Directors’ and Officers’ Accountability for ESG Compliance and Performance.

Society sees it as a great injustice when individuals who are in control of a wrongdoing entity get away, seemingly scot-free, from their company’s failure or misconduct. The Government’s answer to this perceived injustice is more legislation and regulation to ensure that those at the frontline in managing risk, are held individually accountable for wrongdoings. That is exactly what has happened in the UK in recent years. Add this general climate of individual accountability to the weather front coming in relation to environmental, social and governance (ESG) issues, then you have a perfect storm for claims against directors and officers in the coming years.

Although hardly talked about a few years ago, there has been rapid and multifaceted pressure from investors, consumers and regulators alike for businesses to demonstrate and provide transparency in relation to their ESG credentials. 2021 saw a huge focus in particular on the climate change agenda. Whilst claims in this area are evolving and theories relating to liability are being developed, there has been much recent dialogue in relation to claims which are likely to arise from physical climate related risks. For example, the likelihood of increased environmental claims by third parties who suffer loss and damage as a result of a company’s contribution in relation to the physical aspects of climate change. Similarly, a company’s failure to adapt operations to take into account physical climate related risks which have resulted in loss of value in the company and its assets. However, whilst there are clearly multiple potential risks that present themselves in the sphere of ESG, we consider that the greatest for directors and officers relate to compliance with increasing reporting duties, the risk and repercussions of greenwashing and increased shareholder activism.

There has been a significant increase in non-financial reporting duties on UK companies within the last five years. To name but a few, the Wates Corporate Governance Principles for Large Private Companies, the modern slavery statement and the s172 Director’s Duty statement. Currently the application of non-financial reporting duties depends on the size and nature of the company and vary from being mandatory to voluntary. However, it is certain that the future holds more mandatory rules which will increasingly affect a broader spectrum of businesses. For example, from 6 April this year, in line with the recommendations made by the Taskforce on Climate-related Financial Disclosures, thousands of large UK-registered companies and financial institutions will be required to disclose climate-related financial information on a mandatory basis (in accordance with The Companies (Strategic Report) (Climate -related Financial Disclosure) Regulations 2021).  It is likely that within the next few years this requirement will be extended to apply to the majority of UK registered companies (in accordance with the HM Treasury’s “A Roadmap towards mandatory climate-related disclosures”).

Directors and officers will be in the firing line for non-compliance of reporting duties where they know that the company’s statements do not comply or were reckless and failed to take reasonable steps to secure compliance or to prevent any report from being approved. Such a failure may lead to regulatory investigations being made, civil and criminal proceedings, fines and other penalties.

Hand in hand with mandatory disclosures comes “greenwashing”, which is the practice of companies exaggerating their ESG performance and credentials. Again, directors and officers may find themselves subject to regulatory investigations to the extent that any statements were made without reasonable grounds. Litigation may also follow by investors if it is the case that the value of an asset falls due to an asset being greenwashed.

Company directors are of course under a statutory duty to promote the success of the company. This duty will not always sit easily with ESG-related considerations. Any conflict in this regard may increase the potential for claims against the board of directors by investors and other stakeholders. We are also likely to see increased shareholder activism in this sphere with shareholders holding the board responsible for any promises made in relation to their ESG targets and strategies.

Considering the above, it is little wonder that ESG is one of top emerging risks for directors and officers and their insurers. The problem is that the ever-expanding duties in this sphere derive from a wide range of sources and have arrived so rapidly that there is generally a lack of understanding and standardisation. It appears trite to say, but obviously the more rules and obligations imposed, the greater the risk for falling foul of those duties. In addition, ESG issues are generally emotive and the heightened awareness of society and the weight of public interest in this area will undoubtedly aid momentum for investigations and claims against directors and officers in the future.

Now for the positives! Consideration and transparency of ESG issues is obviously a good thing for society and the planet. In addition, with great change comes great opportunity. It is already apparent that businesses that have embraced and adopted strong ESG propositions have seen greater performance. This correlation is likely to motivate other companies to follow suit more quickly than they may otherwise have done. As this new ESG mindset becomes embedded within boards, disputes might decrease.

It is also interesting to note how Insurers have responded to this emerging threat. Exclusions always have a place, but it is clear they are not a panacea. The burden of proof that an exclusion applies is on Insurers and the diverse nature of claims/investigations that arise in this sphere will not likely be easily excluded. As such, many Insurers are taking a more holistic approach seeking more in-depth information on a company’s current and future strategies and rewarding preferential terms to those businesses that perform well against ESG metrics. Such an approach will undoubtedly help motivate more rapid change in the future.