ESG factors: Can directors of UK Companies take them into account?

ESG factors have moved into the mainstream. We look at directors’ duties and whether directors can consider ESG factors as part of their duty to promote the success of the company

01 October 2019

The short answer is yes. The concept of 'enlightened shareholder value' which underpins the core directors’ duty to promote the success of the company enables directors to give proper consideration to environmental, social and governance (ESG) factors alongside all other relevant factors which may have an impact on the success of the company. There is no legal barrier which prevents directors considering, and acting on, ESG factors. The board of a UK company can take a decision based on ESG factors and considerations if their good faith judgment is that doing so is likely to promote the success of the company.

ESG moving into the mainstream

Many companies will have carried out an analysis of ESG risks and opportunities and will be considering that analysis in the boardroom. This reflects the fact that ESG issues have, for good reason, received more and more attention this year. The Financial Times reported that '2019 looks as if it will be the year when environmental, social and governance considerations are moving out of a specialised niche into the mainstream. Financiers and chief executives are realising that it can sometimes be more costly to ignore ESG issues'.

Debt and equity investors and other stakeholders are placing more emphasis on how an investee company approaches ESG considerations and how potentially material ESG risks might affect the long-term viability of its business. Boards of portfolio companies should expect a greater degree of interest from asset owners and investment managers who have signed up to the Principles for Responsible Investment (PRI) following the publication of recent guidance by the PRI for private equity signatories. 

The duty to promote the success of the company

In this context, the technical question for directors of UK companies is the extent to which they can consider ESG factors whilst complying with their directors’ duties. The most relevant duty is the duty to promote the success of the company contained in section 172 (1) Companies Act 2006. This states that a director must act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. The decision as to what promotes the success of the company within s 172(1) is one for a director's subjective judgment exercised in good faith.

What is success?

Success is not defined in the Companies Act 2006. However, in the context of a commercial company which is solvent, success is generally understood to mean a 'long-term increase in value'. For certain companies such as charities and community-interest companies success means achievement of their objectives. It is possible for a company's constitution to be more specific about the appropriate success model for that company but that approach has not been adopted by many companies.

Enlightened shareholder value

The term 'enlightened shareholder value' is not used in the UK Companies Act. Instead, the Act provides that, when acting to promote the success of the company, a director must have regard (amongst other matters) to:

  • the likely consequences of any decision in the long term
  • the interests of the company's employees
  • 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 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

These factors collectively reflect the concept of 'enlightened shareholder value'. The Explanatory Notes published alongside the Companies Act 2006 noted that: 'This list is not exhaustive, but highlights areas of particular importance which reflect wider expectations of responsible business behaviour, such as the interests of the company's employees and the impact of the company's operations on the community and the environment.'

What action should the board take?

The board should consider which ESG considerations are most relevant to the company, its operations and its long-term success.

In line with recent recommendations from PRI, portfolio company boards should consider the following specific actions:

  • initiate an (annual) affirmation process on ESG compliance, including confirmations to ensure that company directors are aware of their duties with regard to potentially relevant ESG factors and that they are exercising them accordingly
  • as part of more general risk assessment, incorporate a regular and strategic analysis of material ESG factors (and processes for mitigation, oversight and resourcing) into existing board processes or committees, or set up a dedicated board committee to conduct assessments
  • proactively seek appropriate advice on ESG risks and opportunities, including regulatory risks and likely changes to the business environment; board members should be prepared to interrogate any advice received and evaluate its implications for the business
  • evaluate whether management of ESG risks and opportunities is adequately delegated to company management, is properly resourced and appropriately monitored by the board
  • evaluate the company’s purpose and identify any relevant ESG factors which may contribute to its long term success; consider how this will be communicated to potential buyers/shareholders, employees and relevant stakeholders and
  • perform an ESG skills audit of the board and provide relevant training for directors to ensure that they have the knowledge they need to perform their duties.

Glossary

ESG - Environmental, social and governance factors. Examples of ESG factors include climate change, plastics, resource depletion, waste and pollution, working conditions (including slavery and child labour), employee relations and diversity, executive pay and board diversity and structure.

PRI - Principles for Responsible Investment. PRI is an investor initiative in partnership with the UN Environmental Programme Finance Initiative and the UN Global Compact. It has published six Principles for Responsible Investment.

Responsible Investment - definitions vary but PRI defines responsible investment as an investment approach which integrates ESG factors in investment decisions and active ownership.

How can we help?

If you would like to discuss ESG factors and how they may affect your company and its governance and compliance structures and processes, please speak to your usual contact at Burges Salmon, Simon Tilling or Nick Graves.

Key contact

Nick Graves

Nick Graves Partner

  • Corporate Advice
  • Mergers and Acquisitions
  • Reorganisations and Demergers

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