International Regulatory Enforcement (PHIRE)
The Evolving Role of Boards of Directors Regarding Business and Human Rights
August 17, 2023
Three years ago, as part of the EU’s initiative on sustainable governance, the European Commission released a lengthy study on directors’ duties. The study affirmed what many already understood: corporate decision makers face pressure to generate financial return in a short timeframe and provide shareholders with dividends, which is often detrimental to human rights and sustainability objectives. The study cited risks related to modern slavery, unhealthy working conditions, a living wage, product safety, and other human rights areas, along with climate change and environmental risks. It noted, as an example, that to reduce costs many EU companies source supplies from entities based in countries with lesser social, human rights or environmental standards, and where the identification and mitigation of related risks and impacts is weak. The study did not break new ground. Indeed, it followed the Business Roundtable’s 2019 proclamation that companies should act in the best interests of all stakeholders, and not just shareholders. However, the study added support to a growing belief that financial materiality and stockholder welfare should no longer be the “sole end” of corporate governance and that a stakeholder-oriented approach must start at the very top of business organizations, with boards of directors.
That conceptual shift, and increased demands of boards, have been critical components of new business and human rights laws and regulations being proposed and adopted around the world. These laws often require certain corporate disclosures regarding human rights practices, and compel or incentivize human rights due diligence. With increasing frequency, the laws and proposals also mandate board responsibility and accountability for human rights issues, clarify that a board’s duty of care encompasses human rights and sustainability principles, and nudge stronger board-sustainability governance through transparency initiatives. As a result, the role of boards and individual directors is in the midst of an evolution.
The Expansion of Board Responsibilities
The expansion of board-level responsibilities to include human rights and sustainability is reflected in leading international standards and domestic regulations. For instance, Principle 16 of the UN Guiding Principles on Business and Human Rights contemplate approval of human rights commitments at the highest level of organizations. The OECD Guidelines for Multinational Enterprises have similar provisions and call upon boards to take into account the interest of a company’s stakeholders.
Similarly, domestic human rights legislation, including the UK and Australian Modern Slavery Acts, and Canada’s new Fighting Against Forced Labour and Child Labour in Supply Chains Act, place explicit responsibility with boards of directors. They demand that boards approve, and that a board member attest to, the steps companies are taking to address modern slavery risks in their publicly-facing modern slavery reports, including policies and procedures, training, a description of the nature of modern slavery risks in their business and how they are being addressed. That approval and attestation, in effect, mandates that a board familiarize itself with management’s approach to addressing modern slavery within the company and its supply chain.
Norway’s Transparency Act, a broad mandatory due diligence law, likewise requires board approval for company human rights due diligence reports. Akin to the modern slavery acts, that approval requirement effectively compels the board to understand how the company seeks to identify potential human rights risks, how the company mitigates those risks, and the effectiveness of those efforts.
In related areas, the SEC’s proposed rule regarding climate change would require – as the Task Force on Climate Related Financial Disclosures contemplates – that registrants disclose information regarding the board’s oversight of climate-related risks, including whether a board committee has responsibility for climate risks, whether individual board members have relevant expertise, how information on climate risks are reported to and discussed by the board, and any targets set by the board. Recent derivative shareholder litigation in Delaware, seeking director liability for mission critical human rights-related issues tied to core business pursuits, is a reminder that human rights issues can also be financially material and that board oversight is expected.
The global reevaluation of the appropriate role of boards of directors regarding human rights and sustainability is perhaps most acutely seen at the EU level, as reflected in the Commission’s sustainable governance study. Certain aspects of the European Green Deal have created new board-related oversight obligations. For instance, the new EU Batteries Regulation demands that entities importing batteries, or products containing batteries, establish a comprehensive due diligence policy and management system, including identifying human rights and environmental risks, developing traceability mechanisms regarding all aspects of batteries, and making certain public disclosures. The regulation assigns oversight responsibility for the due diligence processes to the board, who also are charged with receiving the results of risk assessments and management plans.
In a similar vein, the recently adopted standards for the EU’s Corporate Sustainability Reporting Directive (CSRD) includes detailed board-related disclosures. Under the CSRD, a covered company must publish a single audited report reflecting financial materiality and “impact” materiality, attaching a report on the company’s salient human rights and sustainability risks to its financial reporting. As part of the general disclosures in the European Sustainability Reporting Standard 2 (ESRS 2), companies must describe the composition, expertise, diversity and role of boards in exercising oversight of the process to manage material sustainability risks. The standard includes detailed requirements on how information about sustainability matters are reported to boards, how the issues are addressed, and how sustainability performance is reflected in incentive schemes. The standards also demand disclosure on how the board’s responsibilities for material sustainability risks and opportunities are reflected in board charters and terms of reference, embedding accountabilities within corporate governance documents. Those details are consistent, incidentally, with the International Sustainability Standards Board’s new global reporting standard, IFRS 1. While these transparency standards do not per se require boards to take any particular action, however to avoid a disclosure reflecting a lack of board expertise or oversight over salient human rights issues, they certainly incentivize corporate action.
Other key aspects of the EU’s initiatives also reflect a debate over the appropriate role for boards. Last year, the EU Commission released its vision for a corporate sustainability due diligence directive that increased the obligations of director “duty of care” obligations. The Commission’s draft requires that directors take into account human rights, climate change and environmental impacts in their decision making, and take active steps to ensure that the company is evaluating, addressing, and reporting on its human rights and environmental risks and impacts - just as directors do with financial reporting and material business risks, in a manner largely consistent with the CSRD. The draft also provided that boards must participate in driving company climate policies. The EU Council rejected that approach, deeming it an improper infringement on state provisions regarding directors’ duties of care, and struck all references to director responsibilities. The EU Parliament has taken a middle ground. It retained the provision clarifying that directors have a duty of care under national laws to consider human rights and sustainability issues, as well as the Commission’s proposed director-related climate responsibilities. However, Parliament deleted director obligations for overseeing human rights and environmental due diligence, including identifying and remediating negative impacts. As the EU Commission, Council and Parliament enter trilogue negotiations, the roles and duties of boards will surely be a key topic of discussion, and will lay the foundation for director responsibilities over human rights and sustainability issues for years to come.
The Road Ahead
The role of boards in overseeing human rights remains in flux. Certainly, where human rights and sustainability issues create material financial risks, boards are expected to receive regular reporting from management and take appropriate action when red flags arise. Beyond that, there are important soft law expectations, as reflected in the UNGPs, OECD Guidelines and IFRS 1. Hard law obligations are growing, as reflected in mandatory due diligence and transparency laws, such as the modern slavery acts, Norway’s Transparency Act, the EU’s Batteries Regulation and CSRD, as well as climate change requirements. However, the fractured and varied positions surrounding the debate over whether and how to create board responsibilities surrounding the CSDDD is emblematic of the larger debate.
On a higher level, director responsibilities are clearly moving in one direction. The remaining question is not whether director responsibilities over human rights and sustainability will increase, but the specific manner in which they will manifest and the speed with which it will occur. Whether it is two years or five years, and whether it is memorialized through defined oversight of due diligence processes or a general duty of care, it seems safe to say that shareholders, as well as regulators and other external stakeholders, will expect that boards: (1) embed human rights and sustainability responsibilities in board charters and assign responsibilities to one or more committees; (2) have at least one member with adequate expertise to fully grasp the company’s salient human rights and sustainability risks; (3) receive regular reports from management on how salient risks have been determined and are being addressed; (4) act when red flags associated with those risks appear; and (5) approve non-financial disclosures regarding human rights and sustainability risks and impacts.
Given the pace of change, it is likely prudent to prepare for those demands sooner rather than later.