Australia: Time for directors to take a look behind the Social Licence buzzword

The debate about the corporate 'social licence' and overhaul of shareholder primacy has confused directors about the action they need to take right now to comply with their duties while also leading to calls for law reform that may do more harm than good.

What is the problem?

Post-Hayne Royal Commission, one can barely go a day without reading the latest commentary on companies' alleged 'social licence' to operate. A narrative has been built up about the need for the existing shareholder primacy model to be overhauled by legislative changes to the Corporations Act, so that it will be mandatory for directors to take into account broader interests beyond shareholders such as climate risks, employee rights and building customer trust.

But this self-perpetuating narrative has proceeded on a misunderstanding of the existing law. In doing so, the narrative creates two key risks that directors and their advisors alike need to be mindful of.

First, it encourages directors to believe they are not already required to take into account non-shareholder interests. And yet if directors act on that false assumption, they are at serious risk of breaching their existing statutory and general law duties.

Secondly, if legislative changes to directors' duties are in fact made, it could do more harm than good for the very non-shareholder interests the changes are supposed to protect.

Behind the social licence buzzword, we need to take a deeper look.

What the law already requires

At the heart of the misunderstanding of the existing law is the belief that the interests of shareholders and other interests are automatically in competition – that directors have to choose which to pursue and cannot satisfy both simultaneously.

But the point is that, in a post-Hayne world, consumers now expect more of companies and give their business to those they feel they can trust. Most obviously, this requires stronger internal governance standards and greater transparency on remuneration and board decision-making.

But, just as critically, it means that carbon offset and green investment policies, workforce satisfaction and taking a stance on matters such as gender diversity, poverty and supply chain exploitation and cybersecurity are not 'niche issues' about which directors can bury their heads in the sand.

Appealing to the new breed of 'socially aware'

If directors do not take action on these issues, the risk is not only that customers will take their business elsewhere, but also that companies will not appeal to the new breed of 'socially aware' Gen X and Y employees necessary for innovation and growth and will also find it more difficult to obtain the funding they need to remain competitive and expand as investors and financiers face their own pressures fuelled by this heightened public scrutiny.

This will all cause profits to take a hit, meaning that directors will breach their duties to shareholders currently understood by the law to correspond with the entity we call the 'company'.

For that reason, the interests of shareholders and non-shareholder interests will most often not be in competition – they will actually align.

But it is also the case that shareholder wealth and non-shareholder interests may diverge when directors genuinely take the view that further investment in CSR initiatives and ESG risk mitigation measures will not deliver any additional profit boost by attracting customers, employees and investors to justify the expenditure.

Yet imposing more regulations on directors, in an attempt to take account of that possible divergence and protect the interests of non-shareholders, is not the answer.

Doing so would add to what is already one of the most complex and over-regulated regimes for directors anywhere in the world. It would also leave directors open to lawsuits from aggrieved interest groups for every decision they make, narrowing the scope for the exercise of their genuine business judgment.

This would have a paralytic impact on directors' willingness to take the kind of risks necessary to drive growth and value creation and may even cause some of the most talented, forward-thinking people we need to boost a flagging economy to refuse to take up directorships at all.

The net outcome would risk harming the very interests sought to be protected by such a change – if companies are under pressure, the economy stalls even further, unemployment rises, community welfare falls and achieving united, progressive action on climate change becomes overtaken by other priorities.

So what is the answer?

While certainly greater protection of non-shareholder interests, from action on climate change to increased transparency and disclosure to customers, may be legitimate public policy goals, the best means of advancing those interests is to introduce mandatory laws in the regulatory regime external to directors. That is, attention should turn to enhanced compulsory laws on substantive areas of concern, such as emissions reductions and labour, consumer protection and privacy laws.

This trend has already commenced with the enactment of whistleblower, modern slavery and consumer data right legislation, as well new ASIC and APRA climate change disclosure requirements.

Tailored laws such as this compel compliance from companies as part of their basic ESG risk framework and cost settings without putting public policy squarely on the shoulders of individual directors.

What does all this mean for you?

Investing in addressing tomorrows issues

Taking action to consider and respond to climate risks and invest in programs that enhance a company's appeal to customers, employees and investors alike are not 'tomorrow's issues' – directors need to actively plan for and implement programs addressing these matters now. A dilatory approach will see directors breach their existing duties under the shareholder primacy model.

At the same time, those advocating for change should be careful what they wish for – while not abandoning their pursuit of non-shareholder interests, it should be realised that the best means for doing so is to advocate for substantive law reform, not greater director liability.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.