It's not just the climate that's warming up: new heat on directors

A recent tide of comments from ASIC, APRA and the RBA stress that these regulators consider companies should have regard to the impacts of climate change risks in their corporate decision-making. An update of a landmark legal opinion on "Climate Change and Directors' Duties" comes to the same conclusion.

In this article, we examine these comments and consider how, even under the current legislative regime, directors might already be exposed to personal liability for failure to adequately consider and address climate change risks.  It may only be a matter of time before we see litigation against directors on this issue.

Overview of recent regulatory, judicial and legal attention

Since early 2018 there has been a vocal and persistent call from key regulatory bodies that companies, and their directors, could face liability if they fail to address risks relating to climate change:

• on 26 February 2018, ASIC Report 567 was published.This report flags the idea that climate risks should be disclosed by companies.However, in doing so it refers back to pre-existing Regulatory Guides (Regulatory Guide 247 and Regulatory Guide 228 which were published on 27 March 2013 and 3 November 2016);
• on 18 June 2018, ASIC Commissioner John Price made public remarks foreshadowing that directorial liability could arise from a failure to consider risks related to climate change. Commissioners Sean Hughes (Canberra, 7 February 2019) and Cathie Armour (Sydney, 21 February 2019) also made public addresses concerning climate change risk;
• the Council of Financial Regulators (including ASIC, APRA, the RBA and Treasury) created a working group to help ensure a co-ordinated response by these regulators to climate risk.  That Working Group is yet to make any formal comments or recommendations;
• on 20 September 2018, ASIC published a review of climate change-related disclosures across the ASX 300 to better understand current market practices.  REP 593 Climate risk disclosure by Australia’s listed companies sets out ASIC's findings and high-level recommendations for listed companies (and their directors) on climate risk disclosure;
• in February 2019 the NSW Land and Environment Court rejected an application for development consent for an open-cut coal mine in the Gloucester Valley on various grounds, including because the "construction and operation of the mine, and the transportation and combustion of coal from the mine, will result in the emission of greenhouse gases, which will contribute to climate change";
• on 27 February 2019, the ASX Corporate Governance Council released a revised edition of its Corporate Governance Principles and Recommendations, which provides commentary on what will be expected for boards of listed entities to comply with the ASX Listing Rules from 1 January 2020, including new recommendations specific to disclosing climate change risks;
• on 12 March 2019, the Deputy Governor of the Reserve Bank, Guy Debelle, made an announcement on climate change, particularly focusing on its effects on the Australian Economy and Monetary Policy;
• on 26 March 2019 Noel Hutley SC and Sebastian Davis issued a Supplementary Memorandum of Opinion to their 2016 seminal opinion on "Climate Change and Directors' Duties", which concludes that "the exposure of individual directors to "climate change litigation" is increasing, probably exponentially, with time".

How directors might already be liable under the present regime

While no doubt heartfelt, the barrage of announcements from Australia's key corporate regulatory bodies is yet to result in any tangible change to the current regime.  However, even without such a change there remains potential that, even under the current law, directors could face liability for failing to take climate change into account in their decision-making.   

The Hutley Supplementary Opinion considers that there has been an elevation in the standard of care required from directors in relation to consideration of climate change risks over the last few years, and concludes that "such risks require engagement from company directors in affected sectors, particularly in (at least) the banking, insurance, asset ownership/management, energy, transport, material/buildings, agriculture, food and forest product industries".

ASIC's "stepping stone" approach

ASIC has in recent years used a "stepping stone" approach to litigate against directors personally. This  requires an action against a company for contravention of the Corporations Act or any other piece of legislation, which then allows ASIC to launch a derivative civil liability claim against one or more directors of the offending company for breaching their duty of care in exposing the company to the risk of prosecution. While this approach has up to now only been pursued in connection with a company's breach of the Corporations Act, it could analogously also be applied to a company's breach of other legislation, including a breach of environmental laws as has been recently acknowledged by the Federal Court in ASIC v Cassimatis (No 8) [2016] FCA 1023.

However, although untested, we note that ASIC, as the corporate regulator, may be unlikely to pursue the stepping stone approach where companies are solely in breach of environmental laws. This is because such misconduct may not fall within ASIC's regulatory responsibility, a condition which must be satisfied according to ASIC Information Sheet 151 (ASIC's approach to enforcement), on the basis that the breach may be more appropriately dealt with by environmental regulators.

Additionally, it is important to note that a breach of the Corporations Act or some other law by the company does not necessarily result in an automatic breach of the director's duty of care and diligence. This is since this director's duty is not a duty of strict liability and the duty does not require directors to take every possible step to avoid a foreseeable risk of contravening legislation. Rather, the potential liability of directors in a stepping stone litigation will depend on:

• the company's circumstances;
• the director's responsibilities and influence over the company; and
• the director's balancing of the company's potential risk of harm against potential benefits in the director's attempt to discharge their duty of care and skill.

Breach of directors' duty of care and diligence

In addition to ASIC's ability to prosecute directors personally under the stepping stone approach, directors may also be personally liable for breaching their duty of care and diligence arising from a failure to appropriately consider risks relating to climate change, irrespective of whether the company contravened any legislation.

Under Australian corporate law, directors owe a duty of care and diligence (both at common law and under section 180 of the Corporations Act) to the company.  That duty requires a director to consider foreseeable risks of harm to the company.  To be foreseeable, a risk must not be far-fetched or fanciful but need not be probable.  It follows that, under the current law, climate change risks must be considered by directors where those risks are foreseeable and may be adverse to the company's interests.  These foreseeable risks may include the following:

Foreseeable risks arising from the physical world

The company's interests can include risks arising from the physical world.  Depending on the context, the Courts might consider the following changes to the natural environment as foreseeable climate change risks:

• increases in the frequency and severity of extreme weather events;
• increases in the cost and availability of inputs (including water, energy, land and other weather dependent products such as agricultural yields);
• increases in the future need for energy (particularly for cooling); and
• impacts on tourism or health.

Foreseeable risks arising from the regulatory environment

Acting in the interests of the company could require directors to consider foreseeable risks arising from the company's current regulatory regime, as well as risks from future regulations that may be created to address climate change.  Regulatory change is probably inevitable (particularly in light of the recent media announcements considered earlier in this article) and may present clear and potent risks for companies.  The types of climate related regulatory risks a director might need to consider include the following:

Directors considering climate change risk may be enough to discharge duty of care and diligence

Whether a director has satisfied their duty of care is evaluated on both an objective and subjective basis.  This means the Court considers not only what a reasonable person would have done but also the surrounding circumstances including the company's scale and industry and the director's role and authority.  Accordingly, the foreseeability and magnitude of climate risks would be greater in some industries (such as input intensive productive industries, agriculture, insurance and energy supply or transmission industries).  Directors in these fields might be exposed to greater personal risk arising from climate change. 

However, directors who perceive climate change risks on a properly informed and advised basis, and form their own decision on what steps to take, may well be protected under the business judgment rule.  A decision to do nothing about climate change may be acceptable in many circumstances.  Even a decision to take active steps which damage the environment (including increasing pollution or campaigning against climate regulation) may not attract personal liability, provided those decisions are properly informed and taken in the best interests of the company. Indeed, the Federal Court has held that directors are in fact expected to take calculated risks, and even the pursuit of an activity that might entail a foreseeable risk of harm would not of itself establish a breach of a director's duty of care and diligence.

The relevant test for determining a director's duty of care is whether a particular risk is foreseeable.  Accordingly, it would be unlikely that a director could escape liability for a climate related risk on the basis that they either did not believe the existence of climate change or did not believe it was a consequence of human actions.  The relevant question is whether the director should have known.  Further, even if a director did attempt to dispute the science, many of the risks (particularly the likelihood of regulatory change and reputational damage) exist irrespective of any assessment of the veracity of the science.

What's ahead

Boards cannot ignore climate change risks as a factor in corporate decision-making.  Under the current regime, directors who fail to proactively turn their mind to climate risks could be found personally liable for breaching their duty of care.  A director might also be found to have breached their duty if they do not appropriately disclose climate risks or fail to take steps to address foreseeable risk which causes harm to a company (including reputational harm).  The regulators are unanimous in their belief that companies should be considering addressing climate change risks and it may only be a matter of time before we see litigation against a director on this basis.

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