It's not just the climate that's warming up: new heat on directors

By Brendan Bateman, Janelle Reid, Simon Brady, Faith Taylor, and Anthony Cavallaro
04 Apr 2019
Boards cannot ignore climate change risks as a factor in corporate decision-making.

A recent tide of comments from ASIC, APRA and the RBA stress that these regulators consider companies should have regard to the impacts of climate change risks in their corporate decision-making. An update of a landmark legal opinion on "Climate Change and Directors' Duties" comes to the same conclusion.

In this article, we examine these comments and consider how, even under the current legislative regime, directors might already be exposed to personal liability for failure to adequately consider and address climate change risks.  It may only be a matter of time before we see litigation against directors on this issue.

Overview of recent regulatory, judicial and legal attention

Since early 2018 there has been a vocal and persistent call from key regulatory bodies that companies, and their directors, could face liability if they fail to address risks relating to climate change:

How directors might already be liable under the present regime

While no doubt heartfelt, the barrage of announcements from Australia's key corporate regulatory bodies is yet to result in any tangible change to the current regime.  However, even without such a change there remains potential that, even under the current law, directors could face liability for failing to take climate change into account in their decision-making.   

The Hutley Supplementary Opinion considers that there has been an elevation in the standard of care required from directors in relation to consideration of climate change risks over the last few years, and concludes that "such risks require engagement from company directors in affected sectors, particularly in (at least) the banking, insurance, asset ownership/management, energy, transport, material/buildings, agriculture, food and forest product industries".

ASIC's "stepping stone" approach

ASIC has in recent years used a "stepping stone" approach to litigate against directors personally. This  requires an action against a company for contravention of the Corporations Act or any other piece of legislation, which then allows ASIC to launch a derivative civil liability claim against one or more directors of the offending company for breaching their duty of care in exposing the company to the risk of prosecution. While this approach has up to now only been pursued in connection with a company's breach of the Corporations Act, it could analogously also be applied to a company's breach of other legislation, including a breach of environmental laws as has been recently acknowledged by the Federal Court in ASIC v Cassimatis (No 8) [2016] FCA 1023.

However, although untested, we note that ASIC, as the corporate regulator, may be unlikely to pursue the stepping stone approach where companies are solely in breach of environmental laws. This is because such misconduct may not fall within ASIC's regulatory responsibility, a condition which must be satisfied according to ASIC Information Sheet 151 (ASIC's approach to enforcement), on the basis that the breach may be more appropriately dealt with by environmental regulators.

Additionally, it is important to note that a breach of the Corporations Act or some other law by the company does not necessarily result in an automatic breach of the director's duty of care and diligence. This is since this director's duty is not a duty of strict liability and the duty does not require directors to take every possible step to avoid a foreseeable risk of contravening legislation. Rather, the potential liability of directors in a stepping stone litigation will depend on:

  • the company's circumstances;
  • the director's responsibilities and influence over the company; and
  • the director's balancing of the company's potential risk of harm against potential benefits in the director's attempt to discharge their duty of care and skill.

Breach of directors' duty of care and diligence

In addition to ASIC's ability to prosecute directors personally under the stepping stone approach, directors may also be personally liable for breaching their duty of care and diligence arising from a failure to appropriately consider risks relating to climate change, irrespective of whether the company contravened any legislation.

Under Australian corporate law, directors owe a duty of care and diligence (both at common law and under section 180 of the Corporations Act) to the company.  That duty requires a director to consider foreseeable risks of harm to the company.  To be foreseeable, a risk must not be far-fetched or fanciful but need not be probable.  It follows that, under the current law, climate change risks must be considered by directors where those risks are foreseeable and may be adverse to the company's interests.  These foreseeable risks may include the following:

Foreseeable risks arising from the physical world

The company's interests can include risks arising from the physical world.  Depending on the context, the Courts might consider the following changes to the natural environment as foreseeable climate change risks:

  • increases in the frequency and severity of extreme weather events;
  • increases in the cost and availability of inputs (including water, energy, land and other weather dependent products such as agricultural yields);
  • increases in the future need for energy (particularly for cooling); and
  • impacts on tourism or health.

Foreseeable risks arising from the regulatory environment

Acting in the interests of the company could require directors to consider foreseeable risks arising from the company's current regulatory regime, as well as risks from future regulations that may be created to address climate change.  Regulatory change is probably inevitable (particularly in light of the recent media announcements considered earlier in this article) and may present clear and potent risks for companies.  The types of climate related regulatory risks a director might need to consider include the following:

Disclosure regulations for all companies

Under section 292 of the Corporations Act, companies are presently required to prepare annual financial reports and directors' reports. If the company's operations are subject to any particular and significant environmental regulation, the directors' report is required to give details of the company's performance in relation to that regulation. Further, a company's annual financial report must also present a true and fair view of the company's financial position and performance. This statutory requirement has recently been interpreted to require companies to disclose climate change risks on their financial performance. This interpretation formed the basis of Federal Court proceedings brought against the Commonwealth Bank of Australia (CBA) by two of its shareholders in 2017 for CBA failing to adequately disclose the risk that climate change posed to its financial position in its 2016 annual report. While the proceedings were discontinued following CBA making a number of disclosures acknowledging that climate change risk posed a significant risk to the bank's operations, the proceedings highlight the expectation and obligation on companies and their directors to consider climate change risks and disclose these risks where relevant.

Disclosure regulations for all listed entities

ASX Listing Rule 4.3.10 (which has statutory recognition) requires companies to include within their annual report a corporate governance statement, disclosing the extent to which the company has followed recommendations set by the ASX Corporate Governance Council during the reporting period.

The ASX Corporate Governance Council's current Corporate Governance Principles and Recommendations provide guidance on complying with Listing Rule 4.3.10, recommending that a "listed entity should disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks" (Recommendation 7.4). In addition, ASIC has confirmed its view that an operating and financial review should include a discussion of climate risk when it could affect a listed entity’s achievement of its financial performance or disclosed outcomes.  The present disclosure regime therefore already requires directors to take into account, devise strategies to mitigate and to disclose certain environmental risks, including climate risks (The National Greenhouse and Energy Reporting Act 2007 (Cth) also imposes reporting obligations on certain emitters and imposes sanctions for failure to discharge those reporting obligations, including on directors).

Looking ahead, the ASX Corporate Governance Council has provided further commentary on what will be expected for boards to comply with Recommendation 7.4 from 1 January 2020, and has specifically focused on disclosing climate change risks. In particular, the ASX Corporate Governance Council's newly revised Corporate Governance Principles and Recommendations note that:

  • climate change is a source of environmental risk, and includes: (i) risks related to the transition to a lower-carbon economy, including policy and legal risks, technology risk, market risk and reputation risk; and (ii) physical risks, such as changes in water availability, sourcing, and quality, food security, and extreme temperature changes affecting an organisation’s premises, operations, supply chains, transport needs, and employee safety;
  • many listed entities will be exposed to environmental risks that relate to climate change, even where they are not directly involved in mining or consuming fossil fuels;
  • entities should consider whether they have a material exposure to climate change risk by reference to the recommendations of the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD), and make disclosures in line with the TCFD's recommendations; and
  • entities that believe they do not have any material exposure to environmental risks should consider carefully their basis for that belief and to benchmark their disclosures against those made by their peers.

Additionally, the ASX Corporate Governance Council's Recommendation 7.2 states that as of 1 January 2020, the board or committee of the board should review their company's risk management framework at least annually to satisfy itself of a number of things, including that it deals adequately with climate change risks.

Potential regulatory changes

The threat of climate change might foreseeably bring about other regulatory changes. If Australia's emission reduction targets are to be met, action to achieve this could foreseeably result in:

  • increased difficulty in obtaining, and more stringent conditions accompanying, future environment and planning approvals (as occurred with Gloucester Resources' development application for a new open-cut coal mine in NSW which was rejected in part on climate change related grounds);
  • the implementation of a meaningful market-based approach that puts a substantial price on carbon. Climate change policy in Australia has been the subject of ongoing uncertainty at the federal level and it is understood that the federal opposition may introduce a rigorous emissions trading scheme if elected;
  • regulatory changes otherwise requiring the modernisation of plant or improved energy efficiency; but also
  • potential opportunities through the incentivisation of carbon capture, use, and storage.

Regulatory changes in other jurisdictions may also present foreseeable risk to a company, particularly regulations emerging from Australia's largest trading partners. China's recent reluctance to accept waste from Australia and its demand for higher quality imports (especially thermal coal) are examples of this.

Foreseeable reputational and social risks

The Courts have suggested that reputational damage might constitute harm to the interests of a company. A director's failure to consider foreseeable reputational damage to the company flowing from the company engaging in activities or actions damaging the climate could potentially constitute a failure in that director's duty of care and diligence.

Directors considering climate change risk may be enough to discharge duty of care and diligence

Whether a director has satisfied their duty of care is evaluated on both an objective and subjective basis.  This means the Court considers not only what a reasonable person would have done but also the surrounding circumstances including the company's scale and industry and the director's role and authority.  Accordingly, the foreseeability and magnitude of climate risks would be greater in some industries (such as input intensive productive industries, agriculture, insurance and energy supply or transmission industries).  Directors in these fields might be exposed to greater personal risk arising from climate change. 

However, directors who perceive climate change risks on a properly informed and advised basis, and form their own decision on what steps to take, may well be protected under the business judgment rule.  A decision to do nothing about climate change may be acceptable in many circumstances.  Even a decision to take active steps which damage the environment (including increasing pollution or campaigning against climate regulation) may not attract personal liability, provided those decisions are properly informed and taken in the best interests of the company. Indeed, the Federal Court has held that directors are in fact expected to take calculated risks, and even the pursuit of an activity that might entail a foreseeable risk of harm would not of itself establish a breach of a director's duty of care and diligence.

The relevant test for determining a director's duty of care is whether a particular risk is foreseeable.  Accordingly, it would be unlikely that a director could escape liability for a climate related risk on the basis that they either did not believe the existence of climate change or did not believe it was a consequence of human actions.  The relevant question is whether the director should have known.  Further, even if a director did attempt to dispute the science, many of the risks (particularly the likelihood of regulatory change and reputational damage) exist irrespective of any assessment of the veracity of the science.

What's ahead

Boards cannot ignore climate change risks as a factor in corporate decision-making.  Under the current regime, directors who fail to proactively turn their mind to climate risks could be found personally liable for breaching their duty of care.  A director might also be found to have breached their duty if they do not appropriately disclose climate risks or fail to take steps to address foreseeable risk which causes harm to a company (including reputational harm).  The regulators are unanimous in their belief that companies should be considering addressing climate change risks and it may only be a matter of time before we see litigation against a director on this basis.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.