This briefing by the Commonwealth Climate and Law Initiative (CCLI) and the Climate Governance Initiative is a resource for navigating the rapidly-evolving landscape of sustainability-related corporate responsibilities. It updates previous briefings on climate change litigation, climate-related disclosures and ESG-related risks in value chains. In recognition of the major financial risks posed by biodiversity loss, the interdependence of climate- and biodiversity-related risks and the increasing management of climate risk within broader sustainability standards and regulations, this briefing applies to both climate- and biodiversity-related risks. Like climate-related risks, biodiversity-related risks are not a new risk category but drivers that translate into traditional financial risk categories. As financial and compliance implications of biodiversity loss rise up the business agenda, they are likely to require the application of similar legal and governance principles to those applied to climate, but over a shorter period of time. For an overview of the foreseeable financial and systemic risks and opportunities of climate change and biodiversity loss to companies and their investors, see the Climate Governance Initiative and CCLI’s global Primer (Third Edition) on Climate Change: Directors’ Duties and Disclosure Obligations.
Key developments
- Climate-related derivative claims are being tested. On 21 and 24 July 2023, two UK courts handed down judgements refusing to grant permission for climate-related derivative claims (McGaughey v USS and ClientEarth v Shell). Derivative claims are brought by shareholders on behalf of the company against directors personally. These decisions may affect how directors consider climate risks when performing their duties and could also apply to biodiversity risks.
- Due diligence regulations. On 1 June 2023, the European Parliament voted to provisionally approve the proposed Corporate Sustainability Due Diligence Directive (CSDDD), the latest development in the CSDDD’s progress towards final form and approval. On 29 June 2023, the EU Regulation on deforestation-free supply chains entered into force, requiring companies to investigate the source of a range of commodities sold in or exported from the EU.
- Establishment of reporting standards. On 26 June 2023, the International Sustainability Standards Board (ISSB) finalised its comprehensive set of sustainability-related (IFRS S1) and climate-related (IFRS S2) financial disclosure requirements. On 25 July 2023, the International Organization of Securities Commissions (IOSCO) endorsed the ISSB standards, calling for securities regulators around the world to consider adopting them. On 31 July 2023, the European Commission submitted EU Sustainability Reporting Standards (ESRS) under the EU Corporate Sustainability Reporting Directive. The ESRS were approved by the Parliament and Council in October marking progress toward the realisation of the EU corporate sustainability reporting framework.
- International assurance standards. On 2 August 2023 the International Auditing and Assurance Standards Board (IAASB) opened consultation on its proposed International Standard on Sustainability Assurance (ISSA) 5000.
In focus - Climate-related derivative claims
The ClientEarth v Shell Plc & Ors judgment provides significant insights into the complexities of climate-related claims against directors (which could apply to future similar biodiversity-related claims). A ‘derivative’ claim is a statutory claim brought by shareholders on behalf of the company against directors. In May and July 2023, the High Court rejected ClientEarth’s application to bring a derivative claim against Shell's directors for failing to manage climate change risks. In November 2023 the Court of Appeal refused ClientEarth's request to appeal the High Court decision. This reinforces the high threshold for derivative claims in the UK. Notably, the court agreed that “Shell faces material and foreseeable risks as a result of climate change which have or could have a material effect on it”. The question was whether Shell’s directors had responded to those risks in a way that breached their duties of loyalty and care to the company. Here we examine some of the key elements of the decision and what this might mean for future cases. Since derivative claims can also be made against former directors, decisions that directors make today could lead to future liability once loss has crystallised. The court will consider whether, based on the knowledge that was reasonably available at the time of the decision, directors failed to give due consideration to early warning signs. Reasonable and informed decision-making is particularly important. Directors can ensure that they consider all of the information sources at their disposal (recognising the evolving regulatory landscape and corporate governance best practices) and integrate climate risks into their decision-making (taking into account the long-term implications of decisions, including after they have stepped down), taking expert advice where appropriate. It would be wise to implement procedures for, and evidence of, routine robust climate risk consideration. Such procedures will not protect from challenge if they become a superficial or performative ‘tick-box exercise’ that fails to properly engage with the evidence and risks.
While no biodiversity-related derivative claims have yet been brought, biodiversity-related complaints are being made against companies around the world. For example:
- A November 2023 shareholder claim against an Australian bank, requiring information about the bank’s climate- and biodiversity-related risk management systems and suggesting that it may have breached prudential standards or misleading conduct laws.1
- A November complaint, filed with the French National Prosecutor’s Office in respect of four large French banks calling for a criminal investigation for money laundering. This relates to the banks' financing of Brazilian beef companies whose activities are alleged to be responsible for illegal deforestation, which would make profits derived from those activities the proceeds of crime.2
- A 2022 US securities law class action, brought against a company and its directors relating to misrepresenting the value of its securities in relation to the negative biodiversity impacts of its company’s wood pellet products.3
- A 2021 case against a French supermarket chain, alleging that its yearly due diligence plans failed to detail the environmental harms caused by the supply of cattle from deforested areas to its Brazilian subsidiary.4
Whilst these claims were not derivative actions, they do consider similar types of risks and issues as we have seen considered in climate-related litigation. This suggests that biodiversity-related claims may follow a similar trajectory to climate-related claims, and that lessons learned from climate-related derivative actions may be applicable when considering biodiversity-related risks. In Australia for example, this is reinforced by a new expert legal opinion, co-authored by a senior barrister, on the relevance of nature-related risks to the exercise of directors’ duties.5 Furthermore, the interrelationship between climate- and biodiversity-related risks and the potential trade-offs involved in risk management of both may justify an integrated approach to assessing climate- and biodiversity-related risks as they apply to directors’ duties. 6
| Reason for application being unsuccessful | How a different claim might succeed |
| An English court cannot give permission to a shareholder to bring a derivative claim on a company’s behalf without being satisfied that certain stringent criteria have been met. | In another jurisdiction there may be fewer entry barriers for a claim. Derivative actions are not possible in every country, are rarer in continental Europe than in the US, Japan, South Korea, Taiwan and China (although in Germany ‘rescission lawsuits’ have fewer barriers to entry). Common law countries such as Australia, Canada, and India may have similar limits to the UK. However, the complex interplay between each jurisdiction’s local context (varying over time) and its company laws, particularly in Asia, makes it difficult to draw conclusions on which jurisdictions have more likelihood of claims. (See CCLI’s country papers for further information.) |
| The claimant was seen to be primarily pursuing a policy agenda rather than being motivated by financial loss. | The claimant may be seen to be acting in good faith if the financial loss to the claimant (as a result of impact on the company’s value) is more evident, prominent and/or the claimant is not a high-profile advocacy organisation, or if the claim relies more on actual rather than prospective financial loss. An investor that suffers climate change-related losses across its portfolio might be in a better position to demonstrate a good faith agenda in relation to a derivative claim centred on the directors’ management of the company’s emissions, but it should be noted that since a derivative claim is brought in the name of the company, such loss will not apply to the question of whether the company has suffered harm as a result of the directors’ actions. |
| The claimant took the existing statutory duties and tried to elaborate on them with application to the context of the case. This was seen as an attempt to impose new duties on directors more specific than those required by law. | If the claimant describes how the statutory duties have been breached using accepted descriptions of the duties as found in case law, statute or parliamentary notes, they are less likely to be seen to try to impose new duties. |
| The application rests on a witness statement that summarises consensus opinion from a variety of sources rather than expert evidence. | The claimant produces expert evidence at an earlier stage in proceedings. |
| Lack of evidence of universally-accepted methodology to achieve emissions targets. | Guidance on credible transition plans developed by the Science-based Targets Initiative, the ISSB, the UK’s Transition Plan Taskforce (expected to have global influence), TCFD, GFANZ and OECD (and a wider range of organisations) on transition plans, combined with proposed UK, EU and US regulatory requirements will soon demonstrate consensus best practice methodology on emissions reductions. When combined with evidence that thousands of companies across the world are already preparing (although not necessarily publishing) transition plans, and investor expectations coalescing around the ‘say on climate’ initiative, the expectation of a viable transition plan is emerging as a business norm. |
| The directors had policies and targets to achieve net zero, so could not be said to have failed to consider climate risk. | If it is demonstrable that the directors have completely failed to show consideration of the strategic implications of climate risk, or that they have considered it but not taken actions that fall within a reasonable range of responses in relation to those implications, the procedures around arriving at a decision could be criticised, if not the final decision itself. This might include where directors have created an audit trail giving an impression of considering these issues, but on deeper examination, they have not given due consideration to the implications of the evidence available - for example their decisions clearly conflict with scientific consensus. |
| In a large, complex business, directors are required to consider and balance a range of competing considerations - a management decision with which a court may not interfere (the ‘business judgment’ rule). It could not be said that no reasonable director could properly have adopted the approach of the directors in question. | If the claimants acknowledge the directors’ agency to balance competing considerations but can demonstrate that the directors have either failed to adequately inform themselves in relation to the relevant considerations, or have somehow acted in a way that is manifestly unreasonable when balancing climate risk with other considerations. In Delaware, US the ‘Caremark’ case established that directors may breach their duties for failing to establish or monitor information systems for ‘mission critical’ risks. Since 2019, five similar cases have survived motions to dismiss (while not ultimately succeeding). Directors may be more exposed to such claims in future. Local company laws around the world differ on the weight that directors are expected to place on climate considerations. For example, in India directors must discharge their duties not just with regard to the shareholders, but also the community and the environment. |
| A person acting in accordance with the duty to promote the success of the company would not seek to continue the claim. | If it can be demonstrated that the claim is objectively in the company’s interests and that a hypothetical director might pursue it. |
| A large majority of shareholders voted in favour of the climate strategy in question. The claimant represents a particularly small minority of shareholders. | If the majority shareholders are not aligned with the company’s climate transition plans (or, in future, nature-related transition plans). Claimants representing a larger percentage of the overall shareholdings may have a higher chance of success. Given the growing support of institutional shareholders for this type of action, this is not inconceivable, and directors should therefore be prepared for evolving trends in shareholder expectations. |
| The court was unable to give an appropriate remedy (i.e. damages, injunction or order to perform specific obligations). The remedy requested was insufficiently precise. The claimant requested a declaration that the directors had breached their duties and an injunction compelling the directors to execute a specific climate risk strategy. It would not be appropriate for a court to grant an injunction that would require court supervision. | The claimant seeks a precise remedy that is within the powers of the court and does not require court supervision. The claimant can demonstrate that the remedy sought has substantive effect and is useful in serving a legitimate purpose. |
This summer also saw the UK Court of Appeal dismiss an appeal by members of the Universities Superannuation Scheme (USS) (McGaughey & Anor v Universities Superannuation Scheme Ltd & Ors) attempting to bring a derivative case against USS’s directors. Amongst other claims, the claimants sought declarations that the absence of an adequate plan for divestment from fossil fuel investments was contrary to the interests of the company, constituted a breach of directors’ duties and that such breach had caused or would cause loss to the pension scheme. Exploring similar issues to the Shell case, the Court of Appeal found that the derivative action was an inappropriate mechanism for the claim. There was no loss to the company or claimants, the directors were not acting in bad faith or failing to consider the company’s best interests and had taken proper advice.
The court considered evidence that USS had considered climate-related risk and the exercise of investment power for proper purposes, including evaluation of USS’s strategic role in engaging with its assets and markets instead of divesting, establishment of a set of principles to guide the scheme towards net zero and to consider a range of interim targets. Trustees of funds that neglected to take such steps might be more vulnerable to claims of this nature.
Even if litigation against directors is unsuccessful and it seems as if the risk of incurring personal liability as a result of a derivative claim is low, directors will want to consider climate- and biodiversity-related risk for the following reasons:
- Litigation is often accompanied by negative publicity, causing reputational loss to the company. For large companies whose reputation is a valuable asset, this can translate into substantial financial costs through diverted management time, loss of potential talent in the recruitment market and damage to relationships with investors.
- Litigation is costly (even when the claimant is ordered to pay costs), perhaps even causing a drop in share price or divestment by significant investors. (Research indicates that a climate litigation case can reduce firm value by -0.41% on average, sometimes up to -0.57% following case filings and -1.50% following unfavourable court decisions.)
- Failure to adequately manage climate risks may open the company up to litigation by third parties, which, if successful, could in turn expose the directors to derivative action claims in relation to the company’s loss.
Takeaways for directors:
- Given the jurisdictional differences in admission criteria for bringing a derivative claim, directors and their lawyers could inform themselves about the specific aspects of liability risk in the territory where the company is incorporated.
- While it still seems as if the risk of incurring personal liability as a result of a derivative claim is low, directors will want to consider climate-related risk to avoid potential costs to the company.
- These fluid and fast-moving climate-related developments also hold important lessons for management of biodiversity-related risks, which can be expected to be similarly tested in the courts as a director-relevant issue.
- Avoidance of liability is a low bar. Prudent governance of climate- and biodiversity-related risks to the company that aligns with best practice will enable directors to successfully perform their duties and safeguard their personal reputation and integrity. Aside from liability risk, managing climate- and biodiversity-related risks will be key to companies’ continued financial success over short, medium and long term horizons.
See further Setzer J and Higham C Global Trends in Climate Change Litigation: 2023
Snapshot, Sato M, Gostlow G, Higham C, Setzer J, Venmans F, Impacts of climate litigation on firm value and Climate Change Litigation: What Board Directors Need to Know.
In focus - Due diligence regulations
The EU Regulation on deforestation-free supply chains aims to tackle deforestation and land degradation, addressing climate- and biodiversity-related risks. The regulation mandates that companies investigate the source of a broad range of specified forest-risk commodities7 that are placed on the EU market or exported, including cattle, cocoa, coffee, palm oil, rubber, soya and wood and their derivatives.
Companies have until 30 December 2024 (or 30 June 2025 for micro and small undertakings) to be compliant. The relevant products must be sold with a certification stating that due diligence was carried out and are prohibited from being sold in the EU or exported from the EU unless they are certified deforestation-free (i.e. they and their components have not been produced using land that has been deforested since 31 December 2020, or, in the case of timber, has not led to forest degradation) and have been produced in compliance with local laws (e.g. in relation to land use rights, environmental protection, forest management and biodiversity conservation).
The global trend towards corporate accountability for environmental and human rights issues is evident in cases like that of Cargill, currently facing legal action over its failure to address deforestation in Brazil. This underscores the significance of the extraterritorial nature of the EU deforestation regulation, compelling corporations to rigorously implement due diligence across their supply chains.
This places significant responsibilities on board directors to ensure that their organisations engage in due diligence to prevent deforestation and forest degradation within their supply chains. This entails conducting a thorough assessment of potential risks linked to relevant commodities and products, ensuring active collaboration with competent authorities and stakeholders, maintaining transparent reporting mechanisms, implementing effective strategies to mitigate identified risks, overseeing the evaluation of substantiated concerns and managing an information system designed to support the regulation's requirements. For example, Vietnam has committed to complying with the law's demands, including providing GPS coordinates for traceability and deforestation risk assessment. Conversely, Indonesia and Malaysia have voiced concerns about the regulation's complexity, fearing economic strain on small farmers. Brazilian banks are now refusing credit to deforestation-linked meatpackers, prompting the adoption of tracking systems in the Amazon by 2025. These reactions highlight the necessity for effective collaboration between the EU and affected nations, involving knowledge transfer and recognising the disparity in resources among impacted countries. For board directors whose companies are affected by the EU Directive, it will be important to ensure that as their companies seek to adopt a consistent global policy that aligns with the stringent standard imposed by the EU while reconciling this with how different jurisdictions in the company’s value chain are responding. Directors would be wise to grasp their pivotal role in overseeing the proper execution of these due diligence obligations and engage in specific dialogues with high-risk countries.
The EU Corporate Sustainability Due Diligence Directive (CSDDD) is currently being negotiated by the European Commission, Parliament and Council in relation to amendments to the Commission’s initial proposal advocated by the Council and the Parliament. It is expected to be adopted by the end of 2023, come into force in 2024 with compliance obligations taking effect in 2026 for some companies and potentially not until 2028-2030 for other companies.
The general effect of the CSDDD is that in-scope companies (meeting thresholds for turnover and number of employees, established in the EU or with a threshold of turnover generated in the EU) will be required to undertake due diligence to identify, prevent, mitigate, monitor and report on negative environmental and social impacts in their operations, subsidiaries and value chains. It seems certain that there will be some level of extraterritorial effect of the CSDDD through the cascading of information requests through value chains or ownership structures to those doing business outside the EU.
Some of the key areas of uncertainty in the scope of the final CSDDD are as follows:
- What exact threshold criteria (in terms of turnover and employee numbers) and rules will apply and how soon to companies of different sizes.
- Whether medium-sized companies and non-EU companies doing a certain amount of business in the EU need a percentage of turnover generated from a high-impact sector to be in scope.
- To what extent the CSDDD will apply to different categories of financial institutions.
- The definition of which business relationships will be included in the scope of the due diligence obligations.
- Whether due diligence will be required to cover the entire value chain or mainly the supply chain, with limited application to downstream business partners.
- Whether downstream activities will include the impacts from the use of products or services.
- Whether the CSDDD will impose specific duties of care on directors.
- What size companies will be obliged to prepare climate transition plans.
- Whether large companies will need to link executive directors’ remuneration to climate transition plans.
In any case, as part of their duty of oversight, directors should give serious consideration to initiating evaluation of their company’s material value chain-related risks and readiness for value chain due diligence. This is particularly relevant to larger companies established in the EU that will be the first required to comply, and companies with a high turnover in the EU that will soon be in scope. However, since in-scope companies will request information from business partners, it is likely that companies not directly affected may have to respond to information requests from companies in their value chain.
See our previous update on value chain due diligence for further details.
In focus - Establishment of reporting standards
The issuance of the final ISSB standards in response to demands for uniform disclosure requirements holds significant implications for directors through the introduction of a heightened level of transparency, accountability, and risk management concerning sustainability-related matters. Countries including the UK, Canada, Hong Kong, Singapore, Nigeria, Japan, New Zealand and Australia have expressed intent to incorporate the standards into national regulations. The International Organization of Securities Commissions (IOSCO) endorsed the ISSB standards as being an effective and proportionate global framework of investor-focused disclosures on sustainability- and climate-related risks and opportunities. IOSCO, recognised as a global standard-setter for securities regulation, called on securities regulators in its 130 member jurisdictions (which regulate more than 95% of the world's financial markets) to consider how they might adopt, apply or be informed by the ISSB Standards.
The ISSB framework aims to provide investors with confidence in assessing and comparing how companies identify and manage sustainability-related risks and opportunities over the short, medium and long term. Once a company begins to disclose using the ISSB framework (either voluntarily or to comply with incoming national regulations), directors are likely to need to satisfy themselves as to the accuracy and completeness of their company’s sustainability disclosures, align decision-making with sustainability strategies, and actively oversee management of sustainability risks, in order to comply with local companies and securities regulations around directors’ duties and corporate governance. Since the ISSB standards fully incorporate the recommendations of the TCFD and are seen as a culmination of the work of the TCFD, the Financial Stability Board has arranged for the IFRS Foundation to take over the TCFD’s monitoring of the progress on companies’ climate-related disclosures from 2024. This will simplify the global landscape of sustainability reporting, leaving only the Global Reporting Initiative (GRI) separate from the IFRS.
Directors will no doubt be relieved to learn of the work done by the ISSB to ensure interoperability with other local standards, including by liaising with US Securities and Exchange Commission (SEC) and the European Financial Reporting Advisory Group (EFRAG). This means that companies reporting on the various standards will not have to report vastly different information for each.
The recently-released EU Sustainability Reporting Standards (ESRS) reflect this close work between the ISSB and EFRAG. As the European Commission explains, the ESRS and the ISSB have a very high degree of alignment, so that companies will not have to report separately under the two standards. However, the ESRS will require additional information beyond that required by the ISSB on impacts relevant for users other than investors (e.g business partners, trade unions, social partners, and academics). This means that in addition to ISSB-aligned reporting on how social and environmental issues create near-term, readily measurable financial risks and opportunities for the company, the ESRS explicitly require reporting on the company's impacts on people and the environment. While these wider social and environmental issues do often translate into financial risks over the longer term, they can be difficult to measure within the usual financial modelling horizon, and therefore may not be captured when applying a financial materiality approach. The ESRS are intended to enhance the quality of sustainability reporting among in-scope companies. The ESRS describe the information that companies will need to gather to prepare sustainability statements in their management reports that comply with the Corporate Sustainability Reporting Directive (CSRD).
On 18 October 2023 the European Parliament adopted the Commission’s proposed ESRS, and subject to the Council adopting the proposal on 28 November, the ESRS will be published and enter into force in January 2024. The ESRS will apply in accordance with the CSRD’s phased approach as below (although it is proposed to delay the deadline for sector-specific reporting and non-EU companies by two years). The CSRD classifies a large company as meeting two out of the following criteria: more than 250 employees, a turnover of over €40 million and over €20m total assets (although the Commission has proposed an amendment, yet to be approved by the Parliament and Council, to raise the latter to €50 million and €25 million respectively).
- For the 2024 financial year by ‘public interest’ large companies (or parent companies of a large group) with over 500 employees. Public interest entities are credit or insurance companies, companies listed in the EU or companies designated as ‘public interest’ by a member state.
- For the 2025 financial year by all large EU-incorporated companies.
- For the 2026 financial year by SMEs that are listed in the EU.
- For the 2028 financial year by non-EU companies with a net turnover of €150 million in the EU that have an EU large subsidiary or branch.
Board directors would therefore be well advised to gain a sufficient understanding of the rationale behind ESRS to ensure their companies’ disclose information on relevant social and environmental risks and impacts, so as to enable stakeholders to evaluate their sustainability performance and make responsible investment decisions. Prudent board directors will want to oversee the materiality assessment process, ensuring that significant impacts, risks, and opportunities are captured. By understanding where their company fits into the phased approach to implementation, board directors can guide their company to accommodate adjustments over time and consider voluntary disclosures to streamline reporting efforts. All disclosure requirements, with the exception of the general cross-cutting disclosure requirements under ESRS 2, are subject to a materiality assessment. However, the materiality assessment must be ‘robust’, with a detailed explanation required if climate change is not considered to be material, and disclosure of information deemed material is mandatory. The materiality assessment process should be subject to external assurance.
Directors would be well advised to engage with their management to explore how ESRS will affect their company, and begin gaining the necessary skills, whether internally or through external board training providers, so they are ready to guide their companies through these new sustainability reporting standards.
In focus - International assurance standards
The International Auditing and Assurance Standards Board (IAASB)’s proposed International Standard on Sustainability Assurance (ISSA) 5000 is a principles-based, overarching standard designed for use by assurance practitioners in relation to sustainability information reported across any sustainability topic and prepared under any suitable reporting framework. The ISSA 5000 aims to enhance the trust and confidence of investors, regulators and other relevant stakeholders in sustainability information, aligning with the global trend towards more detailed sustainability and climate-related reporting.
This development underscores the increasing role of directors and board directors in ensuring robust and credible sustainability reporting in the evolving landscape of corporate accountability. Assurance is critical to the integrity of sustainability reporting and can either be provided via a limited or a reasonable assurance engagement, both of which require the information be verifiable, but which differ in terms of the work undertaken by the assurance provider to underpin their conclusion and the ensuing level of comfort for users of the report.8
The CSRD will make assurance mandatory, and while it initially limits this to limited assurance (compliance with the CSRD reporting rules, details of processes and standards adopted and compliance with rules on electronic reporting and the EU Taxonomy Regulation), it foresees moving to reasonable assurance, following a feasibility assessment. It is envisaged that this assurance will be performed by the statutory auditor to provide greater connectivity with financial reports. Member state national assurance standards will apply until the EC adopts limited assurance standards (by October 2026) and reasonable assurance standards (by October 2028, accompanied by details of when reasonable assurance would be required). It has been suggested that companies could benefit from involving assurance practitioners at an early stage in formulating their data collection systems, in order to ensure compliance with the CSRD and the collection of decision-useful information.
The ISSA 5000 should allow companies to rely on consistent application of sustainability assurance and support robust verification of their sustainability information, helping companies to avoid risks around misstatement and allegations of greenwashing. The standard will facilitate feedback to companies on their sustainability reporting that will enable them to continuously improve the accuracy and transparency of their reporting, and in turn better inform directors’ decision-making.
End notes:
Reasonable assurance involves gathering a higher level of evidence to support a conclusion as to whether the information is free of material misstatement, including risk identification, assessment of which matters may be unfairly represented and testing effectiveness of internal controls. While assurance will never be absolute, reasonable assurance is the highest level of assurance and the type used to audit financial statements.
Commonwealth Climate and Law Initiative