Finding higher ground: directors’ duties in an era of change

We are in the middle of an intense debate about corporate accountability and purpose. 2019 was – to borrow a quote from a recent FT article – “the year capitalism went cuddly”. The convergence of multiple factors – the long shadow of the Great Recession, a series of high-profile scandals, the existential challenge to “business as usual” posed by climate change, and the demands being made by increasingly outspoken millennials – has led to intense debate about corporate accountability and purpose.

A rising tide of activism, regulation and litigation is putting directors at the centre of this debate. Directors are facing challenges from at least four directions:

1. A re-imagining of shareholder value. Cyrus Taraporavela, the CEO of State Street Global Advisors (SSGA), wrote in his January 2020 letter that “shareholder value is increasingly being driven by issues such as climate change, labor practices, and consumer product safety”. This echoes BlackRock CEO Larry Fink’s recent call for an “accountable and transparent capitalism”, particularly focused on issues of sustainability. Similarly, the new UK FRC Stewardship Code, effective from 1 January 2020, notes that “environmental, particularly climate change, and social factors, in addition to governance have become material issues for investors to consider”.

2. Demands for greater transparency through enhanced corporate disclosures. 2020/2021 is the first year that amendments to the Companies Act in 2018 designed to improve corporate governance will bite. This includes the first mandatory reporting of the executive pay gap. There is also growing support for the Taskforce on Climate-related Financial Disclosures and it is likely only a matter of time before some form of climate-related disclosures becomes mandatory. The Brydon Report on Audit, published shortly before Christmas, calls for a new “Public Interest Statement” in which directors set out “how they view the company’s legal, financial, social and environmental responsibilities to the public interest”.

3. Climate litigation is intensifying – and using innovative techniques to foster public engagement. Climate change has risen to the top of the corporate agenda. Not only has climate-related litigation against private companies increased significantly in the past five years: climate-related challenges to government actions are also using new ammunition that will ricochet into board rooms sooner or later:

- Yesterday, in a landmark decision, the Court of Appeal ruled that the British Government had a duty to take into account the Paris Climate Agreement when considering the expansion of Heathrow Airport, but had failed to do so.

- This comes only a few months after the Dutch Supreme Court ruling in Urgenda, which established for the first time that a government has a duty, under the European Convention on Human Rights, to reduce emissions. Urgenda was also particularly noteworthy for its use of an innovative political advocacy strategy – including “crowdpleading” legal arguments from the broader Dutch public – which could be applied to a range of actions to increase public engagement with relatively technical legal arguments.

As we see more cases like this, and stakeholder engagement with the energy transition increases, pressure on governments and regulators to act will intensify. Boards will need to be ready to respond to that increase in intensity.

4. Sharpening legislation to deter corporate misconduct. In the wake of high-profile scandals, we are seeing calls to hold individuals to account when things go wrong. Calls for the introduction of US Sarbanes-Oxley style attestations to combat fraud are growing – the Brydon Report suggests the UK government give it “serious consideration”, building on the recommendations of Sir John Kingman in his report a year earlier. In a similar vein, the draft Pensions Bill introduces possible criminal sanctions for decisions taken that detrimentally impact a UK defined benefit pension scheme.

Navigating this rising tide is likely to be a central challenge of the next decade. These developments engage directors’ existing duties – particularly their section 172 Companies Act duty to promote the success of the company for the benefit of its members as a whole while having regard to a range of stakeholder factors (including employees’ interests and the company’s environmental impact) and their section 174 duty to exercise reasonable care, skill and diligence.

- Increasing emphasis is being placed on the section 172 stakeholder factors. This year will see the first mandatory reporting of a “section 172(1) statement” explaining how directors have had regard to stakeholder factors. Contemporary understanding of those stakeholder factors and their importance is evolving too. Considering a company’s environmental impact, or its employees’ interests, is likely to be a qualitatively different undertaking today, in 2020, than it was in 2006 when the Companies Act was enacted.

- At the same time, the objective element of the section 174 duty is evolving – as social norms change, so too do the expectations of what amounts to “reasonable care, skill and diligence”.

Directors who respond effectively to these changes – integrating these developments into the performance of their duties and responding to demands for a more nuanced understanding of shareholder value and corporate purpose – will be able to navigate their companies to higher ground in what is likely to be another decade of intense change.