Company Directors May Be Headed For Litigation Over Climate Change

CPA INTHEBLACK - John Purcell

The Commonwealth Climate Law Initiative is investigating how company directors may be drawn into climate change-related litigation.

Australian directors face the greatest potential liability from the impact of climate change on their businesses.

At a glance A significant challenge in reducing global carbon emissions is the fact that neither national laws nor international public law are designed to address problems that have global reach. Projects such as the CCLI demonstrate adaptations to national laws and innovations to international law, while encouraging company directors to take account of climate change risk. According to the CCLI’s project report, Australian directors face the greatest potential liability from the impact of climate change on their businesses.

The impact of climate change and marshalling global efforts towards emissions reduction present profound challenges. Neither national laws nor international public law are designed to comprehensively address problems that are interconnected and have global reach.
However, there are developments that illustrate adaptations in national laws, and novel innovations are being suggested in international law. These developments occur separately from international treaty arrangements under the United Nations Paris Agreement, where national governments commit to implementing domestic policies to reduce carbon emissions.
The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) provides one of the most readily understandable summations of climate-related risks. There are two major categories: risks related to the physical impact of climate change, and risks related to a transition to a low-carbon economy.
Transition risk can occur from legal action brought by claimants seeking redress or wanting to force protective or remedial action. The TCFD says this could stem from “the failure of organisations to mitigate the impacts of climate change, failure to adapt to climate change, and insufficiency of disclosures around material financial risk”.
How realistic then is litigation risk to companies and their directors?
The Commonwealth Climate and Law Initiative (CCLI), a research project focusing on Australia, Canada, South Africa and the United Kingdom, examines the basis for directors and trustees to take account of physical climate change risk and societal responses to climate change. Each of these countries has common law legal systems where judicial decision plays a key role in interpreting statutes and in building legal rules based on an evolving body of precedent.

The CCLI's project report concludes that Australian directors face the greatest potential liability from the impact of climate change on their businesses.

The “adaptability” of corporate law, and in particular directors’ duties, within the common law tradition provides a sound and practical basis for linking climate-related financial risks with possible governance failures that spanning well-established legal expectations around identification, assessment, oversight and disclosure.
The CCLI’s project report concludes that Australian directors face the greatest potential liability from the impact of climate change on their businesses.
However, fundamental to each jurisdiction are two broad categories of directors’ duties, which the CCLI summarises as:

• Duties of trust and loyalty, including good faith, proper purposes and best interests (fiduciary).
• Duties of competence and attentiveness (due care and diligence).

Of the four countries, Australia is the most stringent in interpreting and applying these duties:

• The duty of care and diligence can be breached in circumstances of “mere” negligence.
• There is a particularly strong adherence to an objective standard of what a “reasonable director” would do.
• There is minimal scope to argue “business judgement rule” protection.

Proof of dishonesty, intention or bad faith is not required for breaches of trust and loyalty.
In these terms, managing climate-related risk falls squarely within well-understood legal expectations of active and inquiring engagement in guiding and managing the affairs of a company – matters that the CCLI says are self-evident given that Australia’s economy operates in high-risk sectors from both physical risk and transition risk perspectives.
Australia is also a well-established litigation funding market. It has a strong track record of class actions for misleading disclosures and an independent regulator willing to test the boundaries of directors’ duties and enforce existing well-understood duties relating to disclosure.
What of the more speculative realm of developments in international public law?
The International Criminal Court, which is created under Article 5 of the Rome Statute (another treaty to which Australia is a signatory), has specific and narrow jurisdiction limited to the most serious crimes recognised by the international community, including genocide, crimes against humanity and war crimes.
Limited but strong lobbying is taking place to amend the Rome Statute to include an international crime of ecocide, defined as “the extensive loss or damage or destruction of ecosystem(s) of a given territory, whether by human agency or by other causes, to such an extent that peaceful enjoyment by the inhabitants ... has been or will be severely diminished”.
The CCLI cautions against overstating the practical likelihood of litigation, but also warns against dismissing the risk as remote or theoretical, particularly for those companies in high-risk sectors. Whether or not the advocates of ecocide succeed in their endeavours, the fact that the prospect is being canvassed adds to what should be self-evident to directors: the physical and economic transition risk realities associated with climate change.

Links

• CPA Australia Podcast: Climate-related risk disclosures. Listen now
• Financial Stability Board's Task Force on Climate-Related Financial Disclosures - linking economic and environmental policy
• Accounting for climate risk is now the auditor's business
• Reporting on climate change risk: accountants will be needed
• Company directors face questions on climate change risk
• Does ethical investment pay higher returns?
• Global food security: are we running out of time?