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| 4 minutes read

ESG - from Boardroom to Courtroom: ESG's Impact on Overpromising and Underdelivering.

Environmental, Social, and Governance (“ESG”) principles have quickly gained significant traction in the business world. Companies worldwide are recognising the importance of aligning their operations with ESG goals to meet societal and investor demands. As ESG becomes more mainstream, so does the scrutiny on companies that overpromise and underdeliver on their commitments. This trend has elevated ESG issues from the boardroom to the courtroom, with legal and regulatory consequences for companies that either fail to deliver on their promises or lack a compelling strategy to implement their commitments.

The Promise

To attract investment and gain a competitive edge, companies often make ambitious ESG commitments in their boardrooms. These promises can range from aggressive carbon emission reduction targets to ambitious diversity and inclusion initiatives. While such commitments may be made with good intentions, the challenge lies in the execution and actual delivery on these promises.

Companies that promote themselves as ESG champions can expose themselves to potential litigation if they fall short of their promises. Shareholders, consumers, and employees are increasingly holding companies accountable for their ESG practices. When companies make bold ESG claims in their marketing materials, annual reports, or public statements, stakeholders are quick to notice if those claims are not backed by concrete actions and results.

The Delivery 

As stakeholders become more discerning, there is an increasing awareness of companies falling short on their ESG promises and stakeholders are turning to legal avenues to hold corporations accountable. Shareholders have filed lawsuits against companies for misleading ESG disclosures. These legal actions can have serious financial and reputational repercussions. Companies found guilty of overpromising and underdelivering on ESG commitments may face fines, penalties, and damage to their brand image.

One high-profile example of stakeholder capitalism is ClientEarth’s (despite having only 27 shares in Shell at the time) unsuccessful lawsuit against Shell’s Board of Directors – which was the first derivative action worldwide to seek to hold directors personally liable for climate risk mismanagement. Although the English Court of Appeal denied ClientEarth's appeal permission primarily on procedural grounds, the case underscores the importance of ensuring that ESG promises are backed with well thought out execution plans.

Increased Regulatory Scrutiny Worldwide 

Staying abreast of regulatory developments is crucial for businesses to effectively manage their ESG agenda. Global regulators are ramping up their efforts to enforce compliance with ESG standards.

In the United States, the Securities and Exchange Commission (“SEC”) has signalled its commitment to scrutinising ESG disclosures more closely, emphasising the importance of consistent and reliable reporting. For example, on 23 September 2023, the SEC acted against DWS Investment Management Americas Inc. ("DWS"), a registered investment adviser and subsidiary of Deutsche Bank AG, in two separate enforcement actions. The first enforcement action addressed DWS's failure to establish a mutual fund Anti-Money Laundering program, while the second action focused on misstatements regarding its ESG investment process. To resolve these charges, DWS agreed to pay a total of $25 million in penalties. The SEC has issued several other fines on non-compliant companies. Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement and head of its Climate and ESG Task Force has stated:

Whether advertising how they incorporate ESG factors into investment recommendations or making any other representation that is material to investors, investment advisers must ensure that their actions conform to their words…

The European Union established the Sustainable Finance Disclosure Regulation (“SFDR”) which is a transparency framework. It outlines the requirements for financial market participants to disclose information related to sustainability. The SFDR is designed to enable investors to evaluate the integration of sustainability risks in the decision-making process, aligning with the EU’s overarching goal of attracting private funding to accelerate the transition to a net-zero economy. The European Commission is currently conducting an evaluation of the SFDR framework to encompass considerations such as legal certainty, usability, and the role of the SFDR in addressing issues like greenwashing.

We are witnessing a similar trend in Oceania. In 2022, Australia's financial watchdog, the Australian Securities and Investments Commission (“ASIC”), took its first action against corporate "greenwashing". ASX-listed company, Tlou Energy, paid fines totalling $53,280 after receiving four infringement notices for alleged false or misleading sustainability-related statements made to the market in October 2021. More recently, in January 2023, ASIC imposed fines on Black Mountain Energy (“BME”), another ASX-listed company. BME paid A$39,960 (US$27,592.2) to comply with three infringement notices related to deceptive sustainability claims made to the stock exchange between December 2021 and September 2022. ASIC was concerned that BME’s statements about its “‘net zero carbon emissions’” gas development project had either no reasonable basis or they were factually incorrect.

Proactiveness 

To mitigate legal risks associated with ESG commitments, companies must prioritise transparency and accurate reporting. Comprehensive and measurable goals, coupled with regular updates on progress, can help build trust with stakeholders. 

To mitigate the risk of legal action, companies must take a proactive approach to ESG. This means not only setting meaningful ESG targets but also implementing strategies to achieve them and regularly reporting on progress. Robust ESG governance structures, data collection mechanisms, and third-party audits can help ensure the accuracy and transparency of ESG disclosures. In an earlier article, I discussed how pre-emption can be a powerful tool to avoid disputes. Read it again here.

Conclusion

ESG has evolved from a buzzword in corporate boardrooms to a significant factor in legal proceedings and regulatory enforcement. Companies that overpromise and underdeliver expose themselves to unnecessary risks and protracted courtroom battles. Companies must prioritise ESG in a meaningful and transparent manner, aligning their actions with their words. ESG is not just a matter of corporate responsibility; it is also a matter of legal liability.

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