Banker Bonuses: Should the Law Allow it?

Banker Bonuses: Should the Law Allow it?
The ‘bonus merry-go-round’, as Ed Miliband described it recently, started to come full circle last February. As the British economy faces the increasingly likely prospect of entering a double-dip recession, combined with enduring the turbulent, perilous state of the Eurozone, the awarding of RBS Chief Executive Stephen Hester’s bonus of around £1 milllion worth of shares succeeded in antagonising the general public; the very public that incidentally own 82 per cent of RBS following their catastrophic demise under Fred Goodwin. The more attentive readers of this article will have noticed the lack of ‘Sir’ preceding the former RBS chief’s name. This is because last week also saw Mr Goodwin’s knighthood removed following the assertion of severe political pressure, in an attempt to go some way to punishing the once notorious chief executive. The weight of public and political pressure has also, thankfully, influenced Hester to waive his bonus. But what I shall be attempting to uncover in this article is why the Companies Act (CA) 2006 is seemingly gathering dust on the shelves of the courts while directors of companies, in particular banks, are allowed to infringe its provisions, whilst still being rewarded with lavish bonuses.

This is because last week also saw Mr Goodwin’s knighthood removed following the assertion of severe political pressure, in an attempt to go some way to punishing the once notorious chief executive.

Directors are engaged in a fiduciary relationship with the company and therefore owe numerous fiduciary duties to the company. This means that they act on behalf of the company in a relationship of trust and confidence, similar to the role of a trustee.[1] Under s.171, a director of a company is only to exercise their powers for the purposes for which they are conferred.[2] At first glance, this provision seems rather broad and even quite vague. However, under the CA 2006 the courts are allowed to interpret it using the common law rules and equitable principles upon which this statute was based.[3] Howard Smith v Ampol[4] promoted the notion of examining the ‘substantial purpose’ for which the power was exercised, and in Hindle v John Cotton[5] Viscount Finlay endorsed the importance of the subjective approach in determining what the state of mind of the director was.[6]

How can Hester, a director, exercise his power to accept this £1 million bonus and yet claim that this is a proper purpose under s.171? Applying the tests established in the aforementioned case law, the substantial purpose and subjective intention of accepting a bonus is for personal gain. The taxpayer’s bailout of RBS somewhat amplifies the injustice of this, because money that could be better spent elsewhere is the substance of a director’s extravagant reward, for fulfilling a role he is paid handsomely to do anyway. So my question is thus: why is the law taking a back seat and allowing this injustice to remain lawful?

You could contend that because the bonus was an award of shares it will provide Hester with an added incentive to grow RBS’s share price. But this is a responsibility that is already an inherent characteristic of his job, and if the price of shares significantly rises, however unlikely that is in the current fragile economic climate, then this would grant Hester an even greater bonus.

Although, what often happens in practice is that directors are capable of relying on s.172 CA 2006, which provides:

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, and in doing so have regard (amongst other matters) to –

Six internal and external factors are then listed that a director should consider, three of which I believe are infringed if a director is to accept such a lavish bonus. The director should consider the interests of the company’s employees,[7] the need to foster the company’s business relationships with suppliers, customers and others,[8] and the desirability of maintaining a reputation for high standards of business conduct.[9] These three provisions, I submit, have been breached by bankers accepting bonuses for the simple reason that the injustice of the bonus quite clearly alienates employees and customers alike and brings the company’s reputation into disrepute. These infringements are all the more poignant in relation to banks, rather than other companies, due to their central role in the recession and the consequential financial hardship that many people have been burdened with.

What adds fuel to the already ferocious fire of public frustration is that, taking Fred Goodwin as a prime example, directors of banks are rewarded generously even when they, and therefore the company, fail. Even after succumbing to pressure to resign as CEO, Mr Goodwin still walked away from an unrecognisably diminished RBS with an excessive pension pay-out. Admittedly, Mr Goodwin had led RBS to brilliant new heights, but key errors such as failing to undertake the appropriate due diligence before the acquisition of ABN Amro led to the Government bailing out RBS by injecting taxpayers’ money.

This is where the law meets its most imposing obstacle, as although it is easy in hindsight to criticise these catastrophic decisions, the courts must afford directors appropriate discretion to make these risky and entrepreneurial decisions. This is essentially due to the fact that the directors are deemed to have more intricate knowledge of the company than the court, as Lord Greene MR identified in Re Smith & Fawcett[10] that directors ‘must exercise their discretion bona fide in what they consider – not what the court may consider – is in the interests of the company’. This is a concept that is hard to disagree with, leaving the law restricted to imposing retrospective sanctions to deter these failings.

Presently, the Company Directors Disqualification Act 1986 is capable of prosecuting directors for matters such as unfitness.[11] However Dr Carsten Gerner-Beuerle, a lecturer in corporate law at London School of Economics, identifies that:

This is where the law meets its most imposing obstacle

What is unsatisfactory in the law is the way shareholders can sue directors – they are severely restricted in that…if you compare it to the United States where it is probably a bit easier for them, that may have a positive effect if private parties can bring law suits.[12]

Also, a problematic element with ss 170-77 CA 2006 is its limited application, because directors seem too hesitant to sue fellow directors. Maybe this is due to their relationship or the cumbersome nature of the legal proceedings. Whatever the reason, this lack of legal intervention is undeniably unsatisfactory.

What can be done to prevent excessive banking bonuses and punish incompetent directors more stringently? It should not be stipulated in the CA 2006 that companies should categorically not be permitted to award bonuses. But I believe that banks should be allocated a different status within this legislation. After all, if a company such as Tesco enters liquidation it cannot be expected to be bailed out by the taxpayer. Banks are considered far too essential to the economy not to be bailed out, thus subtracting a significant degree of risk from their conduct and, in my opinion, setting them apart from other types of company. Since the loss to the economy is greater if a bank fails than if any other type of company fails, surely the punishment should go harder upon them than these other companies? The Financial Services Authority (FSA) has proposed the possibility of making bank bosses strictly liable for banking failures. An advantage of stripping the fault element in this way would make claiming against directors more attractive, in that it may reduce a degree of the ‘he said, she said’ element of the evidence. But strict liability could operate unfairly as such a broad scope may include directors who only made minor mistakes.

My knowledge of company law, unfortunately, does not extend to the level that allows me to propose detailed ideas for reform. Yet, although admittedly largely idealistic, I would generally like to see a rise in legal intervention and disciplining of failing banking directors, and, at the very least, preclude them from obtaining excessive bonuses. The system as it currently stands is unacceptable and it undermines the faith and reliance that the British economy places in the success of banks. The indispensable status of banks should place them in a different category to other companies, which would hopefully allow for more stringent provisions to be introduced in order to regulate the misconduct of these directors. Political pressure has led to the waiving of Stephen Hester’s bonus and the revocation of Fred Goodwin’s title, but until some effectual, decisive law is implemented by Parliament, this injustice will continue to be embodied in banking culture.

  • [1] However they are not trustees.Regal (Hastings) Ltd v Gulliver [1942] UKHL 1 at p.159 Lord Porter: ‘Directors, no doubt, are not trustees, but they occupy a fiduciary position towards the company whose board they form’.
    [2] Companies Act, 2006, s.171(2)
    [3]Companies Act 2006, s.170(4)
    [4] Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 at p.385
    [5] Hindle v John Cotton Ltd (1919) 56 Sc.L.R. 625
    [6] Hindle v John Cotton Ltd (1919) 56 Sc.L.R. 625, at p.630-1
    [7] Companies Act 2006, s.172(b)
    [8] Companies Act 2006, s.172(c)
    [9] Companies Act 2006, s.172(d)
    [10] Re Smith & Fawcett [1942] Ch 304
    [11] Company Directors Disqualification Act 1986
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