New challenges to the narrow interpretation of directors' duties

Rising physical, transition and litigation risks may not alter the essential nature of directors' duties to promote the success of the company 'for the benefit of its members', but they increasingly demand most businesses to make significant changes to governance and management practices.

It is often still assumed that promoting the success of the company automatically equates to maximising short-term financial returns, even if this leads to social and environmental harms. While section 172 of the Companies Act (2006) requires directors to "have regard" for the long-term consequences of decisions, and the social and environmental impacts of business operations, in practice, this is frequently eclipsed by the imperative to deliver short term returns.

However, increasing focus on sustainability and business resilience is leading to a broader understanding that the single-minded pursuit of financial returns can put at risk the quality and availability of the very resources on which a business relies to function. Directors who cling to the mantra of short-term profit maximisation – and who continue to treat sustainability-related risks, impacts and dependencies as secondary considerations – are increasingly finding themselves out of step with emerging market expectations, regulation and legal opinion.

This is reflected in two recent opinions on UK company law, respectively, considering the relationship between nature-related risks and directors' fiduciary duties, and statutory obligation to ensure that financial statements provide a true and fair view of the company's financial position (see key takeaways below).

The former adds weight to the view that identifying, evaluating and managing sustainability-related risks and impacts is integral to the fulfilment of directors' duties, because it's integral to protecting a business's capacity to create and sustain value over time. It concludes that directors who give these risks and impacts active consideration are therefore more likely to have discharged their fiduciary and due care obligations than those who don't.

The latter opinion adds that exercising due care and diligence extends to directors applying their own minds to ensuring that financial statements reflect how sustainability-related risks and impacts may affect enterprise value.

Key takeaways on nature-related risks and directors' fiduciary duties in UK law

• When exercising their duties to promote the success of the company, and to exercise reasonable care, skill and diligence, directors should approach identification and assessment of nature-related risks as they would any other type of risk.
• When conducting such an assessment, companies would be wise to apply a double materiality approach, in line with recommendations from the Taskforce on Nature-Related Financial Disclosures (TNFD) – i.e., identifying and assessing not only how nature-related risks may affect enterprise value (financial materiality), but also how their business activities impact and depend on nature (impact materiality).
• Directors who perform such an assessment, who actively consider nature-related risks, dependencies and impacts, and who document how they do so, are more likely to have discharged their duties than those who give those risks no consideration at all.
• Five key actions may be considered relevant to whether directors have properly discharged their duties under sections 172 and 174 of the Companies Act (2006):
  • Identifying the extent to which the company faces nature-related risks
  • Assessing/evaluating those risks and their potential to adversely impact the company
  • Designing and implementing a framework to systematically manage and mitigate those risks
  • Considering the extent to which risks should be disclosed (ensuring regulatory compliance, at a minimum)
  • Documenting whichever of the above steps directors choose to take (e.g., in board minutes, memoranda or reports)
• Even where TNFD-aligned disclosures are not compulsory (e.g., for those companies caught by the EU Corporate Sustainability Reporting Directive), widespread voluntary adoption will likely establish this as the de facto global norm.
• Provided disclosures are clear, comprehensive and properly corroborated, the scope for potential director liability for voluntary 'over disclosure' (i.e., beyond what is required by regulation) is considered small.

Key takeaways on ensuring that financial statements provide a 'true and fair view'

• Identified risks, dependencies and impacts should inform more than just narrative reporting. There should be a coherent linkage to financial statements, too.
• When approving accounts, company directors (and their auditors) are required to satisfy themselves that those accounts give a 'true and fair view' of the company's assets, liabilities, financial position, and profit and loss.
• Compliance with relevant accounting standards doesn't automatically achieve this requirement. 'True and fair' is a dynamic concept, whose interpretation evolves with changing societal expectations, and whose application therefore involves judgement on the part of directors and auditors.
• This includes consideration of additional disclosures in financial statements that may be necessary to fairly reflect the actual or potential impacts of climate- and other sustainability-related issues on the company's financial position and performance, and its ability to continue as a going concern.
• Directors are expected to apply their own minds in this regard, exercising due care and diligence, and bearing in mind the responsibilities placed on them in adopting/approving financial statements. They cannot simply delegate these judgements to others.

How Mishcon Purpose can help

Using the Mishon Purpose Framework, we help our clients to protect and grow value through assessing the materiality of ESG considerations to their business, and fully integrating them into strategy, governance and risk management. To discuss how we can help, please contact Dan Gray.  

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