Directors Beware: The Climate is Changing with ESG Claims on the Rise

Key Takeaways

• There is a growing trend of shareholders and other stakeholders using litigation to hold companies and their directors accountable regarding ESG issues.
• Shareholder activists and other stakeholders are using the courts in an effort to hold directors personally liable for failing to address ESG issues adequately.
• Where parent companies and private equity sponsors have a large degree of control over portfolio or group companies (including foreign subsidiaries), litigants may increasingly try to hold the parent companies accountable for the acts or omissions of their group or portfolio companies in relation to ESG issues.

Introduction

What clearly emerged from the COP27 conference of 2022 was the significant and increasing levels of public interest in the efforts by both companies and states to improve environmental practices worldwide. Aligned with this, activist shareholders have been finding new and creative ways to use existing laws to hold directors and companies accountable when ESG targets are missed and/or ESG issues are not addressed adequately. One approach that has been seen in the English Courts is a claim in connection with a director's duty to promote the success of the company which requires the director to have regard to ESG factors in their decision-making.

It is expected that this trend will continue, if not grow, with the prospective European Union Corporate Sustainability Due Diligence Directive (the "CSDD Directive") due to be transposed into Member States laws within two years of EU Council approval (currently pending).¹ While the CSDD Directive has now been amended to not include any new directors' duties as originally proposed, current litigation trends indicate that existing directors' duties enshrined in national laws may still be wide enough for activist shareholders and NGOs to accelerate change in a corporate's operations or supply chains by bringing ESG-related claims. In the UK a director must already have regard to ESG factors which include (emphasis added):

(a) the likely consequences of any decision in the long term;
(b) the interests of the company's employees;
(c) the need to foster the company's business relationships with suppliers, customers and others;
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business conduct; and
(f) the need to act fairly as between members of the company.²

This OnPoint examines the current rising ESG litigation trends in the UK, and the U.S.

Current ESG Litigation Trends across the UK

Parent Company Liability

Following the UK Supreme Court's decisions in Vendanta Resources v Lungow³ and Okpabi v Royal Dutch Shell⁴, companies should expect that litigants will use the English courts to hold a parent company liable for the torts committed by a subsidiary if certain conditions are met. Both of these cases involved claims brought in England against the parent companies of foreign subsidiaries that had allegedly caused damage to the claimants.

In Vendanta, a group of Zambian villagers commenced claims in the English courts alleging personal injury, damage to property, and loss of income, amenity and enjoyment of land, in relation to the activities of a Zambian mining company, "KCM". The claims were commenced in England against KCM on the basis that it was the operator of the mines, and against its parent, Vedanta Resources Plc, by reason of the "very high level of control and direction [it] exercised at all material times over the mining operations of [KCM] and its compliance with applicable health, safety and environmental standards".

Similarly, in Okpabi, a collection of Nigerian citizens who alleged that they had been impacted by environmental damage caused to the Niger Delta from the activities of the Nigerian subsidiary of Shell issued proceedings in England against Shell and its Nigerian subsidiary on the basis of the subsidiary's alleged negligence. The decisions of the court from both of these cases established that, under certain circumstances, a parent company could be liable for social and environmental risks and damage caused by its subsidiary if:

• There is a general group-wide policy issued by the parent company and implemented by the subsidiary that has inherent flaws;
• The parent company goes beyond proclaiming policies for the group and takes active steps (by training, supervision, or enforcement) to see that they are implemented; and/or
• The parent company holds itself out as exercising a degree of supervision and control of its subsidiaries even if it does not in fact do so.

More details about Okpabi can be found in an earlier OnPoint from Dechert here.

More recently, the English Court of Appeal gave permission to Brazilian claimants to pursue their class action against BHP Group Plc in England (who had a 50% holding in the operating company of the dam) for damages allegedly caused to them by the collapse of the Fundão Dam in Brazil⁵(Municipio de Mariana v BHP Group Plc (formerly BHP Billiton Plc)). The decision marks a shift in the attitude of the English Courts towards hearing complex class action suits even in circumstances where there are parallel proceedings in other jurisdictions.

The clear message from these cases is that, where there is strong evidence of group-level control of subsidiaries, specifically in the context of environmental and social impact cases, there is a greater potential risk of the English courts finding parent companies liable for the acts of their subsidiaries, even those in foreign jurisdictions. Accordingly, parent companies that are implementing ESG change programs within their group need to strike a careful legal balance between imposing a system that ensures that subsidiaries and portfolio companies are ESG compliant whilst, at the same time, minimizing the potential legal exposure of the parent or sponsor to any future ESG litigation or enforcement claim.

Liability of Directors and Risks for Private Equity Sponsors

In addition to the risks just discussed, directors should be aware that stakeholders and law makers are increasingly setting their sights on them. We can expect activist shareholders and stakeholders to find creative ways to use existing laws to hold directors accountable for the ESG impacts of their business activities.

One example of this focus on holding directors to account for ESG issues is the case of McGaughey v Universities Superannuation Scheme Limited (USSL)⁶ which was handed down by the English Courts in May 2022. The claimants (two members of the Universities Superannuation Scheme) sought permission in the English courts to bring multiple derivative claims against the directors of the University Superannuation Scheme Limited (USSL), a corporate trustee of their private pension scheme. The claimants alleged, among other things, that the directors' continued investment in fossil fuels without a plan for divestment was in breach of their duties to act for proper purposes and to promote the success of the company (sections 171 and 172 of the Companies Act 2006). The claimants alleged that these breaches of duty had prejudiced, and continued to prejudice, the interests and success of USSL and that USSL suffered loss as a consequence. The judge dismissed the claim on the basis that neither the claimants nor USSL suffered any immediate financial loss as a result of the directors' failure to devise a plan to divest from fossil fuels. The judge also considered that the directors' investment decisions were well within USSL's discretion given that the directors had taken legal advice, conducted a survey of members, adopted an ambition of Net Zero by 2050 and adopted policies for working with the companies in which it invests to help them transition to carbon neutrality. This decision is under appeal but directors should note the weight that the judge placed on the above factors in determining whether the directors had complied with their statutory obligations.

Also in 2022, a similar attempt to bring a claim against directors under the Companies Act 2006 was made by an activist shareholder, ClientEarth, which took the first step in initiating legal action against the board of directors of Shell in the UK by sending a letter before action. ClientEarth's letter claims that the board of directors of Shell breached their duties under sections 172 and 174 of the Companies Act 2006 by failing to act in a way that promotes Shell's success and to exercise reasonable care, skill, and diligence by failing to manage Shell's climate risk. It remains to be seen if this case will survive the court process but it is clear that litigants have their sights set on holding directors to account for their ESG actions, or the lack thereof.

To safeguard themselves, directors would do well to understand the ESG legal obligations that impact their companies. They should also ensure that these companies have adequate controls to manage and monitor the ESG risks arising from their own operations and those of their subsidiaries and that those controls are reviewed and, where necessary, updated on a regular basis. Additionally, directors who are appointed by sponsors in private equity transactions should take extra precautions to ensure that portfolio companies comply with any ESG targets or statements set by both the private equity firm or portfolio company; where that is not the case, those decisions are justifiable and properly documented.

Current ESG Litigation Trends across the U.S.

From a comparative perspective, shareholders in the U.S. have also begun derivative claims to enforce social and environmental commitments. In In re Oatly Group AB Securities Litigation,⁷ shareholders alleged in a class action lawsuit that Oatly's management engaged in greenwashing by giving misleading statements to shareholders regarding its environmental commitments and sustainability practices. The plaintiff class alleged that they suffered damages by paying "artificially inflated prices for Oatly" shares based on the defendant's misleading statements. In a similar vein, a shareholder of Danimer Scientific, Inc. alleged that the directors failed in their fiduciary duty by failing to correct misleading statements of the company that overstated the product's biodegradability.⁸

Beyond environmental concerns, U.S. litigants have been pursuing claims on other ESG-related topics, such as diversity goals. Although diversity-related cases have been dismissed thus far,⁹ it shows a general movement that shareholders are taking a holistic approach on their views and expectations surrounding the duties of their board of directors.

What does this new climate of litigation mean for companies?

With new and proposed ESG legislation coming into force in different jurisdictions, it is foreseeable that companies will come under increasing pressure to deepen and widen their due diligence on business partners and prospective acquisitions.

There also appears to be a growing expectation for directors to do more in the ESG space or risk being held accountable for failing in ESG-related compliance controls as well as for any alleged misleading ESG statements in their public disclosures. Shareholders, activists and stakeholders are creatively using existing litigation tools to pressure companies and their directors into complying with their ESG commitments and obligations.

Although the ESG-related environment is becoming more complex, there are things that companies can do to get ahead of the changing legal ESG environment. For example, to minimize exposure to reputational and legal damage, companies should, at a minimum, review existing materials to ensure any ESG disclosures are accurate and not arguably misleading.¹⁰ Companies can also undertake an ESG legal risk assessment of their operations to ensure their operations and controls are compliant with the different ESG mandates that are in effect or are coming into effect across the various jurisdictions in which they operate. In addition, companies should work to ensure there is adequate governance and monitoring of ESG risks and reporting throughout the business.

For more information on our capabilities in this area, please visit our ESG page.

Footnotes:

1) Commission, 'Proposal for a Directive of the European Parliament and of the Council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937' COM (2022) 71 final.

2) Section 172 of the Companies Act 2006.

3) Vendanta v Lungowe [2019] UKSC 20.

4) Okpabi & Others v Royal Dutch Shell Plc & Another [2021] UKSC 3.

5) Municipio de Mariana v BHP Group Plc(formerly BHP Billiton Plc) [2020] EWHC 2930 (TCC). The trial has been set for April 2024.

6) McGaughey v Universities Superannuation Scheme Limited (USSL) [2022] EWHC 1233 (Ch).

7) Second Consolidated Amended Complaint at 60, In re Oatly Group AB Sec. Litig., No. 1:21-cv-06360 (S.D.N.Y. Aug. 17, 2022).

8) Complaint at 3, Perri v Croskrey, No. 1:21-cv-01423 (D. Del. Aug. 6, 2021).

9) City of Pontiac Police & Fire Ret. Sys. v. Jamison, No. 3:20-cv-00874, 2022 WL 884618 (M.D. Tenn. 2022); Lee v. Frost, No. 21-cv-20885, 2021 WL 3912651 (S.D. Fla. 2021).

10) UK Financial Conduct Authority has recently published a Consultation Paper ("CP 22/20") setting out proposed rules to prevent 'greenwashing' in disclosure statements by UK funds, portfolio management mandates and the UK firms managing such products.

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