board papers should understand the implications of section 172 for board decision-making and the circumstances in which reference should be made to the six factors, or any other factors or stakeholders.
  • A system of reviewing board papers before they are included in the board pack is good practice, and this should cover a check that the factors regarding a decision that are relevant to directors' duties have been adequately considered and, where relevant, covered in the paper. This review process would normally be coordinated by the company secretary. Ensuring that all the factors relevant to directors' duties are covered in board papers will assist companies in complying with reporting requirements.
  • The minutes should record decisions taken but do not necessarily need to give detail on how each factor was considered, particularly where the company provides the relevant information in the board papers.

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