Directors Beware: Director Duties and Nature Risks

In March this year, the latest in a series of papers and expert opinions globally on climate and nature-related risks and directors’ duties was published in the UK titled, “Nature-related risks and directors’ duties under the law of England and Wales” (the UK Nature Opinion).

Importantly, the U.K. Nature Opinion does not create new law or advocate for change but clarifies existing legal duties under the U.K. Companies Act 2006. While the U.K. Nature Opinion is not directly applicable to the laws of other countries, it may have implications for directors of non-U.K. companies.

What Does the U.K. Nature Opinion Say?

The U.K. Nature Opinion explains how nature-related risks can arise in myriad scenarios with a wide range of direct and indirect effects on a company. While sectors such as agriculture, forestry, fisheries and aquaculture, food, beverages and tobacco, and construction are wholly dependent on nature for their products, analyses by the World Economic Forum and PwC (and updated analysis by PwC) indicate that over half of global GDP is either moderately or highly dependent upon nature and ecosystem services.

Jasmin Fraser

Rebecca Stubbs KC, Maitland Chambers (co-author of the Opinion) said: “Our analysis demonstrates that nature related risks are no different to any other risks faced by company directors. Directors are required to give consideration to all relevant risks facing their businesses” (emphasis added).

The U.K. Nature Opinion explains how board directors could breach their duties under sections 172 and 174 of the Companies Act 2006 if they fail to identify and (where appropriate) mitigate latent financial risks arising from a company’s unaddressed nature-related impacts and dependencies.

Why Are Nature-Related Risks Relevant to Companies?

Nature-related risks are relevant to the short- and long-term success of companies. They are not a new category of risks but fall within existing financial risk categories.

The U.K. Nature Opinion’s assessment of these risks could be applied to companies around the world:

• Physical risks can encompass a decline or collapse of ecosystems that underpin a company’s operating model and supply chain. For example, the dependence of food and beverages producers on soil health to produce crops, which is degraded by unsustainable practices.

• Transition risks can include shifting consumer and investor preferences and new technology or regulations, for example the EU’s regulation to prevent deforestation.

• Legal risks include the potential for complaints, regulatory action or litigation against companies for the impacts of their activities on ecosystems or misrepresentation of nature-related risks and impacts.

• Systemic risks can affect the whole financial system by way of supply chain disruption, price volatility, collateral and asset depreciation, increases in defaults, and more.

The U.K. Nature Opinion finds that “it is easy to envisage circumstances where the success and best interests of a company (whether in the short or long term) can be affected by nature-related dependencies or impacts” since:

• A company’s dependencies and impacts on nature can have significant effects on a company’s ability to operate successfully.

• Company operations that result in negative impacts on nature can cause the company financial loss, as well as damaging its reputation, goodwill and its share price.

• Financial institutions may face increased exposure where borrowers suffer these types of losses.

Companies and financial systems around the world are dependent on ecosystems. Studies undertaken by central banks in the Netherlands, Malaysia, France, Brazil and Africa have found their national financial sectors to have high dependencies on ecosystem services through lending and investment portfolios.

Source: Recommendations of the Taskforce on Nature-related Financial Disclosures

What Is the Relevance of the U.K. Nature Opinion to Directors Outside the Region?

The UK Nature Opinion has significant global implications. By clarifying that nature-related risks fall within existing financial risk categories, the U.K. Nature Opinion sets a precedent that could influence legal and business practices worldwide.

Across the world, fiduciary obligations generally require directors to act with care and loyalty to their companies. These legal duties are exercised in strategic planning, oversight of foreseeable and material risks, and attesting to disclosure and financial reports. The law commonly assesses the standard of directors’ care and loyalty by reference to the evolving market, social and regulatory context, which means that these duties are not static. External factors may, therefore, raise the standards applicable to directors of certain companies.

A significant body of work has demonstrated that the corporate laws of many countries require board directors to consider governance and disclosure of climate risks in the performance of duties of a) care and diligence and b) loyalty. The Commonwealth Climate and Law Initiative (CCLI) has published papers and commissioned independent legal opinions evaluating directors’ duties to incorporate climate risk in board analyses in eleven countries: Australia, Canada, Hong Kong, India, Japan, Malaysia, the Philippines, Singapore, South Africa, the U.K., and the U.S. It is likely that similar conclusions may be drawn in many countries around the world in relation to nature-related risks to the extent that they have a capacity to pose foreseeable, and in many cases material, financial and systemic risks that affect companies and investors.

Pertinently, a biodiversity risk report CCLI published in 2022 concluded that nature-related risks are likely to be relevant to directors’ duties under a number of company law frameworks. Expert legal opinions in Australia and New Zealand further support this. Although the relevance of nature-related risks to directors’ duties is partly jurisdiction and location specific, there are sufficient commonalities between the laws of different countries that many conclusions of the U.K. Nature Opinion and the Australia and New Zealand opinions may be applicable to other countries.

This is particularly the case in common law countries, evidenced by barristers in Australia and the U.K. drawing broadly similar conclusions regarding directors' obligations to consider nature-related risks. Both opinions gave an authoritative explanation of the legal implications of nature-related risks for corporate governance and disclosure in their respective countries, taking account of comprehensive evidence of recent global developments in:

• Scientific understanding of global nature decline; and

• Financial and economic understanding of risks arising from nature-related issues for companies, lenders, investors and wider financial systems

Jurisdiction-specific legal opinions can have significant ripple effects on corporate governance practices and regulatory landscapes globally, in the following ways:

• Influence Interpretations: Legal opinions in key jurisdictions may influence similar legal interpretations in other countries and can contribute to the development of international standards and best practices. Companies may find themselves aligning with these standards to maintain competitiveness and manage reputational risks.

• Internal Review of Practices: The clarification that directors’ duties in key jurisdictions require consideration of nature-related risks may prompt boards of multinational companies (subject to the laws of multiple countries) to reassess their practices.

• Investor Pressure: Investors increasingly consider sustainability factors when making investment decisions. Legal opinions highlighting the importance of nature-related risks could lead to greater investor pressure on companies worldwide to disclose and mitigate these risks.

• Policy: Governments or regulators may take note of these legal opinions and consider changes to company laws or disclosure regulations, explicitly requiring companies to address nature-related risks.

What Is the Position on Nature-Related Risks in Financial and Non-Financial Disclosures?

In the U.K., certain companies are already required under non-financial reporting regulations to disclose those environmental matters necessary to enable understanding of the company’s business and performance. The U.K. Nature Opinion clarifies that this obligation encompasses material nature-related financial risks to the company and relevant impacts of the company on nature. In countries with comparable regulations, certain types of companies may similarly already be required to disclose material nature-related matters.

Even before the recommendations of the Taskforce on Nature-related Financial Disclosures (TNFD) are likely to be adopted into regulations, they may result in further scrutiny of directors’ responses to nature-related risks, depending on local market awareness and support of the TNFD.

In relation to disclosure in financial statements, another U.K. legal opinion demonstrates that the English company law director's duty to approve accounts if they “give a true and fair view” of the company’s financial position requires directors to consider whether nature-related issues have consequences for financial statements (for example by creating liabilities or impairing asset values).

There is work ongoing to explore the applicability of this duty in other jurisdictions, but similar conclusions may apply to companies that follow IFRS accounting standards, which include a duty under IAS 1 to “present fairly”. There has also been commentary on how IFRS guidance on materiality assessments applies to emerging risks, IFRS educational material on disclosure of material climate-related risks, and a proposal to amend IFRS voluntary guidance on management commentary to include material environmental issues.

What Does This Mean for Personal Liability Risk of Company Directors Around the World?

The U.K. Nature Opinion concludes that board directors could potentially breach their duties by failing to consider or act on relevant nature-related risks, leading to significant consequences such as potential claims for damages or compensation, termination of executive directors’ employment or a challenge to any remuneration or exit package. Similar consequences are foreseeable in other countries.

What Are the Opportunities for Company Directors Around the World?

Directors who steer their company on a competitive path through the nature-positive transition can do so by properly identifying and managing their company’s nature-related risks. But how?

The U.K. Nature Opinion recommends five steps for prudent directors (taking expert advice where appropriate). These steps will be useful for board directors in all countries, especially in the absence of any country-specific legal opinion or guidance on rules applicable to the management of nature-related risks:

1. Identification: A director who fails to take this first step of active consideration of the extent to which a company faces nature-related risks will find it harder to justify action or inaction.
   
   
2. Assessment/Evaluation: Assess which risks are relevant and non-trivial and evaluate their potential to cause harm to the company, aided by TNFD guidance and materiality assessments.
   
   
3. Risk Management/Mitigation: Consider how best to manage and/or mitigate those risks where appropriate, for example through a risk management framework.
   
   
4. Disclosure: Consider a) which identified risks should be disclosed to comply with applicable laws and b) whether additional voluntary disclosure is likely to aid compliance with directors’ duties (for example, where there is an emerging market standard or investor expectation for such disclosure). In larger, listed companies with extensive nature-related dependencies and impacts, directors may wish to consider assessing the company’s significant actual or potential impacts on nature in addition to risks that nature-related issues pose to the company’s financial prospects.
   
   
5. Documentation: Properly record how directors have taken the above four steps, for example in board minutes, agendas, memorandums and reports.

Parting Thoughts

A recent U.K. legal opinion has clarified that company directors have a legal duty to consider nature-related risks that may affect their company. This has set a precedent that could apply to business and legal practices worldwide. To manage their duties with respect to nature-related risks, prudent directors could consider identifying, assessing, mitigating, and disclosing the risks, and documenting that they have done so.

Jasmin Fraser is a UK-qualified lawyer at the Commonwealth Climate and Law Initiative. Jasmin conducts research and commissions legal opinions on the implications of climate change and biodiversity loss pursuant to corporate and financial law, particularly in relation to directors' and fiduciary duties and corporate governance.