ESG to drive a new wave of D&O liability

Directors and officers (D&O) liability over the past 20 years has largely been driven by governance. Following the Enron accounting scandal in 2001 and the global financial crisis in 2008, directors and officers faced a rising tide of regulation and litigation.

The next wave to watch for, however, will more likely be led by the ‘E’ and the ‘S’ in ESG (environmental, social and governance), as directors and officers are increasingly held to account for their organizations’ environmental and societal impact.

Emerging environmental and social risks

From climate change litigation to diversity and inclusion, ESG issues are a key source of emerging liability for directors and officers. Investors, employees and consumers will increasingly expect companies to actively address ESG considerations, while businesses face an evolving and expanding range of ESG-related disclosure requirements and regulation.

Companies that fail to address these issues open themselves up to the risk of litigation and/or regulatory investigations and actions. Currently, ESG litigation has been largely climate related, although many other environmental and social issues could drive future litigation and regulation, including environmental disasters, deforestation, water and biodiversity degradation, as well as equal pay, or human rights abuses within supply chains.

Diversity and inclusion is already emerging as a new area for litigation, as regulators seek increased disclosure and requirements for more diverse representation. Directors of companies face shareholder derivative lawsuits, where the shareholder plaintiffs allege that board members have breached their fiduciary duties by failing to appoint diverse board members. These lawsuits typically allege that the companies have misrepresented their commitment to diversity and inclusion.

Climate litigation on the rise

Climate change litigation has been on a clear upward trajectory. Globally, the cumulative number of climate change-related cases has more than doubled since 2015 to over 2,000. Around one-quarter of these were filed between 2020 and 2022, according to the LSE’s Grantham Research Institute.

Climate-related claims can come from multiple and wide-ranging avenues. Companies can be sued for their direct contribution to climate change, face claims relating to disclosure, or a failure to mitigate/prepare for risks associated with climate change. Recent years have seen the rise of environmental groups and other non-governmental organizations using the courts to raise awareness and challenge a company’s strategy or environmental policy.

Several shareholder suits related to climate risks and disclosures have been brought over the past five years. In the UK, an environmental NGO and minority shareholder of a major energy company is suing the board of directors for failing to manage climate risks and failing to prepare the company for the net zero transition mandated by the Paris climate agreement. Elsewhere, a Peruvian farmer is suing a German utility company, seeking compensation for alleged climate-related damage to the environment.

Greenwashing backlash

Misleading or unsubstantiated ESG claims, known as greenwashing, is another potentially significant source of liability for directors and officers. Incidents of companies providing misleading information to present a more responsible public image have been subject to litigation in the US while regulatory radars have also detected greenwashing as a potential problem. The UK’s Financial Conduct Authority, for example, has developed a set of principles to tackle concerns over false claims, while the EU recently proposed a ban on greenwashing under new consumer rights requirements.

Companies that make ambitious ESG commitments could be vulnerable to shareholder lawsuits. Companies that declare climate or social targets, may struggle to demonstrate progress toward their stated goals, which could in turn lead claimants, such as activist investors or government regulators, to challenge the companies on their statements.

New York City filed a lawsuit in 2021 against three oil and gas companies alleging the companies advertised themselves as leaders in fighting climate change, but instead misled consumers through the promotion of "cleaner" and "emissions-reducing" fuels without disclosing their climate impacts. Earlier this year, a Canadian coffee producer was ordered to pay a $3 million fine after it made false claims about the recyclability of its packaging, while last year the UK Advertising Standards Authority ruled that Ryanair’s low-emissions advertising campaign had misled consumers.

Governance is key to ‘E & S’

ESG-related liabilities have the potential to become a significant exposure for the D&O insurance market. Insurers and risk managers need to start thinking about ESG-liabilities today, and take action to avoid an unnecessary wave of damaging claims.

As an emerging issue, D&O liability underwriters will want to spend more time with insureds to understand the DNA of an organization and ensure that ‘good words’ are met with actions and reflected in company culture. ESG disclosure and certification, while providing valuable information for underwriters, is no substitute for face-to-face meetings with senior management.

There is a solid connection between good governance and fewer, less severe D&O losses. Companies with strong ESG frameworks and governance could find insurers more willing to offer capacity and preferential terms.

Originally published on Commercial Risk Online on August 30, 2022