CSDDD – Whatever happened to article 25?

Many will have heard of the relatively recent adoption of the Corporate Sustainability Due Diligence Directive (CSDDD or CS3D) by the European Parliament back in April 2024. Indeed, after much political haggling, CSDDD’s scope was significantly watered-down and limited to (inter alia) large companies with over 1000 employees and an annual turnover in excess of €450 million. More so, previous efforts to throw high-impact sectors (such as textiles manufacturing and agriculture) into the mix were completely scrapped by the European legislator. This latter omission (which jars with the very spirit of the directive) has been widely publicised as a failure of diplomacy, if you will, but another notable omission seems to have flown under the radar of many. This relates to the complete removal of article 25 of the original CSDDD proposal, which focused exclusively on a ‘revamped’ duty of care of directors.

In a nutshell, the text of this article required directors to take sustainability factors (namely, environmental concerns and human rights issues) into account when fulfilling their fiduciary duty to act in the best interests of the company.

This would have been a ‘game-changer’ on a number of fronts.

From a sustainability point of view, the introduction of this requirement would have significantly boosted the EU’s green agenda by holding directors accountable for the effects of their decision-making on the environment and society at large (what has been dubbed in sustainability circles as ‘impact materiality’). This in itself would have had serious repercussions for the long-standing theory of ‘shareholder primacy’ (which is essentially a theory in corporate governance which prioritises the generation of shareholder value above all else), by definitively replacing the ‘shareholder-centric’ approach which this theory upholds with one which assigns more importance to an entity’s stakeholders and the environment within which it operates.

From a corporate law perspective, this requirement would have had an interesting domino-effect across all EU member states. In Malta, it would have presumably been transposed into domestic legislation by virtue of an amendment to article 136A of the Companies Act (Cap. 386 of the laws of Malta) (the “CA”) which sets out the general duties of directors; prime amongst which is the director’s duty to “act honestly and in good faith in the best interests of the company” (vide article 136A(1) of the CA).

In truth, if one were to adopt an expansive interpretation of the abovementioned article 136A(1), it may be argued that ‘acting in the best interests of the company’ ought to be construed as also requiring the directors to take into account, at the very least, sustainability risks – i.e., environmental, social or governance events which would have an adverse impact on the company and its operations (and potentially therefore, shareholder value!) in so far as they were to materialise. This interpretation does not necessarily give rise to an obligation on the part of the directors to take into account and/or mitigate the company’s adverse effects on the environment in which it operates, however.

Interestingly, UK company law caters for this scenario (to an extent) by adopting the concept of ‘enlightened shareholder value’ (“ESV”). ESV dictates that, in exercising his/her duty to promote the success of the company, a director shall “have regard” to a number of factors, which include the impact of that company’s operations on the community and the environment (vide article 172 of the UK Companies Act 2006). This ‘enhanced’ duty of care very much tallies with the spirit of what article 25 of the CSDDD proposal sought to achieve; albeit admittedly, the latter was more forceful in nature, requiring directors to “take into account” (and not merely, have regard to) the consequences of their decisions on sustainability matters.

The mind boggles as to whether article 25 of the CSDDD proposal would have seen the light of day had it been more akin to ESV – both in nature and in consequence. In any case, in a world where sustainability disclosures and reporting (CSRD, anyone?) become more prevalent, one wonders whether the need for an ‘article 25’ will remain, or whether the consideration of such sustainability matters by directors will in actual fact become a foregone conclusion.

This article was first published on ‘The Corporate Times’ on Sunday 30th June 2024.