ESG: protecting against risks

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This note outlines guiding principles for policymakers to keep in mind in the context of the major ESG-related litigation and regulatory risks facing companies today.

Guiding principles for decision makers

Responsibility is essential. Public demand, be it consumers, investors or otherwise, is emphasizing ESG and making it a boardroom issue. Decision makers in a business should be guided by the following key principles:

  • Board Accountability: there is a growing divergence of priorities between shareholders/investors who want to see a return and those who are ready to prioritize ESG to the possible detriment of immediate return. Boards must manage these competing interests. Clear information about the direction of the board and recorded decision-making are essential to protect the board.
  • Global issues: Global companies must navigate the different legal and regulatory regimes in which they operate. Not only can this be onerous and suffocating, but it can create risks for English parent companies who take responsibility for the conduct of their foreign subsidiaries. A careful balance between a top-down approach and the autonomy of local councils is necessary.
  • Overreach: the legal and regulatory framework, in particular for environmental and sustainability issues, has become vast and complex. Companies need to make sure they understand the initiatives/businesses they are pursuing and try not to do too much too soon. The desire to seize opportunities or simply keep pace with competitors cannot eclipse careful planning, due diligence, risk assessments and taking advice.
  • Surveillance: management must ensure that well-intentioned ESG initiatives or investments are monitored and supervised correctly and at all times. Having internal policies, structures, accountabilities and reporting lines in place will ensure that promises made are kept and any issues that may arise are identified early and resolved. All this minimizes the risks.

The risks

Risk 1: contentious innovation

The litigation landscape is becoming more challenging for companies and their boards due to the number of creative avenues through which plaintiffs bring ESG-related claims under English law. Claims are often brought by NGOs or funded parties with sufficient budget.

Examples of litigation innovation include potential derivative actions against corporate executives for failure to meet climate commitments and, therefore, breach of duty to the company.[1] Activist shareholder ClientEarth touted its letter ahead of the action against Shell directors as a ‘milestone’ in climate litigation, being the first attempt to hold a company’s board personally responsible for failing to properly prepared the transition to net zero.[2] Proving no fault in these circumstances may require extensive disclosure of decision-making at the board level to demonstrate that the directors acted in accordance with their duties.

Another potential avenue for plaintiffs with sufficient resources is to sue the English parent companies here in England in relation to alleged torts committed thousands of miles away by the English company’s subsidiaries. A recent authority from the UK Supreme Court has confirmed that an English company can assume a duty of care towards third parties affected by the alleged negligence of the foreign subsidiary on foreign soil where the English company has assumed proximity and sufficiently close intervention on the management of subsidiaries that can figure in a well-intentioned approach to upgrading the whole group to meet global standards.[3]

While it remains to be seen whether either cause of action would succeed at trial, it may well be that success at final judgment is not the plaintiffs’ innovative goal: when the goal is financial, they can reach a quick settlement and, when the goal is purely altruistic, the media attention and its consequences may prove sufficient to guarantee the desired end result.

In any event, these more innovative avenues may seem legally difficult today, but as the court of public opinion changes, it may well be that legislation and judicial opinion may not be far behind, from so that once ambitious claims will become simple.

Risk 2: Greenwashing litigation and disinformation

The increased accountability of companies, funds and other institutions with respect to their ESG commitments has led to an intense focus on greenwashing and even green-hushing (whereby companies provide very limited ESG information or disclosures of fear of being accused of greenwashing).

Greenwashing is likely to underpin misinformation claims and the possibilities are vast. For example, claims could arise for breach of compliance or accounting safeguards in a stock sale and purchase agreement, misrepresentation by private entities or publicly traded companies under Sections 90 and 90A of the Financial Services and Markets Act 2020, accounting claims for failure to provide adequate provision to meet ESG disclosure commitments or consumer claims for mis-selling. There are also UK and international precedents of complaints being made to advertising authorities for wrongly describing products as ‘green’ or ‘eco-friendly’.

Risk 3: biodiversity

Biodiversity is often referred to as the next frontier in environmental litigation and regulation. The Nature-Related Financial Disclosures Task Force is expected to be finalized by 2023,[4] and this will no doubt encourage a broader focus on the need to protect biodiversity and provide tangible data points related to nature. Internationally, complaints have been filed against private entities and governments due to their perceived contribution to biodiversity decline. It seems logical that claims will follow in England and Wales.

Similarly, the campaign to formalize “ecocide” as an international crime is gaining momentum at the governmental/parliamentary/UN level in several jurisdictions. Ecocide is defined as “unlawful or wanton acts committed in the knowledge that there is a substantial likelihood of serious and widespread or long-term damage to the environment caused by such acts”[5]. The reaction to this global movement is indicative of increased international interest.

Risk Four: Not Keeping Up

The past five years have seen huge changes in England and Wales with respect to ESG-related legislation and litigation. The next five years will likely see bigger changes at a faster pace. Companies must keep pace and must commit commensurate resources to do so.

New legislation could be as broad as a codified right to a healthy environment (which the English court recently confirmed does not exist in current legislation)[6] or revisions to the Companies Act 2006 to ensure shareholders’ interests are advanced alongside wider society and the environment.[7]

Fifth risk: regulatory risk

Companies that operate in financial services also face regulatory risk related to ESG issues. Greenwashing is high on the UK Financial Conduct Authority’s enforcement agenda and the FCA recently proposed a set of new measures designed to reduce greenwashing and improve consumer confidence in electronics products. sustainable investment.[8]

The proposed rules (which will initially apply to asset managers operating in the UK) include: (i) the introduction of sustainable investment labels to identify and categorize investment products according to their sustainability characteristics ; and (ii) new disclosure requirements regarding key sustainability-related features of an investment product. There is also a proposed ‘anti-green money laundering’ rule which will apply to all FCA-licensed businesses and reinforce the existing position that sustainability claims must be clear, fair and not misleading.

The rules are expected to be finalized next year. Meanwhile, the FCA said it is “strengthen its commitment to monitoring sustainable finance and strengthen its implementation strategy”.[9]

The FCA already has an extensive toolkit of oversight and enforcement powers. We are seeing an increasingly active approach to FCA oversight of asset management companies focusing on sustainability. It may take some time to see enforcement results released, but we expect to see an increasing number of enforcement investigations. Board oversight and accountability are likely to be key areas for the FCA and companies should ensure they have appropriate ESG policies and processes in place that are sufficient to withstand regulatory scrutiny.

Conclusion

The focus on ESG is here to stay. It involves business opportunities as well as risks. Companies should not be afraid to seize these opportunities, but at the same time should put in place clear frameworks for risk assessment, liability, reporting and ultimately accountability.

[1] Lawrence Ewan McGaughey v Universities Superannuation Scheme Ltd [2022] EWHC 1233

[2] ClientEarth shareholder litigation against Shell board

[3] Vedanta Resources PLC and others v Lungowe and others [2019] UKSC 20 and Okpabi and others v Royal Dutch Shell and others [2021] UK SC 3

[4] What to expect for nature-related business and finance in 2022 – TNFD

[5] SE+Foundation+Commentary+and+core+text+rev+6.pdf (squarespace.com)

[6] R (at the request of Mathew Richards) v The Environment Agency and Walleys Quarry Limited [2021] EWCA Civil 26

[7] Home – Better Business Act

[8] CP22/20: Sustainability Disclosure Requirements (SDR) and Investment Labels (fca.org.uk)

[9] FCA proposes new rules to fight greenwashing | CIF

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