ESG: safeguarding against the risks

This note outlines guiding principles decision makers should bear in mind in the context of the key ESG-related litigation and regulatory risks faced by businesses today.

Guiding principles for decision makers

Accountability is key. Public demand, whether consumer or investor or otherwise, is driving a focus on ESG and making it a boardroom issue. A business’s decision makers should be guided by the following key principles:

• Board accountability: there is an increasing divergence of priorities between shareholders/investors who want to see a return and those who are willing to prioritise ESG to the possible detriment of immediate return. Boards need to manage those competing interests. Clear board management information and recorded decision-making is key to protecting the board.
• Global issues: global companies need to navigate the different legal and regulatory regimes in which they operate. Not only can this be onerous and stifling but it can lead to risks for English parent companies who assume responsibilities for the conduct of their foreign subsidiaries. A careful balance between a top-down approach and allowing local boards autonomy is required.
• Over-reach: the legal and regulatory framework particularly for environmental and sustainability issues has become wide-reaching and complex. Companies need to ensure they understand the initiatives/ventures they are pursuing and try not to do too much too soon. The desire to take opportunities or just keep pace with competitors cannot over-shadow careful planning, due diligence, risk assessments and the taking of advice.
• Oversight: management must ensure that well-meaning ESG initiatives or investments are properly and continuously monitored and supervised. Putting in place internal policies, structures, responsibilities and reporting lines will ensure that promises made are kept and any issues which may arise are identified early and addressed. This all minimises risk.

The risks

Risk one: litigious innovation

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

Examples of litigation innovation include potential derivative actions against company directors for failing to meet climate commitments and, consequently, breaching their duties to the company.[1] Activist shareholder ClientEarth has briefed its letter before action against the directors of Shell as a “milestone” in climate litigation, being the first attempt to hold a company’s board of directors personally liable for failing to properly prepare for the net-zero transition.[2] Proving no fault in these circumstances can require far reaching disclosure of board-level decision making to demonstrate that directors did act in accordance with their duties.

Another potential avenue for well-resourced claimants is to pursue English parent companies here in England in respect of alleged torts committed thousands of miles away by the English company’s subsidiaries. Recent UK Supreme Court authority has confirmed that an English company can assume a duty of care to third parties affected by the foreign subsidiary’s alleged negligence on foreign soil where the English company has assumed a sufficiently close proximity and intervention over the management of subsidiaries which can feature in a well-meaning approach to levelling up the entire group to meet global standards.[3]

Whilst 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 innovative claimants’ objective: where the goal is financial, they may achieve early settlement, and, where the goal is solely altruistic, the media attention and its consequences may prove sufficient to secure the intended end result.

In any event, these more innovative routes may seem legally difficult now but as the court of public opinion shifts, it may well be that legislation and judicial opinion is not far behind, such that claims that were once ambitious will become straightforward.

Risk two: greenwashing litigation and misinformation

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

Greenwashing is likely to underly claims for misinformation and the possibilities are vast. For example, claims could arise for breach of compliance or accounting warranties in a share sale and purchase agreement, misrepresentations by private entities or listed companies under sections 90 and 90A of the Financial Services and Markets Act 2020, accounting claims for failure to make adequate provision to meet ESG disclosure commitments or consumer claims for misselling. There is also UK and international precedent for complaints being made to advertising authorities for misdescribing products as “green” or “environmentally friendly”.

Risk three: biodiversity

Biodiversity is often referred to as the next frontier in environmental litigation and regulation. The Taskforce on Nature-related Financial Disclosures is due to be finalised by 2023,[4] and it will no doubt encourage more wide-spread focus on the need to protect biodiversity and provide tangible nature related data points. Internationally, claims have been brought against private entities and governments in relation to perceived contribution to the decline in biodiversity. It seems logical that claims will follow in England and Wales.

Similarly, the campaign for the formalisation of “ecocide” as an international crime is gaining traction at the government/parliamentary/UN level in several jurisdictions. Ecocide is defined as “unlawful or wanton acts committed with knowledge that there is a substantial likelihood of severe and either widespread or long-term damage to the environment being caused by those acts”[5]. The reaction to this global movement is indicative of enhanced international interest.

Risk four: failure to keep pace

The last five years have seen enormous change in England and Wales with respect to ESG-related legislation and litigation. The next five years are likely to see greater change at greater pace. Businesses need to keep up and must commit proportionate resource to doing so.

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

Risk five: regulatory risk

Firms which operate in financial services also face regulatory risk in respect of ESG issues. Greenwashing is high on the UK Financial Conduct Authority’s enforcement agenda and the FCA has recently proposed a package of new measures designed to reduce greenwashing and improve consumer trust in sustainable investment products.[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 categorise investment products according to their sustainability characteristics; and (ii) new disclosure requirements concerning the key sustainability-related features of an investment product. There is also a proposed ‘anti-greenwashing’ rule which will apply to all FCA authorised firms and will reinforce the existing position that sustainability claims must be clear, fair and not misleading.

The rules are due to be finalised next year. In the meantime, the FCA has stated that it is “stepping up its supervisory engagement on sustainable finance and enhancing its enforcement strategy”.[9]

The FCA has a vast toolkit of supervisory and enforcement powers already available to it. We are observing an increasingly active approach to the FCA’s supervision of asset management firms with a sustainability focus. It may be a while before we see published enforcement outcomes, but we expect to see a growing number of enforcement investigations. Oversight and board accountability are likely to be key areas of focus for the FCA and firms must ensure they have proper policies and processes in place with respect to ESG which are sufficient to withstand regulatory scrutiny.

Conclusion

The focus on ESG is here to stay. It brings with it business opportunities as well as risks. Companies should not be afraid to embrace those opportunities but at the same time should put in place clear frameworks for risk assessments, responsibility, reporting and ultimately, accountability.

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

[2] ClientEarth shareholder litigation against Shell’s Board

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

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

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

[6] R (On the Application of Mathew Richards) v The Environment Agency and Walleys Quarry Limited [2021] EWCA Civ 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 tackle greenwashing | FCA