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The rise in ESG reporting requirements for UK directors and of related shareholder activism

Environmental, social and governance (ESG) issues are becoming increasingly important issues and so there are ever greater demands on UK directors to demonstrate a commitment to strong corporate governance principles. Directors should accordingly be proactive in complying with current requirements, especially given the public interest in this area and the risk of ESG-driven claims.

What is the section 172 statement?

UK companies of a certain size (set out below) are subject to mandatory reporting requirements in the form of an annual Directors’ report which is a separate strategic report describing how the directors have had regard to the matters set out in section 172 (1) (a) to (f) of the Companies Act 2006 (the Act) when performing their duty under section 172. This is known as a ‘section 172 statement’ and should detail how the directors have acted to promote the success of the company for the benefit of the shareholders as a whole, having regard to

(a) The likely consequence of any decision in the long term;
(b)  The interests of the company’s employees;
(c)  The need to foster the company’s business relationships with suppliers, customers and others;
(d)  The impact of the company’s operations on the community and environment; 
(e)  The desirability of the company maintaining a reputation for high standards of business conduct; and 
(f)  The need to act fairly as between members of the company. 

This information is seen is now routinely used by investors to assess the quality of a company’s management, identify exposure to business risks and assess the company’s ability to leverage business opportunities. It has also become increasingly important in the context of ESG (and therefore section 172(d) in particular) as investors have begun focussing on ESG in their interaction with companies.  

Which companies must make a section 172 statement?

All public companies as well as UK private companies (other than those that qualify as medium-sized under sections 465 to 467 of the Act) or are small companies) must make a section 172 statement. Medium-sized companies must have at least two out of three of the following:

  • turnover of £36m or less;
  • balance sheet total of £18m or less; or
  • 250 or less employees.

What should be included in the statement?

Whilst there is no prescribed format for a section 172 statement, it is expected that the statement should explain the board of directors’ rationale behind why key decisions were taken based on engagement activities, stakeholder involvement and training, using examples where appropriate and plans for the future.  

The section 172 statement is published in the annual accounts, so the timing will tie in with the deadline for publication of annual accounts. In the context of section 172(d) in particular, companies will be expected to discuss strategy and due diligence relating to the environment, employees and human rights, social matters and anti-corruption.  

Companies House may not accept any accounts that do not meet the requirements of the Act, and where acceptable accounts are delivered after the filing deadline, the company is liable to a civil penalty in accordance with section 453 of the Act. The civil penalty for the late filing of accounts is in addition to any action taken against directors personally (or members of an LLP), under section 451 of the Act.

Enforcement

The Conduct Committee of the Financial Reporting Council (the Conduct Committee) is responsible for monitoring compliance of company reports and accounts with the relevant reporting requirements, imposed on companies by Part 15 of the Act and imposed on LLPs.  The Conduct Committee has the power to enquire into cases where it appears that relevant disclosures have not been provided. The Conduct Committee also has the power to apply to the Court, under section 456 of the Act, for a declaration that the annual report or accounts of a company or LLP do not comply with the requirements and for an order requiring the directors to prepare a revised report and/or set of accounts. As far as possible, however, the Conduct Committee will seek to cooperate with businesses whose reports it reviews without seeking recourse through the courts.

ESG specific reporting

The intention is for 2023 to see the beginning of ESG reporting in the UK being formalised through the Financial Conduct Authority’s (FCA) Sustainability Disclosure Requirements (SDRs). The SDRs will provide a framework for corporates to manage sustainability-related risks, opportunities and impacts, as well as set relevant metrics and targets. Additionally, the SDRs will incorporate the UK Green Taxonomy, a classification system of which activities can be considered “green”. While the SDRs will be considered ‘good practice’ to begin with, it is likely they will be made mandatory in the coming years. 

The objectives of the UK SDRs are to ensure protection to consumers by increasing transparency and improving trust in the ESG and sustainable investment products market. They are also designed to meet the needs of investors and to complement the work required by the section 172 statements. Finally, they are designed to require companies to be able to substantiate the ESG claims they make, which is seen as a priority for the FCA.

FCA investigations

With more regulation comes greater regulatory scrutiny and risk of breach, for example by a failure to provide the required disclosure, or providing misleading or inaccurate information, leading to an increase in investigations by the FCA. This will inevitably have an impact on insurance policies (for example, Directors and Officers insurance) to address potential costs arising out of having to respond to an investigation. 

Parent company liability 

Similarly, an increase in regulation also brings the risk of an increase in litigation for civil breaches. There are examples of litigants using the courts to hold a parent company liable for wrongs committed by a subsidiary where claims have been brought in England against the parent companies of foreign subsidiaries that had allegedly caused damage caused by oil or mining activities. From Vedanta Resources Plc and another v Lungowe and others [2019] UKSC 20, Okpabi & others v Royal Dutch Shell Plc and another [2021] UKSC 3 and most recently Município de Mariana v BHP Group (UK) Ltd [2022] EWCA Civ 951, UK-based parent companies should take heed that the English courts are increasingly receptive to such claims.

Impact for company directors: risks of non-compliance

Whilst the proposed measures are designed to increase consumer protection by bringing greater transparency to environmental disclosure obligations, this is not without concern for company directors, officers and their insurers. The reports represent a risk to companies as they could be scrutinised by various disaffected groups such as activist shareholders and third-party special interest groups (for example environmental campaigners who may review statements made on the impact of operations on the environment).

Derivative and other claims

Shareholders may also try and bring derivative claims in order to ‘step into the shoes’ of the company to bring claims on its behalf against its directors, once it has received permission from the court to do so pursuant to section 261 of the Act. Available remedies for successful derivative actions include a) damages to rectify any losses suffered by the company (such as damage to reputation to a diminution in share value), b) an order requiring the offending director(s) to account to the company for any profit obtained, c) an order setting aside a specific transaction and/or d) an injunction to prevent further breaches.

In the recent case of ClientEarth v Shell plc & Ors [2023] EWHC 1137 (Ch) environmental campaigners sought to bring a derivative claim against the company alleging a failure to properly implement a net-zero transition. While the application was ultimately unsuccessful, it does demonstrate the increased public scrutiny over companies in relation to their ESG policies and activist investors’ willingness to harness the legislative tools available to hold directors to account.  To a certain extent bringing the claim itself can be a vehicle for generating valuable publicity for activist causes and so achieve their objectives, particularly if they are only seeking to win in the court of public opinion.

Sections 90 and 90A FSMA

The requirement for greater ESG disclosures on environmental and sustainability issues can open the door to claims that representations made to investors or targets set were inaccurate, leading to allegations of greenwashing and other claims. 

It is expected that sections 90 and 90A of the Financial Services and Markets Act 2000 (FSMA) may increasingly become more prevalent tools in the context of climate litigation. Under these statutory provisions shareholders may claim for loss suffered arising from untrue or misleading statements made either under section 90 in a prospectus or under section 90A in other published information such as directors’ reports. Loss to shareholders may, for example, occur where a company’s ESG credentials are revealed to be false leading to damage reflected in an impacted share price. Unlike under section 90A, under section 90, there is no requirement to prove reliance on the material. Such claims may become more common as investors become increasingly climate-conscious and so may assert that ESG considerations played a significant part in their decision-making processes when investing.

Practical considerations

Given the ever-increasing rise in regulation in this area and ESG-related litigation, it is important for businesses and company directors, now more than ever, to seek early legal and accountancy advice when considering their reporting obligations, including making a section 172 statement. It is also worthwhile having a dedicated team in-house that works with external counsel to help manage and mitigate risk at all reporting stages, including ensuring that all decision making is appropriately recorded. 

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