We are increasingly expecting more of our corporates. Public opinion seems to expect, if not require, companies to profess a purpose beyond pure profit-making, to conduct themselves according to a philosophy. In addition to generating returns, we want them to focus on their impact on the world around them in the broadest sense – to ‘pick a side’ – and we want this sense of purpose to flow through the entire organisation, top down.
Where public expectation leads, legislators soon follow: the regulatory confluence of the above concerns are perhaps most visible in the various legislative initiatives on ESG and sustainability which are taking shape around the world.
This is evident both in how the Corporate Sustainability Reporting Directive (the Reporting Directive) requires sustainability reports to be included in company directors’ reports (and therefore signed off by the board) and also in the detailed standards against which companies will be required to report, the European Sustainability Reporting Standards, or ESRS. Significantly, not only do the ESRS contain a specific disclosure standard on governance matters (ESRS G1 which requires disclosures around a company’s administrative, supervisory and management bodies, and their role in overseeing an organisation’s approach to material sustainability matters, among other topics) but the architecture of the ESRS also requires each sustainability matter being reported to be subject to a governance analysis on policies, actions and targets (as well as around assessment of materiality of what sustainability matters are sustainable), all of which will be described in sustainability reports.
But does the Reporting Directive significantly expand personal liability for company boards? On the whole, the answer here is probably that it does not (although it will be necessary to analyse impending domestic implementing legislation to be definitive on this point). The Reporting Directive requires companies to report on their existing behaviour, rather than dictate what that behaviour should be. Yes, it requires action by reporting entities in preparing their reports (in collecting data internally and in sourcing and diligencing value chain information) but at the heart of the Reporting Directive is what can best be characterised as an information gathering exercise with a twist.
The twist is new standards of consistency and transparency to tackle greenwashing – and the twist is delivered through new reporting standards, double materiality and an external audit. This is intended to allow stakeholders to allocate capital more sustainably thus influencing standards and behaviours in the long run, but does not of itself impose standards of conduct. We expect that failure to prepare compliant sustainability reports in directors’ reports will be subject to Irish company law provisions around the failure to prepare and publish accounts with appropriate reporting, and will sit alongside other failures in financial reporting. In a sense this increases the breadth of information for which directors will be ultimately responsible, but does not in our view amount to a new area of liability. It remains to be seen whether in the fullness of time investor suits are enabled by perceived or actual shortcomings in sustainability reporting.
By contrast, the proposed Corporate Sustainability Due Diligence Directive (the Due Diligence Directive) currently under trilogue negotiation among the institutions of the EU, may up the stakes for corporate leaders. The Due Diligence Directive will require companies to diligence their own operations and those of their established business relationships to identify, prevent, mitigate and account for adverse human rights and environmental impacts of their operations, and these matters will ultimately fall to be disclosed in organisations’ sustainability reports.
Significantly, obligations are due to be imposed directly on corporate leaders. Directors will be responsible for setting up and overseeing implementation of the due diligence processes required by the directive, and for ensuring that an organisation’s business model and strategy are compatible with a transition to a sustainable economy. Further, if adopted in its originally proposed form the Due Diligence Directive may even go so far as to insert a new fiduciary duty on directors explicitly to take into account the human rights and environmental impacts of their decisions when fulfilling their duties to act in best interests of their organisations (which may be a expansion of existing domestic company law in many jurisdictions). This direction of travel demonstrates a legislative intention to drive changes in corporate behaviour and to legally require that leaders take responsibility for overseeing and executing those changes.
For all businesses, the Reporting Directive and anticipated Due Diligence Directive now clearly make sustainability behaviours and reporting a boardroom issue. In the fullness of time, compliance with these regimes will ultimately fall to be policed by the courts. It will be interesting to see how and to what extent our common law judges are able to overcome ingrained judicial reluctance to oversee corporate decision-making – and how this is received by us all in practice.
This article is adapted from an article published in our most recent ESG and Sustainability Bulletin. For access to the Bulletin, please visit this link.
