Held to account: ESG and D&O liability

May 2023  |  FEATURE | BOARDROOM INTELLIGENCE

Financier Worldwide Magazine

May 2023 Issue

2023 has been a challenging year thus far for businesses. Major economic headwinds and the spectre of recession have created a landscape in which areas of potential conflict have expanded exponentially and the desire for recompense multiplied.

One area where organisations are coming under ever increasing scrutiny from shareholders, regulators and governments, employees and the public at large is in relation to how they respond to environmental, social and governance (ESG)-related issues, with directors and officers (D&Os) in the firing line.

“D&O liability over the past 20 years has largely been driven by governance,” notes analysis by Zurich. “Following the Enron accounting scandal in 2001 and the global financial crisis in 2008, D&Os faced a rising tide of regulation and litigation.”

However, according to Zurich, the pendulum has now swung away from governance as the key driver of conflict and toward the ‘E’ and ‘S’ components of ESG, with D&Os increasingly held to account for their companies’ environmental and societal impact.

“From climate change litigation to diversity and inclusion, ESG issues are a key source of emerging liability for D&Os,” continues Zurich. “Investors, employees and consumers increasingly expect companies to actively address ESG considerations, amid an evolving and expanding range of ESG-related disclosure requirements and regulation.”

Taken as a whole, the breadth of the issues and associated expectations strongly suggest that organisations should prepare themselves for a surge in ESG-related D&O liability.

Insurance matters

Increasingly, D&O liability insurance cover is playing a major role in mitigating ESG-related risks – an insurance market that is worth more than $20bn today.

“Given the value of the global D&O insurance market, it is remarkable to consider that there was a time when this coverage did not exist,” observes Jordan Kurkowski, a senior vice president at Amwins Brokerage. “Once there was a time when there were few regulations surrounding the sale of securities, and little to no accountability placed on D&Os for the actions of a business or its impact on corporate profitability and share price.”

In contrast, today, with regulations and societal expectations continuing to evolve, D&O insurance is adapting accordingly. According to Marsh’s 2022 report ‘Directors and officers liability insurance cover considerations’, there are a number of key ESG cover considerations for D&O liability insurance, as outlined below.

First, regulatory investigations fines. One of the main concerns for D&Os is the risk of regulatory action arising from ESG-related issues. Moreover, such regulatory investigations can incur significant defence costs, which should be covered by the D&O policy.

Second, activist and investor action. In addition to domestic laws and regulations, companies are facing increasing litigation risk from environmental groups and activist investors. And with environmental accountability being a cornerstone of corporate responsibility, it is likely that there will be an increase in claims of this nature, particularly in the US.

Third, employee claims. A company’s employees can take action on a wide range of social issues, such as claims of a discriminatory, sexist workplace culture. Where D&Os have not taken action to stamp out such discrimination, they may find themselves exposed to litigation.

Lastly, greenwashing. Companies and boards found to be making false representations about the eco status of their products could face the risk of both regulatory action and litigation, which can result in long term reputational damage for the business.

“The history of D&O insurance demonstrates that this is a market in a constant state of evolution, impacted not just by changes in laws and regulations, but also by evolving societal expectations around what fiduciary duty and corporate conscience mean,” says Mr Kurkowski.

“For companies, managing D&O risks requires good governance and strong frameworks around emerging issues as well as a programme of liability protection from an insurer with the capacity and appetite to offer the broadest coverage available,” he continues. “It is also important to partner with an expert who has the knowledge and market access to navigate this complex landscape, as well as the proven ability to offer programmes and solutions that address changing risk.”

The next wave

With ESG-related issues of increasing importance across the corporate world, the chances of D&Os facing legal challenges and being sued by unhappy creditors, activist shareholders and ESG campaigners on account of their organisations’ ESG deficiencies has been elevated further.

“D&Os today need to navigate a complex minefield of statutory and regulatory responsibilities related to their fiduciary duties of care, loyalty and obedience,” concludes Mr Kurkowski. “They need to balance shareholder expectations of profitability with increased public demands for social responsibility. And increasingly, it is no longer enough for companies just to do the right thing: they must show how ethical behaviour is ingrained in their corporate culture.”

In summary, as new regulations emerge and political debate surrounding ESG issues intensifies, it is reasonable to expect an increase in regulatory and shareholder actions against companies, with D&Os under particular scrutiny and held to account.

© Financier Worldwide

BY

Fraser Tennant