Climate Change impact on directors’ duties and obligations under German Law – practical considerations (pt 2)
Directors’ disclosure obligations and climate change
The German government has implemented the Non-Financial Reporting Directive (NFRD), which provides for disclosure obligations in a non-financial statement, to include the implications of climate change for the company, including potential damage caused by the company to society through its emissions, and those experienced by the company due to physical impacts, regulatory change, technological disruption etc. They require the company to disclose its strategy to address them by means of the CSR Directive Implementation Act of March 2017.
Pursuant to the regulations in sections 289b subsequent of the Commercial Code (HGB), companies with more than 500 employees are obliged to include a non-financial statement in their management report. Within this non-financial statement, the company must address at least the following aspects: environmental issues (including greenhouse gas emissions, water consumption, air pollution, use of renewable and non-renewable energy), employee concerns, social concerns, human rights, and its efforts to combat corruption and bribery.
Further, regarding these aspects, the non-financial statement must provide information necessary for an understanding of the company’s development and performance, its position and the effect of its activities on the aspects referred to above. If the company does not adopt any measures to address one or more of these aspects, it must explain and justify this clearly in the non-financial statement.
Although the implementation of the NFRD generally involves a disclosure obligation for directors regarding climate change risks and impacts, as an explicit exception, the company may, in the non-financial statement, omit any information on future developments or matters under negotiation if the directors, in their exercise of sound business judgment, determine that the information is likely to cause significant damage to the company.
As an additional ramification, the implementation of the NFRD has led to an amendment in the definition of the supervisory board’s responsibilities, insofar as it gives supervisory board members the option of instructing an external party to conduct a content review of the non-financial statement.
In November 2022, the European Commission adopted the Corporate Sustainability Reporting Directive (CSRD), which expands the scope of the companies that are required to make sustainability disclosures, and includes more stringent and harmonised reporting obligations, including plans to align the business model and strategy in line with the temperature-limitation goals of the Paris Agreement, and reporting on a ‘double materiality’ basis.
Sustainability information disclosed pursuant to the CSRD must be disclosed as part of the management report and will be subject to assurance. The first companies required to report under the CSRD (those which are already subject to the NFRD) will be required to make their first CSRD disclosures in 2025, in respect of FY2024. The CSRD has not yet been transposed into national law.
Under the HGB, breaches of the disclosure obligations concerning the non-financial statement are sanctioned in different ways. Misrepresentation or non-disclosure of the company’s relations are subject to criminal punishment, including potential prison sentences of up to three years for board members. Moreover, omitting or incompletely preparing a non-financial statement constitutes an administrative offence, resulting in possible fines of up to €10m. In the event of errors in the non-financial statement, the management board members are also considered to be in violation of their obligations under section 93 Stock Corporation Act (AktG), which may result in liability for damages towards the company.
Practical considerations for directors
Given the German regulators increasing focus on the need for companies and their directors to adopt climate resilience measures in business practices and disclosure, particularly the guidance issued by the German Federal Financial Supervisory Authority (BaFin) to its supervised companies, the German Federal Government’s GHG emissions reductions targets, and the implementation of the EU’s CSRD, well-counselled boards should consider the following steps:
Revisit existing and build future business models
Directors and supervisory board members should conduct strategy discussions and manage the necessary transformation of business models, reflecting also geopolitical risks. On the way to net zero, directors should assess the carbon footprint under Scopes 1 to 3 under the Greenhouse Gas Protocol. Beyond that, it is necessary for the management and supervisory boards to adequately consider both the risks and opportunities of all relevant ESG aspects.
Further, directors should put on the agenda for the board within three or six months a process to start developing a climate transition roadmap to 2050 with transparent carbon neutrality or reduction targets, with clear interim targets to 2040, 2030, and within the current rolling multi-year strategic plan, and periodically thereafter report back to the board.
In addition, directors should delegate to the appropriate committee(s) of the board, such as risk, audit, legal and governance, scenarios/strategy, nominations/remuneration, or sustainability/ corporate responsibility, the task of translating the long-term strategy into a clear decision-making process for each aspect that is relevant to each committee.
Comply with disclosure requirements
Directors and supervisory board members need to gain an understanding of, and directors need to manage legal issues related to, relevant (new) non-financial reporting standards. The supervisory board, in turn, must monitor the directors’ strategy and decisions as part of its supervisory function. This requires sufficient knowledge of the underlying regulation and legal issues and risks.
Further, directors need to discuss with disclosure counsel, to develop an external engagement and communications plan and to oversee rigorous disclosure and accounting.
Review supply chains
Directors should review supply chains to identify potential risks of business disruption due to the impacts of climate change and other business and geopolitical factors. New due diligence obligations will need to be fulfilled under the new German Supply Chain Act as well as further incoming regulation in Europe. Again, the supervisory board must monitor proper fulfilment of directors’ responsibilities.
Implement compliance measures
Directors should implement compliance measures and apply best crisis management practices in the event of a breach, including communication with regulators and third parties. Directors must consider legal requirements and recommendations regarding climate risks for all new projects and activities. Due diligence frameworks and policies and procedures related to employees, assets, operations and transactions must be developed and reviewed. Directors need to be trained on legal issues related to climate risks.
Directors should delegate climate risk identification and evaluation to a clearly identified team in management that reports directly to the CEO and board.
Supervisory board must supervise proper fulfilment of the directors’ responsibilities.
Examine insurance coverage
Directors should review insurance coverage issues in relation to climate-related risks.
Monitor the regulatory and legal environment
Directors and the supervisory board should monitor the regulatory and legal environment and respond to any changes.
Avoid reputational damage
Directors must communicate an ESG strategy, take steps to review it and avoid reputational damage, in particular through greenwashing. Past communication also needs to be scrutinised.
Contributed by Christoph Pies, legal director, Clyde & Co, Germany
Part One of this article can be found here:
