UK Legal Opinion: Nature-Related Risks and Directors’ Duties - What NEDs in England and Wales Need to Know

In March 2024, a legal opinion authored by high-ranking corporate and financial law barristers titled ‘Nature-related risks and directors’ duties under the law of England and Wales’  was published (the Opinion). In this briefing, the Commonwealth Climate and Law Initiative outline the key findings of the Opinion, and actions directors can take to minimise the risk of breaching their legal duties.

What are nature-related risks and how are they relevant to UK companies?

Nature-related risks are potential threats posed to an organisation that arise from its and wider society’s dependencies and impacts on nature. They encompass:

• Physical risks: These result from the degradation of nature and a decline in ecosystems that underpin economic activity. For example food producers, manufacturers, retailers and financiers depend on soil health which can be degraded by unsustainable practices.
• Transition risks: These result from risks to an organisation from a misalignment of economic actors with changes in regulation and policy, legal precedent, technology, or investor sentiment and consumer preferences aimed at restoring and/or reducing negative impacts on nature. For example, relating to forest-risk commodities.
• Legal risks: These arise directly or indirectly from legal claims. For example, complaints, regulatory action or litigation against companies for their impacts on ecosystems or their misrepresentation of nature-related risks and impacts. For example, a legal challenge has been made against a UK energy company in relation to misleading portrayal of the environmental benefits of its biomass energy that have adversely affected share values. Risks may also manifest as class action lawsuits and litigation in relation to the supply chain practices of companies.
• Systemic risks: These can affect the whole financial system by way of supply chain disruption, price volatility, collateral and asset depreciation, increases in defaults, and greater insured losses.

While some sectors such as agriculture, forestry, fisheries and aquaculture, food, beverages and tobacco, and construction are wholly dependent on nature for their products, analyses by the World Economic Forum in collaboration with PwC in 2020 (and updated analysis by PwC in 2023) indicate that over half of global GDP is either moderately or highly dependent upon nature and ecosystem services.

Companies’ nature-related risks can be transmitted to investors – 74% of sectors in the UK FTSE All-Share Index were estimated to be highly dependent on natural capital. Preliminary Bank of England analysis indicates that 52% of UK GDP and 72% of UK lending are dependent on ecosystem services. Furthermore, in April 2024, the Green Finance Institute released a report which found that the UK is one of the most nature-depleted countries in the world. Damage to the natural environment is slowing the UK economy, and could lead to an estimated 12% reduction to GDP in the years ahead – larger than the hit to GDP from the global financial crisis (5%) or Covid-19 (11%). These are preliminary but conservative estimates, and risks will likely increase over time if tipping points are crossed.

Reflecting the evidence from these studies, the Opinion finds it “easy to envisage circumstances” where a company’s short- or long-term success can be affected by nature-related dependencies or impacts. The table below shows some examples of ecosystem services and industries that may depend on them.

What are directors’ duties with respect to nature-related risks?

The Opinion was authored by corporate and financial law barristers, high-ranking silks Sharif Shivji KC and Rebecca Stubbs KC, leading Karl Anderson and Hossein Sharafi, and co-commissioned by the Commonwealth Climate and Law Initiative (CCLI) and Pollination. Counsel were asked to analyse the relevance of nature-related risks to directors’ duties under English law.

Under the Companies Act 2006, the duties of directors in England and Wales include:

• Section 172: The duty to promote the success of the company for the benefit of the members as a whole. This duty is one of loyalty which is broad and flexible. Section 172 contains a non-exhaustive list of factors to which directors should have regard and includes “the impact of the company’s operations on … the environment”. The authors of the Opinion consider this factor to encompass nature-related risk.
• Section 174: The duty to act with reasonable care, skill and diligence.

Whilst the law has not changed, directors’ duties are constantly evolving. The scope of directors’ duties is affected by the factual context in which a company operates, changes in scientific and technological understanding of global nature decline, an economic and financial understanding of associated risks, and shifts in market and societal attitudes.

The Opinion concluded that nature-related risks fall within the category of risks to which a director should have regard when discharging their section 172 and 174 duties. Directors could potentially breach their duties by failing to consider or act on relevant nature-related risks.

This conclusion is consistent with CCLI analysis of directors’ duties with respect to biodiversity in other jurisdictions around the world, and a previous opinion by Sebastian Hartford-Davis and Zoe Bush in regard to directors’ duties with respect to nature in Australia.

A director can face significant consequences for breach of duty, including claims for damages, termination of their position, adverse reputational consequences and challenge to executive directors’ remuneration and ‘bad leaver’ provisions. In addition, inadequate consideration of nature-related issues could expose the company to:

• latent financial risks arising from unaddressed nature-related impacts and dependencies;
• the risk of shareholder and investor claims (including for deceit); and
• reputational risk.

The Opinion notes that the recent court decision in ClientEarth v Shell (discussed further here and in here) is not necessarily a bar to claims regarding directors’ management of nature-related risks.

Will nature-related disclosures be required?

Despite the complexity of the English disclosure framework in relation to narrative reporting (for more information, see here) the Opinion concludes that:

• The current disclosure regime in the UK already covers: a) material nature-related risks, and b) significant impacts of a company on nature, to the extent that certain companies must already disclose environmental matters necessary to enable an understanding of the company’s financial performance.
• Increasing public scrutiny may result in reputational consequences for companies’ disclosure failings.
• The Recommendations of the Taskforce on Nature-related Financial Disclosures (the TNFD Recommendations) may prompt scrutiny of directors’ responses to nature-related risks and eventually be incorporated into regulations.

In relation to disclosure in financial statements, directors have a duty to approve accounts if they give a “true and fair view” of the company’s financial position. The Opinion agrees with the Bompas KC Opinion published in January 2024, which concluded that directors of UK companies “must consider whether and how to reflect relevant sustainability issues, such as their contribution to climate change, in their financial statements, in order to provide a true and fair view”. With respect to nature-related risks, this means that directors are required to consider whether nature-related issues will impact financial statements (for example creating liabilities or impairing asset values).

The world’s largest proxy advisors have also indicated that the risk of insufficient oversight, improper management, or inadequate disclosure of material environmental issues could harm shareholder interests and constitute grounds to recommend voting against the relevant board members (see Glass Lewis and ISS voting policies). Other investors actively engage with companies to mitigate systemic risks that impact future investment opportunities (such as biodiversity loss) and, with respect to board re-elections, will consider whether the company has failed to assess and report on key impacts and dependencies on nature.  This reflects a global trend of investor pledges, frameworks and benchmarks – such as the Finance for Biodiversity Pledge (representing over EUR 3 trillion in AUM), Nature Action 100 (representing more than 200 institutional investors responsible for around USD 28 trillion in AUM) and the Principles for Responsible Investment (a network of over 3,000 institutional investors that has indicated biodiversity as a priority) – all of which point to a growing appetite by the world’s biggest investors to manage nature and biodiversity risk.

What are the opportunities for directors?

Directors can promote the success of their company, discharge their duties, and protect themselves from legal risks using the Opinion’s five-step roadmap to address nature-related risks and steer their company competitively through the nature-positive transition.

Key takeaways

1. Nature-related risks fall within existing financial risk categories and are not new. Nature-related risks are relevant to the short- and long-term success of companies.
2. Board directors that do not appropriately consider such risks may face consequences for breaching their duties.
3. There are opportunities for companies where their board directors proactively follow the clear, practical steps outlined above.
4. Investors are increasingly interested in the relevance of nature-related risks to a company’s financial position. Nature-related risks may need to be considered in financial and non-financial reporting.

The Opinion could signal a significant shift in corporate governance towards greater consideration of environmental factors in decision-making. This could have implications for how companies operate, invest, and disclose information to stakeholders. Company directors should consider their company’s nature-related risks and act on relevant risks as part of their legal duties under the law of England and Wales, or risk breaching their duties which could lead to personal liability.