In February 2019, the World Economic Forum identified that the top 3 risks facing the world in terms of likelihood related to the environment; extreme weather events, failure of climate change mitigation and adaptation, and natural disasters. In Australia, companies are under increasing pressure to address climate change risks. The Australian Institute of Company Directors has said that climate change risk management is driving increasing shareholder engagement, which is self-evident from last year’s AGM season. The intersection of directors’ duties with the issue of climate change is, therefore, front of mind.
Directors’ duties and climate change risk
Does Australian law require company directors to consider climate change in discharging their duties?
To date there have been no Australian court decisions on point. Barristers Noel Hutley SC and Sebastian Hartford-Davis published an opinion in 2016 (which they restated with greater force in 2019), in which they opined that many climate change risks would be regarded by a court as foreseeable and that directors who fail to consider climate change risks could be found liable for breaching their duty of care and diligence. It is a position ASIC has endorsed:
“…in our view, the opinion appears legally sound and is reflective of our understanding of the position under the prevailing case law in Australia in so far as directors’ duties are concerned.”
In our view, climate change risks are no different to any other risk (emerging or otherwise) that directors need to contend with to the extent it affects their company’s business (in the same way as, for example, cyber security). The scope of a director’s duty of care and diligence is predicated on the materiality and likelihood of the particular risk. Once the duty is engaged by virtue of the risk being foreseeable, in considering issues of breach and whether the director can take the benefit of the business judgment rule, the question then becomes one of whether proportionate steps were taken to mitigate the particular risk. So yes - depending on the company’s circumstances, a director may need to consider climate change issues, and respond accordingly.
The factual matrix is critical, given the duty is assessed on an objective basis (what a reasonable person would do) with subjective elements (the specific circumstances). The actions a general insurer may need to take to appropriately mitigate foreseeable climate change risks (e.g. coastal erosion), will necessarily be different to those to be considered (and weighted) by a services group. It remains to be seen how widely a court may interpret what manifestation(s) of climate change risk are foreseeable; this is the defining predicate upon which the duty is engaged.
Recommendation 7.4 of the ASX’s Corporate Governance Principles and Recommendations (4th edition, 2019) (ASX Recommendations) sets out a number of risks for companies’ consideration, including risks of transition to a low-carbon economy.
In recent years ASIC and APRA have repeatedly emphasised the need for companies to address climate change risk as part of their governance and risk management frameworks and to make public disclosures where appropriate. ASIC expects companies to include in their annual directors’ reports a discussion of climate risk when it could affect the company’s achievement of its financial performance or disclosed outcomes (underpinned by sophisticated scenario analysis). Plus any relevant comments as to how risk factors that are within the control of management will be managed. In addition, Recommendation 7.4 of the ASX Recommendations provides:
“A listed entity should disclose whether it has any material exposure to environmental or social risks and, if it does, how it manages or intends to manage those risks.”
Companies which are especially vulnerable to the adverse impacts of climate change are at an increased risk of regulatory, investor and activist scrutiny. Class actions firms are monitoring the disclosure approach closely and at least one large litigation funder is watching this space with interest.
These settings create both direct and (as is increasingly common) derivative risks for directors and are playing out against an uncertain policy outlook, including in relation to government approvals of projects with high carbon emissions. Irrespective, directors should take steps to inform themselves of short and long-term climate related risks to their business to the extent appropriate.