Directors need to act quickly to integrate elements of sustainability into their corporate strategy, decisions, and oversight if they are not already doing so. In the current climate, there is a growing demand among investors and other stakeholders that companies take into account the impact of business operations on the environment, society, and the economy, and they want companies’ boards to actively engage in integrating environmental, social, and governance (“ESG”) factors into the long-term strategy.
Promoting sustainability is a particularly high priority of the European Union. To this end, the EU is currently preparing a proposal for a European Directive on Sustainable Corporate Governance, which aims to introduce new rules on incorporating sustainability in long-term business strategies. Complementary to the proposal for a Corporate Sustainability Reporting Directive, which amends the existing reporting requirements on sustainability matters, this initiative should steer companies towards more long-term visions that incorporate sustainability, including their environmental, human, and social rights impact.
The initiative on Sustainable Corporate Governance seeks to push companies to focus more on long-term sustainable value creation instead of short-term value creation and better manage sustainability-related matters. We expect the proposal for a European Directive on Sustainable Corporate Governance to be published later this year. As the proposal may lead to far-reaching legal reforms for all companies doing business within the EU, here is a look at some of the anticipated new rules …
Directors’ duty of care and liability
The European Commission is exploring the possibility of clarifying and expanding directors’ duties of care, the scope of which is not always clearly defined in all EU Member States. According to the European Commission, this lack of clarity leads to a short-term focus on financial interests of shareholders, and is at odds with achieving sustainable corporate governance.
The European Commission may introduce a duty of care that requires directors to consider the environmental, human rights, and social impacts of their activities, thereby, giving rise to a need to integrate sustainability risks, impacts and opportunities into their company’s strategy and decision-making. Adequate procedures and measurable targets may become mandatory to ensure stakeholder risk and impact are identified, prevented, and addressed. For example, companies may be required to limit their own environmental footprint, or to actively trace the conditions under which production processes further up the supply chain take place.
These procedures and targets could force directors to take a broader group of stakeholder interests, such as environmental issues, into account, and may even prevail in case of conflicts with a company’s commercial interests. Beyond that, the primary focus of the director on the interests and wellbeing of the company itself might be forced to shift towards other interests, with the European Commission looking at a broad range of stakeholders, such as employees, environmental organizations, or any individuals or groups impacted by operations of the company or its supply chain.
Still yet, directors may face new, significant liability risks if their duty of care is extended in favor of this broader group of stakeholders. The European Commission is examining whether it needs to strengthen enforcement mechanisms outside of internal board structures and general meetings of shareholders to include an enforcement role for stakeholder groups, such as those representing environmental concerns. In anticipation of the proposal, companies and its directors are encouraged to check their internal procedures and targets in order to determine whether they currently consider all stakeholders in their corporate strategy and decision-making processes.
Due diligence duty: Human rights & the environment
The European Parliament supports the European Commissions’ Sustainable Corporate Governance initiative, having adopted a legislative initiative report, including a draft directive, that sets out recommendations to the European Commission. The report introduces a new mandatory corporate due diligence duty.
The European Commission is now exploring this corporate due diligence duty requiring companies to establish and implement adequate processes for preventing, mitigating, and accounting for human rights, health, and environmental impacts in companies’ operations and supply chains, and is also considering if a mandatory corporate due diligence duty should be accompanied by an enforcement mechanism. Companies should check whether they already have policies in place and processes to take into account human rights and environmental due diligence in its business and supply chains.
Remuneration & Expertise
The European Commission may also introduce appropriate enforcement measures accompanying the (extended) duty of directors. Different approaches are being considered to ensure directors’ remunerations, for instance, are aligned with longer-term perspectives, such as non-financial performance. At the same time, the Commission is investigating the integration of sustainability risks and opportunities in business strategies, as well as the establishment of sustainability-related metrics that may be linked to the company’s sustainability targets or performance.
Other potential measures include variable remuneration policies and targets for bonuses which include non-financial targets, such as sustainability factors.
Furthermore, the European Commission is considering what actions boards of directors will need to take to enhance their sustainability expertise, such as regularly assessing their expertise level on environmental, social and/or human rights matters and taking appropriate follow-up. Another possibility that is being considered in this same vein is a requirement on a number or percentage of directors to have environmental, social or human rights expertise.
Michelle Krekels is a senior associate at Bureau Brandeis, where she specialized in dispute resolution.