The Implementation of ESG Criteria in the Corporate Governance of Corporations: Practical Note for Unlisted Companies

Is it necessary to set rules?

Several ESG directive proposals are currently under discussion.

Still, should an unlisted company wishing to integrate ESG criteria into its corporate governance voluntarily establish internal rules?

Generally, the adoption of ESG criteria falls within the discretion of the board of directors or similar governing body (hereinafter, the “Board of Directors” or the “Board”).

In other words, the Board is free to make decisions that take into account environmental sustainability, emissions reduction, gender equality, and so forth, also in the absence of specific bylaws provisions or directives from shareholders.

However, in order to avoid a situation where the Board applies ESG criteria based solely on its own views, without oversight or shareholders guidelines, it may be appropriate to establish rules to guide management action and ensure alignment with shareholders’ interests.

Indeed, the scope of ESG criteria is extremely broad: for instance, numerous topics – such as water consumption, CO₂ emissions, use of paper and recyclable materials – would fall under the scope of letter “E” alone. The field is too wide to be managed solely at the discretion of the Board, without risking a sharp increase in so-called agency costs (i.e., the costs deriving from the conflicts of interest between shareholders and directors, causing the shareholders to bear costs to monitor the Board).

Therefore, let’s examine in more detail the tools available to integrate ESG criteria into the corporate governance of the two most common corporate models in Italy: limited liability companies (S.r.l.) and unlisted joint-stock companies (S.p.A.), including those that are part of international groups seeking to align with supranational ESG policies.

The role of shareholders: amendments to the bylaws

Where shareholders intend to define a clear framework for the implementation of ESG criteria, the primary instrument available would be the bylaws.

Through amendments to the bylaws, it is indeed possible to determine the scope and methods by which the company must integrate environmental, social, and governance objectives into its activities, specifying their extent in detail.

Typically, it would be advisable not to modify clauses on corporate purpose to avoid triggering the dissenting shareholders’ withdrawal right. Companies usually opt to insert a specific sustainability clause elsewhere in the bylaws, setting out the company’s commitments in respect of ESG criteria. The consequences and effects of inserting such clauses require complex evaluations, which vary on a case-by-case basis and will therefore not be addressed in detail here.

Such clauses may take various forms:

• Definitional, specifying that the pursuit of the corporate purpose must be carried out in accordance with certain principles (e.g., ethical-social principles);
• Restrictive, e.g., by providing a list of excluded activities or transactions (such as investments in sectors with a high negative environmental or social impact) that would be incompatible with the stated ESG values;
• Consultive, requiring the company to consult with external committees or stakeholders before approving certain transactions – although this kind of clause may have limited practical relevance as its application is often sporadic and non-continuous.

Finally, in certain cases, shareholders may even seek to select the shareholders base by including so-called ethical approval clauses aimed at admitting into the shareholding structure only entities that align with the company’s ESG values.

Both case law and notarial practice – see, in particular, guidelines A.B.1-A.B.6 of the Notarial Committee of Triveneto – recognize the legitimacy of such clauses as long as they remain consistent with the for-profit purpose of the company.

The Role of the Board of Directors

The inclusion of ESG clauses in the bylaws binds the Board of Directors, which must then conduct its management activities in accordance with the principles and limits set out therein.

Where ESG provisions are included in the bylaws, that may result, in particular, in the directors being required to align the company’s organizational structure and management practices to ensure their effective implementation.

So, how should the organizational structure be adapted to the bylaw provisions?

It is the responsibility of the Board – within its discretion – to design the most suitable internal structure. As a general rule, it will likely be necessary to establish a system of delegations and sub-delegations involving the management line as well.

The role of managing directors and managers in pursuing ESG criteria

Depending on the implemented strategies, the Board may assign to one or more directors and/or managers specific tasks, providing – alternatively or in combination – that:

• they will be entrusted with the implementation of corporate policies consistent with the ESG clauses, contributing to the definition of environmental, social, and governance KPIs;
• they will integrate the ESG criteria, if set out in the bylaws, into decision-making processes; in this way, sustainability becomes integrated into the corporate decision-making process, gaining practical relevance in day-to-day management and in performance measurement;
• they will be subject to periodic ESG performance evaluations, with possible direct effects on bonuses and variable remuneration mechanisms. In particular, performance evaluation mechanisms should also take ESG criteria into account, just as they are considered within the Board’s “integrated” decisions (see above).
• In order to prevent ESG directors and/or managers from essentially doing whatever they want, it may be worth appointing independent bodies/advisors to assess the actual ESG results achieved. Indeed, while purely economic criteria are easier to measure and assess (numbers don’t lie), the evaluation of certain ESG goals achieved may be rather “hazy”; therefore, the involvement of an independent evaluator to verify what has actually been achieved is recommended.

The adoption of ESG clauses in the bylaws and their concrete implementation by shareholders, directors, and managers will soon become market practice.

It is just a matter of time.