Environmental, Social and Governance (ESG) is a broad term that encompasses three key factors that can be used to assess a company’s engagement with environmental sustainability, consideration of society and relationships, and internal standards which provide for how an organisation is run. Whilst much of the focus tends to be on the first limb, the Social and Governance elements are equally significant.

The Social aspect of ESG relates to an organisation’s level of commitment to human rights, an ethical supply chain (including compliance with reporting requirements under the Modern Slavery Act 2018 (Cth)), privacy and data security and community engagement.

Attending to the Governance limb of ESG requires an organisation to implement policies and procedures that promote adequate oversight of business decisions, maintenance of accurate records, risk mitigation and robust internal governance documents.

Just as listed company directors are grappling with ESG issues, private company boards need to have regard to ESG in both business planning and ongoing day-to-day management of their enterprise.  At the SME level, key governance documents include a Shareholders’ Agreement, which should deal with the process for business decision making, as well as an up-to-date constitution, an annual business plan, a clear delegation policy and other policy, process and procedures tailored to the Company’s business.

ESG governance becomes very relevant for private company directors and management teams in a situation where an SME needs to approach the broader market to raise capital.  Statements about the current ESG credentials of the enterprise, or observations about, for example, the organisation’s plan to comply with future or prospective policy or legislation, are apposite and potentially necessary for SMEs to attract investment and raise money.

Generally, Chapter 6D of the Corps Act requires full disclosure to investors who are being offered shares or similar securities by a company.  There are some exceptions to this requirement, covered in section 708 of the Corporations Act.  The requirement for disclosure extends to ESG considerations and Directors will need to consider whether or not to make comment on ESG commitments, which by their nature, may relate to future matters.

Increasingly, consumers, and in the context of capital raising, prospective investors expect that companies will commit to goals relating to ESG.  For SME directors, typical disclosure for capital raising at an SME level includes comment regarding:

• net zero carbon emissions by 2050;
• diversity of the Board and/or the entire organisation benchmarks;
• independence of the Board and whistle blower protection mechanisms; and
• ethical supply chain compliance or relationships.

There is increased market pressure and greater levels of expectation for organisations to be conscious of their ethical and social obligations.  When coupled with a director’s duties, best practice governance and good business judgment considerations, directors will increasingly make more definitive and perhaps bolder promises related to ESG.  However, Directors need to be aware of the consequences if these promises cannot be supported, which may include serious civil and criminal liability where capital raising documents contain statements that are misleading or deceptive.

ESG goals cannot be achieved in the short term.  An effective response to climate change, a plan for supporting a more ethical supply chain or ensuring strong internal governance procedures are in place, will require an organisation to have a pathway for addressing these issues in the future.

Directors need to be particularly careful when making representations about future matters. A statement about a future ESG issue will be misleading where a person does not have reasonable grounds for making the representation.

Section 1041H of the Corps Act provides:

A person must not, in this jurisdiction, engage in conduct, in relation to a financial product or a financial service, that is misleading or deceptive or is likely to mislead or deceive.

Section 769C(1) of the Corps Act provides that if a person makes a representation with respect to any future matter (including the doing of, or refusing to do, any act) and the person does not have reasonable grounds for making the representation, the representation is taken to be misleading (emphasis added).

The Australian Securities and Investments Commission Act (2001) contains very similar provisions at ss 12DA(1) and 12BB, as does the Australian Consumer Law (Schedule 2 of the Competition and Consumer Act (2010)) at ss 18 and 4(1) respectively.

Whether a statement relates to a future matter depends upon the words used and their context.[1] It is arguable that commitments related to ESG, such as an organisation stating that by 2030, it will be sourcing inputs from ethical supply chains only, will be deemed to be representations about a future matter.  Whether these types of forward looking statements are deceptive or misleading will take into account the overall impression created for an investor.[2] In the context of capital raising, a Company that makes a representation regarding a future matter must provide evidence of the reasonable grounds on which it was based.

Broadly speaking, a plan or pathway for ‘how’ a company proposes to achieve a certain commitment made to the public, which will include potential investors and existing members of the Company is needed for ‘reasonable grounds’.  In relation to environmental sustainability, such as a promise for an organisation to have net zero carbon emissions by 2050, the promise must be accompanied by the relevant internal systems adopting business practices that will allow the Company to achieve net zero (e.g. replacing 50% of vehicles that rely on fossil fuels with electric vehicles, coupled with other measures that will go towards eliminating carbon emissions).

‘Reasonable grounds’ require “facts sufficient to induce that state of mind in a reasonable person”.[3]  A statement made by the Company to prospective investors that the organisation has an ethical supply chain, or supports anti corruption, while attractive to investors at the surface level, will need to be based on reasonable facts that show how the organisation will practically achieve these representations.  Representations without the appropriate justification may expose the organisation to liability for a claim of misleading and deceptive conduct.

SME Directors and Managers need to be aware of the inherent risks associated with making representations about future matters as they relate to ESG, but also appreciate that failure to comment on ESG when raising capital may not be in the Company’s best interests and that ESG disclosure is increasingly necessary to raise capital.  Key to managing risk in this area is due focus on business planning that is needed, particularly for disclosure concerning the environmental and social aspects of ESG.   Directors need to ensure they have a reasonable basis for making statements about future matters which will assist in avoiding claims for misleading and deceptive conduct.

This article was co-written by Lawyer, David Ifield.