ESG-related litigation is here and growing: check your insurance policies

March 2023  |  SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2023 Issue

If environmental, social and governance (ESG) has not been an important part of a business’ focus over the last few years, then that business is probably lagging behind its peers. News report after news report reinforces the intuitive conclusion that ESG is one of the most important issues, if not the most important issue, on the minds of corporate management today.

ESG presents both challenges and opportunities to directors and officers (D&Os) and others charged with operating a company, but it has thus far eluded the most basic question: what is it? Beyond agreement that the acronym stands for ‘environmental, social and governance’, there is little consensus as to what ESG actually is. It is often used to describe so-called ‘non-financial’ factors that may be important to determining whether to invest in or do business with a company, but even this definition has some obvious limitations.

The term ‘environmental’ can be used to describe how a business impacts the environment, and whether it engages in environmentally responsible behaviour. ‘Social’ can be used to refer to how the business treats its people, including promotion of a living wage, and how it treats those impacted by its business (customers, suppliers and the communities in which it is located). ‘Governance’ can be used to refer to the standards, both legal and ethical, that govern the conduct of a business, including codes of conduct for management and criteria for the selection of diverse board members.

Government regulators throughout the globe have released or are expected to release guidance on ESG-related disclosures that could help to clarify the situation, but obviously these are early days.

One thing is certain though, ESG has led and will continue to lead to litigation. While some of that litigation has focused on companies and their management that are perceived to be moving too slowly to address climate change and other ESG issues, much of that litigation has and will be focused on those companies that seek to tout their efforts to adapt to and even embrace ESG principles.

The US Securities and Exchange Commission (SEC) has initiated enforcement proceedings based on ESG-related disclosures. Shareholders have filed securities class actions alleging that companies and their officers and directors have made false and misleading statements about their impact on climate change (i.e., ‘greenwashing’) and other ESG-related issues. And some are predicting a wave of class actions alleging that consumers have been duped by ESG-related disclosures purportedly designed to get them to buy a company’s products or services.

To complicate matters further, an ‘anti-ESG’ movement has formed. Particularly given the lack of clarity as to what it is, ESG has been swept up in politically driven culture wars. Shareholders have filed litigation asserting that corporate D&Os have breached their fiduciary duties by adopting diversity-promoting measures, which they claim violates federal and state civil rights laws. And governmental officials have passed or promised to pass legislation or take steps to prevent or deter purportedly ‘woke’ considerations from influencing investment decisions and the actions of companies doing business within their borders.

One of the more colourful examples of ESG-related litigation involves Unilever. Ben & Jerry’s ice cream is one of the many Unilever consumer brands. When Unilever acquired that business in 2000, it allowed Ben & Jerry’s to maintain an independent board of directors that had the express ability to pursue its founders’ ‘social mission’.

In July 2020, Ben & Jerry’s board was alleged to have passed a resolution to end ice cream sales in certain Palestinian territories that the company considered to be illegally occupied by Israel, ostensibly as part of the controversial ‘boycott, divestment and sanctions’ movement and with the purported objective of influencing Israel’s relationship with the Palestinians. The resolution was not immediately implemented or even publicly disclosed, but one year later, Ben & Jerry’s publicly announced steps to end sales of its ice cream in certain Israeli-occupied territories.

Tensions between Unilever and the independent Ben & Jerry’s board spilled out into the public, and the announcement and what followed elicited a strong reaction from the Israeli prime minister and a number of US states, with some even promising to divest pension fund investments in Unilever due to its alleged violations of those states’ anti-boycott, divestment and sanctions (BDS) legislation. Unilever’s share price declined, and the inevitable securities class action followed. Shareholders alleged that the resolution was inconsistent with Unilever’s public disclosures and that its omission from those disclosures violated multiple US securities laws.

Against this backdrop of opportunity coupled with challenge and uncertainty, corporate managers would do well to work with their risk managers and other insurance professionals to make sure they understand and have appropriate insurance protection for their companies and the directors, officers and other corporate managers who are charged with navigating the ESG minefield.

One obvious area of focus should be D&O insurance. D&O liability insurance can help to protect private companies and corporate D&Os, managers and even employees in the event they are alleged to have performed wrongful acts in their organisational capacities. Public company D&O insurance can also protect the business itself in the event of a ‘securities’ claim, which is customarily defined to include a securities class action. D&O insurance traditionally has been viewed as focusing on alleged failures with respect to legal governance standards – ostensibly part of the ‘G’ in ESG – but the framework is equally capable of addressing many ‘E’ and ‘S issues as well.

D&O insurance programmes should address the potential for ‘environmental’ exposures. Regulators, investors (activist and otherwise) and environmental groups may seek to impose legal liability on businesses and their management that (in their view) are not taking sufficient steps to reduce the environmental impact of their business. Exposure can come in many forms – regulatory investigations, administrative proceedings and litigation alleging violations of the securities laws or breaches of fiduciary duties. Many of these potential exposures, in particular those involving individuals, can be mitigated at least in part through D&O insurance.

One particular area of focus in using D&O insurance to help protect against ‘environmental’ exposures is the fact that many D&O insurance policies contain a ‘pollution’ exclusion. Earlier versions of this exclusion were drafted broadly to exclude any exposure ‘arising out of’ alleged pollution of the environment, and could (at least in theory) be asserted by a D&O insurer as a defence to ESG-related exposures. More recent versions of the D&O pollution exclusion, however, limit the scope of the exclusion to more traditional ‘pollution’ exposures like environmental clean-up costs that potentially can be covered by other forms of liability insurance.

D&O insurance should also address the potential for ‘social’ exposures. These exposures can come from employee claims as well as, again, regulatory and investor claims concerning the manner in which a company has described its employment standards and the standards by which it assesses or even seeks to govern the vendors in its supply chain (a notable example is a company that widely promoted its efforts at employee diversity but was then later alleged to have conducted ‘fake’ employment interviews to give the false impression that it was satisfying those diversity, equality and inclusion goals.)

A particular area of focus in using D&O insurance to address potential ‘social’ exposures is to confirm the scope of coverage provided by D&O insurance and any separate employment practices liability insurance policy to try to reduce any potential for gaps in coverage.

Overall, a thoughtful corporate insurance programme – one which focuses in particular on D&O insurance – can help to protect businesses and their management from the uncertainty inherent in the fast-developing and often ill-defined arena known as ESG.

 

David Kroeger is a partner at Jenner & Block. He can be contacted on +1 (312) 923 2861 or by email: dkroeger@jenner.com.

© Financier Worldwide

BY

David Kroeger

Jenner & Block

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