New legal opinion connects directors’ duties and climate change risks

Directors need to be considering how climate change might affect their business or they could be opening themselves up to litigation, a Sydney silk argues in a new legal opinion. Louise Petschler, the AICD’s Advocacy General Manager, outlines the key takeaways for directors.

There is little downside, and much potential upside, for directors in properly considering and disclosing climate change risks.

So argues a new legal opinion, Climate Change and Directors’ Duties, by Sydney barrister Noel Hutley SC. Released by the Centre for Policy Development and co-authored by Sebastian Hartford Davis, the opinion was discussed at a business roundtable on climate risk and sustainability on 21 October and has received recent media attention.

With the commencement of the Paris Agreement on 4 November, the opinion casts a timely eye over the relevance of climate change risks to boards. The Paris Agreement aims to limit global temperature increases to well below two degrees Celsius from a pre-industrial baseline.

The agreement also includes a commitment to strengthening nations’ ability to deal with the impacts of climate change. The Federal Government is expected to ratify the Paris Agreement over coming months, and has committed to a review of climate change policies during 2017.

Risky business

Against this backdrop of global and government action, Hutley and Hartford Davis’s opinion makes the case that boards of Australian companies would be well-advised to engage with the risks of climate change, including financial and legal risks.

The opinion defines climate change risks as:

• Physical risks associated with rising global temperatures, such as severe weather events and rising sea levels damaging property and disrupting trade; and
• Transition risks, being indirect financial risks that might arise from a transition to a lower carbon economy, including changes in policy, technology or investor preferences that could impact the value of assets and elements of business strategy.

A detailed case is made that a court would be likely to regard climate change risks as ‘foreseeable risks’, noting that the law views foreseeability differently from probability. Risks will be foreseeable if they are not deemed to be ‘far-fetched or fanciful’. The authors argue that with current policy settings, this threshold has likely been reached for many ‘climate change risks’.

The authors consider the issue in the context of the duty of care and diligence imposed on directors by s180(1) of the Corporations Act 2001 (Cth), concluding that climate change risks may be relevant to a director’s duty of care to the extent that those risks intersect with the interest of the company.

“There is certainly no legal obstacle to Australian directors taking into account climate changes and other sustainability risks, where those risks are, or may be, material to the interests of the company,” the authors contend.

“To the contrary, company directors certainly can, and in some cases should be considering the impact on their business of ‘climate change risks’.” In the authors’ view, directors who fail to actively consider climate change risks now could, depending on the circumstances, risk being found liable for breaching their duty of care and diligence in the future.

“It is likely to be only a matter of time before we see litigation against a director who has failed to perceive, disclose or take steps in relation to a foreseeable climate-related risk that can be demonstrated to have caused harm to a company (including, perhaps, reputational harm)”, argues Hutley and Hartford Davis.

What can directors take away from this opinion?

The opinion is necessarily general, with the authors noting that the relevance of “climate change risks” to a specific company will be assessed on a case-by-case basis. But in discussing how directors should view their duty of care in light of climate change risks, the opinion states that directors are ‘well-advised’ to at least consider the impacts of these risks on their business.

Further, the authors argue that:

• Directors’ duties oblige directors to obtain knowledge about factors affecting their business, and accordingly directors should consider and take steps to inform themselves about climate-related risks to their business, including obtaining expert advice if appropriate;
• In some cases – such as insurance businesses – the duty of care will likely require a director to go further than merely considering risks. Action may need to be taken in terms of strategy and planning; and
• Directors who are proactive in turning their minds to climate change risks for their business, even if they decide on a properly informed and advised basis not to act, may have the protection of the business judgement rule against claims of breach of duty.

Discussions on climate change often involve strongly held opinions. Other commentators have made the case, however, that it’s not individual views on climate change science that matter, but the potential risks and their impacts on a company. Hutley and Hartford Davis share this view:

“It would be difficult for a director to escape liability for a foreseeable risk of harm to the company on the basis that he or she did not believe in the reality of climate change, or indeed that climate change is human-induced. The Court will ask whether the director should have known of the danger.”

The opinion draws parallels with instances where courts have had to deal with liability for negligence in the context of developing science, such as employee exposure to asbestos or the transmission of the HIV virus through unsafe intravenous blood transitions.

“At a certain point, however, ignorant defendants become liable for those risks on the basis that a reasonable person would have known of them,” the authors state. Most importantly, it is a timely reminder for directors to consider whether they are turning their mind appropriately to ‘climate change risks’ in the exercise of their strategic and risk management roles.

Some directors may be surprised at the authors’ conclusion that a court would find ‘climate change risks’ to be ‘foreseeable’, and potentially open up exposure for directors to a breach of duty of care.

While the phrase ‘climate change risk’ may not yet be common parlance in boardrooms, the issues that it encompasses are likely very much on directors’ minds. In defining climate change risks the opinion draws together many issues that will already be occupying boards – for example, reputational harm, physical damage from weather events, changing regulatory settings, stranded assets, and disclosure rules – viewing these with a specific climate risk lens.

In a context where current reporting on the issue by boards is variable, the opinion sets out the importance of considering disclosure obligations relating to exposure to climate change risks.