The proposal for a Corporate Sustainability Due Diligence Directive – potential rise in D&O claims?

November 2023 | SPOTLIGHT | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

November 2023 Issue

On 23 February 2022, the European Commission (EC) came forward with a proposal for a directive on corporate sustainability due diligence (COM(2022) 71 final). The proposal has been subject to discussions in both the Council of the European Union and the European Parliament. Both have suggested changes to the original proposal and the discussions and work regarding the proposal are still ongoing.

The directive revolves around an aim for companies in the European Union (EU) to contribute to sustainable development and assist in the sustainability transition. The directive consists of a set of due diligence obligations in relation to both companies’ own operations, their subsidiaries’ operations and value chain operations. The obligations are only applicable to some companies. In general, the directive will apply to larger EU companies and some companies that are formed in a third country but active in the EU (cf. article 2). This article will not go into detail about the specific obligations but instead focus on some of the potential consequences in relation to directors and officers (D&O) liability.

The EC’s proposal for the directive lays down rules on liability for violations of the due diligence obligations. In relation to the question of D&O claims it is worth noting that the proposal contains an article on directors’ duty of care in general. More specifically article 25 proposes the following regulation: “1. 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 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. 2. Member States shall ensure that their laws, regulations and administrative provisions providing for a breach of directors’ duties apply also to the provisions of this Article.”

Furthermore, article 26 in the EC’s proposal specifies that member states shall ensure that directors are responsible for setting up and overseeing the due diligence obligations established in the directive.

Article 26 was removed during the Council and Parliament’s revisions. So, at this point in time it seems less likely that article 26 will be included in the final text. Regarding article 25, the Council suggested removing it, whereas it is included in the Parliament’s amendments. Consequently, it is also still uncertain whether article 25 will be part of the final directive or not.

However, it is likely that the directive, in many jurisdictions, will entail a number of new obligations for management. Even if the obligations end up being aimed at the company, management will risk consequences if they do not ensure that the company adheres to relevant regulation. A potential consequence of management failing to make sure the company complies with the rules on due diligence could be liability. Below, some of the possible implications and issues that the proposed directive will give rise to in relation to D&O claims are touched upon.

D&O liability in relation to corporate sustainability due diligence

If article 25 of the proposed directive finds its way to the final text, member states will be obliged to ensure that management’s duty to act in the best interest of the company also includes taking sustainability matters into account. This includes, “where applicable, human rights, climate change and environmental consequences, including in the short, medium and long term”. In other words, management will have a general duty to take not only shareholder or creditor interests into account but also sustainability matters. This will potentially be a significant addition to D&Os’ traditional duty to act in the interest of the company in some member states. Depending on how the regulation is implemented and pre-existing regulations in member states, it will mean a change in the interests that management need to safeguard, as well as potentially an opportunity for stakeholders to raise claims against management if these interests are not sufficiently safeguarded. Therefore, the introduction of a new element to the ‘company’s interest’ could result in a change in management’s basic responsibilities toward the company.

However, article 25 is not particularly concrete and can, to some extent, be said to be a vague regulation. Therefore, it is uncertain what the impact of it will be and how it will materialise in national legislation. As such, it will be interesting to see how member states choose to implement the specific article if it is part of the final directive.

Further, even if article 25 is removed, D&Os still face the risk of liability if they fail to make sure that the company complies with the due diligence obligations set forth in the directive. This is emphasised by the fact that the directive contains an article on civil liability toward the company. According to article 22, member states must ensure that companies are liable for damages if they failed to comply with the directive’s obligations and that failure has resulted in damages. A version of article 22 is present in the EC, Council and Parliament’s suggestion for a directive. If a company ends up liable there is a risk that shareholders or other stakeholders will then turn to management to be indemnified. This makes it easier for D&O claims to proceed if the relevant due diligence obligations aimed at the company are not met.

It is also worth noting that the company will be responsible for not only its own operations but also to some extent the operations of subsidiaries and value chain operations. Hence, D&Os risk claims related to operations carried out by other parties than the company itself if the company is found liable on the basis of a breach of the due diligence regulation.

D&O insurance in relation to corporate sustainability due diligence

Another interesting question arises in relation to insuring D&O claims stemming from the obligations set forth in the directive, including whether such claims are covered or not. Hence, if a company is found to have failed to comply with the obligations in the directive and that failure has resulted in damages, the claim might be substantial. If shareholders or other stakeholders then turn to management, it will be of great importance to the latter whether they are sufficiently covered by D&O insurance.

In that regard, it can make a difference whether a claim is an action for damages or a declaratory action, since the latter might not be covered under D&O insurance. Stakeholders could potentially bring legal action against D&Os aiming to influence management of the company and force them to take certain actions in relation to sustainability matters. It is therefore relevant for D&Os to consider the different kinds of claims the directive might give rise to and how they are covered under their insurance in relation to these types of claims.

Concluding remarks

In summary, the proposed directive on corporate sustainability due diligence is expected to impose several new obligations on management. One of these will potentially be a more general duty to take sustainability matters into account. In any case, D&Os in companies that fall within the scope of the directive should expect new regulation in relation to sustainability due diligence and they should further expect these obligations to have an impact on management’s responsibilities as well.

It will be interesting to follow the development and the final wording of the directive since it will help determine the consequences of the directive in relation to D&O claims as a result of the new obligations under the directive.

Jacob Christian Sølling is a partner and Julie Bryske Møller Nielsen is an assistant attorney at Poul Schmith. Mr Sølling can be contacted on +45 50 77 84 06 or by email: jcs@poulschmith.com. Ms Møller Nielsen can be contacted on +45 40 21 55 82 or by email: jumn@poulschmith.com.

Jacob Christian Sølling and Julie Bryske Møller Nielsen

Poul Schmith