ESG regulation: opportunities, more duties of care, increasing likelihood of liability

Those who still see ESG as a specialist subject will soon be overtaken by reality. ESG is directly linked to governance, reporting and policy. Inherently, there is an increasing risk of liability.

The case brought by Friends of the Earth NL against Shell to force the company to reduce its CO2 emissions more quickly illustrates this development. Friends of the Earth NL won: the court ruled that Shell must reduce its CO2 emissions by 45% by the end of 2030, compared with 2019, and judged the company's climate policy to be too vague. This ruling is groundbreaking in the way the court interpreted the unwritten standard of care in Article 6:162 of the Civil Code. The case is still pending on appeal.

ClientEarth in the UK went a step further earlier this year by focusing not on Shell as an organisation, but on Shell's directors. The allegation was that they had been too lax in their commitment to the company's switch to renewable energy. Mismanagement, ClientEarth called it. The British court did not go along with this for the time being, but this case, too, is ongoing.

The ClientEarth case is so far the only one of its kind: To our knowledge, directors have never been held liable for so-called 'failing' ESG policies. We expect this to become more common. A growing focus on management is also evident in criminal law. We also see this in criminal charges where the role of directors is explicitly considered. With increasing transparency and other obligations and responsibilities in the ESG area, there will be an earlier (public) focus on ESG policies and their implementation, and the actions of the company and its de facto managers will be scrutinised earlier. It is advisable to take this into account.

The initiatives before us

Many initiatives are coming out of Europe and the Netherlands that will have an impact. These include the following areas:

1. Reporting. The Corporate Sustainability Reporting Directive (CSRD), which has now entered into force, requires companies to report on the impact of their activities on people and the environment. This will be phased in from 2024. Instead of reporting on ESG separately, companies will now have to do so in their annual report, using the far-reaching European Sustainability Reporting Standards (ESRS). ESG will become an integral part of corporate policy. This is of course a good thing for the transition to a sustainable world. At the same time, those who think things are not going fast enough or well enough will be critical of the board's report.

2. Due diligence. The European Parliament adopted its position on the Corporate Sustainability Due Diligence Directive (CSDDD) on 1 June. The CSDDD imposes due diligence obligations on companies in their value chain. This includes not only identifying human rights abuses and negative environmental impacts, but also preventing, reducing and, where necessary, ending them. The European Commission, the Council and the European Parliament are still debating the content of this directive, so it remains to be seen what it will look like, when it will come into force and how it will be transposed into Dutch law. It is still under discussion, for instance, whether the CSDD will include a duty of care provision on the personal responsibility of directors to consider the consequences of their decisions on sustainability issues.

3. Environmental policy. This is another area where Europe is introducing more extensive and stricter regulations. Initially, this will apply to larger industries, but later (in national legislation) smaller companies may also fall within the scope. Among other things, companies will have to draw up transition plans, there will be a stricter duty of care, and the burden of proof will be reversed. We return to this below.

4. Corporate governance. At the end of 2022, the Corporate Governance Code Monitoring Committee updated the 2016 Corporate Governance Code. Among other things, it is worth noting that it now explicitly states that directors are responsible for sustainable long-term value creation and that companies should develop diversity and inclusion policies.

As noted above, this gives ESG tools an unprecedented scope and scale. Not only will companies have many more obligations to report and act, but these obligations will also apply to many more companies. One challenge is that information, which often resides in different places within a company, needs to be brought together to meet these transparency and other obligations. The sheer number of regulations makes it more vulnerable. Critics could, for example, look for discrepancies in transition plans and annual reports. Either way, transparency is increased. The same goes for mandatory reporting to the government. Under the Open Government Act (WOO), such reports (containing company data) can be requested, and these too can be critically examined in context.

Our advice when it comes to reporting is therefore: check very carefully what is included and what is not and, if so, how (and how strongly) it is worded. Too little information makes you vulnerable, but so does too much. Make sure that what you report is substantiated and verifiable. Sustainability reporting is no longer optional. Retrospection is always easy, and failing to report, even unintentionally, can have repercussions years later. Moreover, not only NGOs will be interested in ESG reporting, but also hedge funds. Class activists are increasingly using ESG factors in their campaigns.

From soft to hard law and a reversal of the burden of proof

The nature of the rules is also changing. We are seeing a clear shift from soft law to hard law. An example of soft law are the OECD Guidelines. Every country has an OECD hotline where people can report violations. In the Netherlands, for example, there is an ongoing case related to the Colombian 'blood coal'. In April, victims of paramilitary violence in Colombia filed a complaint against four European energy companies, the ports of Rotterdam and Amsterdam, and the Rotterdam storage company HES in connection with the violent eviction of peasant families around Colombian 'colazones'. However, such a procedure of the OECD can achieve no more than to hear the parties and to mediate between them.

‍How different it will soon be under the CSDDD. A company will be breaking the law if it fails to act against human rights abuses. Those affected will also be able to claim their rights. The Dutch version of the CSDDD, the Bill on Responsible and Sustainable International Business, also contains a due diligence reporting obligation that is enforceable under criminal law. Incidentally, this bill, which has been put on hold pending action at European level, also includes a reversal of the burden of proof. In such cases, the company will have to prove that the law has not been broken. Such a reversal of the burden of proof is also planned for future European environmental directives. Interested third parties will no longer have to prove that there were too many emissions, but it will be up to the company to prove that there were none.

Naming and shaming

ESG responsibility does not automatically translate into liability. The threshold is high: there must be serious misconduct (or manifestly improper performance of duties). A single policy error is not enough. Duty of care in environmental law requires an "unmistakable breach" of that duty. Even in the context of criminal "de facto management", more than bad management is required. However, as mentioned above, there is an increasing focus on directors, including in criminal law. It is to be hoped that restraint will be exercised in this context, as mere "suspicion" can lead to irreparable reputational damage. This often affects not only the reputation of the director concerned, but also the reputation of the company in which the director works.

Round-up

We believe that the objectives of many ESG-related initiatives are worth pursuing. At the same time, we want to raise awareness. Not to instil fear, but to ensure that space is created to move beyond compliance and take responsibility for developing a sustainable strategy.