2021 will be seen as the year where international, environmental and market forces coalesced to bring climate change into sharp focus in Australian courtrooms and boardrooms.
With the UN Biodiversity Conference of the Parties (COP15) and UN Climate Change Conference of the Parties (COP26) both set to be held later this year, this trend is unlikely to dissipate. These conferences represent significant international events that will bring about further debate on how to tackle climate change and the associated biodiversity risks to the environment, human health and business.
Given the recent rise in shareholder activism and significant judicial decisions relating to climate change, the message is clear – if corporations do not actively take steps to meet rapidly evolving climate change benchmarks through proper due diligence, risk management, target setting and transparent reporting, it is likely that those corporations will be compelled to do so.
In Australia, regulator activity in this area has been sporadic, but numerous international developments indicate it is soon likely to come into sharp focus. While the regulators play ‘catch-up’, it is anticipated that shareholder activism and climate change litigation will emerge as one of the greatest threats for corporations over the next 2-3 years.
The legal, financial and reputational risks associated with failing to robustly engage with climate change are significant. Apart from the imposition of penalties, the resulting reputational damage could be debilitating, and impact the ability to secure financing or result in the withdrawal of capital. For company directors, individual liability under the Corporations Act 2001 for breach of fiduciary duty is also a very real risk.
However, the shifting public sentiment also presents opportunity. The Edelman Trust Barometer 2021 indicates that public trust in companies is currently higher than trust in the government – 66% of respondents voted that CEOs should take the lead on change rather than waiting for the government to impose change, while 68% endorsed the notion that CEOs should step in when the government does not fix societal problems.
The community is looking to company directors and industry to create change where government regulation may be lagging, with significant market rewards to follow for those who adapt early.
Climate change litigation trends and developments
“…each reduction of greenhouse gas emissions has a positive effect on countering dangerous climate change… RDS cannot solve this global problem on its own. However, this does not absolve RDS of its individual partial responsibility to do its part regarding the emissions [which] it can control and influence.”
Hague District Court in Milieudefensie et al v Royal Dutch Shell Plc (2021)
A number of significant international and domestic court proceedings in 2021 illustrate the increasing willingness of the courts to adopt the science based evidence of climate change, link human rights to climate change and hold both corporations and governments to account against greenhouse gas emission (GHG) targets.
Two high profile examples include:
- The recent Sharma by her litigation representative Sister Marie Brigid Arthur v Minister for the Environment (Sharma) judgment, in which the Federal Court of Australia held that the Commonwealth Minister for the Environment owes a duty of care to Australian children to consider the longitudinal human health risks associated with climate change when granting environmental approvals for activities which will produce significant volumes of greenhouse gases. The Commonwealth is appealing this decision. Notwithstanding the outcome of the appeal, legal challenges are likely to arise in other States and Territories, particularly given the recent announcement that the WA Conservation Council and Environmental Defenders Office are presently considering launching a test case to establish that a similar climate change duty of care exists for consent authorities under the Environmental Protection Act 1986 (WA).
- The Milieudefensie et al. v Royal Dutch Shell plc (Shell) judgment in the Netherlands with The Hague District Court ordering Shell to bring its corporate policy into alignment with the Paris Agreement and to reduce its net GHG emissions by 45% of 2019 levels by 2030.
Following the Sharma judgment and having regard to the principles in the Shell decision, it is not inconceivable that Australian courts could soon find that corporations owe a duty of care to Australian children to adopt appropriate frameworks and align their conduct to adopted international climate change goals, such as the Paris Agreement.
Climate change activism is also likely to manifest itself in a number of ways in the future, including:
- Actions against major greenhouse gas (GHG) emitters, seeking damages or restraining them from carrying out particular actions – for example, if the development of a project does not align with a NetZero 2050 target, then action may be taken against that corporation to restrain it from developing that project.
- Actions against specific project approvals or extensions – for example, a legal challenge against a decision of an authority to grant an environmental approval for the expansion of a new resource project that conflicts with any adopted international obligations to reduce GHG emissions. There is also an increasing pattern of rights based claims where the litigation is founded upon human rights or a duty of care.
- Actions against corporations and directors – generally for failures to align corporate policy to climate change benchmarks and/or disclose material climate-related financial risks.
- Actions against governments, including in respect of their climate change policies, or lack thereof – for example, an action was commenced against the French Government alleging failure to implement appropriate measures to effectively address climate change. The Paris Administrative Court ruled that France’s failure to meet its climate and carbon budget goals under national and European Law had caused ecological damage for which it was responsible. More recently, judicial review proceedings have been brought in respect of the Climate Change Commission’s advice to the New Zealand Minister for climate change. The primary allegation is that the emissions budgets recommended are inconsistent with the steps required to limit warming to 1.5 degrees, as set out in the Paris Agreement.
- Actions brought against Government funding and grants decisions which have impacts on the operations of corporations and funding of projects – for example, the recent Beetaloo NT Basin challenge, which is a Federal Court administrative law challenge to a decision of the Commonwealth Resources and Water Minister to provide a $21 million grant to an oil and gas company for a gas exploration project in Beetaloo Basin, NT. The grounds of challenge are that the Minister failed to make reasonable enquiries about the increased risks of climate change if gas resources in the Beetaloo Basin are developed, and the economic risks of expenditure on gas exploration projects in the context of decarbonisation and Australia’s movement towards renewable energy. The matter is yet to be heard by the Court.
The significance of these developments is heightened by the release of the Intergovernmental Panel on Climate Change 6th Assessment Report in August 2021 (2021 IPCC Report), which provides a comprehensive global assessment of the current status and projections as to the future trajectory of climate change on the basis of the best available physical science. Significantly, the 2021 IPCC Report found that even if Net Zero is achieved globally by 2050, with negative emissions thereafter, the chance of limiting global warming to 1.5 degrees is less than 50%.
The 2021 IPCC Report is likely to be used in evidence given by experts in any litigation where climate change grounds form part of the legal challenge. It is also likely unavoidable that consent authorities, regulators and government agencies will need to consider this report when exercising their executive powers where they are linked to climate change issues.
How can corporations shield themselves from climate change litigation?
There are various actions that can be taken to minimise the risks of legal challenge. For example, challenges to project approvals and government funding are likely to be minimised if the corporation involved has:
- made significant commitments to reducing GHG emissions;
- thoroughly considered climate change related impacts from GHG emissions in project specific environmental assessments and opportunities for reductions in emissions in an operational context, including potential offsets;
- aligned its targets with the Paris Agreement (or any new targets set); and
- put in place robust and transparent disclosure frameworks.
Further, corporate climate change risk and disclosure frameworks, where relevant, should include climate change considerations in alignment with UN recommendations. For example, any such frameworks should align with the Task Force on Climate-related Financial Disclosures (TCFD) global framework for the identification, assessment and financial disclosure of material climate change risks.
Collectively, the above law and policy developments underscore the need for companies to proactively and robustly engage with climate change related risks and dependencies, both within their primary operations and across their supply chain. This will involve elements of horizon scanning and adapting to climate change benchmarks as they develop. The more a corporation can be seen to be taking action, the less likely it is to be the target of any potential legal challenges.
Shareholder activism and impact investing: ESG challenges and strategies for boards
“Shareholders have the right and obligation to set the parameters of corporate behaviour within which management pursues profit.”
Shareholder activism and impact investing are on the rise in Australia. Recent trends in the US and Europe, coupled with an increased focus on climate change issues, suggest that this is a growing area of risk for boards, and targeted strategies are required to respond adequately.
Shareholder activism typically takes the form of:
- economic activism – where shareholders seek to change the corporate strategy of a firm or influence specific business decisions to increase the value of a company for near- to medium-term economic gain; or
- social activism – where shareholders seek to influence a company’s operations and strategy on environmental, sustainability and governance (ESG) matters. This sort of activism typically takes a medium- to long-term view.
Impact investing, on the other hand, is a hybrid of both forms of shareholder activism – it can be characterised as investing with the purpose or intention to generate positive, measurable social and environmental impact alongside a financial return.
Shareholder activism and impact investing are effectively two sides of the same coin, each presenting risks and opportunities for boards across Australia.
The challenging landscape and risks
While climate change is only one plank of ESG considerations for boards, sustainability issues from a climate perspective necessarily form a key part of scenario planning, given:
- the increased focus from Australian regulators on climate risk disclosures;
- decisions on allocation of capital from institutional investors; and
- the push towards advisory resolutions on climate issues by industry associations and shareholder groups.
The consequences of failing to take into account the demands of investor stakeholders in this area can range from reputational damage to a failure to secure finance or the withdrawal of capital.
In Australia, managed investment schemes and superannuation funds are frequently able to take into account sustainability factors alongside financial returns in determining how best to allocate their capital. Additionally, a high proportion of activists are increasingly prepared to exercise their voting rights to drive change, for example, by removing directors from the board and proposing advisory resolutions or constitutional changes. This is compounded by a growing body of commentary that suggests asset owners and investment managers could be held legally liable for breaching their duty to act with care and skill, or their duty to act in the best interest of a company, if they fail to consider financially material ESG factors.
Shareholders are undoubtedly becoming more proactive and demanding, questioning whether they can do more than manage their assets than for financial performance alone.
How to ‘de-risk’ your organisation
The idea of engaging with activist investors remains a daunting one for many directors, especially those in industries where sustainability issues are likely to put them in conflict with their stakeholders.
Set out below are six practical suggestions or ‘rules of engagement’ for boards on how to de-risk their organisations and engage effectively with activists and impact investors.
- Scenario planning is key. Ideally, companies should arm themselves with a team that has expertise in identifying different shareholder activist agendas, the opportunities and value of impact investing, managing communications and preparing appropriate response strategies. Make investor engagement a regular agenda item at board meetings.
- Understand your strategy and longer term value. Having a clear understanding of the strategy of your company and the ability to maximise value for all stakeholders in the medium to long-term is critical. A board that is unable to articulate a clear vision for its company’s future strategy and direction will inevitably struggle to argue against alternative propositions put forward by shareholder activists and attract impact investors.
- Adopt a constructive mindset and culture. Maintaining an open dialogue to better understand an activist or impact investor’s interests and goals can lead to surprising perspectives and results. If nothing else, a board will learn more about their motivations to enable it to better craft a response strategy.
- Engage respectfully, not combatively. As tempting as it might be to dismiss a shareholder activist or impact investor’s approach or proposition, respectful engagement often leads to more effective outcomes.
- If you don’t like it, change it. If a shareholder activist proposes a blunt advisory resolution, rather than resisting the resolution, an alternative for boards is to craft and tailor a more nuanced alternative resolution. This demonstrates a more considered approach to addressing shareholder concerns which can consequently attract impact investor approval.
- When in doubt, refer to your director’s duties. The aims and objectives of the company, shareholder activists and impact investors can sometimes be diametrically opposed. In recent years, directors’ duties have evolved from the concept of shareholder primacy (i.e. where directors have a duty to their immediate shareholders) to an understanding that directors also owe duties to the company as a corporate entity and, to some degree, to their creditors.
Shareholder activism and impact investing undoubtedly pose significant legal, financial and reputational risks for organisations. Careful planning and the implementation of appropriate response strategies will enable directors to engage effectively, minimise risk and deliver better outcomes for all stakeholders.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.