Getting serious about the role of company law in sustainability: a rewrite of Articles 64 and 72(2) of the Portuguese Companies Code?

Abstract: The article examines the evolution of company law in response to the demands of environmental and social sustainability. It argues for a 'duty of sustainability' on the part of directors, which would operate as a residual duty alongside the duty of legality (which makes directors personally liable for ESG duties directed at the company). It is shown that the duty of sustainability can be built on the basis of the current legal framework, but that its effectiveness could be enhanced by amending Article 64 of the Portuguese Companies Code, which regulates directors' duties. A proposal is therefore made for a new wording for this provision, as well as for Article 72(2) of the same Code, which regulates the business judgement rule. The aim is to launch a public debate on the issue.

Keywords: Sustainability; director's duties; business judgement rule

1. Introduction to the Duty to Promote Environmental and Social Sustainability: A Review of Corporate Law Structures

The aim of this text is to show that, in the light of the changes dictated by the objectives of environmental and social sustainability, company law has undergone a structural transformation and that the current legislative and recommendatory framework has given rise to a ‘sustainability duty’ on the part of the director.¹ This duty is not limited to compliance with the specific rules to which the company is subject in environmental and social matters, but encompasses the entire sphere of action of the director and the company. This movement tends to be accompanied by the convergence of investors, financiers and the market, but does not depend on the individual priorities of the subjects considered.^2-3.

The present moment is characterised by the international emergence of climate litigation with a focus on managers.⁴ Making directors responsible and not the company represents an additional step, which should be approached with caution. Furthermore, the liability of directors, where it exists, is in principle internal, i.e. to the managed company, which will then be liable to third parties. However, the exceptional possibility of third parties suing directors is not excluded when the rule or duty violated has a direct protective effect on them. The possibility of direct actions against directors will continue to be tested in the near future.

The current legislative framework already binds directors to this duty of sustainability, which doesn't mean that there isn't an interest and convenience in making it clear that company law serves the value of sustainability.

Ultimately, what is at stake is a process of deepening the ethical vector of company law, which is not opposed to the ultimate goal of profitability. The transformation is radical and will involve the pie-growing mentality to which Edmans emblematically introduced us:⁵ we are aware that companies can benefit from creating value for investors and creating value for society by overcoming the pie-splitting mentality, insuch a way that the company will achieve a win-win situation andfinancial success and social and environmental success become inseparable. But there is no denying that in the day-to-day decisions that managers make, there will always be a choice between the most beneficial solution for shareholders and the one that best balances profitability and sustainability.

2. The Regulatory Framework

In the age of sustainability, company directors are operating within a very dense regulatory framework, European and national, that leaves little or no room for business decisions that are not predetermined.⁶ The regulatory web is vast, in order to achieve the objectives of the Paris Agreement and the conclusions of the 2019 European Council, which aim for a climate neutral European Union by 2050.^7-8

The attainment of climate and social EU's objectives is ensured through intense and far-reaching regulation, using both hard law requirements and market incentives. One can identify four pillars that make up the EU's sustainability framework in what Corporate Law is concerned:⁹

1. The classification system, or ‘taxonomy’ of sustainable activities:¹⁰ Taxonomies make it possible to assess whether and to what extent an asset is in line with sustainability objectives. Taxonomies provide a consistent system for identifying certain characteristics that are considered ‘sustainable’. In the European context, the Taxonomy Regulation and its delegated acts harmonise the criteria for determining whether an economic activity is environmentally sustainable.
2. The disclosure framework for financial and non-financial companies. This includes the Non-Financial Reporting Directive (NFRD),¹¹ the Sustainable Finance Disclosure Regulation (SFRD),¹² the Corporate Sustainability Reporting Directive (CSRD),¹³ supplemented by the future Corporate Sustainability Due Diligence Directive (CSDDD), as well as Article 8 of the Taxonomy Regulation.
3. Investment instruments, including benchmarks, standards, and labels: (a) Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 (Low Carbon Benchmark) amending Regulation (EU) 2016/1011 as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks; (b) the aforementioned Taxonomy Regulation; (c) the Regulation on European Green Bonds;¹⁴ and (d) the EU Ecolabel Regulation.¹⁵
4. Proposed Corporate Sustainability Due Diligence Directive (CSDDD). The directive makes companies responsible for the impact on human rights and the environment of the company's operations and its value chain. But the Directive states in Article 25 that Member States must ensure that, in fulfilling their duty to act in the interests of the company, directors take into account the sustainability consequences of their decisions, including, where appropriate, the consequences in terms of human rights, climate change and the environment, including in the short, medium and long term. The direct accountability of directors, provided for in Article 26, has disappeared in the latest version of the proposal.

These acts are applicable in Portugal, either directly or indirectly. The NFRD, in particular, was transposed by Decree-Law 89/2017 of 28 July, which amended the Companies Code (introducing Articles 66-B, 508-G and 546 and amending Articles 65, 451 and 528) and amended Article 246-A of the Securities Code, while the transposition of the CSRD is still underway.

In addition, Portugal's commitment to sustainable finance is enshrined in the Basic Climate Law,¹⁶ with Article 3(m) stating that ‘public climate policies aim to achieve ecological balance by fighting climate change and pursuing the following objectives: m) boosting sustainable finance and promoting information on climate risks for economic and financial agents’. Sustainable finance - whether at the State or private level - is governed by a set of principles laid out in Article 34 of the Basic Climate Law.

For its part, Article 38 of this law requires that ‘the duties of care, loyalty, management reporting and presentation of accounts include prudent consideration and the sharing of transparent information on the risk that climate change poses to the business model, capital structure and assets of companies’.

What's more, we can't ignore the so-called ‘multiplier effect’, which means that a country's legislation or European legislation (for example) becomes applicable to companies to which prima facie itwouldn't apply, through contracts: companies subject to a jurisdiction where such duties are in force contractually impose them on companies in other jurisdictions.¹⁷  This well-known ‘cascade effect’ (or ‘Brussels effect’, when applied to European legislation) is also accompanied by the adoption of international sustainability standardsin contracts and the adoption by companies of codes of governance, to which they are bound even in the logic of comply or explain.

Sustainability concerns are addressed, for instance, in the Governance Code of the Portuguese Institute of Corporate Governance,¹⁸ revised in 2023. Principle I.A states that ‘in their organisation, operation and in the definition of their strategy, companies shall contribute to the pursuit of the Sustainable Development Goals defined within the framework of the United Nations Organisation, in terms that are appropriate to the nature of their activity and their size’. For its part, Principle I.B. states that ‘the company periodically identifies, measures and seeks to prevent the negative effects related to the environmental and social impact resulting from the exercise of its activity, in terms adjusted to the respective nature and size of the company’. Principle I.C. indicates that ‘in its decision-making processes, the management body weighs up the interests of shareholders and other investors, employees, suppliers and other stakeholders in the activity of the company’. The issue of sustainability also deserves attention in Chapter VIII of the Governance Code, regarding the adequacy and disclosure of non-financial information, as well as in Chapter VII, dedicated to internal control, which incorporates recommendations on environmental and social risk.

Sustainability in soft lawstill has a long way to go. The revision of the UK Corporate Governance Code¹⁹ is a good example of the process that is needed.

There are conflicting views on the changes underway: some emphasise the risk of excessive liability for directors due to the dense web of duties related to sustainability that have been added to the traditional set of duties; others, on the other hand, believe that the existence of new benchmarks for directors' actions creates room for them to invoke the pursuit of the interests of certain stakeholders in the face of any potentially harmful action, and that ‘responsibility to all is responsibility to none’. Admittedly, there can be little doubt that the demands placed on directors and the risks inherent in their activity have worsened, especially when the very requirements for the operation of the business judgement rulehave also changed, as we shall see.

3. The Juridification of Stakeholders' Interests and the Structural Transformation of Corporate Law

Rather than being at the center of governance systems, shareholders act almost exclusively as referees to the company's management, although the latter is obliged to take other interests into account. In private limited companies, shareholders have formal control over management. Even in public limited companies,²⁰ the general meeting - as the meeting or representation of the company's owners - is the sovereign body, is neither elected nor appointed by anyone else and decides on the most important corporate issues (e.g., corporate changes and structural modifications).²¹ This means that, in practical and legal terms, directors - elected and controlled by the shareholders - are empowered to decide on management matters, but these powers are merely a consequence of the necessary professionalisation and streamlining of company management. Thus, the operational or practical centrality belongs to the management body, but the structural or fundamental centrality continues to belong to the general meeting, which naturally poses difficulties when it comes to introducing different corporate management references.

The truth is that in public limited companies, where the challenges of regulating interests are most acute, the board of directors concentrates almost all of the company's powers, but its centrality is merely functional and not structural. Structural centrality belongs to the shareholders. Corporate governance was therefore centered on ensuring that the directors' interests were aligned with those of the shareholders, without prejudice to the lateral consideration of the position of other stakeholders. 

Quite simply, the above set of duties means that today we are witnessing a ‘juridification of stakeholderinterests’,²² which is dictating a structural change in company law that is moving towards putting shareholdersand stakeholderson an equal footing. In the new green and social company law, the very foundations of company law are at stake: with more or less enthusiasm, the new company law is at the service of sustainable transformation, regardless of the wishes of the company's owners. If until now, in the confrontation between shareholder value and stakeholder value,the latter had no weapons with which to prevail in concrete, the regulatory change that has taken place dictates an equalisation of interests and the end of the practical prevalence of shareholder interests.

It cannot be denied that this change represents an interference by public policies in the purely private structure of company law²³ and translates into a functionalisation of private law, albeit justified by the climate emergency. Corporate law is recovering some of the institutional interference that had disappeared.

While it is often argued today that financial and sustainability interests naturally converge, in the day-to-day practice of corporate decision-making it will always be a matter of managing conflicting values.²⁴

4. The Duties of Directors Related to Sustainability

Directors have a relevant set of duties related to sustainability:

• Duty of legality (duty to ensure compliance with sustainability regulations): although ESG duties are directed at the company,²⁵ they indirectly become duties of the directors, despite the legal personality of the company, due to the phenomenon of organic representation. The purpose of the duty of legality is to impose directly on the director, in a personal capacity, the duty to ensure compliance with the legal, contractual and other duties that affect the company. This duty, in principle, is only internal, but it cannot be excluded that, in exceptional cases, it may be interpreted as a duty to protect third parties, thus opening the door to external liability of the directors, with the inherent dangers.²⁶ This is an issue to be discussed further.
• Duty of organisation and compliance: the duty of legality derives from the duty to monitor compliance with sustainability obligations, dogmatically situated in the area of the duty of care. Depending on the size of the company, its complexity and the specific risks involved, it may be necessary to formally implement internal risk management and compliancesystems.
• Duty to monitor ESG risks in general: the scope of the duty of complianceis unclear, particularly in terms of whether it extends to a duty to monitor sustainability risks. Monitoring compliance with specific legal rules and duties is not to be confused with the duty to implement internal reporting and control systems for ESG risks (e.g. climate aspects, scarcity of environmental resources, labour issues, human rights). The Portuguese Institute of Corporate Governance (IPCG) Governance Code establishes, in Chapter VII on internal control, a duty for the company to set up processes to collect and process data related to environmental and social sustainability, to alert the management body to the risks the company is incurring and to propose strategies for mitigating them. It also must report on how climate change is taken into account in the organisation and how it takes climate risk analysis into account in decision-making processes.
• Duty to adopt the most sustainable solution, provided that it does not involve an unreasonable sacrifice of shareholder interests. Placing the interests of stakeholders at the forefront of corporate action, alongside profit, implies that, in addition to the specific duties imposed by law or contract, directors have a duty to adopt the most sustainable decision that does not involve a disproportionate sacrifice of shareholders' profit interests. This is a residual duty that comes into play only in the absence of a specific rule.
  

  The affirmation of this general duty to act sustainably is directly related to the interpretation of the meaning of the business judgement rule. According to Article 72(2), ‘liability shall be excluded if any of the persons referred to in the preceding paragraph proves that he acted in full knowledge of the facts, free from any personal interest and in accordance with the criteria of commercial reasonableness’. In order to define the limits of the manager's discretion, the rule needs to be reinterpreted in order to define the intended link between sustainability and profitability.

• Commitment to implementing a culture of sustainability: organisational culture²⁷ plays a fundamental role in putting sustainability principles and rules into practice. The culture should be ‘ethical’, i.e. conducive to an allocation of capital that contributes to economic stability, employment and general well-being. There are two ways of promoting an ethical culture: top-down and bottom-up. In the first case, standards are set by international and national regulators to deter unethical behaviour and promote ethical behaviour; in the second, companies themselves promote an ethical culture. This is ‘instrumental ethics’,²⁸ which does not contradict the development of business, but rather serves it. The ethical elements - trust and reputation - are generated by the market and aim to maximise shareholder value. In addition to approving the Code of Conduct, it is the responsibility of the Board of Directors to develop a ‘speak-up’ culture, i.e. an environment that encourages questioning of information and behaviour in the area of sustainability.

5. Business Judgment Rule and sustainability

In the age of sustainability, the meaning of the business judgement rule needs to be reviewed in the light of the balance of interests that it is supposed to seek. In line with the conclusions we have drawn so far, we can say that

1. On the one hand, sustainability goals can and should be pursued by managers: a rational business decision can take into account environmental impact as well as economic impact. This means that it is legitimate for the director to justify the adoption of measures that generate less profit than could be achieved in the name of pursuing environmental or social objectives.²⁹ This is particularly clear when the company has a statement of purpose, but it is also true in the absence of such a statement, given that the legislation in force legalises the interests of stakeholders, making them legitimate (and perhaps necessary) references for the company's actions.
2. A reasonableness or proportionality test applies: the commercial enterprise remains fundamentally profit-driven. Therefore, a director who deviates from shareholder value in order to pursue stakeholder value is acting within the scope of his recognised management freedom, only as long as he remains within the bounds of reasonableness. This is the solution that emerges from the combined interpretation of the Portuguese Companies Code and the Basic Climate Law, and (even if it doesn't formally change the national legal landscape) the future CSDDD.
3. On the other hand, as long as the imperative standards of sustainability are being met, a less favourable decision from an environmental or social point of view may still be justified by the creation of shareholder value, always within the logic of balance and proportionality. Thus, the application of thebusiness judgement rulepractically becomes an exercise in balancing interests and incorporates a criterion of reasonable sacrifice.
4. We should go one step further and impose a mandatory test of compliance with environmental and social standardsin the application of the business judgement rule. In other words, managers must justify their behaviour in the light of sustainability standards, which become part of business rationality, even if this is not explicitly stated in the law.

6. The Proposed New Wording of Articles 64 and 72(2) of the Portuguese Companies Code

In view of the above, the current wordings of Articles 64 and 72(2) are capable of meeting sustainability objectives and the new role of company law: their wording is not committed to a single benchmark for corporate action but is flexible enough to take into account the interests of the various stakeholders.

Nevertheless, we believe it is important to launch a debate on amending the rules in question in order to clarify that the value of environmental and social sustainability is not subordinate to the interests of shareholders. In order to promote this debate, we have formulated the following proposal for a new wording for Article 64:³⁰

1. The company's managers or directors must observe:

• Duties of care, demonstrating the availability, technical competence and knowledge of the company's business appropriate to their duties and, in this context, employing the diligence of a judicious and orderly manager; and
• Duties of loyalty, in the long-term interests of the company, with the aim of promoting its performance and sustained development.

2. In fulfilling the duties referred to in the previous paragraph, managers or directors shall consider the interests of shareholders, employees, customers, creditors, suppliers and other interested parties, as well as the sustainable development of the community in which the company operates, taking into account the dimension and the individuality of the company.

3. Company officers with supervisory duties must observe duties of care, employing high standards of professional diligence and duties of loyalty in the long-term interests of the company’.

In nuclear terms, the proposal is generally characterised by making clear the commitment of company law to the objectives of sustainability, without disturbing the legal system in force:

1. conservation of the structure of article 64.
2.  the introduction of a new paragraph 2, relating to the entire scope of directors' fundamental duties, which calls for the interests of shareholders and other relevant stakeholders to beweighed up, without subordinating the interests of the latter to those of the former.
3. clarification in the new paragraph 2 of the need to take into account the specificities of the company, including its size. This proportionality requirement is further clarified in the new wording proposed for Article 72(2).
4. simplification of point b) of paragraph 1, relating to the duties of loyalty, which are reported to the long-term interests of the company, as was already implicit in the current wording; clarification, in the same point, of the purpose of promoting the sustained performance and development of the company.

For the sake of the system's clarity, the change to Article 64 should, in our view, be accompanied by an amendment to Article 72(2), aimed at clarifying that the reasonableness of the decision adopted must also take into account sustainability factors.³¹

‘2. Liability shall be excluded if any of the persons referred to in the previous paragraph proves that they acted in an informed manner, free from any personal interest, according to criteria of business rationality and adequate and proportionate standards of environmental and social sustainability’.

7. Conclusion

The proposals for interpretation of the current legal system and for legislative change are intended to take seriously the role of company law in the area of environmental and social sustainability and imply a recognition that company law is an essential part of the necessary change in the legal system. However, little can be expected from the specification of directors' duties in the area of sustainability. More promising are structural interventions in corporate governance, in terms of appointments and remuneration. The selection of profiles appropriate to the company's purpose and the alignment of directors' remuneration with an organisational culture of sustainability (with concrete well-designed environmental and social metrics) create real conditions for company law to be an instrument of change towards sustainability rather than a reflection of it. Bringing public policy objectives into company law in a way that does not depend on the strategic decisions of investors and financiers is the aim of the Climate Change Act in Portugal. Interpreting the legal system as a whole, it can be concluded that company law is being transformed both from within, due to the changing priorities of investors and financiers, and from without, due to regulatory pressure. Strictly speaking, a new corporate law is emerging, with new standards and objectives for corporate behaviour. The final stage of its development will come when it is taken for granted within the institutions that the long-term financial success of the company includes the realisation of an environmental and social purpose, and, moreover, when the conditions are in place for the two interests to be weighed equally in each and every decision. For the time being, it is not realistic to expect this to happen spontaneously. Our proposal for a new wording of Articles 64 and 72(2) is intended to stimulate debate rather than to be a final proposal.