Navigating The Waters Of ESG Disputes

Have you ever typed the term "ESG" into a Google Search? When we did, Google reported over 580 million results. So, what is ESG and why is it so widely searched?

ESG is an acronym for Environmental, Social and Governance. It refers to nonfinancial factors that may impact a participant's decision-making when engaging with an organization as an investor, donor, worker or in other roles.

• The Environmental component refers to how organizations preserve and protect natural resources. Example: Environmental factors include pollution mitigation, decarbonization and water conservation.
• The Social component refers to how organizations value people. Example: Social factors include diversity, equity and inclusion; employee health and safety; human rights (including child labor and slavery); and social justice.
• The Governance component refers to how organizations police themselves. Example: Governance factors include management behavior, transparency and executive compensation.

Why ESG Matters

ESG is not a new phenomenon. This concept dates back to at least the year 2000 when the United Nations Global Compact was launched. This pact was "a call to companies to align strategies and operations with universal principals on human rights, labour, environment, and anti-corruption, and take actions to advance those goals."¹ In 2004, then-UN Secretary General Kofi Annan invited over 50 CEOs of major financial institutions to participate in a joint initiative under the auspices of the UN Global Compact. The goal of the initiative was to find ways to integrate ESG into capital markets.²

Now, there are over 550 ESG investment funds.³ Between 2018 and 2020, sustainable investing strategies grew from $12.0 trillion to $17.1 trillion, an increase of 42 percent. This represents 33 percent of the $51.4 trillion in total U.S. assets under professional management.⁴

Aside from attracting more investors that place an emphasis on sustainable investing strategies, many companies recognize ESG's potential long-term benefits and opportunity for value creation. Companies with a robust ESG program may have better access to customers and lenders. It can also help companies achieve better top-line growth, reduce operating costs, and lead to higher employee productivity and talent retention. According to an ESG survey of C-Suite executives and investment professionals, 83% indicated that they expect ESG programs will yield more shareholder value in the next five years.⁵

More Activity, More Risk, More Scrutiny

Despite the positive attributes that can come from a well-executed ESG program, the development and maturity of ESG initiatives can result in pushback, occasional overreach and other challenges that lead to new areas of disputes. The amount of ESG-related litigation has risen in recent years. For example, between 1986 and 2020, 1,727 climate-related litigation cases have been documented worldwide. Of those cases, 1,308 were in the United States, and more than 50 percent were brought since 2015.⁶

The evolving nature of risks associated with ESG investing has not gone unnoticed by the U.S. Securities and Exchange Commission (SEC). On March 3, 2021, the SEC announced that its Division of Examinations would enhance its focus on climate and ESG-related risks.⁷ The next day, the SEC announced the creation of the Climate and ESG Task Force. The SEC Task Force is focused on:

• Identifying any material gaps or misstatements in issuers' disclosures of climate risks under existing rules
• Analyzing disclosure and compliance issues relating to investment advisers' and funds' ESG strategies
• Evaluating and pursuing tips, referrals and whistleblower complaints on ESG-related issues

In other words, the SEC Task Force's goal is to develop initiatives to proactively identify ESG-related misconduct.⁸

The SEC has also started to propose rule changes related to ESG disclosures. In March 2022, the SEC proposed rule changes that would require public companies to include certain climate-related disclosures, including information in their public filings about climate-related risk and certain climate-related financial statement metrics. The required information about climate-related risks would also include disclosure of companies' greenhouse gas emissions.⁹ In May 2022, the SEC proposed amendments to require funds and advisers to provide more specific disclosures in their reporting based on the ESG strategies they pursue.¹⁰

What Does the Future Hold?

Currently, the SEC-proposed rules are expected to be finalized in early 2023. These types of additional requirements will likely result in more litigation, including "greenwashing" lawsuits. Greenwashing refers to allegations that an entity misrepresented its product's impact on the environment. For example, representations that a company's products are "environmentally friendly," "recyclable" or "humanely raised" have been subject to litigation. These cases typically involve claims for misrepresentation, unfair business practices and securities fraud.

Although there has been some suggestion that companies may place less emphasis on ESG issues due to an impending recession, it is unlikely to slow down ESG litigation. A recession could potentially add more fuel to the ESG litigation landscape if companies that are struggling to stay afloat engage in greenwashing to attract customers and increase sales.

Recent efforts by over 15 states to pass "anti-ESG" legislation could also spur more litigation. For example, Texas passed legislation last year that requires state pension and school funds to divest shares held in financial groups that "boycott energy companies." This has raised discrimination, exclusionary as well as antitrust issues.

Even though the concept of ESG has been around for decades, the momentum to both implement and halt these types of initiatives is just starting to build. As a result, it is likely that there will be more disputes in this area as parties navigate through uncharted territory.

How to Navigate Through Uncharted Waters

Although the ESG legal arguments are still in their infancy, a key element for success is to go back to basics, such as linking liability arguments to the claimed damages (i.e., demonstrating causation). For example, did the consumer purchase the product because of the alleged greenwashing? Would the consumer have purchased the product but for the alleged greenwashing? Did the alleged greenwashing impact the price the consumer was willing to pay for the product or the quantity purchased?

Another simple but critical element for success is ensuring the claimed damages are based on detailed analyses of financial and operational records. For example, if it is a claim for unjust enrichment, what are the specific product sales at issue? What are the associated costs? What is the relevant time frame? Do the contemporaneous business records support this? As simple as it sounds, addressing these basic issues will help strengthen any ESG case.

Footnotes