The growing risk of ESG litigation


Guest post from James Whitaker, a partner at international law firm Mayer Brown

Whitaker: ESG is a tool to achieve behavioural change

The rapid rise of environmental, social and governance (ESG) issues, and the intense focus of legislators, regulators and investors on sustainability, across jurisdictions and industry sectors, has led many businesses to look closely at their ESG credentials.

Similarly, as investors and financial services providers flock to sustainable products and companies, ensuring ESG credibility is quickly becoming imperative for all businesses, in order to respond effectively to growing shareholder, and other stakeholder, demands.

Good corporate citizenship – as commonly measured against ESG metrics – is, now more than ever, a fundamental business issue. The increased public awareness of, and pressure to improve performance against, those ESG metrics brings with it a new range of risks and exposures, with which all companies should be familiar.

What is ESG litigation?

The concept of ESG litigation covers a multitude of exposures, some of which are long established, others of which are more recently emergent, but all of which are becoming more prevalent.

The nature of much of the emerging ESG litigation – and ESG-specific extra-judicial dispute resolution mechanisms – reflects the interrelationship, and overlap, between the three strands of ESG, but it is clear that all three are increasingly fertile ground for action, from multiple stakeholders, including private claimants, NGOs and pressure groups.

While the aim of ESG litigation may still be to obtain compensation, it is also emerging as a tool to achieve a broader objective of behavioural change.

Environmental

Litigation focusing on the ‘E’ of ESG continues to grow at a considerable rate, but it builds on a wealth of established cases.

Climate litigation specifically, has been a feature of the broader litigation landscape for many years. High-profile cases targeting national governments in respect of their climate strategies and measures, encouraged by the outcome of the Urgenda case in the Netherlands, in which the Dutch Supreme Court found that the government had a legal obligation to seek to prevent climate change, are increasingly emerging.

So too, particularly in more recent year, are claims against companies and financial institutions, often deploying developments in climate attribution techniques and methodologies to overcome the traditional causation difficulties encountered in much of the early climate-related litigation.

These cases involve a range of stakeholders, from investors to non-profit pressure groups, seeking to use existing legal frameworks to pursue redress, either on behalf of themselves, or of others thought to have been impacted.

Social

More recently, the increasingly prevalent actions targeting companies whose supply chains reveal human rights or other ethical infringements (for example, inadequate health and safety procedures and safeguards); the growth of litigation arising out of data protection lapses and privacy infringements, as well as the recent employee and workforce actions in the UK courts, often in the context of the gig economy, reflect the increasing litigation exposures in the context of the social issues.

Governance

Similarly, the increasing focus on individual performance and accountability of those running and managing companies, whether in the context of directors’ duties and obligations, or anti-bribery and corruption and other ‘white collar’ practices and offences, has in recent years seen an increase in litigation around governance issues.

(The UK government’s recently launched consultation on corporate governance exemplifies the focus on this area.)

This is evident in the high-profile board diversity and inclusion disputes that have emerged in the US in particular; the multiple regulatory investigations and court actions concerned with alleged bribery and corruption; and the number of claims targeting directors for alleged breaches of statutory and fiduciary duties.

ESG disclosures

Perhaps the single most significant emerging factor in the context of ESG litigation, which overlays each of the three elements, is the prevalence of ESG reporting and disclosures, whether on a voluntary basis (perhaps in response to investor pressure) or pursuant to one or more of the growing number of mandatory reporting requirements.

Of course, there can be many benefits to companies making accurate and considered ESG disclosures, but there are also risks.

In that context, a principal area of exposure for corporates, and financial institutions, arises from the dangers of misstatements, misrepresentations or omissions, regarding ESG performance. The recent high-profile Australian case of McVeigh v Retail Employees Superannuation Trust, which concerned an alleged failure to provide adequate information on the risks to a pension fund’s investments posed by climate change, is one such example.

As voluntary disclosure frameworks are increasingly replaced by mandatory requirements, this risk will increase.

Notable examples of this trend are the 2017 recommendations regarding financial disclosures of the Task Force on Climate-related Financial Disclosures (TCFD); the UK government’s subsequent announcement of its intention to make TCFD-aligned disclosures mandatory across the economy by 2025 (and in many instances potentially far earlier); and the EU’s Sustainable Finance Disclosure Regulation, which seeks to address the phenomenon of ‘greenwashing’, whereby organisations misrepresent their green credentials.

Similarly, the UK Modern Slavery Act’s requirement for mandatory annual modern slavery statements – and the accompanying ‘name and shame’ policy in respect of non-compliance – is also reflective of the trend towards mandatory human rights reporting.

If organisations are found to have misstated the position in some way, regulators will take a close interest, as will investors, particularly if – in the context of public companies – there is a steep fall in share value once corrective disclosures are made.

Company directors will also increasingly find themselves in the crosshairs. Statements to the market around performance in ESG areas, whether pursuant to mandatory reporting requirements or otherwise, which turn out to inaccurate or misleading in some way, may form the basis of an action, from shareholders, regulators, or other stakeholders.

Why is ESG litigation on the rise?

The evident societal shift in favour of sustainability, ethical business conduct and accountability for that conduct, mirrored in the wealth of emerging legislation and regulation and growth of shareholder (and other stakeholder) activism, has discernibly increased the extent, or risk, of ESG litigation.

Legislative and regulatory developments, in the UK, the EU and across the world, have continued, and will continue, apace.

As mandatory ESG disclosure obligations (particular, but not exclusively, in the context of climate impact and human rights) become more pervasive, businesses will need to contend with stricter requirements, and will be under close scrutiny in doing so.

Recent high profile judicial developments in the UK – notably the Supreme Court judgments in Vedanta (2019) and Okpabi (2021) – mean that parent companies will increasingly be held accountable for the conduct of and standards within their overseas subsidiary companies, as well as in their supply chains, thereby expanding the scope of responsibilities and, of course, exposures.

Against that backdrop, in the UK in particular, the recent rise of ESG awareness coincides with a number of other market dynamics that, together, are contributing to a spike in ESG litigation.

The emergence of viable collective litigation options in the UK is well-suited to the nature of the harms caused by ESG failings, in the sense that these issues commonly impact a large number of parties, whether they be local communities, employees, data breach subjects, or shareholders.

The huge increase in the availability of litigation funding capital is also a significant contributory factor.

The rapid rise of ESG up the corporate, social and political agenda is to be welcomed, but ensuring best practice is observed, against metrics which have not previously been used, will increasingly become imperative, as stakeholders use litigation to target those perceived as falling short.




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