How the EU Commission wants to hold private companies accountable to the 1.5° target of the Paris Agreement

The issue

The proposal for a directive on corporate sustainability due diligence of 23 February 2022 (“Draft Directive”) imposes an obligation on some companies to observe the 1.5 °C target of the Paris Agreement in their business strategy. We have investigated which companies are affected by this obligation, what specific measures need to be taken by these companies and what the consequences are of not complying with this obligation.

Basic idea and addressees of Article 15 of the Draft Directive

Article 15 of the Draft Directive stipulates that companies with more than 500 employees and net annual turnover of over €150 million should adopt a plan to ensure their business model and strategy are compatible with limiting global warming to 1.5° C in accordance with the Paris Agreement.

This obligation is intended to apply to both EU and non-EU companies that exceed the above thresholds.

This plan must, in particular, identify, on the basis of information reasonably available to the company, the extent to which climate change is a risk for, or an impact of, the company’s operations.

According to recital 8 of the Draft Directive, this due diligence obligation also serves to implement the obligations of the Paris Agreement on the EU and its Member States as signatories. Although the Paris Agreement only addresses the signatory states, the Commission stresses that the private sector also has a central role to play in implementing the climate targets.

Specific measures in the Draft Directive

Article 15(2) of the Draft Directive and recital 50 mention emission reduction objectives as a possible specific measure to be included in the company’s plan. According to Article 15(2), if climate change is or should have been identified as a principal risk for, or a principal impact of, the company’s operations, the company must include emission reduction objectives in its plan.

In addition, recital 8 also mentions that the investment strategies of companies are decisive for implementing the climate targets. However, the Draft Directive does not contain any specifications as to how these investment strategies are to be designed.

There are no other specific measures mentioned in Article 15 or in the recitals. The further provisions of the business plan therefore seems to be at the discretion of the company, unless the Commission publishes further guidelines and recommendations on that topic.

Management’s responsibility

According to Article 25 of the Draft Directive, a company’s management, when carrying out its duty to act in the best interests of the company, should also take into account the effects of its decisions on aspects of sustainability, such as climate change, in the short, medium and long term. Any breaches of this obligation are to be sanctionable under national law in the same way as other breaches of duty by company management.

In addition, Article 15(3) of the Draft Directive states that based on the terms of its variable remuneration components the management should be given an incentive to take into account the duties mentioned in Article 15 or that the amount of variable remuneration should be conditional on the fulfilment of these duties.

With this provision, the Commission aims to both oblige and incentivise company management to take into account not only short-term profits for shareholders in their decisions, but also long-term sustainability considerations. The Commission already commissioned a study (European Commission, Directorate-General for Justice and Consumers, Study on directors’ duties and sustainable corporate governance: final report, Publications Office, 2020) on sustainable corporate governance in 2020 to examine the problem of short-term profit-seeking, which may have influenced the drafting of the Directive in this respect. The authors of the study came to the conclusion that the objectives of the Paris Agreement would not be achieved under the current status of corporate practices and recommended enacting binding legal requirements.

Consequences of non-compliance with climate targets

The obligation arising from Article 15 is not mentioned separately in the provisions on penalties (Article 20 of the Draft Directive) or in the provisions on civil liability (Article 22 of the Draft Directive). The Member States should therefore have some discretion as to the extent to which they impose fines for breaches of the obligation to comply with the climate targets.

Article 22 of the Draft Directive provides for civil liability only if the company has breached its obligations from Articles 7 and 8 of the Draft Directive, and as a result, an adverse impact that should have been identified, prevented, mitigated, brought to an end or its extent minimised through the appropriate measures laid down in Articles 7 and 8, occurred and led to damage.

The due diligence obligations from Articles 7 and 8 refer to adverse human rights impacts and adverse environmental impacts in the company’s own business or that of its business partners that are to be determined by risk analysis according to Article 6 of the Draft Directive. Article 3(b) of the Draft Directive defines these adverse environmental impacts as an adverse impact on the environment resulting from the violation of one of the prohibitions and obligations pursuant to the international environmental conventions listed in the Annex, Part II. The Paris Agreement is not included in this Annex.

Therefore, a breach of the obligations under Article 15 of the draft Directive does not lead to civil liability, even if a corresponding damage based on the breach can be proven. An action for damages due to a breach of climate targets, such as the one brought against Shell in the Netherlands, is therefore not possible according to the wording of the Draft Directive to date.

Summary

So far, the Draft Directive on corporate sustainability due diligence contains only a few specific measures that companies must observe in order to implement the 1.5 °C target. According to Article 15 of the Draft Directive, emission reduction objectives are to be specified if climate change has been identified as the principal risk for, or the principal impact of, the company’s operations. The specific terms of the business plan are therefore largely up to the company.

It appears that after implementation of the Directive by the Member States a breach of Article 15 of the Draft Directive would be punishable by fines. However, a breach of Article 15 does not give rise to civil liability under Article 22 of the Draft Directive.