Climate change impact on directors’ duties and obligations under German Law – practical considerations

Climate change poses an existential risk to humanity, the planet and the global economy on a scale never before seen. The 196 parties to the Paris Agreement have agreed to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels. In 2018, the European Commission adopted an Action Plan on Sustainable Growth to identify future legislative steps on climate change.

The evolution of our understanding of climate change from an ethical or environmental issue to one that presents foreseeable financial and systemic risks (and opportunities) has significantly changed relevance to the governance of both corporations and investors with potentially serious implications for the duties of directors and officers.

The EU has made substantial progress in preparing and implementing climate change-related policy and legislation. In June 2021, European Regulation (EU) 2021/1119 (the European Climate Law) entered into force, which includes a legally binding objective for the EU to reach climate neutrality by 2050, a commitment to negative emissions after 2050, and a target of at least a 55% reduction of net emissions of greenhouse gases by 2030 compared to 1990.

The related set of policies and legislation is likely to have significant impacts on the legal and commercial contexts in which companies operate – as developments that are likely to take effect in the short and medium term, they affect directors’ governance of their companies and disclosure of material risks.

Corporate governance and directors’ duties in Germany

The German Federal Government (Bundesregierung) – in a world first for a government – set out binding national climate targets in a Climate Protection Act that entered into force on 18 December 2019. The Climate Protection Act provides for a gradual reduction in greenhouse gas emissions compared with 1990 levels, with at least a 55% reduction target by the year 2030. In the long term, the Federal Government is pursuing the goal of greenhouse gas neutrality by 2050. This goal is also clearly stated in the Act. In August 2021, following a ruling by the German Constitutional Court, the Climate Action Law was strengthened, including introducing a more ambitious greenhouse gas reduction target of 65% by the year 2030, and 88%by the year 2040.

The German Federal Financial Supervisory Authority (BaFin) requires regulated entities to manage climate risks and to integrate them into their risk management frameworks. With a guidance notice published in December 2019, updated in January 2020, BaFin has provided its supervised companies, in particular banks, insurance companies, pension funds and capital management companies, with non-binding good practice guidelines on how to deal with sustainability risks, in particular, climate risks. BaFin has also proposed amendments to its minimum requirements for risk management (MaRisk) to include the integration of ESG risk management into the general risk management framework.

In March 2022, the Sustainable Finance Committee (SFB) of the German Federal Government published a report on 31 recommendations on how the German economy can be transformed with a sustainable financial system, including on policy, reporting obligations, knowledge building and financial products. The SFB recommended that the German government increase the number of companies subject to reporting under the Non-Financial Reporting Directive (NFRD) and that TCFD-aligned reporting be made mandatory.

On 27 June 2022, the new version of the German Corporate Governance Code (DCGK) was published and entered into force. The responsible Commission previously adopted the new version on 28 April 2022. The DCGK has, in a previous version, already established an explicit expectation that companies and their management need to be aware of their role in and responsibility to society. In fact, social and environmental factors are considered to be relevant for business success. This is a clear commitment to sustainability principles.

The new version of the DCGK states that the board must consider the social and environmental factors that influence the performance of the company, and the company’s impacts on people and the environment. Under the new DCGK, a company’s management board must systemically identify and assess social and environmental risks and opportunities for the company and ensure that the company’s strategy considers social and environmental matters.

The supervisory board is required to give supervision and advice on sustainability issues and should comprise members with sufficient skills and expertise in sustainability matters, which should be disclosed in a qualification matrix in the company’s Corporate Governance Statement. The new DCGK also requires one member of the audit committee to have expertise in auditing, and another to have expertise in accounting, which should include sustainability reporting and its auditing and assurance. The chair of the audit committee is required to have expertise in either accounting or auditing (and therefore, sustainability reporting to the relevant degree).

Most recently, the German Supply Chain Act came into force. Since 1 January 2023, companies that have their head office, principal place of business, administrative headquarters or registered office in Germany or have a branch office in the country and usually employ at least 3,000 employees (1,000 from 2024) in the domestic market are subject to new and expanded duties of care. They are required to implement risk management systems that monitor the companies’ entire supply chain, particularly regarding human rights and environmental risks. This is accompanied by extended due diligence and reporting obligations that include an annual risk and effectiveness analysis. Companies that fail to follow the imposed obligations can face fines of up to 2% of their annual revenues.

Against the backdrop of the anticipated Corporate Sustainability Due Diligence Directive (CSDD) at EU level, however, an amendment of this law is to be expected to create adherence to the stricter EU requirements.

Directors’ duties and climate change

Germany is a civil law jurisdiction. Directors’ duties are codified in the Act on Limited Liability Companies (GmbHG) and the Stock Corporation Act (AktG) and fleshed out further in case law. The AktG provides for a dual board system with different duties and responsibilities for management and supervisory board members. Whereas the management board is responsible for the day-to-day business and the company’s strategic direction, the supervisory board is focused on controlling and monitoring the management board’s decisions. Notwithstanding these different functions, pursuant to sections 93, 116 AktG, all board members owe the company a duty of care, duty of loyalty and duty of confidentiality, and must exercise their duties “for the benefit of the company”.  The duty of care requires the directors to “exercise the diligence of a prudent and conscientious manager”.

Notwithstanding the wide scope of directors’ duties under German law, according to the codified business judgement rule, a management board member does not breach his or her duties if, when making a business decision, the management board member could reasonably assume, based on appropriate information, that he/she was acting in the best interests of the company.

The same rule applies, in principle, to supervisory board members. Accordingly, there is no breach of duty if the supervisory board member, when making a business decision, could reasonably assume that he/she was acting in the best interests of the company on the basis of appropriate information. In addition, it is the supervisory board members’ duty to diligently supervise and challenge the decisions made and proposed by the management board.

Applying these standards to directors’ duties regarding the risks resulting from climate change, BaFin has summarised in its guidance notice for regulated companies that the management board is responsible for the business and risk strategy, its implementation within the company, and its communication. Thus, as a first step, management board members are expected to understand climate risks and their potential impact on the company’s business.

Further, management board members are responsible for fostering an effective risk culture and institutionalising processes and systems to control and oversee the impacts and implications of climate risks, applying a short, medium and long-term perspective. This also applies accordingly to the supervisory board. In addition, although the NFRD and its implementation in German law are silent on directors’ duties, the disclosure obligations at least implicitly oblige the management board members to develop an understanding, and assess the impacts, of climate change on the business, incorporate the results in the entity’s strategic plans and scrutinise and challenge the company’s resilience to climate-related risks.

In Germany, there is currently a significant litigation matter before the Higher Regional Court of Hamm (file no. I-5 U 15/17) based on a complaint brought by a Peruvian farmer against German energy provider RWE alleging damage due to the consequences of climate change caused by the defendant. The farmer accuses the German company of being co-responsible for climate change through the greenhouse gas emissions it produces, with consequences that will cause a glacier in the Andes to melt, with meltwater threatening his house and village. The farmer is demanding that RWE pay 0.47% of the cost of protective measures for his house and village. In an oral hearing in November 2017, the judges considered a claim for compensation to be sufficiently pleaded as to move into the next procedural stage of evidence taking.

This case is currently in the evidentiary phase. An on-site visit, in which judges, experts and other parties involved in the process were able to assess the situation in Peru for themselves, took place in May 2022. The further outcome is largely dependent on the expert opinion currently underway. If, following trial, the Court were to determine that the defendant is liable to the claimant, and if such decision was upheld by the German Federal Court of Justice on further appeal, the decision could have very far-reaching consequences for high-emission companies in Germany, as it could establish a route for claimants affected by climate change around the world to bring claims against German companies for their contributions to climate change.

Contributed by Christoph Pies, legal director, Clyde & Co, Germany

[Part Two of this article will be published shortly]