Investors, financiers, customers, employees and, of course, regulators are increasingly taking an interest in environmental, social and governance (ESG) issues, putting pressure on businesses with their money, their feet and the law. A team from Norton Rose Fulbright across the UK, the US and Australia asks whether positive action on things like climate risk can be seen as a new type of director’s duty and considers the personal liability risks that might arise from breaching it.
The transition to a greener, more sustainable future has been gaining significant momentum for some time. There is now a high level of pressure for companies to take action on various environmental, social and governance matters – with climate change and environmental responsibility and sustainability areas of particular focus. The pressure comes from multiple sources.
First, investors are increasingly using ESG metrics and ratings to shape their investment decisions in companies. According to figures from July to September, there are now over 5,300 signatories, representing more than US $120 trillion in assets under management worldwide, to the United Nation’s Principles for Responsible Investment (PRI), a group with a core goal of helping investors protect their portfolios from climate-related risks.
Banks and insurers are also actively transitioning their loan, insurance and investment portfolios away from high-emitting customers – including under the auspices of global sustainability frameworks such as the Equator Principles, the UN Principles for Sustainable Insurance and the UN Net Zero Banking Alliance – as green bonds and finance are becoming more prevalent in the market.
The Equator Principles are a set of 10 principles that are intended to serve as a common and risk baseline and management framework for financial institutions to identify, assess and manage environmental and social risks when financing projects. At the end of 2022, 138 financial institutions from 38 different countries had signed up as Equator Principles Financial Institutions.
The UN Principles for Sustainable Insurance, meanwhile, are a global framework for the insurance industry to address environmental, social and governance risks and opportunities launched at the 2012 UK Conference, and the UN Net Zero Banking Alliance is a group of leading global banks committee to finance ambitious climate action to transition the real economy to net-zero greenhouse gas emissions by 2050.
The expectation to take action on climate change and other sustainability goals is also reinforced by customers and employees. A recent IBM study released on 13 April 2022 found that 68% of respondents are more willing to accept jobs from organisations they consider to be environmentally sustainable. A PwC study also found that 83% of consumers think companies should be actively shaping ESG best practices.
New regulations have also been introduced that require companies to actively consider, measure, manage and disclose the key climate risks impacting their businesses.
The United Kingdom was one of the first jurisdictions to introduce these requirements, with large entities required to include material disclosures on climate risks in their annual financial reports with effect from 6 April 2022 under the Companies (Strategy Report) (Climate-related Financial Disclosures) Regulations 2022 and the Limited Liability Partnerships (Climate-related Financial Disclosures) Regulations 2022.
The disclosure standards in that legislation align with a framework established by the Financial Stability Board’s Task Force on Climate-Related Financial Disclosure which was established in 2015 to increase reporting of climate-related financial information and disbanded last year after fulfilling its remit.
In the US, California has enacted two laws, the Climate Corporate Data Accountability Act and Greenhouses gases: Climate-Related Financial Risk (see below for full references) that would require large companies that do business in California to disclose certain climate-related information, including direct and indirect carbon emissions starting in 2026, upstream and downstream indirect emissions of customers and suppliers starting in 2027 and to publicly disclose a climate-related financial risk report every other year.
In addition, the United States Securities and Exchange Commission has proposed similar disclosure rules for all US public companies. The final rule remains pending.
The Australian government is currently in the process of drafting legislation with a view to mandatory climate reporting from the 2024-25 financial year, commencing with listed entities and large financial institutions ahead of other entities in later years.
In all three jurisdictions, the form of the disclosure requirements is expected to align with the new standards released by the International Sustainability Standards Board (ISSB) in June 2023 – a sustainability standard (IFRS S1) and a climate-related disclosure standard (IFRS S2).
An important question is whether these developments fit comfortably with the core duties and responsibilities owed by directors of a company. Aside from any mandatory disclosure rules to what extent can taking positive action on mitigating climate risks and driving sustainability be seen as an incident of directors’ existing duties to the company? What are the personal liability risks if climate and sustainability measures are not adopted? And finally what improvements might be needed to existing laws to provide a clearer climate and sustainability governance framework for directors in the future?
This article seeks to address these issues focusing particularly on directors’ duties, with reference to recent developments in the United Kingdom, Australia and the United States.
Under the UK Companies Act 2006 a director has a duty 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 the members as a whole, having regard to certain considerations including the likely consequences in the long term and impact of the company’s operations on the community and the environment (section 172). In addition, section 174 requires directors to exercise care, skill and diligence both measured on an objective and a subjective basis in carrying out their duties.
In 2023 ClientEarth, a non-profit environmental law organisation and UK registered charity, took a derivative action against the directors of Shell Plc for breach of those duties in relation to the company’s climate strategy. The claim was rejected by the court for not having a prima facie case that the directors were in breach but more notably on the basis that it was not for the court to interfere with the commercial decisions taken by directors.
Although this decision was dismissed on prima facie grounds and therefore the actions of the directors were not considered in detail, it is difficult to see at present how in the absence of exceptional circumstances, a UK court will give weight to the duties of directors to have regard to the cost to the environment as a consequence of their actions and it may always be a defence for them if such actions were, nevertheless, in the interests of the shareholders alone.
If there were more support among other shareholders as encouraged by the PRI – and if the agitating shareholders held more than a de minimis shareholding – then the result may be different in a similar matter in future. Of course, it is important to note that there is no easy way to take an action for breach of directors’ duties if you are not a shareholder.
In addition to the promotion of the PRI among the investment community, it is also interesting to see that the UK’s Institute of Directors is increasingly focussing on reforming directors’ duties in section 172 to reflect changing attitudes towards ESG. In its Corporate Governance paper from September 2023, Shareholders or Stakeholders – For whom do directors govern the corporation, the merits of stakeholder value over shareholder value were discussed and the paper concluded that the balance is changing “…towards a situation in which company direction is more complex than simply maximising shareholder value”.
That said, given the difficulty of pursuing directors for personal liability for the failure to manage ESG risks on the current framing of the legislation, a policy goal to achieve greater alignment of corporate conduct with climate change mitigation and the management of other ESG issues may only be pursued through legislative change.
This is what the “Better Business Act” coalition in the UK seeks to achieve, a campaign for a change to section 172 to ensure businesses are legally responsible for benefitting workers, customer, communities, and the environment while delivering profit.
In Australia, directors have core statutory duties under sections 180 and 181 of the Corporations Act 2001 (Cth) – and corresponding general law duties – to act with reasonable care, skill and diligence, and in good faith in the best interests of the company.
There is a basis to argue that, if directors do not take action on climate change, for example seeking to reduce emissions and moving lending and investment portfolios and supply chains away from heavy emitting entities and projects, they may breach these duties by exposing the company to clearly foreseeable risks. Those risks may take the form of a quantifiable impact on profits, not only as climate physical and transitional risks materialise under current forecasts, but also as customers, employees and investors decline to do business with the company and as financiers and insurers become more unlikely to offer credit and insurance at affordable commercial rates.
In that sense, climate risks are not “non-financial” risks at all, and it could be argued that the “shareholder primacy” model, under which directors’ duties to the company are commonly understood as a duty to maximise profits and shareholder value, inherently reflects a need to take into account and properly balance ESG risks.
Recent test cases have sought to explore this theory, including a claim lodged by Friends of the Earth against ANZ Bank with the Australian National Contact Point for Responsible Business Conduct – an organisation responsible for promoting the OECD Guidelines for Multinational Enterprises on Responsible Business Conduct—asserting non-compliance. Another claim filed by a shareholder of ANZ in the Federal Court of Australia in November 2023 asserts that ANZ has failed to properly manage the material risks of climate change and biodiversity loss.
While targeted at the corporate level, it would not be a difficult link to assert personal liability for directors on a “stepping stone” basis – that, in exposing the company to legal breaches, the directors have breached their own duties to the company. Such a claim would be advanced under section 180 of the Corporations Act and framed as a breach of the duty to act in the best interest of the company.
At the same time, however, it cannot be assumed that ESG risks impact all companies equally, and in balancing the extensive range of competing interests and factors impacting the success of the company in both the short-term and the long-term, it may be the case that investment in a potentially costly climate change mitigation program, and other ESG-focused measures, need not be pursued in the commercial judgment of the directors.
Indeed, given the difficulties experienced by ClientEarth in its derivative action filed against Shell’s board in the UK, which emphasised the managerial prerogative of directors in commercially assessing the best interests of the company and determining the relative importance of ESG risks among many other commercial factors, the basis for personal liability for directors resulting from the failure to mitigate and manage ESG risks is anything but certain.
In the US, the standard for director liability is governed by the law of incorporation of a company. Given that Delaware has historically been the preferred place of incorporation, this article focuses on director duties under Delaware law.
Under Delaware law, a director has two principal duties: a duty of care and a duty of loyalty. Duty of care generally requires a director to exercise the amount of care that an ordinarily careful and prudent person would reasonably believe to be appropriate in similar circumstances. The focus is generally on the decision-making process. In this respect, a director should inform himself or herself of all material information reasonable available and otherwise act prudently. The duty of loyalty requires a director to protect the interest of the company and avoid conduct that would harm the company. The duty of loyalty includes (1) a duty to deal candidly with fellow directors, and (2) a duty to inform directors of information material to the company, and (3) a duty to act in good faith with honesty of purpose and a genuine care for the company and its shareholders.
Directors may be considered to have a duty to at least consider ESG issues when they present material risks to the company. However, a board’s decisions are typically entitled to deference under the “business judgment rule.” The Business Judgement Rule recognises that for a board to maximize value of the company, it has to take risks without undue fear that the decision will be overturned or result in liability.
Accordingly, a court will rarely substitute its judgment (or another’s) absent a showing of fraud, illegality, or a conflict of interest. In that respect, in re Simeone v. The Walt Disney Company (see full citation below) the Delaware Court of Chancery held that a board’s decision to “speak (or not speak) on public policy issues is an ordinary business decision” and not evidence of wrongdoing. Accordingly, the court denied a shareholder’s request to inspect the company’s corporate books and records.
The business judgment rule seemingly presents a substantial impediment to the pursuit of directors of traditional companies for personal liability relating to climate change and other ESG risks.
In addition to the traditional corporate entities, Delaware law authorises the formation of a “Public Benefit Corporation” or “PBC.” Under Section 362(a) of the Delaware General Corporation Law a PBC is a for-profit corporation that “is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.” The same section states that a director must balance “the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation’s conduct, and the specific public benefit or public benefits identified in its certificate of incorporation.” Under section 365(b) of the Delaware law, that balancing requirement is satisfied if the director’s decision is “informed and disinterested and not such that no person of ordinary, sound judgment would approve.”
The protections given to a director’s decision-making may explain why there apparently have not been substantial legal proceedings filed against directors for alleged breach of duties relating to ESG risks in the United States.
There does, however, appear to be an increase in litigation involving allegations of deficiencies in corporate disclosure relating to key climate risks and “greenwashing” (i.e. the misrepresentation of credentials relating to climate issues and risk management).
Businesses are led and operated through their boards and while legislation in the UK, Australia and the US appear to focus directors to maximise benefits to their shareholders and courts remain reluctant to interfere in directors’ commercial decisions, it is difficult to see that a director can be criticised or held liable when a company’s actions to do so conflict with the interests of the environment or indeed encourage directors to prioritise ESG matters.
However, there is a significant movement from a multitude of organisations representing all stakeholders towards change, and it might just be a matter of time when the relevant governments look to amend their laws to reflect these changing attitudes.
There are important insolvency and restructuring implications at play here also. To comply with obligations that will arise in a future focusing on sustainability and net zero emissions, companies will need to effectively operationalise climate commitments, especially in energy-intensive sectors, as they restructure core business functions, supply chains and relevant investment and finance portfolios. And conversely, given the changing attitudes of investors, lenders and other important stakeholders towards a more sustainable future, companies that do not embrace such change may not be in a position to invest and/or refinance their businesses.
Climate Corporate Data Accountability Act, Cal. Health & Safety Code § 38532 (West 2024)
Greenhouses Gases: Climate-Related Financial Risk, Cal. Health & Safety Code § 38533 (West 2024)
Enhancement and Standardization of Climate-Related Disclosures for Investors, 87 Fed. Reg. 21334 (proposed Apr. 11, 2022) (to be codified at 17 C.F.R. pt. 210,229,232, 239, 249)
ClientEarth v Shell plc [2023] EWHC 1897 (Ch)
Shareholders or Stakeholders – For whom do directors govern the corporation, taken from the text of a speech delivered by Dr Roger Barker at the NEXT Corporate Governance Conference, Seoul National University 22 September 2023
In re Simeone v. The Walt Disney Company, 302 A.3d 956, 969 (Del. Ch. 2023).
This article first appeared in the February 8, 2024 edition of Global Restructuring Review and is reprinted with the permission of Law Business Research.
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