Section 172 CA 2006: A walk in the park for directors?

Here is the second article in our series on what lessons can company directors and their insurers learn from the Oscars (or for film buffs!)

Part 2: Jurassic Park – Takeaways from InGen/John Hammond for company directors

In 1994, Jurassic Park won three Academy awards at the 66th Academy Awards. You won't be surprised to hear these were: Best Visual Effects, Best Sound and Best Sound Effects Editing. What you may not know, is that Jurassic Park also illustrates the impact of Section 172 of the Companies Act 2006. In our second article of this mini-series, with the benefit of some creative licence, we will take you through a 'walk in the park' to explore the duty to promote the success of the company.

Why Jurassic Park?

Apart from being one of Steven Spielberg's most highly praised films, section 172 CA 2006, also goes to the heart of what the film is all about. Under Section 172, "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 Jurassic Park, we see John Hammond (played by Richard Attenborough) with visionary but reckless decision making, unreserved risk taking coupled with the failure to balance long-term success with safety and stakeholder interests.

Background

To refresh your memory, John Hammond founded and was the CEO of International Genetic Technologies, Inc (InGen). Through this company, John Hammond sought to bring his life-long dream into being: to create dinosaurs using DNA gleaned from mosquitos that had been preserved in amber. John identified an island off the coast of Costa Rica, Isla Sorna, and began setting up labs to research and breed the dinosaurs. Despite recruiting top talent to aid his quest and, before the park officially opened, a preview visit by dinosaur experts ended up in a high-casualty (and high-thrilling) event.

Section 172 through the lens of Jurassic Park

Section 172(1) requires a director to 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 to have regard to:

(a) the likely consequences of any decision in the long term

John Hammond, whilst creative and full of ideas, becomes fixated on getting the park open and impressing his investors. We learn early on that the park can run on minimal staff by relying on the latest technology. Whilst this seems impressive at first, it soon becomes apparent that John Hammond has not carried out extensive and structured long-term risk assessments. There is no evidence of: any testing or management of risk if the systems become redundant; a contingency plan in case the power fails; evacuation plans (particularly given the island has little signal and it can only be reached by boat which takes a number of hours) or the reputational impact to the company of a mass-casualty event.

Throughout the film, the narrative is that the founder of the company has 'spared no expense' in this business venture, however, this reassurance is short-lived. This is an example of the necessity of balancing long termism against immediate commercial benefit. Long termism requires focus on decisions that are good for the business over many years, which can include factors such as investing in strong systems and people (we touch on this next, below), building trusted client relationships and accepted slower short-term profits to create a stable and valuable business for the future. It may have taken John Hammond some time to get the company up and running, but throughout the film we see him chasing that quick win and the excitement it brings by focusing on what is profitable in the immediate future. There's clear evidence the company has been cutting important costs like on compliance or training. There is no safety training nor safety plans in place to protect either the staff or the buildings, or even the dinosaurs themselves. The 'spared no expense' motto may have reassured the early investors in the company, however, the audience soon starts to see the company's limitations.

(b) the interests of the company’s employees

It soon becomes apparent that all the company's employees are subject to real and extreme physical risk. This is evident from the opening scene where a mistake during the feeding of a velociraptor results in us witnessing the first death of an employee. We soon learn that this was not the only death that occurred during the initial stages of the park.

Whilst we are told the park is running on minimal staff, what this means is that there is little or no staff working in pivotal infrastructure roles. However, there are still game wardens, kitchen staff, cleaners, porters, lab technicians etc. and these are all at risk of death, primarily by being eaten by an escaped dinosaur.

Not only are they exposed to risk in this way, but the company's treatment of Dennis Nedry, the instrumental personnel in developing the technology the park relies on, leads to him becoming disgruntled. We hear his many complaints of being overworked, underpaid and unsupported and this eventually results in complete company sabotage. Poor governance of the company and a complete failure to engage with key staff highlights how this can directly threaten corporate success.

(c) the need to foster the company’s business relationships with suppliers, customers and others

Prior to the opening of the park, John Hammond enlists the assistance of key stakeholders to attend the park. This includes, investors, a legal advisor, contractor, scientists (Alan Grant, Ellie Sattler and Ian Malcolm) and his grandchildren (Lex and Tim) who he calls his key audience. However, even though he seeks approval from experts to gain reassurance for his investors (following the death of the employee in the opening scene), there is no risk management or real care taken in ensuring the safety of those people and thus placing the relationships with key stakeholders entirely at risk.

In addition, and as we referenced above, John Hammond's relationship with Dennis Nedry, who is the critical supplier of the IT infrastructure, is mishandled. He shows no oversight, no segregation of duties and no proper vendor management. Dennis is able to negotiate a deal with a competitor for the sale of dinosaur embryos and set up a 'back door' in the IT system so he can override the security settings across the whole park and lock their personnel out of the system by use of a password: ' you didn't say the magic word'….

(d) the impact of the company’s operations on the community and the environment
The environmental impact of Jurassic Park is obvious. Resurrecting extinct species, thereby disturbing ecosystems, not to mention the risk of the animals escaping into the wider environment is huge.

Even if the company was legally permitted to create the dinosaurs, as Ian Malcom states, the company was so caught up in trying to work out if they could, "they didn't stop to think if they should". It is imperative that directors consider the environmental impact their company has as well as any risk mitigation strategies and processes. Not only is it the right thing to do but the reputational risk to the company must always be considered.

(e) the desirability of the company maintaining a reputation for high standards of business conduct

When things go wrong in the park, the reputational damage is catastrophic. The company has to deal with many deaths, the regulatory scrutiny for all of its actions and decisions, not to mention the ethical outrage for creating such a park and placing lives at risk in the first place.

(f) the need to act fairly as between members of the company
Whilst it has taken a number of years for the park to come to fruition, John Hammond makes it clear that the early-stage investors are keen for returns. However, a quick return is not always beneficial for the longer-term interest of the company, particularly in respect of its solvency and thus survival.

This element of Section 172 requires the company to exercise balanced decision making and ensuring all decisions are not exclusively benefiting a majority or controlling shareholder at the expense of others. John Hammond's decision making throughout the film is focused on his own self-interests in the park, his dream and making a quick profit rather than considering the interests of other members of the company.

Compliance vs breach
There is evidence in the film of John Hammond attempting to promote the success of the company. He has an innovative concept which is designed to create enormous shareholder value. The fact that John Hammond insisted on the external experts of Alan Grant, Elie Sattler and Ian Malcolm visiting the island and giving him their views, could be seen to be carrying out due diligence. There was also even some investment made in security and containment, as well as a (basic) contingency plan (the lysine contingency).

However, there are even stronger indications of breaches of the section 172 duty.

John Hammond places too much reliance on Dennis Nedry, the one IT specialist, who has complete control over the development and continuity of the technological infrastructure of the island. Nedry is not given any proper oversight and there is no evaluation or risk management of the long-term consequences of this and to business relationships.

Whilst there may be some, it can most definitely be described as insufficient regard to not only visitor safety but the safety of company employees. Not to mention the impact to the community of the business, especially if the dinosaurs managed to get off the island completely (but wait, that's The Lost World).

The one contingency plan in the event any dinosaurs escaped the island, involved the need for the dinosaurs to be manually fed lysine from the staff. This was evidently not realistic. It failed to take into account the lysine rich sources naturally occurring on the island that the dinosaurs could eat themselves.

John Hammond showed a complete lack of realistic emergency planning both in terms of long-term consequences of the park and therefore the future of the company, as well as its reputation, not least due to the clear ethical questions that should have been raised at the outset with regards to the genetic manipulation of animals as well as the welfare of the animals themselves.

Even if John Hammond genuinely believed that he was promoting the success of the company, a court would scrutinise whether he had proper regard to all the factors (a) to (f) set out above and, implement the appropriate governance.  It is safe to say John Hammond would not succeed under any such scrutiny.

Our top 5 risk management tips for directors to consider (and their insurers to keep in mind)

1. Ensure all board minutes are documented – having a clear documentation process in place will help evidence decision making if challenged at a later date

2. Embed stakeholder impact into board decision making – ensure the board explains stakeholder impacts clearly and considers any relevant alternatives Board decisions that ignore systemic risks are fertile ground for shareholder claims. and decisions are well-balanced to ensure fairness for all shareholders

3. Strengthen governance processes and documentation – ensure why the chosen option best promotes the long-term success of the company

4. Align incentives and risk appetite with long-term success – ensure decisions reward sustainable performance and good conduct. Don't focus on the short-term profits.

5. Monitor, review and report on section 172 compliance – regularly reviewing company compliance with section 172 will ensure risks are adequately managed and the discharge of the duty is evidenced

We would be delighted to discuss any queries arising from this article. Please contact Matt Watson in the first instance.