The Companies (Directors Duties) Amendment Bill has recently been introduced to Parliament. This member's bill seeks to include a new provision in s 131 of the Companies Act 1993 which requires directors to act in good faith and in the best interests of the company. The new provision, if enacted, would make it clear that directors may consider recognised ESG factors when performing that duty.
In this article we consider the proposed amendment and its potential impact on D&O claims.
The proposed amendment
The proposed change would introduce clarity ("to avoid doubt") as to what directors may consider when making decisions:
(5) To avoid doubt, a director of a company may, when determining the best interests of the company, take into account recognised environmental, social and governance factors, such as:
(a) recognising the principles of the Treaty of Waitangi (Te Tiriti o Waitangi);
(b) reducing adverse environmental impacts;
(c) upholding high standards of ethical behaviour;
(d) following fair and equitable employment practices; and
(e) recognising the interests of the wider community.
This list of factors that directors would be permitted (not required) to consider when acting in a company's best interests are non-exhaustive and widely framed.
As well as providing clarity, this Bill would mark the current transition in how we view companies and the role they play in society. In New Zealand, according to conventional corporate governance theory, companies have traditionally been viewed through a "shareholder primacy" lens, which usually translates to maximising returns.
The proposed amendment would endorse a shift away from shareholder primacy to the approach where the interests of wider stakeholders have an increasing importance when exercising directors' duties. This can include the interests of employees, customers and the community, as well as environmental issues. The stakeholder approach promotes a broadening of companies' functions and objectives beyond simply increasing returns.
Radical change or just part of the continuum?
How radical a proposal is this? Although perhaps important at a symbolic level, in our view, the amendment does not significantly alter legal obligations on directors for two reasons.
First, it is expressed to be 'for the avoidance of doubt' implying that directors are already permitted to take these factors into consideration.
Consideration of ESG factors by directors often has a tangible impact on a company's financial performance and value preservation and so sits comfortably with the existing obligation to act in the best interests of the company. For example, companies failing to address foreseeable issues of environmental impact or modern slavery may well suffer a loss of reputation, customers and investors. It is also clear from high-profile legal opinions released in various jurisdictions that directors most likely already have a duty to at least consider climate related financial risk within the current legislative framework.
We know that many company directors in New Zealand already consider the factors listed in s 131(5). Examples include endorsing strategies that promote good ESG outcomes such as parental leave policies that go beyond government requirements, requiring ethical conduct in excess of strict legal requirements, monitoring supply chain for modern slavery issues, commitments to reducing carbon outputs, and involvement in pro-bono work.
The second reason is that the amendment does not require directors to consider these factors but says that they may consider them. This recognises that, ultimately, directors are agents of their shareholders and different companies will have different purposes. Directors have always had to engage in a complicated trade-off process to balance competing requirements and interests. This amendment does not alter the position that, so long as a company is not mismanaged and remains solvent, directors generally have broad discretion to operate a company however they see fit within the mandate given to them by their shareholders.
Implications for D&O claims?
Introduction of this Bill may jangle some nerves among D&O insurers and their director clients, particularly as the market has already seen significant increases in D&O premiums to reflect an increase in risk. Undoubtedly it could be used as a vehicle to launch shareholder or other activist claims against directors as we have seen in other jurisdictions. However, there is an argument that any motivated activist or class action funder already has the knowledge and the tools to bring these types of claims against directors and so this change is unlikely to create a new stream of litigation.
To date, D&O claims in New Zealand are still mostly based on traditional grounds of insolvency or financial mismanagement. This is unsurprising given the difficulties in establishing that a director breached their duty by failing to protect the interests of one stakeholder group out of a range of other diverse interests, and in proving any resulting loss.
That said, with the increasingly multi-faceted nature of risk management, it is beyond doubt that the landscape within which directors must operate has become considerably more complex in the past few years. This is a trend that is set to continue including, for example, with the introduction of mandatory climate change related disclosures for the financial sector, and the new financial conduct regime.
For directors wishing to protect themselves, whether under the current legislation or under the proposed Bill, the best safeguard is to be able to demonstrate a conscious consideration of wider stakeholder interests, even if ultimately decisions are made adverse to those interests. As with all ESG considerations, this cannot be a 'set and forget' exercise and will need to make a regular appearance on the Board agenda.
The Bill is currently awaiting its first reading.
