ESG stands for “Environmental, Social and Governance” and is the metric used for measuring the sustainability and ethical impact of a business or company.
For the purposes of ESG, the three key measures are:
- Environmental. How an organisation acts towards the welfare of the planet and what kind of impact it has on the environment.
- Social. How an organisation treats its employees, customers, suppliers and local communities. This includes factors such as racial diversity, inclusiveness and recruitment practices.
- Governance. How an organisation is run, including the way it is audited and the way it administers shareholder rights. This also covers attitudes to executive pay as well as how a business communicates and generally interacts with its shareholders.
Climate Change and The Paris Agreement
The Paris Agreement is a legally binding international treaty on climate change, It was adopted by 196 parties at COP 21in Paris, on 12 December 2015, and entered into force on 4 November 2016. Its goal is to limit global warming to well below 2 degrees Celsius (preferably to 1.5) compared to pre-industrial levels.
To achieve this long-term temperature goal, countries aim to reach global peaking of greenhouse gas emissions as soon as possible to achieve a climate neutral world by mid-century.
According to the Grantham Institute’s 2021 ‘Global Trends in Climate Change Litigation Policy Report’, the number of climate change-related cases has more than doubled since the Paris Agreement.
UK companies and business owners are not immune. Earlier this year, ClientEarth started legal action against Shell PLC’s 13 executive and non-executive directors, seeking to hold them personally liable for failing to properly prepare a climate strategy consistent with the Paris Agreement.
In the first case of its kind, ClientEarth claims that the board’s failure to adopt and implement a climate strategy that truly aligns with the Paris Agreement is a breach of the directors’ duties under sections 172 (the duty to promote the success of the company) and 174 (the duty to exercise reasonable care and skill) of the UK Companies Act 2006.
It is anticipated that this landmark case will open up the floodgates to further ESG related claims; enabling action to be taken against not only businesses, but also the individuals who control the companies and make the decisions if a case can be made that there has been a failure to meet climate related responsibilities.
What to expect in 2023
According to the Grantham Institute, as at 31 May 2022 there were 2,002 cases of client change litigation globally.
As we move into 2023, we expect to see a growing trend in ESG litigation brought by private individuals, not just climate activist groups. The main driving factors behind this are:
- A developing ESG Regulatory Framework globally. New obligations on companies in the ESG arena are emerging all the time and are a reason to hold companies to account. A new directive passed by the European Commission in February 2022 for example imposes a corporate due diligence duty on in-scope large companies operating in Europe to ensure that they contribute to sustainable development and the sustainable transition of economies by identifying, bringing to an end, preventing, mitigating and accounting for human rights and environmental impacts in their value chains.
- Anticipated disclosure requirements in the US. The U.S. Securities Exchange Commission (SEC) is finalising rules to require climate change disclosure in the annual reports, prospectuses and registration statements of all public companies registered with the SEC, including any company (domestic or foreign) whose stock is listed on any U.S. stock exchange. Where the US leads other financial regulators may follow.
- Growing climate-related group actions. Climate Group litigation such as the dirty diesel cases against various car manufacturers are on the rise in the UK, as are the size of such claims. The fact Volkswagen agreed to pay £193m to settle the 91,000 legal claims brought against it in England and Wales following the “dieselgate” emissions scandal is likely to make similar group actions attractive to litigation funders and litigants.
- Increased funding options. The growth of the litigation funding market is helping to support many ESG related claims. There are now estimated to be £13bn of litigation funds operating in the UK market place.
- Crackdown by Watchdogs. UK authorities are beginning to crackdown on how organisations present their ESG credentials. In October 2022, for example the Advertising Standards Authority (ASA) found that HSBC had misled customers by making unqualified claims and omitting material information about its environmental credentials in two high street adverts that appeared the run up to COP26. Earlier in the summer the Competition and Markets Authority (CMA) launched its first so called greenwashing investigations under the Green Claims Code into the eco-friendly and sustainability claims made by ASOS, Boohoo and George at Asda about their fashion products, including clothing, footwear, and accessories. We can expect to see more regulatory scrutiny of green marketing in other sectors future.
Future trends in litigation
In terms of what types of claims we might see on the rise in relation to ESG, the main areas are:
- Shareholders of private limited companies might claim that they were misled into relying on ESG information that later turned out to be false, giving rise to a potential action for negligent misstatement, the tort of deceit for fraudulent misrepresentation, or for negligent misrepresentation under the Misrepresentation Act 1967.
- Similarly, investors might bring claims against companies where they have invested in funds based on false statements made about ESG practices.
- Shareholders in listed companies who claim to have been misled into investing might bring claims under either s90 or s90A of the Financial Services and Markets Act 2000 (FSMA). Section 90 applies in relation to information published in listing particulars or the prospectus, while section 90A applies to a wider scope of published information, such as annual reports and accounts and interim reports, including but not limited to directors’ reports, strategic reports and corporate governance statements.
- Shareholders might also bring claims against individual directors under the Companies Act 2006 for acting in breach of their fiduciary duties by way of a derivative action.
- Shareholders of a subsidiary might bring claims against parent companies where a parent company holds itself out as exercising a degree of supervision and control of its subsidiaries, but when it does not in fact do so. The failure to exercise an appropriate degree of supervision and control may constitute the abdication of a responsibility that it has publicly undertaken through its ESG disclosures, and thus leave it liable to claims.
- Businesses bringing breach of contract and / or claims for misrepresentation against other businesses where there have been ESG breaches in a supply chain.
- Individuals and businesses might bring professional negligence against financial advisors who have given incorrect advice as to a company or fund’s ESG credentials prior to them investing.
- Corporations requiring reputation management advice where “green washing” or other wrongdoing (e.g. modern slavery) is alleged.
Bringing claims in such scenarios will not be straightforward, and claimants will likely face some tricky hurdles, for example when it comes to proving reliance on the statement(s) in question and quantifying losses.
Mitigating ESG risks
As the pandemic has shown, planning for every eventuality is impossible. However, companies can anticipate and mitigate ESG risks. Ways of doing this might include:
- Conducting risk assessments
- Planning for the low-carbon / carbon-neutral economy
- Setting achievable targets and commitments
- Undertaking public engagement
What is certain is that ESG is not going anywhere anytime soon, and businesses need to adapt and evolve if they intend to survive.