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ESG director-duty shake-up beyond mere financials

ESG describes a set of environmental, social and governance factors used to evaluate investment and company impacts – and to measure sustainability and long-term shareholder value beyond traditional financial measures, writes solicitor John Gaffney (small picture).

Its emergence marks a shift from the dominant model of shareholder primacy (focusing on maximising short-term shareholder value) to a stakeholder-capitalism model that adopts a long-term view of shareholder value, and takes account of the needs of all stakeholders – that is, employees, customers, and the communities in which businesses operate.

ESG impact on director decisions

The emerging attention of companies to ESG factors means that decisions being taken by directors are increasingly being assessed from the perspective of what they mean for all stakeholders, not just shareholders.

This raises the question of whether directors’ duties under Irish law provide the sound legal foundation needed to allow companies to take account of the needs of all stakeholders, as well as shareholder value.

Irish law on directors’ duties

Considering the way in which directors’ duties are formulated under Irish law, there appears to be no robust statutory basis for directors to take account of all ESG factors in their decision making.

Section 228 of the Companies Act 2014, in requiring directors to act:

• In good faith,
• Honestly and responsibly, and
• According to the company’s constitution,

only requires them to have regard to the interests of the company’s employees, as well as to the interest of its shareholders.

It does not mention other ESG factors.

English law on directors’ duties

English company law provides a sounder, less limited footing. Section 172 of the Companies Act 2006 provides that the fiduciary duty of the company’s directors is the promotion of the success of the company for the benefit of its members as a whole.

In so doing, directors must have regard to certain other stakeholders – including (but not limited to) employees, suppliers, customers, the community, and the environment, bearing in mind also its reputation.

In addition to section 172, the UK Corporate Governance Code 2018 calls on the boards of certain listed companies to ensure that their role is to promote the long-term sustainable success of the company.  

Further, the Companies (Miscellaneous Reporting) Regulations 2018 require companies to which they apply to include an ‘s172 statement’ in their strategic reports, describing how the directors have had regard to the matters set out in section 172, as well as statements on the factors relating to employee engagement and business relationships.

The need for reform  

It is suggested that, in this ESG era, section 228 of the Irish Companies Act 2014 needs to be overhauled.

As may be seen, it lags far behind its equivalent in English company law, which itself has been the subject of calls for reform.

As Lord Sales (of the British Supreme Court) has noted: “the very traditional view of the undemanding nature of directors’ duties is now outmoded”.  

In this vein, commentators have suggested about section 172: “…since many businesses already make significant efforts to account for stakeholders’ interests in the real world, it is arguably time for the law to catch up. This could, in turn, offer much-needed clarity on how to square a shareholder-first view of the role of directors with the increasing expectations of ‘stakeholderism’.”

Better Business Act campaign

A range of initiatives has been announced to amend s172 or, at least, to contribute to the conversation around it, such as the ‘Better Business Act campaign’.

These may provide some guidance for updating section 228 of the Irish Companies Act 2014. The BBA’s proposed reforms are intended to change English law to embed purpose and stakeholders’ concerns into businesses.

This would mean that, rather than a director being required to act in the way that the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders, they must act in the way most likely to advance the purpose of the company.

In turn, under the BBA reforms, the purpose of a company would be defined in the amended section 172 as a balance between the need to benefit its shareholders, and also to benefit wider society and the environment.

Size and nature of operations

This should happen in a manner commensurate with the company’s size and the nature of its operations, while looking to reduce or eliminate wider social and environmental harms or costs (akin to the requirements of the UK Corporate Governance Code).

Moreover, the business would have to specify this purpose in its articles of association.

The fiduciary duties of directors under Irish law are not fit for purpose in this ESG era and, after consultation with the business community and all stakeholders – including employees, customers, and the community of operation – need to be updated. 

John Gaffney is a solicitor and an adjunct professor at University College Cork. He represents Ireland as a member of the ICC Commission on Arbitration and ADR.