Is Having an Environmental, Social and Governance (ESG) Policy Part of a Director’s Duty of Care?

Society is more attuned to social causes than ever, and the business world is taking notice.  

As a result, companies are looking to meet Environmental, Social, and Governance (ESG) criteria to uphold their reputation and make a positive contribution to society.  

But have we reached a point where following ESG criteria is a requirement, instead of just a noble cause, for company directors?   

What is ESG?  

ESG criteria are a set of standards that evaluates a company’s performance in achieving social objectives.  

Consulting firm onValues first coined the term in their 2005 “Who Cares Wins” Report.  

While related to the older and more widely known term of Corporate Social Responsibility, ESG takes the notion a step further by focusing on measurable actions, rather than a framework.  

The environmental aspect of ESG evaluates how a company is addressing environmental concerns. This includes climate policies and approaches to environmental sustainability, conservation, energy use, and reducing waste and pollution.  

The social aspect of ESG evaluates how a company is addressing social concerns. These can include encouraging diversity within the organisation, contributing positively to their community and supporting wider social causes (eg human rights).  

The governance aspect of ESG evaluates the structure of the company itself, and how it is run. These include the level of transparency provided by the organisation to its stakeholders, and how it treats its employees.  

The Growth of ESG Investing 

As consumers increasingly look to a company’s social policies when making a purchase decision, investors are placing more and more weight on ESG criteria in evaluating the viability of companies. 

In an upward trend accelerated by the impact of the COVID-19 pandemic, ESG investing has reached unprecedented heights.  

A report by Morningstar highlights the growth of sustainable investing. Between 2020 and 2021, the value of assets in sustainable investments (those that meet ESG criteria) increased by 73% to $38.077 billion.  

And taking consumer expectations into consideration, it is easy to understand why. Responsible Investment Association Australia’s 2020 “From Values to Riches” report found that nine out of ten Australians expect their financial institution to invest ethically and responsibly. Furthermore, the report found that young people are much more likely to consider ethics in their investments.  

So, while having an ESG policy that attracts responsible investment is certainly good for business in the current climate, whether it falls under a director’s duty of care under the corporations act is still up for debate.  

What is a Director’s Duty of Care?  

 Directors of a company have a duty of care and due diligence under the corporations act.  

Section 180 of the Corporations Act 2001 (Cth) provides that: 

(1)  A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they: 

                     (a)  were a director or officer of a corporation in the corporation’s circumstances; and 

                     (b)  occupied the office held by, and had the same responsibilities within the corporation as, the director or officer. 

 Of course,  there is no hard and fast rule for what is expected of a “reasonable person”. And in most cases, the response to a director’s actions (i.e. whether they have breached their duty of care) will differ depending on the context.  

Should directors breach their duty of care, they can be held personally liable for any associated wrongdoing. Put simply, it is something all directors must take seriously.  

Importantly, a director’s duty may require them to consider what is in the best interests of a range of stakeholders, including shareholders, employees, suppliers, customers, and even the community at large.  

As outlined in a July 2022 practice statement published by the Australian Institute of Company Directors, directors have discretion to determine: 

• What are the best interests of a company.  

• Over what time horizon those interests should be assessed; and  

• The precise nature of interests that are to be advanced or protected. These can be purely financial, reputational or otherwise. 

Taking the above into account, you can make solid arguments for and against an ESG policy forming part of a director’s duty of care. On one hand, not having an ESG policy closes the door to a large pool of investors, meaning the company is not making an effort to maximise its value to shareholders. On the other, the same can be said for marketing, yet directors are not compelled to blow their budget on a marketing campaign, even if doing so will be in the company’s best interest.  

What do the Courts Say?  

In recent cases where the impact of companies’ ESG policies (or lack thereof) are the subject of scrutiny, courts have foundin in favorFavour of socially conscious investors. 

McVeigh v Retail Employees Superannuation Pty Ltd is one such example. In this case, the plaintiff alleged that their super fund was acting against the interest of its members by not disclosing a plan to mitigate the impact of climate change on their business.  

In the end, the parties agreed on a settlement. As part of the settlement, the fund agreed to incorporate the risk of climate change in its future investment decisions. They also pledged to reach a net zero carbon footprint by 2050.  

Is an ESG Policy Part of a Directors’ Duty of Care?

That brings us to the burning question: is failure to have (or oversee) an ESG policy a breach of a director’s duty of care and diligence?  

Even though there aren’t many cases that have explored this issue, recent trends suggest that the answer may soon be yes. With consumers increasingly invested in ESG issues, companies without an ESG policy – and their directors – will face increased scrutiny should things go wrong.  

So as a director, establishing and monitoring a comprehensive ESG policy is not only a good business decision, but one that will ensure company directors, are setting up their business, and themselves,  for a successful future.  

The contents of this article does not constitute legal advice and should not be relied upon as such. If this article pertains to any matters you or your organisation may have, it is essential that you seek legal and relevant professional advice.