Peter Godwin and John Ling
Under the laws of most jurisdictions, directors of a company are duty-bound to act in the best interest of the company. Traditionally, fulfilling this duty meant that directors would need to have regard to the benefit of shareholders as a whole, shareholders being the ultimate owners of the company. However, recently, there has been a shift away from this short-term shareholder-focused view towards a more long-term sustainable value creation-focused view.
Globally, there has been an increasing recognition that the conduct of a company affects various stakeholders around it, and that companies should have regard to environmental, social, human, and economic considerations. These considerations – commonly referred to as ESG considerations – once seen as a voluntary part of companies’ corporate governance framework, are now rapidly being enacted into hard law across different jurisdictions.
How are these recent shifts affecting the legal position on directors’ duty to act in the best interest of the company? In this article, we will explore the current legal positions in the UK, Europe and Malaysia on directors’ duty to act in the best interest of the company vis-à-vis ESG considerations.
Position in the UK
Presently, UK law incorporates ESG considerations as part of a director’s duty to act in the best interest of the company.
The Company Law Review Steering Group (CLR) was formed by the UK government in 1998 to review UK’s company law with a view of creating a more competitive economy. One of the key recommendations of the CLR was for there to be a shift in focus away from the individual interests of members to a focus on the “managing of the complex of relationships and resources which comprise the company’s undertaking”.
These recommendations were reflected in the law when the Companies Act 2006 was enacted. Under Section 172(1) of the Companies Act 2006, a director of a company must act in the way 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, directors are obliged to have regard to (amongst others):
- the likely consequences of any decision in the long term;
- the interests of the company’s employees;
- the need to foster the company’s business relationships with suppliers, customers and others;
- the impact of the company’s operations on the community and the environment; and
- the desirability of the company maintaining a reputation for high standards of business conduct.
Since Section 172(1) of the Companies Act 2006 came into force in 2007, directors of UK-incorporated companies have been legally obliged to take into consideration various ESG matters as part of their decision-making processes. These include matters such as climate change, maintaining biodiversity, human rights, health and safety, bribery, corruption, competition and so on. A failure to comply with these obligations may result in directors being liable for losses suffered by the company as a result of such a breach.
Position in Europe
Recently, in February 2022, the European Commission published a proposal for a directive on corporate sustainability due diligence which includes an article providing that member states shall ensure that, when fulfilling their duty to act in the best interest of the company, directors must take into account the consequences of their decisions on sustainability matters, including matters such as human rights, climate change and environmental consequences. This obligation would not apply to companies meeting certain thresholds calculated based on the number of employees and worldwide turnover and would not apply to small and medium enterprises.
This proposal is currently being presented to the European Parliament and the Council for approval. Once adopted, member states will have two years to transpose the directive into national law.
Current position in Malaysia
As the position currently stands, there is no strict legal obligation on directors of Malaysian companies to specifically take ESG matters into consideration as part of their decision-making process.
Similar to the CLR, the Corporate Law Reform Committee (CLRC) in Malaysia was formed by the Companies Commission of Malaysia in 2003 to conduct a review of Malaysian companies law. While the CLRC acknowledged the importance of a company having regard to long-term, sustainability concerns, the CLRC was of the view that social obligations of the company should not be expressly incorporated into the scope of directors’ duties under the Companies Act.
Under Section 213(1) of the Companies Act 2016, a director of a company is required to exercise his powers in good faith in the best interest of the company. A breach of this duty is a criminal offence and may additionally result in directors being liable for losses suffered by the company.
Reflecting the CLRC’s position and in contrast to the UK Companies Act 2006, there is no express obligation under this section on directors to have regard to ESG considerations. We are also not aware of any Malaysian caselaw which has extended the scope of obligations of directors under Section 213(1) to specifically cover ESG matters.
That is not to say directors of Malaysian companies do not have any legal obligations vis-à-vis ESG considerations at all. Local regulators and governing bodies have also come up with their own standards in adopting ESG matters. Since 2016, Bursa Malaysia has required Malaysian public-listed companies to include sustainability reporting in their annual reports. Directors of large, listed companies are also required to apply the corporate governance and sustainability practices in the Malaysian Code on Corporate Governance.
Possible future direction for Malaysia
In terms of the impact on the ESG movement on director’s duty to act in the best interest of a company in Malaysia, we see two possible directions of travel:
- Following the trends in other jurisdictions, Section 213(1) of the Companies Act 2016 may at some point in time be amended to expressly oblige directors to have regard to ESG considerations. That said, given the wide-ranging scope of ESG considerations, the liability (currently, a criminal liability) for a breach of this duty may need to be reconsidered. Following the approach taken in Europe, de-minimis exceptions may also be applied such that only directors of larger companies with sufficient resources are subject to this duty.
- Even if legislative change does not occur, Malaysian courts may read into Section 213(1) of the Companies Act 2016 an obligation for directors to have regard to ESG considerations. A failure to manage ESG issues may result in legal, reputational, operational and financial implications on a company, and it can be argued that managing these risks are intrinsic to a director’s obligation to act in the best interest of the company.
Given the global focus on ESG, it would be prudent for directors of Malaysian companies to start incorporating ESG practices into a company’s business model where possible.
For further information, please contact Peter Godwin, John Ling or your usual Herbert Smith Freehills contact.
Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.