The term "ESG" has risen to prominence in recent years. It is used to describe the various environmental, social and governance factors which are of increasing importance to companies and potential investors. It includes matters such as climate change, pollution, gender pay gaps and modern slavery.
With CEOs ranking these factors of parallel importance to financial performance – according to a study by ECI Partners, 74% of CEOs rank sustainability as one of their core priorities – it is important to consider how ESG factors interact with directors' duties or, more specifically, how these interact with the s172 duty to promote the success of the company.
What is the s172 duty?
Under the Companies Act 2006 (the "Act"), directors of UK companies have seven general duties which last for the duration of their directorship. Amongst these is the s172 duty which requires directors to act in good faith to "promote the success of the company for the benefit of its members as a whole". Whilst the term "success" remains undefined, it is generally understood, in the commercial context, as long-term financial success. S172 requires directors to have regard to:
- the likely long-term consequences of any decision;
- the interests of the company's employees;
- the company's business relationships with customers, suppliers and others;
- the impact of the company's operations on the community and the environment;
- the desirability of the company for maintaining a reputation for high standards of business conduct; and
- the need to act fairly between members of the company.
This list is not exhaustive and the explanatory notes to the Act comment that these areas are highlighted as being of particular importance, but a director should have regard to all other relevant factors when considering their duty to promote the success of the company. Therefore all relevant ESG factors must be considered when directors are making short, medium or long-term decisions.
The impact of ESG
The impact ESG has within the current commercial and regulatory landscape is undeniable. The UK has implemented various different initiatives to raise the profile of ESG. For example:
- the Modern Slavery Act 2015 requires companies with a total turnover of £36 million or more to report on what actions they have taken to eliminate modern slavery within their organisations, and more specifically, their supply chains; and
- the Gender Pay Gap Regulations 2017 require companies with over 250 employees to publish information on their gender pay gap each year, including the mean and median gender pay gap figures for hourly pay. The report must be published on the company's website and be accompanied by a signed written statement from a senior individual confirming its accuracy.
However, it is clear that one of the main driving forces behind this increased focus on ESG is climate change. The most recent reporting requirement was introduced via The Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022, amending sections 414CA and 414CB of the Companies Act 2006. Now, certain companies – including those which have more than 500 employees and a turnover of more than £500 million – need to include climate-related financial disclosures within their strategic report. Climate-related financial disclosures include a description of how the company's governance function assesses and manages climate-related risks and opportunities and a description of the targets used by the company to manage climate-related risks and to realise climate-related opportunities and of the company's performance against those targets.
Possible Liability?
If a director fails to consider ESG factors when making a decision which affects the success of the company, they could be in breach of their director duties. The rise of ESG has been complimented by an increase in claims brought by activists and shareholders who seek to ensure that companies meet their ESG commitments. If it can be shown that a failure to consider ESG factors has led to a decision which is detrimental to the company, there is the potential for litigation.
In February 2023, ClientEarth (an environmental organisation with a minority shareholding in Shell) filed a claim in the English High Court seeking permission to commence a derivative action against Shell's board of directors. A derivate action is an action brought by a shareholder of a company on the company's behalf (for further explanation on derivative actions, see our blog post here). ClientEarth allege that the board's poor handling of the company's energy transition strategy has risked the company's long-term commercial viability and accordingly the directors have breached their duties under the Act, including the s172 duty. ClientEarth's claim is reportedly supported by a group of Shell's institutional investors who hold over 12 million shares in the company. This case is still in the early procedural stages with the High Court still to decide whether to grant ClientEarth permission to commence the proceedings. However, it stands as a stark reminder to directors of the consequences which may arise if they fail to consider ESG factors.
Concluding Thoughts
It is clear that ESG factors fall within the scope of s172. Given the increase in reporting obligations and the possibility of potential litigation, directors should be mindful of these factors when making strategic decisions to promote the success of the company.
