Directors’ Liability and Climate Risk: White Paper on India
Commonwealth Climate and Law Initiative
65 Pages Posted: 5 Oct 2021
Date Written: October 4, 2021
Climate change has garnered significant attention given that it poses a serious challenge to sustainable development. No longer is it merely within the domain of voluntary conduct on the part of corporations. Instead, it is a material financial risk that corporations encounter, thereby imposing duties on the boards of directors of corporations to recognise and address climate risk.
In India, the jurisprudence in the context of section 166(2) of the Companies Act, 2013 suggests that directors ought to consider the long term interests of the company. The duty to act in the interests of the company would require directors to examine climate risk and engage in a balancing act between the long term sustainable value for the company as a whole on the one hand and any other interest, including their own, on the other. Practical manifestations of this duty would include making a detailed assessment of climate risk for their company, considering expert advice (where appropriate), determining strategies to address the risks, following through and implementing the strategies, and constantly reviewing the risks and updating the strategies and their implementation. Directors could be exposed to liability if they display conscious disregard or wilful neglect towards the associated financial risks arising from climate change.
The Companies Act (in section 166(3)) also requires directors to act with reasonable care, skill and diligence. In addition, independent directors are subject to several specific duties, including risk management. Given that climate risk is not only a key risk for Indian companies, but is one that is gaining greater prominence over time, directors’ duties to account for climate risk can undoubtedly be determined against the aforesaid legal framework in India. Hence, directors of Indian companies cannot afford to ignore climate risk without exposing themselves to the risk of consequences for breach of directors’ duties. Even if they were to acknowledge climate risk, the competence duties they owe require them to make further investigations to obtain adequate information, to appoint experts and obtain their advice, and to oversee and supervise management to whom they may have delegated tasks for identifying, strategising and implementing a framework to address climate risk. Illustratively, this would include making appropriate levels of disclosure under recognised frameworks such as the Taskforce on Climate-related Financial Disclosures (‘TCFD’), undertaking scenario modelling to assess the viability of the business under different carbon price and temperature settings, and formulating strategies to ensure that the business of a company can sustainably operate in a net zero globalised economy.
Both corporate law as well as securities law in India impose considerable disclosure obligations on directors of companies. Both bodies of law recognise the need for transparency regarding climate risk – as a matter of recognising and dealing with financial risk and also as a matter of non-financial disclosure. When a company is in the process of engaging in a securities transaction, disclosures are required to be made in a prospectus, giving rise to the risk of both criminal and civil liability for directors for misstatements. Secondary market disclosures require directors to disclose matters of climate risk in the annual reports, as well as on an ongoing basis in the case of material occurrences that impact the company’s business and finances, such as extreme weather events. Finally, as part of the annual reports, companies must specifically include business responsibility and sustainability reporting, of which the issue of climate change plays a crucial part. In all, directors of Indian companies bear the responsibility that their companies engage in climate risk disclosures through this multi-pronged approach, the failure of which would expose them to liability under both corporate and securities law.
When it comes to enforcement mechanisms, shareholders have a number of avenues through which they can agitate claims for breach of directors’ duties to deal with climate risk, including to make adequate disclosures. These include both private enforcement measures as well as public ones. While the private enforcement tools seem wide in nature and, in certain cases such as class actions, wider than other Commonwealth jurisdictions, constraints, such as costs, delays and a lack of litigation funding mechanisms, may limit the effective use of such remedies.
Even though the substantive law goes as far as requiring directors of companies to act in the interest of stakeholders, this provision is not justiciable by the stakeholders for whose benefit the directors are required to act. This is because duties are owed to the company, which only can bring an action. Even a derivative action or other forms of claims enumerated under the Companies Act can be brought only by shareholders. It remains unclear whether they can do so for anyone’s benefit other than their own.
Keywords: board of directors, climate change, corporate governance, sustainability, ESG
JEL Classification: K22, K32
Suggested Citation: Suggested Citation