ESG disputes: steps to mitigate risk

April 2022 | EXPERT BRIEFING | RISK MANAGEMENT

financierworldwide.com

The focus on environmental, social and governance (ESG) obligations has increased significantly in recent years, leaving organisations more exposed to becoming involved in an ESG dispute. With developments occurring rapidly, and the scope and extent of potential ESG disputes evolving in real-time, it is important to ensure that your organisation is ahead of the curve and has implemented effective risk mitigation strategies to avoid an ESG dispute arising.

This article examines the nature of ESG disputes and key trends, as well as outlines practical guidance to help organisations assess ESG disputes risk and take steps today to mitigate it.

ESG disputes

ESG obligations have the potential to give rise to a wide variety of legal claims, including in relation to human rights, data breaches, anti-money laundering, supply chain failures and public statements about ESG issues (particularly in respect of climate change). Novel test cases are being commenced in numerous jurisdictions.

ESG-related claims have been brought by individuals, groups of individuals (i.e., class actions), non-governmental organisations (NGOs), activist groups and regulators. Notably, some claimants are motivated by influencing corporate behaviour, rather than compensation. This adds further complexity to traditional dispute dynamics.

Based on major developments in ESG disputes in Europe, the US, the UK and Australia, below are emerging trends to watch.

Greenwashing. There has been an increase in climate change litigation challenging the disclosure of ESG-related issues to the market, as well as consumer protection claims relating to the ‘greenwashing’ of climate change statements or commitments. For example, in August 2021, the Australian Centre for Corporate Responsibility commenced proceedings against gas company Santos Limited, alleging that Santos engaged in misleading or deceptive conduct in relation to its claims that natural gas provides clean energy and that it has a plan for ‘net-zero’ emissions by 2040. This is the first case worldwide to challenge the accuracy of a company’s ‘net-zero’ emissions target.

Recent greenwashing claims in the US have broadened the scope of climate change litigation beyond the energy sector. For example, in August 2020, a class action was filed against Procter & Gamble alleging, among other things, that the company’s marketing of laundry detergent as ‘plant based’ was false because the product contained ingredients derived from petroleum. Also, in July 2021, a shareholder class action was filed against Oatly, one of the world’s largest oat milk companies, and certain of its directors and officers. The claim alleged, among other things, that the company made misleading statements about the greenhouse gas emissions and energy consumption associated with its product.

Lack of compliance with the Paris Agreement. In May 2021, the Hague District Court ordered Royal Dutch Shell to reduce its CO2 emissions by 45 percent (compared to 2019 levels) by 2030. The court held that Shell’s previous emissions commitments were insufficient to meet the goals of the Paris Agreement, noting Shell’s contribution to global emissions. While the decision turned on the terms of the Dutch Civil Code, it demonstrates that companies can be compelled to reduce their greenhouse gas emissions in line with the Paris Agreement. This decision follows a series of cases in which states have been found accountable for failing to take adequate measures to address climate change, in violation of the human rights of their citizens.

Human rights violations. There has been an increased number of tort claims brought against multinational companies in the UK for human rights violations. In Vedanta, claimants were permitted to sue a parent company for conduct by a subsidiary operating a copper mine in Zambia. The UK High Court found that a duty of care may be owed not only to a subsidiary’s employees, but also to those affected by its operations.

Regulatory scrutiny. Regulators are paying close attention to ESG issues, particularly in reviewing and monitoring the disclosure of climate change and environmental matters. For example, in October 2021, the Australian Securities and Investments Commission committed to examine the potential greenwashing of financial products by conducting targeted surveillance to identify misleading statements relating to ESG claims. Secondly, in March 2022, the Australian Competition and Consumer Commission included environmental claims and sustainability in its compliance and enforcement priories for 2022-23. Finally, in 2021, the US Securities and Exchange Commission (SEC) commenced work to consider a new proposed rule requiring public companies to make certain climate change-related disclosures.

Alternate dispute resolution mechanisms. Non-judicial dispute resolution mechanisms are also being used to hold organisations accountable to ESG policies. Companies are increasingly facing complaints under ‘OECD Guidelines for Multinational Enterprises to State-based National Contact Points (NCPs)’. The OECD guidelines contain standards relating to topics including the environment, human rights and labour, which multinational enterprises are expected to comply with.

While the OECD guidelines are not binding, NCPs publish complaints online including findings and recommendations for further action. This can cause reputational damage for organisations and expose them to potential related litigation.

Risk mitigation strategies

Below are steps companies can take today to help them assess and mitigate ESG disputes risk.

Identify and prioritise areas within the organisation at greater risk. Undertake a risk assessment to identify ESG related practices within the organisation that may be at greater risk of potential claims. This could involve: (i) reviewing ESG policies to assess whether they appropriately reflect the organisation’s activities, including the activities of subsidiaries; (ii) considering whether there was sufficient legal oversight in the drafting and implementation of ESG policies and statements; (iii) monitoring recent legislative, court and regulatory developments about ESG issues to prioritise areas within the business which may be at heightened risk of claims or regulatory scrutiny, including tracking similar developments in comparable overseas jurisdictions which may also provide insight into what is to come locally; and (iv) reviewing the organisation’s previous public statements, including disclosures and marketing materials made in relation to ESG matters, to confirm those statements can be substantiated.

Ensure the organisation has systems and processes that reflect key risks. Once any higher risk areas are understood, ensure the organisation has appropriate systems and processes in place to mitigate ESG claims risk. First, establish governance structures, including robust senior management and board reporting, to facilitate ongoing oversight of ESG issues. Second, implement training on the organisation’s ESG statements to ensure people are committed to and familiar with them and do not make overstatements. Third, introduce controls to ensure public statements and disclosures about ESG activities are accurate. This may include scrutinising language in public documents, recording evidence to substantiate claims and benchmarking ESG messaging against peers. Finally, continually assessing whether the organisation is meeting its ESG commitments, or whether further action or disclosure is required.

Brief the board on its expectations and responsibilities. The board should be aware of its responsibilities in relation to ESG issues – properly balancing increasing pressure from the community and investors to positively report on ESG activities against the need to avoid making statements which expose the organisation to an ESG claim.

Therefore, it is important for the board to understand that if there is an inconsistency between a company’s stated position in relation to ESG issues and its internal policies and actions, or the statement is not made on reasonable grounds, the company may be liable for making a misleading disclosure under corporations laws or consumer protection laws. Also, depending on the jurisdiction, directors and officers may be personally liable for a misleading disclosure made by a company or as a person involved in the relevant contravention.

In addition, climate change impacts and other ESG issues may also be relevant to the discharge of directors’ duties. In Australia, leading lawyers consider that the standard of care to be exercised by directors with respect to climate change is rising and that it may not be sufficient for directors to merely consider and disclose climate-related risks in discharging their duties. In some sectors, directors may be expected to take reasonable steps to ensure that positive action is taken to identify and address those risks.

Develop a crisis management action plan. If an ESG dispute arises, an organisation’s initial response can impact its potential exposure and reputation. Developing an ESG disputes crisis action management plan puts the company on its best footing.

First, establish a core response team. This may include stakeholders with knowledge of key ESG risk areas or with ESG expertise, as well as internal and external legal counsel.

Second, implement clear processes to allow the organisation to seek and be provided with legal advice in relation to its ESG obligations and any dispute in a manner which preserves legal professional privilege. Failure to do so may result in those communications being disclosable to a litigation opponent, to a regulator or other third parties (including prospective class action claimants).

Third, issue document preservation notices to relevant stakeholders to preserve relevant materials, establishing a communications protocol which governs the creation of new documents about the ESG dispute, noting all documents relevant to the dispute may ultimately be required to be disclosed to a litigation opponent or regulator.

Fourth, consider whether steps should be taken to brief third parties, including insurers or auditors. If the organisation is publicly listed, consider its disclosure obligations in relation to an ESG dispute.

Finally, identify any ‘lessons learned’ or ongoing risks as early as possible, so that high risk practices are ceased and rectified as soon as possible, and the organisation’s risk of further losses and future ESG-related disputes is reduced.

Philippa Hofbrucker and Ilona Millar are partners and Elizabeth Jones is a lawyer at Gilbert + Tobin. Ms Hofbrucker can be contacted on +61 (2) 9263 4248 or by email: phofbrucker@gtlaw.com.au. Ms Millar can be contacted on+61 (2) 9263 4723 or by email: imillar@gtlaw.com.au. Ms Jones can be contacted on +61 (2) 9263 4365 or by email: ejones@gtlaw.com.au.

Philippa Hofbrucker, Ilona Millar and Elizabeth Jones

Gilbert + Tobin