Litigation Trends Analysis
ESG Compliance: Mitigating the Risk of Litigation
Environmental, Social, and Governance (ESG) is an evaluation of a firm’s collective awareness of social and environmental factors. ESG issues include, for example, biodiversity (environmental), workplace diversity (social), and executive compensation (governance). Companies are carefully managing their initiatives in order to deliver positive results and meet certain criteria. But, ESG-related deficiencies have become the subject of lawsuits against companies, creating an increased pressure on the companies to establish ESG goals. In particular, the U.S. Securities and Exchange Commission (SEC) is experiencing investor demands for ESG information, prompting it to develop an agenda as it faces the risk of litigation. This is especially true for public companies, where shareholders are concerned with ESG issues such as board diversity and climate change.
Demand for ESG initiatives has led to public statements promising certain initiatives, and these may create other litigation risks. Companies making disclosures in securities filings are publicly committing to meet their ESG goals, and to the extent they fail to meet those goals, activist litigants are seeking to hold them accountable. ESG-related lawsuits may also cause reputational harm to the companies being held accountable for their unsuccessful initiatives, which may ultimately affect their financial performance.
ESG issues are top of mind for many industries. Regulators and agencies like the U.S. Treasury Department have called for more robust disclosures. Stock exchanges like Nasdaq have implemented rules regarding board diversity requiring companies to have one diverse board member by 2023, and two by 2025. U.S. Customs and Border Protection is preventing products produced with forced labor from entering the United States. Companies like Exxon are being sued for failing to adequately disclose climate change risk.
The importance of addressing ESG issues cannot be overstated. Inadequate disclosure or failure to comply with ESG initiatives may result in not only regulatory enforcement action, but also class action lawsuits by investors and derivative shareholder claims. Companies must be knowledgeable of their initiatives, public disclosures, and risks associated with noncompliance. Some precautionary measures that can be taken include enhanced due diligence in transactions, adequate representations and warranties in contractual agreements, and audit rights allowing for evaluation of a company’s ESG efforts. As the ESG regulatory environment is fluid and evolving, appropriate considerations of ESG issues are critical to a company’s ability to manage litigation risks.