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Section 172 – and why even unlisted businesses face new scrutiny

11 August 2020

By Zoë Sibree, Associate Partner

Greenwashing is not a new phenomenon, it was a phrase coined in the 1980s by environmentalists writing about the ubiquitous signs in hotel bathrooms, inviting you to keep towels for more than one use.

The accusation at the time was that hotels only introduced the measures because it saved them money but they ‘spun’ the environmental benefits to encourage their customers to buy-in. While that may well be true, the reality is that financial and environmental / social benefits going hand-in-hand is a core foundation for the ESG movement.

There is however a broader nagging doubt that keeps resurfacing about business and its desire to clean-up its act. Transforming organisations and production processes requires significant investment and there are many reports of listed businesses boosting their ESG credentials by merely off-loading ‘problematic’ assets and divisions to other firms, particularly those that are unlisted and less open to public scrutiny. 

While some may argue that selling ‘problematic’ assets to focus on the ESG-friendly ones does equate to large listed businesses ‘cleaning up their acts’, from an environmental and social perspective it’s also a massive can kicking exercise that leaves the original problem unresolved.

If I have a factory that requires millions of pounds of investment to cut emissions, bring in sustainable power and which produces plastic widgets of dubious social benefit then flogging it to a private entity doesn’t really make the world a better place or save that many dolphins.

Yet this year has seen the UK Government implement a significant change in corporate reporting requirements that helps close that particular ESG escape hatch and make it far harder for listed and privately-owned organisations to undertake greenwashing.

If you speak to the IR director or C-Suite at a listed business they will be well aware of Section 172 of the Companies Act. There are certain disclosure requirements that need to be included in their annual reports, but these changes  also apply to unlisted businesses.

Section 172 (‘s.172’) of the Companies Act was one of the most debated aspects of the major revision to the Companies Act in 2006. It has subsequently slipped down the order of priority for many boards, but the concept of ‘enlightened shareholder value’ that s.172 introduced is now once again a high-profile issue, with its range of factors that directors need to have regard to when promoting the success of the company for the benefit of the members (that is, the shareholders). In particular, the relationship between companies and their employees and external stakeholders has been at the heart of the governance reform debate. And investor groups, proxy advisers and a range of other pressure groups are increasingly focusing on ‘ESG’ in their interactions with companies.

By way of summary, for periods beginning on or after 1 January 2019, all large companies (including large subsidiary companies) have to include a separate statement in their strategic report that explains how its directors have had regard to wider stakeholder needs when performing their duty under s172 of the Companies Act 2006. Large companies qualify as such by meeting two of these three criteria: more than 250 employees; turnover in excess of £36m, balance sheet assets in excess of £18m.  

The introduction of this new disclosure requirement has not changed the purpose of the strategic report or the underlying statutory duties of a director. The specific requirement in the Companies Act is: “…a statement (a “section 172(1) statement”) which describes how the directors have had regard to the matters set out in section 172(1) (a) to (f) when performing their duty under section 172.” Therefore, a simple confirmation that s.172 has been considered is not enough. The disclosure must also explain how the directors have carried out their duties.

For some companies this new reporting requirement will not entail significant changes. However, others may have had to enhance policies and practices, or introduce new ones, to withstand public scrutiny. For example, most very large companies will already have clear stakeholder engagement programmes but the linkage of that engagement into the boardroom and to decision-making might not previously have been that clear. 

While on the surface s.172 may not stir the soul of the green consumer and capitalist, it does mark a significant milestone and one that will now have seen many larger businesses report their decisions against its criteria and demonstrate how they considered the impact of their actions on wider stakeholders.

While s.172 is not single-handedly going to solve concerns about greenwashing, it does shut another door on it. Offloading problem assets and passing them between listed and unlisted entities may not have the same appeal when the ‘buyer’ realises that they are compelled to report back through public statements on the performance of the ‘bad assets’ and the decision making process in acquiring them.

The incentive to invest in cleaning up assets and adopting ESG-friendly behaviours has become more compelling and activists and journalists looking to ‘follow the money’ on ESG concerns now have another route of disclosure that they can use.