Duty of loyalty and duty of care

As fiduciaries, directors owe two core duties to the company: the duty of loyalty and the duty of care and diligence. The precise nature and contours of these duties vary by jurisdiction. In common law jurisdictions, directors’ fiduciary duties are articulated in statutes and in the case law, as developed over time by courts. In civil law jurisdictions, these duties are set out in statutory provisions that govern the conduct of directors.

While subject to variation across jurisdictions, the overarching concepts of loyalty and care in corporate governance are widespread. In general terms, the duty of loyalty requires that directors act honestly and in good faith in the best interests of the company, typically, but not exclusively, defined in financial terms. The duty of care requires that directors exercise reasonable care, skill, and diligence in the discharge of their stewardship functions, including by taking reasonable precautions against reasonably foreseeable harms.

What these duties require as a matter of good governance and prudent risk management is constantly evolving, in line with changes in the factual context in which directors act, knowledge of foreseeable risks, changes in regulations and market practices. A reasonable decision for a director fifty, ten or even five years ago might not look so reasonable today. Understanding these duties in the context of a changing external context is particularly relevant in the case of climate change, where the evidence of climate-related risks and opportunities is becoming ever more apparent, and changes in regulation are gathering momentum such that the likelihood of a disorderly and disruptive transition increases.

To discharge their duties, therefore, directors must integrate climate risks and opportunities into their governance roles.

The ‘business judgment rule’

The courts in many jurisdictions will defer to directors’ knowledge and expertise in making business decisions, and directors are unlikely to face liability as a result of simply a bad decision. This is known in some jurisdictions as the ‘business judgment rule’. This may not protect directors in cases where they have failed to act in good faith (which could be done, for example, by completely failing to consider climate risks facing the company which the company has disclosed), but may operate to protect directors where they take actions to ensure the long-term success of the company which may not be the most profitable in the short-term.