Company law, the corporate board and mandatory sustainability due diligence

By Beate Sjåfjell, 9 June 2021

kvinne, ansikt, briller, smil

Beate Sjåfjell is Professor at the Faculty of Law, University of Oslo, and Adjunct Professor at the Faculty of Economics and Management, The Norwegian University of Science and Technology (NTNU)]

Photo: Eilif Ursin Reed

There is an overwhelming support, also from business, for mandatory sustainability due diligence. Due diligence should be seen as an integral aspect of duties for the corporate board, to ensure that companies mitigate the risks of unsustainability – for the sake of the company itself and for society. Any true improvement in this area needs to directly and explicitly include the role of the corporate board.

Company law is no holy cow

There is a lesson to be learned from decades of various sustainability reporting initiatives intended to influence the decision-making of the board without regulating directly. Experience has shown that this has had limited effect. To bridge the gap between what boards see as their duty and what the company is asked to do, it is time to include company law in the regulatory tool box. Company law is not a holy cow, which cannot be touched while all other areas of law around the company are gradually seeing changes to promote corporate sustainability.

The problem with company law today

Company law allows companies to shift away from business models that undermine the possibilities for a sustainable future by exploiting people, destroying the environment and undermining the economic bases for resilient societies. Yet, the voluntary transition is far too slow.

One reason is the still very strong social norm of shareholder primacy. I use this term, drawing on multijurisdictional comparative analysis in several projects, as a short form for a range of complex interactions between economic incentives and financial market expectations of companies. Shareholder primacy dictates, contrary to company law, that the duty of the board is to maximise returns for shareholders. The result is an extreme externalisation of the responsibility for social, environmental and economic harm committed by companies through their global value chains.

As long as company law does not challenge that social norm, various forms of ‘self-regulation’, including corporate governance codes, which increasingly include references of some sort to sustainability, will have limited effect.

Corporate duty and a duty of the corporate board

Setting out mandatory sustainability due diligence as a corporate duty is important because it places the onus on the legal entity that has a potentially everlasting life. To operationalise this and to give legal certainty to those on boards and in senior management, this should also be very clearly spelled out in company law as a duty for the corporate board.

A duty for the corporate board to undertake mandatory sustainability due diligence should be a part of a comprehensive legal reform. It should be spelled out explicitly for the board that its duty is to promote the interest of the company. That would be a valuable clarification of what company law, usually implicitly, requires across jurisdictions.

To support the transition to sustainability, the board’s duty should further be to promote the interests of the company in a way that creates sustainable value within planetary boundaries. This should encompass setting a sustainable value creation strategy for the whole business of the company, including its global value chains, assessing the business model of the company and adjusting or changing it where and when necessary. Sustainability due diligence should be included as a clearly spelled out mechanism for the board to be able to do its job. 

A level playing field and legal certainty

Sustainability due diligence as hard-core company law responds to the call for a level playing field from businesses that are trying to contribute to the transition to sustainability. Such a reform would contribute to bringing into more foreseeable forms the international trend of lawsuits against companies for environmental and human rights harms, which illustrate the growing lack of acceptance of the status quo of corporate unsustainability.

It is crucial that due diligence does not act as a safe harbour or devolve into box-ticking exercise. Yet, proper compliance with a mandatory sustainability due diligence regime will serve as a potential defence for the company and its board. It thereby provides legal certainty for all involved and for those affected within and outside of the company.

What companies meet today in their globalised activities is a very fragmented and chaotic picture of some national sector-based rules on due diligence, some reporting requirements, increasing societal expectations, and guidelines and principles in various forms. Without a level playing field consisting of mandatory rules and enforcement, it may even be irrational for a company to do a full due diligence and be open about what they find, because they may then look worse than their competitors who are still getting away with greenwashing, blue washing or SDG washing (the latter referring to the UN Sustainable Development Goals).

Respecting human rights is not enough – nor is including the environment

The UN Guiding Principles for Business and Human rights (UNGPs) have informed much of the debate on mandatory due diligence.

Yet, protection of human rights and securing company respect for human rights will have limited effect if we do not work more broadly to secure the social foundations for humanity now and for the future within planetary boundaries. This definition of the goal of a sustainable future entails that more is required also than the call for human rights and environmental due diligence. A broader approach to securing social foundations is necessary, with a range of social, economic and governance implications. It therefore has to be a full sustainability due diligence and it has to be mandatory.

Clicking into place a missing piece of corporate sustainability

Reforming company law means putting into place a missing piece in the jigsaw puzzle of corporate sustainability. The success of the EU’s Sustainable Finance Initiative relies on investors, fund managers and banks being able to reliably assess the sustainability of their clients, their investments or project plans. This is not possible without reliable and relevant information from companies. This is recognised in the EU Commission’s preparation of the reform of the so-called Non-Financial Reporting Directive – now more appropriately named in the proposal as a Corporate Sustainability Reporting Directive. Although this major step towards corporate sustainability reporting is positive, it needs the connection with hard-core company law to realise its potential.

Without company law, it is not only sustainable finance that risks failing. The entire EU Green Deal, with its various initiatives, aiming to influence production and consumption so that they become more sustainable, cannot realise its potential unless we connect the other pieces with the rules governing the key decision makers in companies. Ultimately, it is about securing a sustainable future for us all.

This is a revised and shortened version of the blog post first published as B. Sjåfjell, ‘Company law: the corporate board and mandatory sustainability due diligence’, Nova Centre on Business, Human Rights and the Environment, 25 May 2021.

Tags: Business and global value chains, Planetary boundaries, Social foundation, Reform proposals, Sustainability
Published June 9, 2021 2:04 PM - Last modified June 9, 2021 2:20 PM

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