A claim by ClientEarth, the environmental pressure group, that Shell had breached legal duties by failing to adopt and implement a climate strategy to align with the Paris Agreement has focussed attention on directors and officers supply chain liability.

The letter was sent to Shell’s board members by the influential non-governmental organization (NGO) and earlier this year the “Annex to the Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937”,  stipulated that companies are liable for violations of their duties under the directive which could lead to an increase in claims brought against directors and officers.

The directive is designed to improve corporate governance practices “better integrate risk management and mitigation processes of human rights and environmental risks and impacts, including those stemming from value chains, into corporate strategies.”

With the German Act on Corporate Due Diligence Obligations in Supply Chains (LkSG) coming into force on 1 January 2023, the potential liability of directors and officers for duties under the LkSG and its coverage under D&O policies in Germany is acting as another warning sign post.

This is the first time the responsibility of German enterprises to respect human rights in global supply chains has been put on a legal footing. The aim of the LksG is to require companies that trade and sell goods produced in other nations to run background checks on their suppliers in order to prevent European wealth based on exploitation.

The LkSG stipulates fines of up to €800,000 for individuals and up to two percent of the company’s annual turnover for corporates for violations of the duties of care imposed on the directors and officers. Legally, fines can be imposed on the directors and officers, on the company or on both. However, companies will only be responsible for what they can control within their supply chain.

A D&O policy is designed to insure civil damages awarded against directors or officers (known as Side A cover), or to reimburse companies where the company paid such sums to the director or officer (known as Side B cover). Standard D&O policies also cover the legal defence costs and investigation costs as well as the award of damages. Some policies also extend to cover punitive and exemplary damages, where legally permitted. Typically a D&O policy does not cover fines or penalties, particularly where these are criminal sanctions, as to insure these would be deemed against public policy.

While civil claims for violations of the LkSG duties appear to have limited success, it is important directors and officer clearly understand the potential risks and put in place specialist insurance coverage. Documentation of all actions related to the duties set out in the LkSG is paramount for both companies and individuals.

Based on the current German general tort law provisions (Sec. 823, 1004 BGB) there have only been a limited number of lawsuit successes. There is an appeal pending on a lawsuit against RWE, a German energy company,  after the company succeeded in the first instance and Daimler prevailed over an NGO in the first instance in proceedings over injunctive relief. However, the LkSG could provide NGOs with another avenue for activist litigation by pursuing the directors and officers of companies instead.

The LkSG itself does not provide a basis for civil liability for violations of the duties set out under the LkSG – Sec. 3(3) and goes as far as explicitly negating any civil liability for the violation of these duties.

The correct interpretation will be for the German courts to decide but it is conceivable for an NGO to bring a claim based on Sec. 823(1), 1004 BGB  and if granted, D&O policies would likely cover any recourse claim for damages brought by companies against their directors and officers who violated duties stipulated by the LkSG . Claims for injunctive relief would likely not be covered under D&O policies. Policies from outside of Germany sometimes cover fines.

Under German law there is an ongoing  debate whether a recourse of the company for fines imposed on it due to violations of LkSG duties by its directors and officers is admissible with a clarifying decision of the German Federal Court of Justice expected. However, even if a recourse would be admissible under German law, it would generally be exempted from coverage under A-7.10 of the GDV conditions, which excludes all coverage for fines against the companies.

W Denis Europe offer Directors and Officers Liability Insurance to companies across the EU, from small start-ups, to major public listed entities with global exposures. For any enquiries, please contact Vida Jarasiunaite Vida.jarasiunaite@wdenis.eu or Mark Dutton mark.dutton@wdenis.com