News

Partners Simon Fawell and Paul Brehony, and Counsel Kate Gee examine the heightened risks directors face from external claims by shareholders and investors in relation to ESG in the second of a three-part series for Accountancy Daily discussing directors’ duties trends for the year ahead.

Simon, Paul and Kate’s article was published in Accountancy Daily, 28 March 2022, and can be found here. The first article in the series can be found here.

Risks for company directors are on the rise. In this second of a three-part series looking at some of the key areas for directors to keep front of mind for 2022 and beyond, we focus on heightened risk to directors from external claims by shareholders and investors.

Environmental, Social and Governance issues (“ESG“) will doubtless be at the forefront of those claims. Increased governmental and societal focus on ESG means that companies will need to say more about these issues, with greater specificity and be prepared to back up their statements in this space. Directors, more than ever before, need to engage and understand what is being said on their behalf and whether they can stand behind it.

Breach of directors’ duties 

The Companies Act 2006 makes clear that directors’ obligation to “promote the success of the company” requires them to take account of ESG in their decision making. Directors must look beyond the short-term financial implications of a decision and take account of other factors including the likely long-term consequences, the interests of the company’s employees and the impact of the company’s operations on the community and the environment.  Crucially, the UK is first G20 country to force its largest businesses to disclose their climate-related risks and opportunities in line with Taskforce on Climate-related Financial Disclosures (TCFD) recommendations. Directors will need to be confident and transparent in that disclosure process and accountable for inadequacies.

Where directors are in breach of their duties under the Companies Act 2006 or more generally to act in the best interests of the company, they may be required to account to the company for the loss, most likely via a claim by shareholders.  For example, Client Earth has recently notified Shell that it intends to pursue a claim against its board of directors for climate risk mismanagement.  Client Earth is expected to argue that the directors have breached their duties under the Companies Act to promote the company’s success and exercise reasonable care, skill and diligence by failing to adopt and implement a climate strategy consistent with achieving certain environmental targets linked to the Paris Agreement.

Historically, claims brought by pressure groups with a minority shareholding against large organisations have faced a number of challenges and these duties on directors have been relatively difficult to enforce.  However, increased ESG disclosure requirements, combined with more specific governmental targets, gives a much firmer footing for potential claimants – and whatever the outcome of the Client Earth action, it will no doubt attract significant publicity and drive ESG issues further up a director’s list of priorities.  With great corporate transparency comes greater corporate responsibility: not least because losses are likely to be more easily identifiable and quantifiable on the back of increased reporting requirements and scrutiny.

Greenwashing

As ESG becomes increasingly important to investors, there is greater pressure on companies to demonstrate green credentials of the business and products.  Investors will be better able to show that they were influenced by ESG credentials. It is no longer good enough for companies to make vague claims about sustainability. Instead, both investor sentiment and regulation require that they have clear plans to achieve stated goals. For example, where a company states that it is “on course to be carbon neutral by 2040“, the directors must be confident that they understand precisely what they mean by that phrase, that the plans in place really do have the company on course to achieve the stated aim and that the company’s interpretation of the goal is defensible should it be challenged.

Where there is evidence of greenwashing, we anticipate shareholders or those with an interest in the company’s shares bringing a claim for damages based on untrue statements made in (or omission from) prospectuses or listing particulars (s90 of the Financial Services and Markets Act 2000 “FSMA“). Similarly, we expect to see claims by shareholders who have relied on untrue or misleading statements published by the company or a dishonest delay in publishing relevant information (FSMA s90A). Claims against individual directors are also likely.

Modern Slavery

There are also moves to tighten corporate reporting requirements on modern slavery and to introduce sanctions for both companies and individual directors should they fail to meet them. The 2015 UK Modern Slavery Act requires any company “doing business in the UK” with an annual global turnover in excess of £38 million to publish a statement each year setting out the steps taken to ensure that its business and supply chain is free from modern slavery.  As it currently stands, that requirement is relatively loose (there is only a recommendation regarding the content of the statement and companies are permitted to state that they have taken no steps to eradicate slavery) and cannot sensibly be enforced (the only sanction is for the relevant government ministry to obtain an injunction forcing compliance). The UK government has, instead, relied on reputational risks of non-governmental interest groups to ‘name and shame’ companies not in compliance or perceived not to be doing enough.

There have been various attempts since 2015 to strengthen this regime. Most recently, a bill was launched in the House of Lords last year which, if enacted, will make it a criminal offence if directors publish a statement that is knowingly or recklessly false or incomplete in a material manner. Among the possible sanctions would be fines or imprisonment for individual directors and corporate fines of 4% of global turnover up to a maximum of £20 million.

This development highlights the seriousness with which the UK lawmakers are treating reporting issues and gives rise to another potential avenue for disgruntled shareholders and investors to claim for losses as a result of director mis-judgment.

Facing a claim

It is, of course, essential that all directors take steps to manage these risks by engaging effectively with company processes and taking legal advice from in-house counsel to ensure their duties are being properly discharged. They must question the information put before them (and, in some instances, the information that is not put before them) and keep ESG issues firmly in mind when fulfilling their duties.  A robust and transparent approach to ESG needs to form part of a company’s culture, at all levels.

However, what steps should directors take if claims are threatened against the company or against them as individuals?

• First, directors need to understand the scope and extent of any D&O cover in place, together with the notification requirements under those policies.
• Directors should consider carefully at an early stage whether they should seek independent legal advice, even if it is the company that is the subject of any threatened claim rather than the directors themselves. Although the interests of individual directors and the company may be broadly aligned at the outset, those positions may drift as any claim continues.
• Once litigation is in contemplation, any documents relating to the potential claim must be preserved. Depending on the nature of the potential claim, directors must consider this obligation in a personal capacity as well as in his or her capacity as a director.
• Directors (and other officers) must take care over their communications; although litigation privilege will kick in once litigation is in contemplation, not all communications will benefit from it. Directors must establish clear communication channels such that privilege – where attracted – is maintained.