June 2022 – Bulgarian law requires that the directors of Bulgarian joint-stock companies perform their functions as directors by adhering to the “duty of care” standard of a prudent businessperson and always in the interest of the company and its shareholders. If a director fails to comply, they could be held liable for any damages caused to the company.
The required duty of care standard is not easily reconciled with the current shift in corporate governance towards compliance with material ESG factors. While important for all stakeholders (e.g., employees, customers, vendors, and the communities where the company operates), ESG compliance could trigger additional financial costs and potentially be an obstacle to maximising profits. As it is expected that a prudent director would not trigger unjustified or unnecessary costs, ESG could be reconciled with the duty of care standard for directors only if it can be demonstrated that integrating ESG factors at an additional cost creates a long-term value for the business (even if not immediately shown on the company’s balance sheet).
Although Bulgarian law is silent on the scope of a director’s duty of care, it can be safely assumed that any risk management activity that maximises shareholder value will be consistent with the duty of care standard. Risk management in such a context is rather broad – it can cover all risks that a company faces in its operations, including legal, compliance and reputational risks. Failure to address such risks could result in a decline of the customer base, costly litigation, or revenue reductions and could ultimately adversely affect the company and its shareholder value. If ESG factors are incorporated with the goal to mitigate or eliminate these risks, ESG integration would in this case be in line with the duty of care standard. It could even be argued that failure to prevent such risks by not addressing ESG factors in company operations is a breach of the director’s duty of care.
ESG-related risk management could be developed on different levels.
First, and most importantly, ESG risk mitigation is about how the company is run – its transactions, operations and infrastructure. Specific ESG adjustments depend on the industry in which the company operates, but in all cases each company should consider its use of resources, environmental impact, employee work conditions and the way it deals with customer concerns, vendors and, more broadly, the wider community.
ESG risk mitigation also requires that directors set forth the goals and directions of the company towards ESG compliance and implement mechanisms to ensure that all employees and officers are engaged in identifying and mitigating ESG-related risks. To that end, it is critically important for directors to roll out specific ESG compliance standards of conduct for employees and officers. These could be brought in through company policies, codes of conduct, ethical rules, etc. They can (i) provide guidelines for employees on how to perform day-to-day operations in an ESG compliant way, and (ii) generally enhance the firm’s culture related to ESG compliance.
Additionally, directors could set up multi-layer control within the company to ensure ESG compliance of the entire business. One possible avenue is to hire ESG specialists to improve the overall quality of ESG compliance. Alternatively, the company could consider assigning internal control/oversight functions at all levels to experienced employees who would specifically identify and mitigate ESG risks to preserve the business and its reputation.
Finally, specific attention should be paid to public perception. Failure to address ESG risks as part of a company’s activity could negatively affect its reputation, especially given the popularity of voluntary ESG standards and disclosure schemes. Proactive promotion of an ESG narrative and showcasing a company’s robust credentials and strategy could not only minimise reputational risks, but also attract new investors and customers. The long-term benefit for companies that make the adjustment is becoming clearer, as international ESG legislation and regulation supersede voluntary standards. Companies— and by extension, their directors – become more and more defined by their ESG credentials. As noted by the European Commission’s Platform on Sustainable Finance in its latest recommendations to EU legislators, executive pay should be linked to sustainability factors as a response to what is already happening in the real economy.
In summary, aligning business activities with ESG goals and setting up internal mechanisms for ESG compliance as part of a company’s risk management policies could be considered as creating long-term value for the company and its shareholders, despite any additional costs incurred. In fact, it is likely that such ESG integration will steadily become a core part of the standard of care required from directors under Bulgarian law.
The article was originally published in the first-of-its-kind ESG Report for Bulgaria by SeeNews. The full report is available here.