3/08/2023·4 mins to read
Controversial change to directors’ duties passes
On 1 August 2023, Parliament passed the Companies (Directors’ Duties) Amendment Bill (the “Bill”).
The Bill amends the duty of a director to act in good faith and in the best interests of the company set out in section 131 of the Companies Act 1993.
Once the Bill takes effect, section 131 will include that a “director may consider matters other than maximisation of profit (for example, environmental, social, and governance matters)” in deciding what is in the best interests of the company.
The Bill will take effect the day after it receives Royal Assent, which we expect will happen shortly.
A controversial change?
Although this Bill is in line with a growing international trend to recognise ESG factors in corporate decision making, the Bill has been controversial. The Select Committee was unable to agree on whether the Bill should pass, and there has been criticism that the Bill is unlikely to significantly impact company decision-making.
However, many believe that this Bill merely reflects existing corporate practice and that directors should already be considering ESG factors when determining the company’s best interests.
Failure to consider ESG factors can increasingly pose a risk to a business’s reputation and its business generally, leading to poor long-term financial outcomes for the company and its shareholders if directors fail to incorporate ESG risks into the decision-making process.
For example, a company that fails to consider ESG factors could risk losing social licence to operate or risk the stranding of carbon-intensive assets, resulting in a decrease in the value of the company and a reduction in its long-term viability.
Good ESG credentials are becoming increasingly important if businesses want to stay competitive and many, if not most, directors are already incorporating ESG factors into their decision making.
Simpson Grierson’s 2022 Expanding Horizons report, which surveys offshore investors, found that 75% of respondents viewed ESG factors as important to their organisation’s decision-making, with 43% citing reputational risk as one of the key reasons to consider ESG.
The way forward
There have been concerns that the Bill will increase litigation risk for companies and directors.
However, the Bill leaves the consideration of ESG factors to directors’ discretion, making litigation a lower risk than in countries where consideration of ESG factors is mandatory, such as the United Kingdom.
Directors in the UK are obliged to consider ESG factors when deciding what is most likely to promote the success of the company. Since 2019, large companies have been required to include a statement in their annual report explaining how the directors have considered the interests of stakeholders when carrying out their duty to promote the success of the company.
Despite the mandatory obligation to consider ESG factors, thus far there have only been two actions brought against directors, both relating to climate change. The courts did not allow either action to proceed.
In the most recent case against the directors of Shell, the judgment reiterated that courts will be reluctant to second-guess or interfere in decision-making by directors, which should reassure directors anxious about potential personal liability.
However, for directors or boards that are concerned about litigation risk, there are practical steps that boards can take to mitigate and safeguard against potential liability for failing to consider ESG when deciding the company’s best interests:
- having ESG factors as an item on each board agenda;
- ensuring they understand any risks that ESG factors pose to the business and how those risks are being managed;
- taking external advice if the board does not include members with the necessary expertise;
- directing the risk management committee to consider and address ESG issues; and
- clearly documenting steps taken to identify and assess ESG factors that might affect the business.
To stay competitive and attract investors, directors and business leaders need to be proactive about incorporating ESG factors into their decision-making. This will help support sustainable growth and long-term value creation for shareholders and helps build stronger stakeholder relationships.
For more guidance on how boards can mitigate ESG risk and how ESG factors can contribute to the company's overall long-term success, contact one of our experts.