ESG Duties for Directors: Legal Obligations and Risks Under English Company Law
Environmental, Social, and Governance (ESG) considerations are key in shaping corporate governance. Whether a regulatory mandate or a voluntary commitment, ESG is becoming entrenched in the corporate landscape. For English directors, the stakes are potentially high, with increasing pressure to integrate ESG into boardroom strategies, or face mounting risks under statutory duties and/or reputational consequences. Potential risks for directors could be wide ranging and include criminal and civil liability.
In order for directors to comply with duties owed under the Companies Act 2006 (CA) they increasingly will need to have a strong handle on ESG policies. This includes in-depth knowledge of a company’s supply chain, its advertising strategies and corporate governance. Directors are expected to take a central role in implementing strategies relating to ESG issues to ensure the company is acting in line with relevant and evolving laws and regulations, as well as keeping up with societal expectations.
The overarching duties of directors
An important principle of company law, with some limited exceptions, is that a company has its own legal personality or legal identity, which is separate from the identities of its directors, its shareholders and parent or subsidiary companies.
However, directors have fiduciary duties to act in the best interests of the company. For example, section 172(1) of the CA charges directors with a duty to act in good faith to promote the company’s success for the benefit of its members as a whole. This is not a narrow mandate. It demands a broad lens that requires balancing long-term consequences, employee welfare, stakeholder relationships, environmental and community impact, ethical reputation, and fairness among members. ESG is therefore woven into the fabric of directors' legal obligations.
Director ESG Reporting Duties in Annual Reports and Accounts
What Is a Section 172 Statement and Why Does It Matter for ESG?
All public and large private companies[1] must adhere to mandatory reporting obligations, including preparing an annual directors' strategic report. Directors are expected to lead and manage that process. The section 172 statement is published as part of this report, forming part of the company’s annual report and accounts. Specifically, in relation to section 172(1)(d) CA - the impact of the company's operations on the community and the environment - companies must discuss strategies related to environmental issues, employee relations, human rights, social matters, and anti-corruption. This statement is not simply a box-ticking exercise, it is a public declaration of the board of directors' rationale for key decisions, backed by genuine engagement and concrete examples.
For a failure to comply with the section 172 statement requirements, Companies House may reject accounts, which could trigger late filing triggers penalties. Directors can also be held personally liable under section 451 of the CA for furnishing false information and could be subject to personal fines.
Climate-Related Financial Disclosure Requirements for English Companies
Another mandatory disclosure obligation is the disclosure of material climate related financial information. This is designed to help support investment decisions in a move towards a low-carbon economy. Under the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022[2] ,in-scope companies and LLPs are required to disclose material climate change related risks and opportunities.
The disclosures need to cover:
- how climate change is addressed in corporate governance,
- how risks are managed,
- impacts on strategies and
- performance measures and targets applicable to managing these issues.
What Are the Legal and Financial Risks for Directors Around ESG?
Boards of companies have little choice but to comply with the mandatory reporting requirements and to ensure they are on top of a company’s ESG strategies.
The role of the Financial Reporting Council (FRC)
The FRC has the responsibility to monitor the contents of strategic reports and has the power to make an application to court for a declaration that the annual report and accounts of a company do not comply, or a strategic report or a Directors’ report does not comply, with the requirements of the CA. The court may then order the preparation of revised accounts (including the revision of the strategic report) and such other matters the court thinks fit. There may also be scope for special interest groups to exert pressure on the FRC to hold it to account over strategic reports. For example, by engaging with relevant authorities, engaging in public scrutiny and advocating for changes in reporting practices. This may ultimately have the effect of influencing the FRC’s guidance and enforcement actions.
Director Liability for misleading ESG statements and greenwashing
Directors might have to compensate the company for losses from false or misleading statements or omissions in the director's reports, especially if they knew the statements were false or were reckless. Misrepresentation claims against directors in respect of annual reporting are nothing new, however, the new ESG disclosure rules amplify this risk. For example, misleading or unsubstantiated "greenwashed" disclosures, may have the effect of making those directors personally liable and could result in regulatory investigations and fines.
Derivative actions
A breach of directors’ duties could also spark legal action from a company against the director or a derivative claim by a shareholder. Derivative claims are claims brought by one or more shareholders on behalf of a company under section 260 of the CA against directors for breach of statutory and/or common law director duties.
Perhaps the most notable case on this recently has been ClientEarth v Shell plc & Ors[3] in which environmentalists challenged Shell’s net-zero strategy, alleging directors failed in their duties to properly implement a net-zero transition. Notably, it was argued that the following duties were engaged:
- Duty to promote the success of the company (s172 CA 2006). This duty requires a director to act in in good faith when promoting the success of the company for the benefit of the members as a whole, having regard, amongst other matters, to an identified list of considerations, such as the likely consequences of any decision in the long term and the impact of the company's operations on the community and the environment. This is a subjective test.
- Duty to exercise reasonable skill, care and diligence (s174 CA 2006). This duty requires a director to exercise the care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions they carry out, and the general skill and experience that director actually has. This therefore includes both subjective and objective elements.
The court ultimately dismissed the case because it was decided that it is not for the court to interfere with the commercial decisions taken by directors, which is a long and well-established principle and was consistent with the fact that generally speaking, directors have limited liability and can be shielded by the company’s separate legal personality.
However, this case has demonstrated that while the primary target in most ESG-related actions is the corporate body, there is likely to be an increase in shareholders and investors seeking to hold directors accountable for their ESG policies. Even if such claims are unsuccessful, the activists’ aims are arguably achieved by bringing the claim and highlighting the issues they wish to raise by the associated publicity.
The Future of ESG and Director Accountability in English Law
In a bid to work towards a more sustainable future, efforts such as the "Better Business Act" (“BBA”) aim to replace and/or amend section 172 to ensure businesses align long-term interests with "people, planet, and profit". The BBA is a legislative campaign designed to promote a “triple bottom line” approach, which would require businesses to be operated not just for the benefit of its members, but also wider society and the environment. Directors should align their duties with ESG goals to prepare for potential legislative changes.
In the light of the potential shift away from a focus on section 172 of the CA, and following Shell we may see section 174 brought into the spotlight, which mandates a director of a company to exercise “reasonable care, skill and diligence” in their decision making.
Section 172 of the CA is a subjective duty and so a director is more able to justify their actions based on their own judgment. However, section 174 is an objective one. How compliance with section 174 in a litigation context for ESG related issues remains to be seen, but we may see a focus on expert evidence to assess whether a director has complied with their duties.
How Directors Can Mitigate ESG Risks Through Governance and Compliance
It is crucial for company directors to proactively seek legal and accountancy advice regarding their reporting obligations. While most SMEs are not caught by the reporting requirements mentioned in this article, it is nevertheless advisable for SMEs to work on an ESG strategy and to think about, and take advice on, their potential obligations.
Here are some of the ways directors can protect themselves:
- Take a pro-active risk-based, rather than compliance based approach – invest in external advice or personnel to assist with creating a strategy at board level for staying on top of reporting requirements and ESG regulation, ahead of time. Prioritising ESG compliance by the company will mitigate and minimise the risk of directors becoming liable.
- Stay informed of the latest developments - have procedures for ensuring the company stays on top of its obligations and both the board and compliance/ risk teams are well-informed
- Building an in-house ESG risk management team – ideally create an in-house dedicated ESG team, synced with external counsel to help manage and mitigate risk at all reporting stages. Directors can use this team to help verify disclosures and stress-test public statements about the company's ESG policies and risk management practices.
[1] Defined by meeting certain thresholds of turnover, balance sheet total and number of employees
[2] Which amend sections 414CA and 414CB of the CA
[3] ClientEarth v Shell plc & Ors [2023] EWHC 1137 (Ch)
