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Lindsay, Bruce --- "The use of 'best available science' in environmental and natural resources law" [2020] PrecedentAULA 10; (2020) 156 Precedent 40


THE EMERGING THREAT OF CLIMATE-RELATED LITIGATION FOR COMPANY DIRECTORS

By Elisa de Wit and Dr Kai Luck

Climate risks are foreseeable issues that all directors need to proactively consider and plan for now. The current regulatory framework, together with a more aggressive approach to enforcement by regulators and the rapidly evolving trends in shareholder activism and the class action industry, have created climate change risks for company directors which have now reached a critical level.

Directors can no longer bury their heads in the sand over climate change or treat it as an issue for ‘tomorrow’s board’. The climate change risks for directors exist now, requiring immediate action by boards to identify how a changing climate and moves to transition to a lower-carbon economy will impact a company’s current and future operations; and, where the impact is sufficiently material, to take steps to mitigate the effect of climate threats on the company’s operations.

If directors fail to respond to climate change, they will face two primary risks:

• a regulatory and litigation risk, arising from the potential for action to be taken by regulators and shareholders, which may expose companies and individual directors to significant criminal sanctions and/or civil penalty and compensation orders; and

• a position risk, arising from the potential for shareholders to pass resolutions that may lead to a board spill and the removal of a director from the board.

Importantly, these risks are not unique to directors of companies in the resource and energy sectors. They also extend to sectors in which companies purchase and consume, in the course of producing and delivering goods and services, emissions-intensive inputs (such as non-renewable fuel). These sectors include manufacturing, agriculture, infrastructure, transport, real estate and tourism. Financiers, insurers and superannuation trustees also face climate risks due to their lending and investment exposures to entities in other climate-affected sectors.

REGULATORY AND LITIGATION RISK

Climate risk disclosure obligations

Listed entities

In August 2019, the Australian Securities and Investments Commission (ASIC) released its revised Regulatory Guides 228[1] and 247 (the revised Guides).[2] For the first time, ASIC has mandated the disclosure of climate risks by:

listed entities, as part of the operating and financial review required by the Corporations Act 2001 (Cth) (Corporations Act) to be included in the annual directors’ report for those entities;[3] and

all companies when issuing a fundraising prospectus to investors.

In the revised Guides, ASIC recommends that companies adopt the climate change reporting standards set out in the June 2017 Final Report of the G20 Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD).[4]

In its Final Report, the TCFD recognises that climate risks are now significant for many companies, and that companies must thoroughly consider, quantify and disclose these risks to ensure stakeholders are able to make informed investment, lending and underwriting decisions.[5] The TCFD recommendations are designed to provide entities with consistent measures for identifying and disclosing – as part of their annual financial reporting – the specific climate risks that have an impact on their operations. In what is now widely accepted industry terminology, the TCFD classifies climate risks into two primary categories:

physical risks arising from the physical impact of a changing climate, such as the impact on a company’s supply chain and asset values from the increased incidence of drought, floods, wildfire, rising sea levels and cyclones; and

transition risks, being the non-physical risks arising from the global transition to a lower-carbon economy.[6]

Transition risks are especially significant for many companies and include:

• regulatory changes that mandate specific emissions reduction targets and investment in carbon offsets and renewable energy;

• consequences flowing from a breach of mandatory requirements, including reputational damage, criminal and civil penalties, compensation orders, the refusal of a licence that an entity requires in order to operate, or the rejection of a development application sought by an entity; and

• lower demand for both the non-renewable fuel sources supplied by resources companies and the products supplied by heavy emitters.

Non-compliance with the revised Guides may have regulatory and shareholder enforcement implications for both companies and directors, as discussed in further detail below.

Bolstering the amended Guides, the Australian Securities Exchange (ASX) revised its corporate governance standards, covering reporting periods from 1 January 2020, and listed entities are now expected to disclose any material exposure to climate risks, and how they manage or intend to manage those risks.[7] The ASX also now requires climate risks to be included as part of a listed entity’s risk management framework, which must be reviewed and updated at least annually.[8]

Other public and large proprietary companies

While the revised Guides apply only to listed entities (apart from fundraising disclosures), under the Corporations Act all public (not just listed entities) and large proprietary companies are required to prepare and lodge annual financial reports and annual directors’ reports.[9] In view of the significant attention given to climate risks over the last 12 months, those risks are plainly foreseeable for companies and their directors. Accordingly, these risks will need to be identified and disclosed in annual reports; and directors will be exposed to regulatory and shareholder enforcement akin to those that arise for listed entities for non-compliance with the revised Guides.

APRA-regulated entities

In March 2019, the Australian Prudential Regulation Authority (APRA) released a paper (the Information Paper)[10] which provides an overview of APRA’s approach to climate risks and the results of a survey it conducted to assess the climate-related disclosure practices of the banks, financial institutions, insurers and superannuation funds which APRA has prudential oversight of.

In the Information Paper, APRA is clear that the ‘awareness phase’ has come to an end and it now expects entities subject to its oversight to proactively and thoroughly investigate, disclose and plan for climate risks.

For APRA-supervised entities, climate risks are derivative, in the sense that they follow as a necessary consequence from an entity’s exposure to borrowers, insured persons and investments which in themselves are likely to carry climate-related physical and transition risks. This exposure causes very real financial risks for APRA-supervised entities, a point that has also recently been emphasised by the Reserve Bank of Australia (RBA) in its October 2019 Financial Stability Review.[11]

In responding to these financial risks, APRA cautions entities to not only consider and disclose climate threats in their annual financial reports, but also to include climate threats as part of their operational risk frameworks.[12]

Consequences of non-compliance with disclosure obligations

Listed entities have general ‘continuous disclosure’ obligations under the Corporations Act and the ASX’s Listing Rules, which require them to disclose to the market all information that a reasonable person would expect to have a material effect on the price or value of their securities.[13]

If a listed entity does not consider and disclose the specific climate risks that may have an impact on its operations, the entity is likely to be in breach of its continuous disclosure obligations. Enforcement action by ASIC for breach of these obligations can result in the imposition of criminal and civil penalty orders against an entity.[14] Individual directors of these entities may also face civil penalties,[15] compensation orders[16] and disqualification orders.[17]

Further, shareholders may seek compensation for losses arising from a share price that did not reflect the climate threats confronting the entity.[18]

Listed entities and their individual directors may also contravene statutory prohibitions on misleading and deceptive conduct.[19] Further, as all public companies and large proprietary companies are required to prepare and lodge annual financial reports and directors’ reports, the omission of climate risks that impact on a company’s operations from these reports may also expose these companies and their directors to liability for misleading and deceptive conduct.

An additional specific risk for directors in each of the above cases is that a company’s breach of the Corporations Act may also constitute a breach of directors’ duties (to act with reasonable care, skill and diligence and to act in the best interests of the company) and result in civil penalties and/or compensation orders being made against individual directors.[20]

For entities regulated by APRA, failure to consider and plan for climate risks may result in APRA issuing an infringement notice, requiring an entity to enter into an enforceable undertaking in which it commits to better climate disclosure protocols and/or disqualifying directors from continuing to hold senior management positions.

The risk of regulatory action is magnified in the post Banking Royal Commission world, in light of the more aggressive enforcement approaches announced by ASIC and APRA.[21]

In relation to shareholder compensation proceedings, the litigation risk for both companies and directors is also heightened due to the explosion in shareholder class actions over the last five years. Shareholder class actions are now the most common type of class action in Australia, a trend due largely to the expansion of third-party litigation funding in Australia.

Shareholder class actions typically allege breaches of disclosure obligations and misleading and deceptive conduct arising from inaccurate or incomplete information. For this reason, climate change disclosure breaches are widely predicted to be the next ‘boom area’ in shareholder class actions.

An additional risk for companies seeking approval of new facilities or infrastructure is the increased prospect that authorities will take into account the projected carbon emissions from a proposed project, and refuse applications if emissions are unacceptably high and entities do not commit to emissions reductions measures as a condition of development approval. This risk has been emphasised in two recent NSW decisions: in the Land and Environment Court for the Rocky Hill Coal Mine Project,[22] and in the Independent Planning Commission for the Bylong Coal Project.[23] In each of those cases, while the projects were ultimately refused on non-climate grounds, it was made clear that decision-makers have an obligation to consider a proposed development’s projected greenhouse gas emissions, including ‘scope 3’ downstream customer emissions, as part of the assessment process. In future decisions, an unacceptably high level of emissions, without any proactive plans from the applicant to mitigate or offset those emissions, could itself form the basis for a development application being refused.

Taking mitigating action

Of course, disclosure is only one aspect of the regulatory and litigation risks arising from climate change.

If directors identify, in the course of considering and quantifying the climate risks impacting on the company that may require disclosure, that those risks are material, they must begin to take specific mitigating action to position the company to address the climate risks in the short to medium term.

Failure to do so places directors at risk of direct personal liability for failing to act with reasonable care, skill and diligence and in the best interests of the company. Again, this may result in both civil penalty and compensatory liability at the suit of ASIC and shareholders.

POSITION RISK

In order to properly manage the threat of shareholder activism, it is important for directors to proactively consider, disclose and take action in response to any climate risks that impact on a company. By ‘shareholder activism’, we mean attempts by shareholders to pass resolutions designed to bring climate risks and mitigation measures (along with other risk matters outside climate change) to the forefront of directors’ minds (rather than the pursuit of class actions, discussed above).

The Australian Prime Minister was recently critical of this kind of activism, along with much broader ‘secondary boycott’ threats from ‘Extinction Rebellion’ and other climate protestors, in a speech to the Queensland Resources Council on 1 November 2019.[24] Those remarks were later echoed by the Australian Attorney-General in a media statement on 4 November.

There has been strong growth in shareholder activism in Australia over the last ten years. It has become especially pronounced in the climate change context in the last 18 months, stirred by environment-focused investor advocacy groups such as Market Forces and the Australasian Centre for Corporate Responsibility (ACCR). Those groups have been especially active against resources companies in recent times.

Absent a provision in a company’s constitution to the contrary, shareholders have no power to pass a binding resolution requiring directors to take action on climate change; that is a management issue, and managing the affairs of a company is a matter for the board of directors.[25]

Further, the case law indicates that shareholders also cannot make non-binding advisory resolutions expressing an opinion on how the board should exercise management powers, including in relation to climate change, unless permitted by the company’s constitution or statute.[26]

Despite this, Market Forces and the ACCR continue to push non-binding resolutions to draw attention to climate risks through media exposure. There is also a prospect that the existing law will be challenged by those organisations (so that advisory resolutions are permitted) in future proceedings, particularly if backed by a ‘deep pocket’ litigation funder.

That aside, the more immediate threat to directors arising from shareholder activism is that shareholders can and do exert pressure on directors of listed entities indirectly. Under what is known as the ‘two strikes rule’, shareholders of a listed company can vote down the company’s remuneration report at an annual general meeting (AGM). If the report receives a ‘no vote’ of 25 per cent or more, the company is given a ‘first strike’, and at the following year’s AGM, the board must explain the action it has taken to address shareholder opposition. If at least 25 per cent of shareholders vote against the new remuneration report, the company receives a ‘second strike’, requiring directors to put a spill resolution to shareholders which, if passed, means that the entire board faces re-election.[27]

The two strikes rule is designed to ensure greater remuneration accountability. However, in practice, some shareholders have used their power under the rule as a general protest vote against board policies.

With Market Forces and the ACCR continuing to aggressively agitate for shareholder interventionist tactics, there is a strong risk for directors of listed entities that shareholders may increasingly resort to the two strikes rule in order to incentivise directors to take action on climate change to avoid losing their positions on the board.

CONCLUSION

While some directors may take the legitimate view that the immediate climate risks facing their companies are low, such that there is no need for directors to take mitigating action right away, directors of every company must at the very least proactively consider, quantify and disclose the unique impact on the company posed by a changing climate and the transition to a lower-carbon economy.

The impact of climate change is now a clear foreseeable risk for directors and an inadequate response to that risk will mean directors expose the company, and themselves, to significant penalties and compensation payouts. Those regulatory and litigation risks are heightened by the more aggressive enforcement approaches now being taken by ASIC and APRA and the continued growth in shareholder class actions.

Further, shareholder activism designed to place pressure on boards to take action on climate change is likely to become more pronounced in the future, potentially causing directors to lose their positions altogether if they fail to take climate risks seriously.

Climate change is not just a ‘fad’ that will die down before a return to ‘normal’ – the risk is now. It is time for directors, and their advisors, to take immediate action to identify and manage climate change threats in order to best protect themselves against the threat of future litigation.

Elisa de Wit is a Partner at Norton Rose Fulbright and is the head of its Australian climate change practice. EMAIL elisa.dewit@nortonrosefulbright.com.au.

Dr Kai Luck is a Senior Risk Advisor at Norton Rose Fulbright. EMAIL kai.luck@nortonrosefulbright.com.au.


[1] Australian Securities and Investments Commission (ASIC), Regulatory Guide 228, Prospectuses: Effective Disclosure for Retail Investors, August 2019.

[2] ASIC, Regulatory Guide 247, Effective Disclosure in an Operating and Financial Review, August 2019.

[3] Corporations Act 2001 (Cth) (Corporations Act), s299A.

[4] Taskforce on Climate-Related Financial Disclosures, Final Report – Recommendations, June 2017.

[5] Ibid, 1–3.

[6] Ibid, 5–11.

[7] Australian Securities Exchange, Corporate Governance Council, Corporate Governance Principles and Recommendations, 4th ed, February 2019, Recommendation 7.4.

[8] Ibid, Recommendation 7.2.

[9] Corporations Act, ss292, 298.

[10] Australian Prudential Regulatory Authority (APRA), Climate Change: Awareness to Action, 20 March 2019.

[11] Reserve Bank of Australia, Financial Stability Review, October 2019, 57.

[12] APRA, above note 10, 12–17.

[13] Corporations Act, s674(2); ASX Listing Rules, rr3.1–3.1A.

[14] Corporations Act, ss1317E, 1317G(1A), 1317G(1B).

[15] Ibid, ss674(2A), 1317E, 1317G(1A), 1317G(1B).

[16] Ibid, ss1317HA, 1325.

[17] Ibid, s206C.

[18] Ibid, ss1317HA, 1325.

[19] Ibid, ss1041H, 1041I.

[20] Ibid, ss1801.

[21] ASIC, ASIC Corporate Plan 2019–2023, August 2019, 7; APRA, Enforcement Strategy Review, Final Report, 29 March 2019, 24.

[22] Gloucester Resources Limited v Minister for Planning [2019] NSWLEC 7.

[23] NSW Independent Planning Commission, Bylong Coal Project (SSD 6367), Statement of Reasons for Decision, 18 September 2019.

[24] See <https://www.pm.gov.au/media/address-2019-queensland-resources-council-annual-lunch>.

[25] Corporations Act, s198A(2).

[26] Australasian Centre for Corporate Responsibility v Commonwealth Bank of Australia [2016] FCAFC 80; (2016) 113 ACSR 600.

[27] Corporations Act, ss250R250Y.


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