1. Introducing Company Law and Climate Change

1.1.  Companies and Company Law

Company law is primarily concerned with:

• the establishment and legal personhood of different forms of company;
• the internal governance of companies, including the allocation of roles, responsibilities and liabilities between company management (the board of directors, supported by officers) and shareholders (as members); and
• the relationship between companies and external stakeholders, such as creditors who provide capital to companies through debt.

Although there are many forms of business organisation — including sole proprietorship, partnerships and business trusts — the company^[1] has become the dominant form for incorporated businesses in Australia^[2] and in most other countries. The modern company is an abstract entity, recognised by law as an autonomous legal person even though it does not take a physical form. It is endowed with legal personhood — a company can buy and sell property, borrow money, bring legal proceedings and be subject to legal proceedings. It also enjoys perpetual succession, meaning that it can continue to exist despite a change in membership. Importantly it also shields those who benefit from the company’ activities — its officers and shareholders — from liability for its debts.

A company is often described as being ‘owned’ by its shareholders, although the actual legal relationship is more complex.^[3] Shareholders are generally not liable for the debts of the company (limited liability) beyond the value of their shares. Ownership rights and management rights are split in relation to companies. The board of directors manages, or oversees the management of, the company (separation of ownership and management). Board members in turn are generally appointed by the general meeting (‘GM’) of members — that is, those shareholders who are registered as members.^[4] Members are often passive investors who may not actively participate in GMs, especially in large companies.

These core features of the modern company — particularly limited liability and separation of ownership and management — provide the structural foundation for capitalist market economies. The economic model assumes that social benefits come through economic growth, which is best served by more efficient and profitable businesses and stable, fair and competitive markets. Companies are vehicles to facilitate the investment of capital to expand production and consumption and thereby drive economic growth — with relatively low risk for those who govern and those who directly profit from a company’s activities and in-built protections for market actors that interact with companies, such as creditors, suppliers and insurers, which often provide the main working capital of the company through debt and financing instruments. An economic system predicated on unlimited growth, which fails to adequately factor accountability for social and environmental harms into the price of production and consumption, and which operates beyond the biophysical limits of the planet, is also the root cause of problems like global climate change.^[5]

Company law does not directly regulate the business activities of companies, which contribute to environmental and social harms like climate change. Indeed, in capitalist market economics, problems such as climate change are typically treated as market ‘externalities’, which are regulated directly (whether more or less effectively) through substantive climate laws that constrain harmful business activities.^[6] Examples include environmental licensing regimes for high-emitting activities, or taxation or emissions trading to price GHG pollution.

However, it is important to recognise that company law itself — foundational as it is to capitalist market economies — is a significant, albeit indirect, determinant of how companies respond to climate change and can therefore significantly impact society’s response to climate change, particularly where substantive climate law is weak or lacking. In this chapter, we encourage you to think about the relationship between company law and climate change in two dimensions:

• How is climate change relevant to the legal obligations of companies and their directors established by company law?
• How is company law relevant to society’s response to climate change? Does it facilitate, or does it impede, timely and effective responses to climate change?

1.2.  How is Climate Change Relevant to Company Law?

To explore this question, we focus on three core areas of company law (as set out in the Corporations Act 2001 (Cth) and the general law): directors’ duties, member (shareholder) rights and meetings, and disclosure and reporting. Our particular focus is on large, investor-owned public companies.

Directors’ Duties

Company directors, as members of the board of directors, play a pivotal role in setting the strategy of a company and monitoring its management. The board has a significant influence over which business lines are pursued by companies, how companies allocate capital and resources and how they manage assets over time. Company law sets out the legal duties of directors that apply to their office, powers and functions. Most of these obligations also apply to officers of the company, but this discussion focuses on company directors.

For example, the duty of good faith requires directors to exercise their powers and discharge their duties in good faith, in the best interests of the company and for a proper purpose.^[7] Older Australian cases interpret the ‘best interests of the company’ to mean the ‘best interests of the shareholders as a general body’.^[8] However, courts have also found that the best interests of the company can be broader than the interests of shareholders. For example, when a company is insolvent or sliding into insolvency, the best interests of the company should be determined with reference to the interests of the creditors, not the shareholders.^[9] Further, directors are permitted (and may indeed be advised) to consider the interests of non-shareholder stakeholders and related social and environmental considerations (like climate change) if this is undertaken in the context of acting in the company’s long-term interests, including with a view of avoiding reputational harm.^[10]

Also relevant is the duty of due care and diligence, which requires directors to exercise their powers and discharge their duties with the degree of care and diligence that a reasonable director in their position would exercise.^[11] This includes informing themselves of foreseeable risks to the company’s interests and adopting proportionate measures to manage such risks.^[12] In discharging this duty, directors are granted some discretion to exercise their judgment in making business decisions, which often involve complex risk calculations. The business judgment rule provides a defence for a director who acts, or decides not to act, based on an informed, rational assessment of the company’s best interests.^[13] Where climate change poses material risks to a company, its directors are understood to have legal duties to identify, disclose and take steps to manage these risks, as part of their duty of care and diligence.^[14]

Importantly, these legal duties are owed by directors to the company itself. The corporate regulator — the Australian Securities and Investments Commission (‘ASIC’) — can bring an enforcement action for breach of duty, with a range of civil and criminal penalties available.^[15] The company, or the company’s liquidator, can apply to the court for a compensation order for breach of duty.^[16] Members can also seek leave of the court to bring a derivative action against directors for breach of duty on behalf of the company.^[17]

As we discuss in part 2, a series of influential legal opinions have articulated the evolving standard of care expected of company directors in relation to climate change. Strategic litigants are also seeking to enforce directors’ duties as a pathway to compel companies to address climate change in a timely fashion.

Member Rights and Meetings

Reflecting the separation of ownership and management in the company form, company law makes a clear distinction between two spheres of decision-making. The board of directors is empowered to manage the affairs of the company (eg staffing, finance or investment decisions) whereas the general meeting (GM) of members (shareholders who are registered on the members’ register of the company) have certain control rights over the company and can, for example, make decisions to appoint or remove directors, or to change the company constitution.^[18] The boards of public companies are furthermore compelled to report to members by tabling an annual financial report, directors’ report and auditor’s report at the annual GM (‘AGM’) (see further below).^[19]

While members have specific statutory rights to requisition a GM^[20] and to bring a resolution to the meeting,^[21] these rights are constrained by the strict division of powers between the board of directors and GM of members. Members cannot requisition, or put a resolution to, a GM if the subject is a matter of management exclusively vested in the board.^[22] Unlike other jurisdictions, like the United States (‘US’) and United Kingdom (‘UK’), there is no express provision for non-binding advisory member resolutions in Australia, through which members can express their views on how directors might exercise their powers.^[23]

Members also vote annually on the company’s executive remuneration report, which includes the salaries and bonuses for directors and executives. If more than 25% of the members vote against this report at consecutive annual meetings, then the entire board faces a ‘spill’ motion. If the spill motion passes by a simple majority, directors will be required to stand for re-election.^[24]

In part 2, we explore how activist shareholders and institutional investors like superannuation funds are using member resolutions and voting on the appointment of directors and their remuneration to pressure companies on their approach to climate change, even within this comparatively restrictive legal framework.

Disclosure and Reporting

One of the key functions of company law is to ensure that adequate information on the financial position of companies is provided to market stakeholders to inform and support their decision-making, particularly in relation to the allocation of capital. Accordingly, companies are subject to various disclosure obligations, including the preparation of an annual report, which includes the company’s financial statements and the directors’ report discussing business strategy and prospects.^[25] Financial reporting in Australia is informed by accounting standards adopted by the Australian Accounting Standards Setting Board (‘AASB’), which are based on international standards.^[26]

A key focus of company reporting is identifying and quantifying any financially material risks to the business. Such risks should be discussed in the directors’ report^[27] and reflected in the financial statements and any notes to the statements.^[28] According to the AASB, information is considered to be material ‘if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users (potential investors, creditors or lenders) of financial statements make on the basis of those financial statements.’^[29]

Directors and auditors must sign off on the financial statements to confirm they accord with prescribed accounting standards and present a ‘true and fair view’ of the company’s financial position and performance.^[30] Conduct (including disclosure) which is misleading or deceptive, or which is likely to mislead or deceive, is prohibited.^[31] Representations made about future matters which lack a reasonable basis will be taken to be misleading,^[32] and in such cases a court may impose civil liability or order injunctive relief.^[33]

There is now broad recognition that climate change poses financial risks to companies across the economy and that information on the potential impacts of climate change on a company’s financial position, performance and prospects is therefore decision-useful and material to a reasonable investor.^[34] This has the effect of enlivening legal obligations to disclose climate-related financial risks in the annual report, both within the management commentary in the directors’ report and within the financial statements.

In part 2, we note significant recent developments in relation to climate risk disclosure, including pressure from investors to adopt voluntary best practice standards, increased scrutiny and guidance from corporate regulators, and most recently, the introduction of mandatory climate reporting standards.

1.3.  How is Company Law Relevant to Society’s Response to Climate Change?

The three areas of company law discussed above can all indirectly influence company behaviour in relation to climate change.

For example, directors’ duties can influence whether and how social and environmental issues like climate change are considered by directors, how directors balance competing considerations (short-term versus long-term interests and shareholders versus external stakeholders) and to whom directors are held accountable. This is particularly important when short-term, profit-driven considerations conflict with longer-term considerations of the social and environmental impacts of decisions on company value and reputation. These are pertinent questions for many companies engaged in climate-damaging business activities such as fossil fuel extraction and production. If directors’ duties are interpreted to oblige them to maximise profits for shareholders in the short term, they will have little scope and incentive to take account of the social and environmental impacts of company activities (shareholder primacy).^[35] If they have discretion to consider the interests of a broader group of parties either affected by the company or with a stake in the company and some influence over its success, or are required or incentivised to do so, they may make decisions which contribute positively to addressing climate change (stakeholder capitalism).^[36]

As significant shareholders, institutional investors like superannuation funds can play a role in stewarding investee companies in relation to climate change and other environmental and social issues. Member resolutions and voting provide tools for investors to engage with and escalate pressure on companies and their directors in relation to these issues.^[37] These tools can help to focus company attention on climate change and incentivise companies to develop, disclose or better defend their approach to relevant risks and impacts.

It is important to understand the underlying drivers for investors to engage with these tools. For diversified and universal investors^[38] such as superannuation funds, which hold shares in companies across all sectors of the economy, financial returns depend on the overall performance of the economy, not just the profits of an individual asset.^[39] Further, superannuation funds typically manage assets over long timeframes (with the purpose of providing a retirement income to beneficiaries). Such investors therefore have a financial imperative and implied legal duty to mitigate sustainability-related systemic risks through their allocation of capital and their stewardship of investee companies.^[40] In theory, such investors should therefore place expectations on individual companies to disclose information about the environmental impacts of their operations that threaten the stability of the economy and to take reasonable steps to address these impacts. However, the financial imperative to address sustainability-related systemic risks is not fully understood across the financial sector.^[41] Further, like companies themselves, institutional investors face many pressures to prioritise short-term investment returns over longer-term considerations, which will impact their decisions on capital allocation and stewardship.

Finally, reporting and disclosure can draw internal attention to climate risks and impacts, which may incentivise companies to take steps to address these. Reporting also provides information on a company’s risk exposure, management and performance to external actors — such as investors, lenders, civil society — who may use this in their decision-making and advocacy, thereby also influencing the company. Yet the impact of information instruments on company behaviour depends heavily on what a company is required to report. For example, if companies are only required to disclose climate-related financial risks to the company and not report on their GHG emissions and other harmful climate impacts, they may have less incentive to take timely steps to reduce emissions and adverse impacts. If climate risks are only discussed in the management commentary of the annual report or indeed outside the annual report, this may have less impact on decision-making than if these risks are covered in the annual report with quantification in the financial statements. If companies are not required to follow a specific reporting standard, which allows for comparison across other business entities in the same industry and for measuring performance over time, information can be more easily obscured or omitted and will not necessarily be decision-useful for investors and other stakeholders.

Before we turn to a more detailed consideration of the interaction of these areas of company law with climate change, we invite you to explore some recent academic literature which scrutinises the influence that company law can have on social and environmental harms like climate change.^[42]