What does climate reporting mean for directors’ liability?

Mandatory climate reporting will soon likely be a reality for many Australian entities. Our article, When will climate-related financial disclosures come knocking at your door summarises the Government’s current proposals, which are outlined in its second Consultation Paper from 27 June 2023. Applying a phase-in approach over a three-year period:

  • Group 1 large entities are likely to be expected to report for the first time during the 2024-2025 financial year
  • Group 2 medium-sized entities for the 2026-2027 financial year, and
  • Group 3 smaller entities for the 2027-2028 year.

Forward-looking statements

Mandatory climate reporting means entities will be expected to disclose how climate-related risks and opportunities could affect their future financial position, financial performance, and cash flows. They will also have to disclose climate-related targets.

When making ‘forward-looking statements’, there is always a risk of being wrong. For example:

  • Directors could be unreasonably optimistic and fail to consider all the down-side scenarios
  • Directors may apply caution, but future uncertain events, such as the availability of green technology, could affect the extent to which an entity achieves its projected financial performance.

The Corporations Act 2001, Australian Securities and Investments Commission Act 2001 and Competition and Consumer Act 2010 all contain provisions prohibiting a person from making false or misleading statements, or engaging in dishonest, misleading or deceptive conduct in relation to a financial product or service. Directors should therefore have reasonable grounds for making forward-looking statements.

What does this mean for directors’ liability?

Directors of listed entities and large unlisted Group 1 entities are likely to be most affected by potential liability claims in the short-term. This is because they are the ‘first cabs off the rank’ for climate reporting, and their systems may still be evolving to enable them to capture the level of detail required to produce comprehensive Scope 1, 2 and 3 measures of greenhouse gases. In addition, the science for measuring many types of emissions is still a developing area, so predictions could turn out to be different from previously disclosed estimates.

What is the Government doing to help?

In response to the Government’s first Treasury Consultation Paper, there were a variety of competing views regarding directors’ liability for forward-looking statements:

  • Some stakeholders noted that directors would have to take a position on inherently uncertain matters that leaves them open to liability for misleading and deceptive conduct. In addition, they expressed concern about Australia’s class action regime and heightened scrutiny around climate and sustainability issues.
  • Others considered the ‘reasonable grounds’ threshold sufficiently flexible to account for the inherent uncertainty referred to above.

In its second Treasury Consultation Paper, the Government has proposed introducing a ‘modification of liability approach’ to balance these competing views. Recommendations for protection for good faith disclosures and safe harbours were not adopted. Comments on these proposals closed on 21 July 2023 and are not yet final.

What is the ‘modification of liability’ approach?

This approach seeks to limit directors’ liability for forward-looking statements relating to climate reporting by applying scope and time limits.

Scope limits

Climate-related financial disclosure requirements will be drafted as civil penalty provisions under the Corporations Act 2001. Directors would be protected if they have acted honestly and ought fairly to be excused for the breach.

Infringement notices will also be available to enable flexibility in the way regulators respond to non-compliance by companies with their climate-reporting obligations.

Time limits

For three years from the commencement of the mandatory climate-reporting regime, directors are expected to be protected from misleading or deceptive conduct, false or misleading representations, and similar claims in relation to:

  • Scope 3 reporting
  • Scenario analysis
  • Transition planning.

This three-year protection only applies to private litigants, and ASIC would still be allowed to take action where appropriate.

It is possible that Group 3 entities reporting for the 2027-2028 period may not benefit from this three-year protection if the commencement of this reporting regime is set as the beginning of the 2024-2025 financial year (i.e. 1 January 2024 for entities with 31 December reporting dates and 1 July 2024 for entities with 30 June reporting dates). This is because three years will have elapsed by the time Group 3 entities produce their first mandatory climate reporting. Group 3 entities should therefore not delay preparing and bedding down systems for Scope 3, scenario analysis and transition planning disclosures.

How BDO can help

No matter where you are on your sustainability journey, our national team of sustainability experts can help with:

  • Sustainability reporting
  • Developing your sustainability strategy
  • Carbon footprint calculations or mandatory climate-related disclosures
  • Carbon emission reduction strategies
  • Assurance over your carbon footprint or sustainability reporting.

Contact us today.