Within the European Union, the divergencies between the twenty-seven legal frameworks on directors’ duties and the related enforcement mechanisms are considerable, making any harmonisation attempt at EU level hard. Trying to regulate their accountability standards on human rights, climate change and other ESG factors, extremely critical yet politicised subjects, inevitably raises additional technical, but also policy-making, challenges.   

In our recent paper, we focused on Art. 25 of the long-awaited European Commission’s Proposal for a Directive on Corporate Sustainability Due Diligence (‘CSDD’). Art. 25, titled ‘Directors’ duty of care’, seeks to harmonise directors’ duty to consider the ‘consequences of their decisions for sustainability matters’ as the final legacy of the ambitious Sustainable Corporate Governance Initiative. It stands out for its concise wording, as well as for its disconnectedness from the surrounding context of a Directive which otherwise relates to public regulation matters.

We analysed Art. 25 from three different perspectives: first, we examined the preliminary studies that influenced its formulation; second, we compared it to S. 172 of the UK Companies Act 2006, as an authoritative forerunner of the proposed EU provision; third, we drew from the comparison to assess the potential harmonising effects of Art. 25.  

These perspectives are not unrelated.  For instance, the 2018 Final report of the High-Level Expert Group on Sustainable Finance already provided a recommendation to the Commission to ‘strengthen directors’ duties related to sustainability’. The proposed wording heavily drew from S. 172, as the table below shows.

S. 172(1) UK Companies Act 2006 Final Report 2018 of the High-Level Expert Group on Sustainable Finance Art. 25(1) CSDD Proposal
A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to—

To act in a way the director considers in good faith is most likely to promote the success of the company for the benefit of its owners and other stakeholders. This includes: 

Member States shall ensure that, when fulfilling their duty to act in the best interest of the company, directors of companies referred to in Article 2(1) take into account

the likely consequences of any decision in the long term,

The likely consequences of any decision in the longer term (beyond three to five years). 

the consequences of their decisions for sustainability matters, including, where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term.

the interests of the company’s employees, The interests of the company’s employees.   
the need to foster the company’s business relationships with suppliers, customers and others, The need to foster the company’s business relationships with suppliers, customers and others.   

the impact of the company’s operations on the community and the environment,

The impact of the company’s operations on the community and the environment (externalities), safeguarding the world’s cultural and natural heritage.   

the desirability of the company maintaining a reputation for high standards of business conduct, and the need to act fairly as between members of the company.

The integrity of the most significant business partners in the company’s supply chain (for example, no corruption, no child labour, observing human rights including those of indigenous peoples).  

S. 172 identifies a list of aspects that directors must consider while promoting the success of the company. According to the ‘Enlightened Shareholder Value’ (ESV) interpretation of the provision, all these aspects follow the ‘benefit of its members as a whole’, ie the paramount interests of shareholders. By contrast, the High-Level Expert Group suggested a similar list of interests, but it recommended placing the ‘success’ of ‘other stakeholders’ at the top of the hierarchy alongside that of ‘owners’ (ie shareholders). This wording would pave the way for a ‘pluralist’ interpretation of directors’ duties (also contemplated in the discussions prior to the introduction of S. 172), which would involve the need to balance all the interests of different stakeholders.

In our article, we described the winding path leading to the current wording of Art. 25, covering the preparatory documents ahead of the EU proposal, the almost unanimously and fiercely criticized Ernst & Young’s 2020 Report on directors’ duties as well as the surrounding academic discussion stemming from  the Sustainable Companies Project, the SMART Project, and the Statement on Corporate Governance for Sustainability. The conclusion of these projects was that directors owe their duties to the company as a legal entity and not to shareholders under the existing legal frameworks of the EU Member States. Therefore, the prevailing interpretation of their duties, according to which directors need to maximise shareholders’ interests (‘Shareholder primacy’),  only amounts to a ‘social norm’ and is incorrect as a matter of positive law.  However, this reductionist interpretation does, according to these projects, persistently deter directors from creating sustainable value

Correspondingly, Art. 25(1) resonates with S. 172 by providing an open-ended list of additional aspects directors must consider, but it refers to the more general ‘best interest of the company’. In other words, the Proposal places the company as a separate entity on top of the pyramid of directors’ priorities. Even though this different wording aims to drive away from the prioritization of shareholders’ interests, it may yield no effect without a clarification of the notion of ‘ interest of the company’. The European Company Law Experts Group (ECLE) persuasively noted that the concept is unknown to many EU jurisdictions, and that the provision is likely to cause confusion and uncertainty due to its vagueness and lack of precision.

This ambiguity suggests that it would be enough for Member States to require directors to take the other interests into account, ie to consider them within their decision-making process, in order to align with the Directive. At the same time, they could also be in line with Art. 25 if their company law frameworks identified the ‘interest of the company’ with that of shareholders. Conversely, Member States could embrace a more ‘pluralistic’ approach and require a more thorough balancing exercise between the interests of different stakeholders. For this reason, we noted that if the text of Art. 25 is approved in its current form, the harmonising effect of the provision will likely be remarkably low and will not suffice to harmonise different corporate law regimes across different corporate law regimes.

We also examined Art. 25(2), which requires Member States to ‘ensure that their laws, regulations and administrative provisions providing for a breach of directors’ duties apply also to the provisions of this Article’. The provision should pave the way for enforcement mechanisms in case of non-compliance with Art. 25(1) by extending the application of existing remedies. However, the application of S. 172 has already brought the challenges of enforcing directors’ duties to the fore. Under UK law, only shareholders and creditors—under limited circumstances—have the power to bring judicial action vis-à-vis directors for the breach of S. 172. So far, to our knowledge, there has only been one (unsuccessful) claim based on S. 172 for directors’ failure to take environmental interests into account (R (on the application of People & Planet) v. HM Treasury, 2009), although Client Earth has recently brought legal proceedings against Shell on similar grounds. The limited effect of S. 172 on the enforcement of directors’ duties reveals the potential shortcomings of introducing a similar provision at EU level. Arguably, Art. 25(2) could only have a relevant impact on the law of Member States if it allowed the entities listed under Art. 25(1) to bring challenges for breaches of the provision (a regulatory option with its flaws), or if it requested Member States to lay down new specific measures and penalties applicable to its infringement.

All in all, the vaguely formulated Art. 25 may prove unnecessary on every front (if not even damaging). The upcoming phases of the legislative process are a crucial opportunity for the European Parliament and the Council of the European Union to consider amending the provision.

Federica Agostini is Graduate Teaching Assistant in Corporate & Financial Law and PhD student at the University of Glasgow.

Michele Corgatelli is a PhD student in law at the University of Bologna. 

This post is published as part of the OBLB series on ‘The Corporate Sustainability Due Diligence Directive Proposal’.

Share

With the support of