Corporate Governance

ESG is becoming an increasingly important element of Corporate Governance

10-11-2022
ESG is developing rapidly. Some would even call it an ESG revolution. Both national and European politics increasingly call for (more) ESG regulations. At the same time, we are seeing sustainability and climate litigation being brought against companies (for example, the proceedings brought by Milieudefensie against Shell and the Urgenda cases). Other stakeholders, such as employees and customers, also increasingly expect ESG commitment. For that reason, it is important for each company to proactively make ESG a part of its corporate governance.

This chapter will outline the most important ESG aspects in the field of corporate governance. What ESG responsibilities do the company and its directors have? What is the impact of the proposal for the new Directive on Corporate Sustainability Due Diligence (CSDD) ? And what are the liability risks for the company and its directors if they fail to comply with ESG regulations?

This chapter will not address the Non-Financial Reporting Directive (NFRD), Corporate Sustainability Reporting Directive (CSRD) or EU Taxonomy. These are discussed in Chapters 1 and 4, which also discuss the CSDD.

ESG and corporate governance

Recently, a large group of professors proposed including a statutory duty of care for directors and supervisory directors for responsible participation in society. But, for now, Dutch company law does not include any specific ESG obligations. Of course, ESG is an increasingly important factor when implementing the general rule that, in the fulfilment of their duties, directors and supervisory directors should be guided by the interest of the company and the business associated with it.

As the Netherlands has a stakeholder model, the board must weigh the interests of all its stakeholders (including shareholders, employees, suppliers and customers) in its decisions. In this respect, the interests of the shareholders (such as profit maximisation) are important, but not decisive. Particularly for non-listed companies, where the shareholders are often closely involved in the governance of the company, it is essential for the board to recognise that ESG is a relevant factor. Many stakeholders expect the company to consider ESG. Failure to do so could, therefore, also have economic consequences; for example, if customers or employees prefer parties where ESG is a priority.

The Corporate Governance Code 2016 (the Code), as it applies to listed companies, contains additional rules for directors and supervisory directors in the field of ESG. These rules are expanded even further in the proposal to update the Corporate Governance Code from 2022. The proposal links, among other things, long-term value creation to ESG. In addition, it contains amendments in relation to diversity, recognising that diversity is about more than just gender. For example, it proposes to add experience, personal qualities, age, gender, nationality and cultural background as factors that should be properly balanced on the management board and the supervisory board.

Despite the fact that the Code does not apply to non-listed companies, the Code can, indeed, be used as a checklist and inspiration when giving effect to ESG within the organisational culture. Furthermore, the Code is relevant to non-listed companies through the principles of reasonableness and fairness and proper administration of the company (for more detailed information, see the paragraph on 'directors' personal liability' in Chapter 7).

Putting long-term value creation and the duty for the management board to formulate a strategy to that effect at the centre was one of the most important changes of the Code in 2016. The proposal to update the Code describes that an ESG strategy is an important element of the overall business strategy. In the management board’s report, the management board renders account about this ESG strategy, the actions taken, the results targeted and realised, including the effects in the production and value chain. For that reason, it is important for companies to enter into a dialogue with relevant stakeholders about that ESG strategy.

A way to start a stakeholder dialogue is through a committee or council in which the various stakeholders are represented. The European Parliament is considering a statutory duty to have such an advisory or stakeholder committee in place. Such a committee could even request an audit of the sustainability strategy. Since the stakeholder committee is not yet provided for by law, it can take on a variety of roles. For example, as a forum for discussion and collection of information, for active involvement in designing ESG policy, or as an advisory body for ESG matters.

In anticipation of the foregoing, it would be wise to consider whether such a committee could be useful for the company. And, if so, how it should be composed. Also essential is to determine what the board will do with the committee's input. This must then transparently be communicated in order to avoid discussions about greenwashing.

ESG competencies of directors

The Netherlands does not have any statutory regulation of required ESG competencies for directors. It is, however, useful to include certain ESG expertise in the profile for directors and supervisory directors. Arrangements regarding required ESG competencies of directors can also be made among shareholders (for example, in a shareholders’ agreement).

When working out the details of the directors' duties in terms of ESG, there is no one-size-fits-all solution. The actual details will depend on the activities of the company. Relevant in this respect are, among other things, the sector in which the company is active, the composition of the management board, the relevance of certain ESG issues, and the expertise of management and employees.

Make ESG competences part of the profile for directors.

As management is a collective matter, it is important that each managing director has sufficient ESG expertise and, where necessary, seek information from experts. In many companies, the management board under the articles of association is small and the company is mainly managed by a management team or an executive committee. These are often comprised of the directors under the articles of association and members of senior management. If such a committee has been set up, the Code stipulates that the board must ensure that the expertise and responsibilities of the board and adequate provision of information to the supervisory board is constantly safeguarded. This means that it is important to ensure that the committee members have sufficient ESG expertise as well.

Directive on Corporate Sustainability Due Diligence

Following calls of the European Parliament and the European Council to draw up rules for companies focusing on sustainability and ESG, the European Commission made a proposal for a Directive on Corporate Sustainability Due Diligence (CSDD). The proposal for the CSDD Directive is an important part of the European Green Deal, which also includes the CSRD proposal, the SFDR proposal and the EU Taxonomy. For more detailed information, see Chapters 1 and 4. The purpose of the CSDD Directive is to have companies that are active in the EU market contribute to the transition to a sustainable economy by identifying and preventing or mitigating adverse human rights and environmental impacts.

Both EU and non-EU companies come under the scope of the CSDD Directive. Pursuant to the CSDD proposal, the companies are divided into two groups. Group 1 EU companies have more than 500 employees and a net worldwide turnover of more than 150 million euros. Group 2 EU companies include companies with more than 250 employees and a net worldwide turnover of more than 40 million euros, provided that at least 50% of that net turnover is generated in a high-risk sector (textiles and leather, agriculture, forestry and fisheries, or mineral products). Group 1 of the non-EU companies includes companies with a net turnover of more than 150 million euros within the EU. Group 2 non-EU companies have a net turnover within the EU of more than 40 million euros, at least 50% of which is generated in a high-risk sector.

The CSDD may even be relevant to companies that do not come under the foregoing scope, if they are directly or indirectly part of the value chain that does come under the scope of the CSDD Directive. This may, for example, lead to a duty to disclose information, or even to measures being taken by a company that does come under the scope of the Directive.

Seven elements

The CSDD Directive contains seven elements focusing on identifying and addressing adverse impacts on human rights and the environment.

1. Due diligence policy
   Companies are required to adopt an annual due diligence policy, including: (i) the long-term due diligence approach; (ii) a code of conduct for employees and companies; and (iii) a description of the due diligence processes.
2. Identifying adverse impacts
   Companies must take appropriate measures to identify actual or potential adverse impacts on human rights or the environment, based on qualitative and quantitative information. Consultation with potential stakeholders is a mandatory part of this identification process. This could, for example, be implemented through the setup of a stakeholder committee, discussed above.
   
   The adverse impacts must be identified by the company for its own company, but also for all the direct and indirect business relations within the value chain. Furthermore, the adverse impacts must be assessed on a regular basis, at least once a year, and before undertaking any new activities or entering into any new relationships, or making important decisions or changes.
3. Appropriate measures
   Not only is there an obligation to identify the adverse impacts on human rights and the environment, the company must also take appropriate measures to prevent or - where prevention is impossible - mitigate potential adverse impacts. These measures may include: (i) developing a prevention action plan; (ii) seeking contractual assurances to ensure compliance with the company's code of conduct (perpetual clauses); and (iii) providing targeted support for an SME where compliance with the code of conduct or the prevention action plan would jeopardise the viability of the SME.
   
   Actual adverse impacts that have been identified must be stopped and, where possible, mitigated by taking appropriate measures, for example, through the payment of damages to the affected persons, a corrective action plan, temporary suspension of commercial relationships, or even, as a last resort, terminating the business relationship altogether.
   
   So, even companies that do not directly come under the CSDD Directive must be aware that a potential business relation may request ESG information.
4. Complaints procedure
   Companies must also have an adequate complaints procedure in place for employees, workers' representatives and civil society organisations in relation to adverse human rights and environmental impacts.
5. Periodic assessments
   Furthermore, companies must periodically assess their own activities and value chain to monitor compliance and effectiveness. Such assessments must be carried out at least once a year, and whenever new risks can reasonably be recognised. Moreover, companies must update their due diligence policy in accordance with the outcome of those assessments.
6. Reporting requirements
   Companies that do not qualify under the thresholds set in the NFRD/CSRD Directive (as discussed in Chapter 4) must publish an annual ESG statement on their websites. The requirements for such a statement are yet to be set by the European Commission.
7. Plan in accordance with the Paris Agreement
   In addition, Group 1 EU and Group 1 non-EU companies are required to draw up a plan to ensure that their business strategy and business model are compatible with the limiting of global warming to 1.5°C in line with the Paris Agreement. The variable remuneration of directors must be linked to the realisation of the plan if the remuneration takes into account ESG aspects.

Enforcement

The obligations ensuing from the CSDD Directive are not noncommittal. Compliance will be safeguarded through a combination of administrative law enforcement and civil liability. Enforcement will primarily take place through the national regulatory authority, which is yet to be designated and which will be authorised to impose sanctions that are effective, proportional and dissuasive. Any monetary sanctions to be imposed will be based on the company's turnover.

The company is exposed to civil liability for damage if it has failed to comply with its duty to identify adverse human rights and environmental impacts or to take appropriate measures against those impacts. The CSDD Directive entails liability not only for the legal entity, but also for directors. Under the proposal for the CSDD Directive, in the fulfilment of their duties, directors must take into account the consequences of their decisions for sustainability issues, including the impacts on human rights, climate change and the environment, in the short, medium and long term. Failure to do so will qualify as neglect of directors' duties under national law.

Liability in the context of ESG

Thinking of climate issues, one will easily remember the Urgenda case against the Kingdom of the Netherlands and the case brought by the NGO Milieudefensie against Shell. For now, it is mostly listed companies that are being scrutinised, but it is not inconceivable that this may, in time, also affect non-listed companies. Until the liability standard under the CSDD Directive has been transposed into national law, Dutch law does not have any specific basis for liability of companies or directors in the context of ESG.

Liability of the company

Claims against the company will have to be based on an unlawful act (onrechtmatige daad), as was the case in the Milieudefensie judgment. An unlawful act is any infringement of a right or any act or omission contrary to a statutory duty or to generally accepted standards according to unwritten law. In the Milieudefensie judgment, the Court held that Shell was subject to a certain unwritten standard. This unwritten standard of care imposes on Shell the obligation to reduce the carbon emissions of Shell Group and its suppliers and buyers. The Court held that this unwritten standard applies to all companies, whatever their size or sector. It should, however, be noted that the standard set has not been sufficiently crystallised. As a result, it is not clear what standards will apply to other companies. Important caveats are that, according to the Court, Shell has not acted unlawfully yet (but that there is merely an impending infringement of the reduction obligation), and that Shell has lodged an appeal against the judgment. See Chapter 7 for more information on ESG liability for the company.

Directors' and officers' liability

Directors' and officers' liability consists of internal and external liability. In this chapter, we will limit ourselves to the internal liability under Article 2:9 of the Dutch Civil Code (DCC) and the external liability under Article 6:162 DCC. For a legal entity to be successful in holding a director liable under Article 2:9 DCC, the director must be personally and seriously to blame for improper fulfilment of their management duties and must have been negligent in taking measures to avert the consequences of improper management. The threshold for internal liability is high, and in its assessment the court must consider all the circumstances of the case. As long as there is no specific ESG legislation, a director acting in good faith will not easily be held liable on this ground.

When it comes to external liability, in principle, the company, rather than the directors, will be liable. An exception is liability on grounds of unlawful act. There is not yet any case law focusing on external directors' and officers' liability on grounds of ESG-related regulations. The existing case law in the field of external liability particularly relates to directors of legal entities that have (almost) gone bankrupt. This case law can be summarised as follows: if a director is held personally liable on the grounds of an unlawful act, that director must be under personal and objectified reproach, subject to a similar standard of serious blame as under Article 2:9 DCC.

Tips & Tricks

• Determine what ESG regulations are relevant to the company: many regulations also apply indirectly to non-listed companies.
• Make ESG competences part of the profile of directors and encourage directors to continue to develop those competences.
• Identify the ESG information of the company according to the CSDD Directive, so that it can be disclosed to new and existing business relations.
• Draw up a concrete and transparent ESG policy to avoid reputational damage due to greenwashing.
• Identify the best way to start a stakeholder dialogue about the ESG policy and design an effective and transparent process to that end.