All directors will face greater scrutiny of their firms’ climate strategies, says Melanie Wadsworth, corporate partner at Faegre Drinker.
We are all aware of the increased pressure on organisations to keep the target of net zero greenhouse gas emissions by 2050 high on their agenda. Although climate-related reporting obligations are increasing, and more sustainable finance regulation is coming down the tracks, for now, climate change legislation generally applies to only the largest businesses operating in the most challenging sectors.
However, the recent case brought against Royal Dutch Shell by ClientEarth, an environmental charity which seeks to use the law to create systemic change, relies on a piece of legislation which came into effect as long ago as 2006 and applies to every company incorporated in the UK. Section 172 of the Companies Act 2006 requires company directors to act in the way they consider, in good faith, is most likely to promote the success of the company for the benefit of its members as a whole.
In doing so, each director must have regard (amongst other things) to the impact of the company’s operations on the community and the environment. ClientEarth is arguing that those duties have been breached by the failure of the Shell board to adopt and implement a climate strategy that is fully aligned with the goal of the Paris Agreement to keep global temperature rises to below 1.5°C by 2050.
This is not the first time that Shell has found itself in court over its climate strategy: in May 2021 the Hague District Court in the Netherlands ordered Shell to reduce its group-wide global emissions – and those of its end-users – by 45% by the end of 2030. This ruling, which is under appeal, accepted the claimants’ argument that Shell’s climate policy and intentions were so intangible and ill-defined as to be incompatible with achieving its stated goals.
This provides an interesting challenge for boards, particularly in the context of their public disclosures regarding climate change strategy. It is entirely sensible and prudent for directors to acknowledge in their annual report and elsewhere that delivery of certain climate-related targets may be subject to factors outside their control. However, if those caveats and disclaimers are too broad or non-specific, the report itself may be subject to challenge.
Under section 174 of the Companies Act 2006, directors have a statutory duty to exercise reasonable skill, care and diligence in the performance of their role. This is a deliberately wide duty and encompasses not only the general knowledge, skill and experience that would be exercised by a reasonably diligent person in that role, but also the actual knowledge, skill and experience of the director concerned. Accordingly, if a member of a board has particular expertise in relation to ESG matters, the expectations of him or her will be higher.
To establish a claim for breach of duty (bearing in mind that the directors owe their duties to the company, and not to the shareholders themselves) is typically a cumbersome and costly process. However, it is likely that increasing environmental legislation will, in due course, lead to more companies facing fines or other penalties for non-compliance, which could demonstrate a failure to have adequate regard to environmental issues or to exercise sufficient diligence. In such circumstances, a director would need to persuade the court that he or she acted honestly and reasonably and, having regard to all the circumstances of the case, ought fairly to be excused.
Historically, the likelihood of a director becoming liable for environmental issues has been limited to the rare cases in which an offence committed by the company (e.g. a pollution event) was committed with the consent or connivance of the director or was attributable to his or her neglect. Personal exposure was generally only a concern for directors of businesses with high-risk operations, where direct environmental damage was a genuine possibility. Now, the concept of environmental responsibility is infinitely wider, and few organisations can escape its reach.
In March this year, the International Sustainability Standards Board (ISSB) published two draft standards which would require companies to disclose material information about all significant risks and opportunities to which they are exposed in the areas of sustainability and climate. These new accounting standards, which the ISSB aims to finalise by the end of the year, will bring environmental reporting firmly within the audit remit. While increasing transparency in ESG reporting is to be encouraged – particularly if it results in disclosures which are more easily comparable – directors will need to be very careful that the information on which such disclosures are based is reliable and fully verified if it is to be fair and not misleading.
Further evidence that environmental matters should be firmly on the board’s agenda is the proposed amendment of section 172 by the draft Better Business Act such that the duty to “promote the success” of the company for the benefit of shareholders, with its profit-oriented overtones, becomes a duty to “advance the purpose of the company” which is stated to involve operating in a manner that benefits wider society and the environment and reduces and seeks to eliminate any harms or costs the company creates or imposes on them. The shift in emphasis is clear and part of a wider pattern which suggests that Shell is not the only company whose board may face greater scrutiny of how climate change is accommodated in their strategic planning and operations.