Can directors see the regulatory threat on climate?

Bushfires have tragically claimed lives and severely affected communities across Australia. Months, if not years, of recovery cannot begin in earnest until the danger abates.

In the immediate aftermath, politicians, activists and other commentators have re-ignited debates over climate policy. Over the longer term, Australian company directors will not be insulated from the consequences of climate wars.

Late last year, former High Court judge and banking royal commissioner Kenneth Hayne QC warned company directors they have a duty to respond to climate-related risks and must take account of, and report publicly on, climate-related risks and issues.

However, this warning does not capture the full extent of the risk. With the new year’s re-focus on climate change issues, we are advising our clients that company directors should be concerned about the risk of climate-based litigation. This is because – rightly or wrongly – neither the law nor Australian regulators provide sufficient clarity on potential climate liability.

Mr Hayne remarked that Australian directors’ duties laws on climate-related risk are “clear”. With respect, that is a gloss on the overlapping and inconsistent morass of case law, legislation and regulation that applies to Australian company directors.

For example, a director might discharge their duty to act in good faith in the company’s best interests (which was the focus of Mr Hayne’s remarks), but they can still be found guilty of a breach of the separate duty to act with reasonable care and diligence.

A number of cases now have made it clear that that a director’s duties to the company require more than a myopic focus on short-term financial returns to shareholders.

However, it is far from clear to what extent the interests of other stakeholders, and broader economic, social and environment issues such as climate, can be prioritised at the potential expense of (at least short term) shareholder interests.

Regulators regularly add to the compliance burden with additional prescriptions. In the last year, ASIC pronounced that company disclosure on climate risks must be “meaningful and useful”, while the ASX’s latest Corporate Governance Principles recommend that boards should have a risk management framework that deals with climate change risk.

Complexities and inconsistencies in directors’ duties can be exploited by regulators and activist litigants. ASIC demonstrated this last year when it successfully sued some of the former directors and officers of Vocation. The central question: Should Vocation’s directors and officers be personally liable for causing the company to breach its continuous disclosure obligations?

In the Vocation case, ASIC commenced civil penalty proceedings against only some – not all – of the company’s former executive and non-executive directors and officers, even though relevant decisions may have been taken collectively by, or may be the collective responsibility of, a company’s board.

Additionally, ASIC’s successful litigation against the selected defendant directors exploited a clear inconsistency in Australian corporate governance laws. ASIC had two bites at the cherry.

“A number of cases now have made it clear that that a director’s duties to the company require more than a myopic focus on short-term financial returns to shareholders.”

 First, ASIC argued – unsuccessfully – that the defendant directors were accessories to a breach of the company’s continuous disclosure obligations. This essentially required ASIC to demonstrate the defendant directors knew that certain withheld information was material and should have been disclosed under continuous disclosure rules. The Court found that the knowledge of the defendant directors was not sufficient to establish liability.

So far, so good for the directors. But then came the second bite. ASIC succeeded with an alternative argument – that the defendant directors had acted in breach of their separate statutory duty to act with reasonable care and diligence.

The law on this point requires the Court to examine objectively what a reasonable person in each defendant director’s position would have done. And the Court accepted that a reasonable person would have exercised greater care to prevent the company’s breach of the continuous disclosure rules.

Further illustrating the complexity of the law, the Court held that the business judgment rule did not excuse the directors because the decisions were compliance decisions (relating to continuous disclosure) rather than business judgments (relating to business operations).

While ASIC’s victory on the second bite of the cherry may be understandable to legal eagles, it is hardly an illustration of the clarity or conciseness of the law.

Applying this approach to something as vague as climate-related risk and directors’ potential exposure, the scales are tipped against company directors.

Hayne is right that directors have a duty to respond to climate risks, but the law on what that duty looks like is complicated. Regulators (and activists) can target individual directors even though Board decision-making is a collective exercise. And litigation against directors can be multi-faceted, exploiting inconsistencies in the law.

It’s a rough climate for Australian company directors, but you don’t need us to tell you that.