Directors due diligence defence: Revisited in a climate change context

  • Opinion

    16 October 2023

Directors due diligence defence: Revisited in a climate change context Desktop Image Directors due diligence defence: Revisited in a climate change context Mobile Image

Directors of climate reporting entities (CREs)[1] are currently grappling with the new climate-related disclosures (CRD) regime and the steps they should take to ensure that the CRE’s climate statements comply with the Part 7A climate-related disclosure provisions[2], under the Financial Markets Conduct Act 2013 (FMCA). They have a comparable level of responsibility[3] as directors have for financial statements, but the subject matter of CRD is inherently more forward looking and uncertain, making the task more demanding. 

While there are various sanctions and potential defences available to directors under the FMCA[4], this article focuses on the standard required by the core defence in section 501(2) for directors if they prove they took “all reasonable steps” to ensure that the CRE complied. The defence applies to civil liability in relation to disclosure of initial offer documents, ongoing and simplified disclosures, financial reporting obligations and now climate-related disclosures.[5] 

The “all reasonable steps” defence

The “all reasonable and proper steps” defence in s 501(2) was introduced with the FMCA in 2013, following the global financial crisis and the associated finance company collapses in New Zealand. The previous Securities Act 1978 did not have the defence, only one of honest and reasonable belief.[6]  

When the FMCA was in the process of being enacted, the Ministry of Business, Innovation and Employment (MBIE) advice made clear to the Select Committee that it was intended to allow reasonable delegation (when appropriate) of due diligence processes, such as through a due diligence committee, to increase efficiency and flexibility[7].  

The wording of the s 501(2) defence as enacted was similar to that contained in s 40 of the Financial Reporting Act 1993 (FRA 1993) (for offences related to financial statements)[8]. Its application to offer documents was a conscious reaction to some of the cases under the Securities Act which suggested directors were expected to personally verify prospectuses and investment statements in all cases.[9]  

In 2019, s 501(2) of the FMCA was amended to remove “and proper”, leaving the standard as solely “all reasonable steps”[10]. Given the lack of available commentary by MBIE or Parliament on the removal of “and proper”, our view is that the change to the FMCA defence was simply intended to achieve alignment with the comparable provisions in the Financial Reporting Act 2013, which replaced the FRA 1993.

During the Financial Markets Conduct Bill discussions, MBIE officials noted that although governance is a “collective responsibility”, individual directors will best protect themselves by actively engaging in this collective due diligence process – the extent of which will depend on the type of product and the nature of the business.[11] 

Compliance with the new CRD regime clearly starts at the top, with directors being required to sign off on climate statements that are compliant with the External Reporting Board (XRB) climate standards (NZ CS)[12].   However, that leaves open the question as to the level of enquiry directors should personally engage in to ensure the accuracy of the contents. Do they each need to become climate experts and personally verify the contents of the disclosure? Or if they do decide to delegate preparation, what level of oversight will they be expected to exercise? 

The first point is that the CRD regime has a different, and more formal status than the voluntary climate disclosures that many companies have engaged in to date, often by reference to the TCFD Recommendations.[13] 

Voluntary climate-related disclosure falls under the general conduct obligations in Part 1 of the Fair Trading Act (FTA), which prevent voluntary climate reports from reflecting any misleading and deceptive conduct, or contain any false or misleading representations or unsubstantiated representations[14]. Where financial products and services are concerned, voluntary climate reports are subject to the fair dealing provisions under Part 2 of the FMCA which mirror the Part 1 FTA provisions[15]. A voluntary climate report may also be an “advertisement” for the purposes of Part 3 of the FMCA, bringing them under the advertising requirements, but only if the entity is issuing a specified product[16]. However, there are no formal requirements as to the content, and importantly liability falls primarily on the legal entity issuing the disclosure, rather than personally on directors or others (assuming they are not knowingly involved in the contravention). 

By contrast, mandatory CRD disclosure, in addition to the relevant fair dealing regimes as discussed above, must also comply with the prescribed requirements of the Part 7A FMCA provisions. Those include making disclosures in compliance with the requirements of the NZ CS. In broad terms, the requirements and legal responsibilities parallel those under Part 7 of the FMCA (for financial reporting). 

Climate statements and financial statements are intended to be released in tandem with the climate reporting period being the same as the financial reporting period[17], but directors should consider whether the same due diligence approach makes sense for both reporting regimes. Although financial statements are in part forward looking, unique requirements in the NZ CS like scenario analysis are a particular pressure point for directors given their hypothetical and scientific nature.[18] 

Penalties for directors

The FMA have a range of enforcement tools available to them, one of which is seeking pecuniary penalty orders against a director. 

The maximum civil penalty for a contravention, or involvement in a contravention of disclosure, financial and climate reporting provisions will be the greatest of (s 490):

  • if ascertainable, 3 times the amount of the gain made, or the loss avoided, by the person who contravened the civil liability provision; and
  • $1 million in the case of an individual or $5 million in any other case. 

For climate reporting contraventions, a range of criminal sanctions are possible for directors:

  • Directors who are knowingly or recklessly contravening provisions related to defective disclosures on a register entry (where climate statements will be filed) will be liable on conviction to imprisonment for a term not exceeding 10 years, or an individual fines of up to $1 million.
  • Directors of CREs who knowingly fail to comply with climate standards will be liable on conviction to imprisonment for a term not exceeding 5 years, or an individual fine of up to $500,000.  
The New Zealand case law

Case law has also informed what an entity’s due diligence process should look like for the s 501(2) defence to apply. The most recent case to consider “all reasonable steps”, in the context of financial reporting under the FRA, is Prain v Financial Markets Authority (Prain).[19] 

Prain v Financial Markets Authority

In Prain, Apple Fields Limited (AFL) had failed to deliver audited financial statements to the Registrar of Companies under the FRA 1993. AFL’s directors raised the “all reasonable and proper steps” defence in the FRA 1993, arguing that AFL’s failure was due to the accountant’s advice that generally accepted accounting practice required consolidation of AFL’s financial statements and those of Noble Investments Limited (NIL). NIL was an in-substance subsidiary, but it refused to provide the necessary financial information to AFL to allow preparation of the consolidated financial statements. AFL’s directors acted on the accountant’s advice and did not register the unconsolidated financial statements. 

There was no question that AFL’s directors failed to meet the obligation to register the financial statements. Rather, the question was whether the financial statements had to be consolidated to be compliant with the relevant standards. The Court of Appeal was not prepared to infer that the accountant’s advice was wrong because the unconsolidated financial statements would still have been compliant for reasons which are not relevant for the purposes of this article, and the Court decided the directors were reasonable to follow the consolidation approach in reliance on the accountant’s opinion[20]. Accordingly, the Court held that the directors of AFL were not required to have sought a second accountant’s opinion or legal advice to meet the “all reasonable steps” defence. 

The Prain decision also indicated that the substance of the directors’ steps will be the primary focus for the purposes of the defence.

Accordingly, the Court of Appeal considered two questions in addressing the FRA 1993 defence[21]:

  • Was it reasonable for the directors to not seek a second accountant’s opinion about the consolidation requirement?
  • Was it reasonable for the directors to not seek legal advice about requiring NIL to provide the necessary information? 

Firstly, the Court of Appeal raised the District Court’s finding that AFL’s directors had honestly relied on the accountant’s advice and made diligent efforts to consolidate the financial statements. On that basis, the Court went on to find that they must be taken to have acted reasonably unless a second opinion should have been sought and there was a reason to suspect that the second opinion may have been different (that consolidation was not required).[22]   

The Court’s conclusion was that the directors were reasonable to rely on the accountant’s advice, as there was no evidence suggesting the directors had reason to suspect that the advice was incorrect[23]. To require a second opinion would be “to prefer process to substance”, but the Court acknowledged that a second opinion may be necessary in different circumstances, such as where the directors have (or should have) doubts about the accuracy of the first opinion.[24]

On the second question, the directors were found to have acted reasonably in not seeking legal advice. Even though the evidence suggested that legal advice would have made no difference, because AFL “did not control [NIL] in any orthodox sense”, the Court concluded regardless that the FRA 1993 defence did not require the directors to take legal advice.[25]

Substantive reasonableness therefore may look like obtaining expert advice, and whether directors can rely on that advice without going further will depend on whether the circumstances give rise to any doubt as to the merits of the advice[26]. Exhausting every single avenue in an attempt to comply may not be reasonable in situations like getting a second opinion when directors reasonably believe the first one is correct, or seeking legal advice knowing it will not solve the non-compliance.

Ministry of Economic Development v Feeney

An earlier District Court decision that was referenced in the Prain proceedings, Ministry of Economic Development v Feeney (Feeney)[27], also considered the due diligence defence under the FRA 1993 and came to a similar conclusion. The Court found that the directors of Feltex Carpets Ltd reasonably relied on the company’s financial management team and on Ernst & Young who reviewed and produced a report on the company’s financial accounts[28]. The directors had engaged in a variety of prudent due diligence steps[29], and Doogue J concluded that the directors would have had to undertake extensive analysis of the new NZIFRS standards to pick up on the breach – an unrealistic and unreasonable expectation.[30]

Although the Feeney decision was only at the District Court level, its circumstances have parallels with the CRD regime, in that it involved a new regime, and the directors were relying on a substantial due diligence process which involved external experts. 

Directors of CREs may have to lean on external experts and sources to produce NZ CS-compliant climate reports, such as in relation to the strategy disclosures like scenario analysis and reporting greenhouse gas (GHG) emissions. If not now, CREs will be required to obtain assurance engagements over their GHG emissions for reporting periods ending on or after 27 October 2024.[31]

The Australian approach

It is important to be aware that the Australian Courts have taken a somewhat different approach. 

The Federal Court of Australia’s most recent consideration of a similar defence in s 601FD(1)(f)[32] of the Corporations Act 2001 (Cth), in Trilogy Funds Management Ltd v Sullivan (No 2) (Trilogy)[33] can be argued to be broadly consistent with Prain and Feeney, even though the defence was unsuccessful. In that case, the Court accepted that there are circumstances in which directors would be entitled to delegate compliance steps. However, this would likely not be reasonable if it became apparent to the directors that the delegation would result in non-compliance, or if they failed to monitor the person they had delegated to.[34] 

However, the New Zealand approach in Prain and Feeney contrasts with the earlier Federal Court of Australia’s decision in Australian Securities and Investments Commission v Healey (Centro).[35] In Centro the Court held that the directors must have read and understood the financial statements to have taken “all reasonable steps”, and because they had failed to do so they were found liable. The Court considered that the directors would have identified the error in the statements had they properly considered them[36], behaviour that sets them apart from the more prudent and actively engaged directors in Prain and Feeney. Interestingly the Federal Court in Trilogy referenced the Centro statement that directors must monitor and familiarise themselves with the company’s financial position[37], a reference that may seem counter intuitive to its acceptance of delegation and reliance. Perhaps the reconciliation is that the meaning of “all reasonable steps” is very context dependent.

The Supreme Court of Victoria in Clarke (as trustee of the Clarke Family Trust) v Great Southern Finance Pty Ltd (Receivers and Managers Appointed) (in liq) (Great Southern)[38] took a similar approach to Trilogy and Feeney by concluding the directors were reasonable to rely on the due diligence committee alongside an effective review and monitoring process of that committee, and therefore had the benefit of a defence in s 1022B(7) of the Corporations Act.[39] The proceedings related to defective offer documents for a managed investment scheme, and although they ended in a settlement, Croft J attached an annexure to the Court’s judgment approving the settlement with a discussion of the establishment of the reasonable steps defence. 

Final takeaways

Although due diligence processes will differ across different types of products and business types, generally the approach should involve:  

  • Delegating the verification of disclosure documents, financial statements, and climate statements to a due diligence committee;
  • Ensuring that the members of the due diligence committee and its processes are adequately monitored and reviewed regularly;
  • Obtaining expert advice – externally or internally – provided the directors are assured the advice is given by someone with the requisite skills and competence. Whether the directors can rely on that advice depends on if the directors have reason to doubt its accuracy; and
  • Directors signing off on a compliance report from the due diligence committee and undertaking a post-process review.

In a practical sense, a crucial part of a due diligence process is to establish and document a plan for how the process is actually conducted for each relevant disclosure document, including climate statements, and then ensure that plan is followed. 

The Financial Markets Authority (FMA) has released draft record keeping guidance for CRD records which has relevance for a documented due diligence process.[40] The guidance is about supporting evidence rather than evidence of a good due diligence and verification process, but the FMA states “Without proper supporting documentation, it can be unclear whether an entity and its directors have sufficiently considered, understood, and reviewed their disclosures, and whether these are based on reasonable and well-considered inputs and assumptions”.[41] 

Having good record keeping policies in place ensures that the content of climate statements can be substantiated. Efficient record keeping may look like using one central digital platform to store all evidence related to the climate report and the accompanying due diligence process, which would be readily and easily accessible and able to be updated by all parties involved.[42] 

Echoing the level of involvement in due diligence processes for financial reporting, in relation to climate reporting, the XRB said in its guidance that “directors play a critical role in providing high-level strategic oversight of an entity’s climate-related disclosures”.[43] CREs must disclose how the governance body is addressing climate-related risks and opportunities and how management is structured to share this responsibility.[44] These requirements are in relation to a CRE’s approach to climate change itself rather than the process for disclosing and lodging climate statements. Even so, the same ideas should be applied to ensuring a workable and effective due diligence process for compliance with the CRD regime.

Considerations for a due diligence process 

Due diligence processes should be documented in a written plan. Directors should actively assess whether it is appropriate to have individual plans for each document to be verified, or whether a single plan can provide for multiple documents. 

In each case, the objective of the process should be both to make sure that all representations and factual statements are substantiated, will not be false, misleading or confusing, and will comply with the specific legal requirements for content, in this case in Part 7A of the FMCA (and regulations) and the NZ CS.

When creating and monitoring these documented plans, directors should consider:

  • who has the various roles and responsibilities, and how and why those persons have been selected;
  •  what exactly those persons are going to do and to what standard;
  • how verification is done and by who;
  • how other stakeholder comments are obtained and incorporated;
  • how facts are substantiated and how evidence is stored;
  • what written evidence and sign-offs will be produced during the process (and to whom the sign-offs are addressed); 
  • how and where that written evidence will be retained so that it can be accessed in the event of challenge to the content of the relevant document; and
  • what the post-process review and improvement process is, to allow for continuous improvement.  
This article was co-authored by Hannah Cross, a Solicitor in our Banking and Financial Services team. 


1. The definition of climate reporting entity can be found in the Financial Markets Conduct Act 2013 [FMCA], s 461O. It is expected to capture around 200 entities.
2. Defined in s 461ZK (3) and (4) of Part 7A, as being s 461V (climate reporting entities must keep proper CRD records); ss 461Z to 461ZC (climate statements and group climate statements must be prepared); s 461ZI (climate statements must be lodged); and s 461X (CRD records to be kept for 7 years).
3. Under s 534 of the FMCA, every director of an entity at the time of the contravention must be treated as also having contravened the relevant disclosure provision, and may be ordered to pay a pecuniary penalty unless a defence applies. 
4. Section 499(1)(a) (defence if a director is able to prove that contravention was due to reasonable reliance on information supplied by another person (not being a director, employee or agent of the director); s 500 (defence where the director proves they made all inquiries (if any) that were reasonable in the circumstances and after doing so, believed on reasonable grounds that the statement was not false or misleading or that there was no omission from disclosure materials); s 503 (defence covers civil liability provisions more generally, and could apply to a director involved in a contravention).
5. Section 501(1) provides that the relevant provisions are ss 82 (defective disclosure in a PDS or register entry), 99 (defective ongoing disclosure), 427 (defective disclosure statements for DIMS licensees), 460 to 461B, 461D, and 461H (financial reporting obligations), 461Z to 461ZC, and 461ZI (climate-related disclosures) or cl 27 of sch 1 (defective simplified disclosure under cl 21 of sch 1).
6. Securities Act 1978, s 56(3) (in relation to civil liability) and s 58(2) and (4) (in relation to criminal liability).
7. Ministry of Business, Innovation and Employment Financial Markets Conduct Bill – Officials’ Report Part B: Table of Submissions with Comments and Recommendations (26 July 2012) at 100-101.
8. Which has since been repealed and replaced by the Financial Reporting Act 2013, where the comparable defence is now in ss 36H and 38. 
9. Office of the Minister of Commerce “Financial Markets Conduct Regulations Paper 2: Disclosure and General Matters” (Paper addressed to the Chair of the Cabinet Business Committee, June 2013, MBIE-MAKO-4717978) <> at [29].
10. Financial Services Legislation Amendment Act 2019, s 41.
11. Ministry of Business, Innovation and Employment Financial Markets Conduct Bill – Officials’ Report Part B: Table of Submissions with Comments and Recommendations (26 July 2012) at 106.
12. See ss 461Z – 461ZC of the FMCA; External Reporting Board Director preparation guide (December 2022) <>.
13. The Task Force on Climate-related Financial Disclosures (TCFD) Recommendations, published in June 2017 (available here), are a leading framework for climate-related disclosures and were endorsed by the New Zealand Government in 2019.
14. Fair Trading Act 1986, ss 9, 12A and 13.
15. This latter requirement is particularly important because it means that an entity must ensure that it has reasonable grounds for the representation at the time it is made, irrespective of whether the representation is false or misleading, or true. Practically, this requires a degree of due diligence, and retention of evidence of the reasonable grounds, so that if later challenged, the entity can prove its substantiation. 
16. Those specified products being financial products of a kind that are issued by a registered bank, debt securities issued by a registered bank, or financial products of the kind prescribed that are issued by a subsidiary of a registered bank or prescribed currency forwards that are issued by a registered bank or its subsidiary.
17. Although for NZX-listed issuers who are CREs there may a one-month mismatch. The Financial Markets Authority is currently considering a class exemption for these entities from the requirement to include a link to their climate statements in their annual report for this reason (the consultation document is available here, but submissions closed on 7 August 2023).
18. An entity must report on its scenario analysis to identify its climate-related risks and opportunities, including a description of how an entity has analysed, at a minimum, a 1.5 degrees Celsius climate-related scenario, a 3 degrees Celsius or greater climate-related scenario, and a third climate-related scenario: External Reporting Board Aotearoa New Zealand Climate Standard 1: Climate-related Disclosures [NZ CS 1] at page 8.
19. Prain v Financial Markets Authority [2016] NZCA 298 [Prain v FMA].
20. At [35] – [36].
21. At [30]-[40].
22. At [30].
23. Prain v FMA at [36].
24. At [32]. See also R v Graham [2012] NZCCLR 6 at [34]. 
25. Prain v FMA at [39] – [40].
26. Prain v FMA at [32].
27. Ministry of Economic Development v Feeney (2010) 10 NZCLC 264,715 (DC).
28. Ministry of Economic Development v Feeney at [78]-[84].
29. These steps included declarations by the chief executive officer and chief financial officer regarding compliance with the FRA, using an audit committee and establishing a transition process and steering committee for the effect of the new NZIFRS standards on the company.
30. Ministry of Economic Development v Feeney at [143].
31. FMCA, s 461ZH.
32. Corporations Act 2001 (Cth), s 601FD(1)(f) is a duty for an officer of a responsible entity of a registered scheme to take all steps a reasonable person would take, if they were in the officer’s position, to ensure the entity’s compliance. 
33. Trilogy Funds Management Ltd v Sullivan (No 2) [2015] FCA 1452.
34. Trilogy Funds Management Ltd v Sullivan (No 2) at [222]-[223].
35. Australian Securities and Investments Commission v Healey [2011] FCA 717 at [16]-[22].
36. At [23] and [579].
37. Trilogy Funds Management Ltd v Sullivan (No 2) at [203].
38. Clarke (as trustee of the Clarke Family Trust) v Great Southern Finance Pty Ltd (Receivers and Managers Appointed) (in liq) [2014] VSC 516. See more Australian case law: Termite Resources NL (in liq) v Meadows (No 2) [2019] FCA 354 at [180], citing Australian Securities and Investments Commission v Maxwell [2006] NSWSC 1052 at [101]. See also Australian Securities and Investments Commission v Flugge & Geary [2016] VSC 779 at 1874. 
39. Corporations Act 2001 (Cth), s 1022B(7) provides a defence in relation to defective disclosure if the person took reasonable steps to ensure that the disclosure document or statement would not be defective.
40. Financial Markets Authority Proposed guidance and expectations for keeping proper climate-related disclosure records (June 2023).
41. Financial Markets Authority Proposed guidance and expectations for keeping proper climate-related disclosure records (June 2023), page 5.
42. One of the proposed regulations in the MBIE Exposure Draft of the Financial Markets Conduct (Climate-Related Disclosures) Amendment Regulations 2023 is regulation 252A, which will require records to be identifiable and comprehensible to reasonably enable the person requesting them to ascertain whether the records are compliant.
43. External Reporting Board Director preparation guide (December 2022) <>.
44. NS CS 1 at page 6 -7.