Claims Against Companies’ Directors for ESG Breaches Are Coming

Many fashion companies are garnering attention for putting environmental, social, and governance (“ESG”) elements at the forefront of their businesses. Chief among them: Patagonia, whose owner last year sold the company to an environmental non-profit organization. But equally there are fashion brands making headlines for missing the mark: Boohoo, for example, has fced claims of poor working conditions and treatment of staff in its Burnley warehouse early this year. At the same time, retailers like H&M, Next, and Inditex have been accused of failing to pay the minimum production value of their goods to workers in their suppliers’ Bangladesh factories. 

Not only are such ESG-centric shortcomings “bad for business,” but they may also be problematic for companies’ directors, who could be personally liable for such ESG failings. Against that background, we look at directors’ duties and how they apply in relation to corporate sustainability and ESG requirements.

First things first, who is a director and what are a director’s duties? There are three different ways that someone can be considered a director … 

(1) De jure (or legal) directors are those who are formally appointed, with no ambiguity as to their role or authority in relation to the company.

(2) De facto directors are never formally appointed but exercise a degree of control or influence over the company. They are part of the company’s governing/decision making process, they appear as directors and carry out the functions that directors typically do.

(3) Shadow directors are neither formally appointed nor carry out the typical director functions but are there in the background exercising influence over the company’s affairs and advising the board how to act on certain issues.

In terms of duties, directors owe statutory duties to the company that they serve. Known as the “general duties,” these duties generally relate to acting with integrity, care, and skill, and avoiding conflicts of interest to ensure that the company is as successful as possible.  

As for who owes the duties and who enforces them, the “general duties” apply not only to legal directors, but also to “de facto” and “shadow” directors. Under company law, directors’ duties are owed to the company itself, and enforcing these duties is a matter for the company. Failing to discharge their duties is one of the few exceptions to the liability protection that a company affords its directors and shareholders. Broadly speaking, if directors are found to have breached their duties, thereby, causing the company suffering a loss, then those directors can be held personally liable and may be ordered to “make good” the loss suffered by the company. If the breach is severe, it may result in a director – or directors – being disqualified on the grounds of being unfit to hold office.

The Subsidiary Six

In respect of a director’s duty to promote the success of the company, there are many factors which a director must take into consideration if they are to act in the company’s best interests, including: (1) The likely long-term consequences of any decision; (2) the interests of the company’s employees; (3) fostering the company’s business relationships with suppliers, customers and others; (4) the impact of the company’s operations on the community and the environment; (5) maintaining a reputation for high standards of business conduct; and (6) acting fairly between members of the company. These considerations are known as the “subsidiary six.” 

In the context of retailers that are paying their Bangladesh factory workers less than the manufacturing cost of their products, the directors of these companies may have already fallen afoul of a few of the six points above. Underpaying suppliers (or failing to increase payments to meet rising production costs and minimum wage levels) does not foster strong, positive relationships with suppliers, nor does it have a positive impact on the community where the factory is based. And beyond that, such underpayment is not conducive to building a reputation for high standards of business conduct. 

Taken together, such payment practices could deter companies’ target markets from purchasing from their brands; this includes consumers who are increasingly aware of ESG and demanding that companies engage in sustainable and ethical approaches to fashion manufacturing. And if bad business practices alienate companies’ customers, that means fewer sales and revenue, and over a sustained period, fewer profits for a company’s shareholders. 

ESG & the widening of directors’ duties

In March 2024, the European Commission approved a final draft of the Corporate Sustainability Due Diligence Directive (“CSDDD”), which is expected to come into force by 2025, following necessary approvals from the plenary of the European Parliament and then the European Council. The goal of the proposed legislation is to require businesses to undertake corporate sustainability due diligence in order demonstrate what actions they are taking to protect the environment and human rights.

As such, the CSDDD will require businesses to put in place processes and procedures to prevent, mitigate, and account for the detrimental impacts that their immediate business – and other businesses within the value chain in which they operate – may have on human rights and the environment. For example, large companies (with a turnover of more than 150 million euros) will be required to ensure that their business practices are compatible with the Paris Agreement target of limiting the increase of global warming to 1.5°C.

In addition to requiring companies to enhance existing – and implement new – policies and procedures relating to sustainability, the CSDDD will also introduce ESG-related duties and requirements for companies’ directors that fall within the six categories identified above, including setting up and overseeing the implementation of the CSDDD, and considering the consequences of their decisions on human rights, climate change, and the environment when acting in the best interests of the company. Additionally, where a director’s remuneration is linked to company performance, his/her overall contribution to sustainability will be considered when deciding his/her overall remuneration package.  

The European Commission has proposed that directors’ duties will be enforced through existing Member State laws.

Time will tell if the CSDDD will result in the fashion world seeing fewer accusations of modern slavery, poor working conditions, and unethical relationships with suppliers. But with good corporate governance, ESG-driven initiatives, and an emphasis on environmentally-friendly products starting to come to the forefront of many consumers’ and regulators’ minds, fashion businesses (and their officers) would do well to ensure their directors are complying with their statutory duties and the subsidiary six.

Paul Taylor is partner on Fox Williams‘ corporate team, where he advises on a broad range of corporate transactions, particularly for SME clients. 

Georgie Glover is an associate on Fox Williams’ corporate team, where she advises on a range of domestic and cross-border transactions.

Hannah McCullagh is an associate on Fox Williams’ Commerce & Technology team, where she advises clients in the fashion and technology industries.