Why green directors will stay out of court

In a world constrained by regulations such as Sarbanes-Oxley and Basel II, woe betide the company that fails to implement strict governance controls. Financial and security risks have come to the fore in debates about governance, but what about corporate social responsibility? How accountable are companies for their impact on communities and the environment?

Legislation that came into effect last October may make firms more accountable than they realise. At 1,300 pages, the Companies Act 2006 is the longest piece of legislation in UK history. It levies a set of responsibilities against company directors, who will be statutorily required to abide by them and made personally liable if they fail to do so. Many of the listed responsibilities already existed, but were buried in case law. This legislation officially puts them on the books.

The Act sets out mandatory directorial duties and restrictions in many areas including, somewhat bizarrely, rules governing the use of underage directors. But from a corporate social responsibility perspective, there are two crucial sections. One involves decision making, and the other involves reporting.

Section 172 requires a director to “promote the success of the company for the benefit of its members as a whole”, but to bear in mind various issues at the same time. These include the interests of employees, the need to foster good relationships with business partners, and the need to balance the interests of different members of the company. But the most significant issues from a CSR perspective are to consider “the likely consequences of any decision in the long term”, and “the impact of the company’s operations on the community and the environment”.

This means that directors have to pay more than lip service to the environment and community when considering their company’s actions, or risk breaching their duty. Could this be the law that finally enshrines CSR as a mandatory responsibility?

Currently, explicit contraventions of particular rules (such as releasing prohibited chemicals into rivers) are actionable under environmental laws set by government agencies. “Water pollution would be an offence under water legislation, and the company would be prosecuted by the environment agency,” says Helen Keele, a senior associate specialising in environmental law at legal firm Pinsent Masons. “There is a provision within the Water Resources Act, that if the company offence was deemed the responsibility of one director, then since 1991 you have been able to personally go after that director.”

However, such personal lawsuits are extremely rare and are normally limited to very small companies where the line of responsibility between directors and company operations is very clear, and very short.

Outside of such small-scale cases, the options have been even more limited, says Hannah Ellis, co-ordinator of the Corporate Responsibility Coalition (CORE), an organisation created by Friends of the Earth. “There is very little resource for victims and their representatives in cases of corporate abuse at the moment,” Ellis says.

UK-based companies - especially those responsible for offences overseas in developing nations, where oversight can be less effective - can be brought to task in only two ways. One is a complaint through the UK National Contact Point (NCP) of the OECD (Organisation for Economic Co-operation and Development). NCPs are government offices set up to ensure that the OECD’s guidelines on the conduct of multinational firms are being followed. However, their influence extends only to multinational corporations and it is beyond an NCP’s scope to command compensation for victims.

The second avenue relies on the courts. “There is recourse for people to go to a UK court, but the cases are extremely difficult to prove. The burden of proof is on the victims,” Ellis says. “Lawsuits are incredibly complicated, really time consuming, and very expensive. They're not realistic for most people.”

In theory the 2006 Companies Act will change all this by making company directors personally responsible for their firm’s environmental performance, and understandably it has plenty of directors feeling a little worried. “Directors that I work with are always very interested in their personal liability, obviously,” says Keele. “Obviously you can get insurance, but no-one wants that personal liability.”

However, green groups hoping that the new law means open season on environmentally irresponsible firms are likely to be deeply disappointed. Holding directors personally accountable sounds good in theory, but anyone wanting to make it stick would be in for a long and painstaking process.

Firstly, if a director is felt to be breaching their fiduciary duty by making an environmentally irresponsible decision, the director’s company would have to instigate the initial lawsuit against that individual to recover the loss arising from a breach of duty, Keele argues. A shareholder wanting that outcome (such as an environmental lobby group holding a single voting share) would have to approach the court and ask for permission to sue the director in the company’s name, and success would be far from certain, she concludes.

Directors are being asked to consider environmental stakeholders as one factor in a much wider set of issues, including the company’s financial success. A corporate decision that environmentalists disagree with may still be considered valid, especially if, as outlined in CORE’s guide for directors, the directors responsible for the decision can show that they have given careful consideration to those issues rather than simply paying lip service to them.

When it comes reporting, requirements on directors are equally open to interpretation. Section 417 of the Act requires a listed company to provide a business review document, outlining the environmental and community activities of the company where they have a bearing on its financial performance - but crucially no reporting standards have been set.

Ellis says the lack of clear definitions on what should and should not be included in these environmental reports represents a major flaw in the Act. “Firms have been getting away and to some extent continue to get away with not reporting on their environmental and human rights impacts,” she says. “Unfortunately, in the legislation, no clear reporting standard was set. We’ve yet to see how relevant the content of those reports will be.”

A reporting standard such as the Global Reporting Initiative could have provided a useful framework to guarantee truly transparent reporting, she suggests. The UK authorities have promised to review the need for a reporting standard in 2009, so reporting requirements may yet be clarified.

But despite some vagaries in the new law, those directors at firms with a less than perfect green record who choose to ignore the Act’s environmental elements - hoping they can argue their way out of trouble if it comes to court - may be storing up trouble. In its guide for campaigners using the Companies Act 2006, CORE advises not only pressuring directors with personal letters referring to the Act, but also potentially complaining to the Companies Investigation Branch of the Department for Business, Enterprise and Regulatory Reform (BERR) , which is responsible for enforcing the law. Firms that do not make enough effort to comply with the new legislation and release token CSR reports could well see their name dragged through both the mud and the courts by green groups.

Much of the legislation's CSR-focused provisions still have to be tested in the courts, and competent directors will already have been abiding by the rules. But for those who habitually disregard community and environmental issues would do well to shape up and pay some serious attention to their duties in this area.