In recent years, there has been an undeniable shift towards a more sustainable, inclusive, and environmentally aware society. Individuals are making more ethically-conscious decisions: the boycott of unethical brands, the rise of ‘green’ investments and career moves based on companies’ workplace culture and diversity. Therefore, while having the ‘right’ environmental, social, and governance (ESG) strategy can be instrumental to a company’s success, getting it wrong can lead to reputational damage, regulatory investigations, and fines or litigation.
In February 2023, the UK Competition and Markets Authority (CMA) published draft guidance intended to provide more certainty on antitrust risk for businesses that enter into agreements aimed at achieving environmental goals, the latest in a stream of green codes and guidance issued by regulators over the last few years. We have recently seen regulators start to crack down on greenwashing violations and there has been a steady rise in climate change-related litigation, with the number of cases doubling since 2015.
We expect this increase in regulatory investigations and litigation to continue given the current focus on ESG issues, an increase in related regulations and disclosure requirements, as well as increasing access to third-party funding, which enables individuals and classes of individuals to bring claims which they otherwise may not be able to.
The ESG litigation landscape will continue to evolve, and we discuss the types of claims that are being brought and how loss and damages may be quantified.
An agent to change conduct or obtain compensation?
Climate and broader ESG-related disputes fall into two categories: cases that are brought with the intention of changing conduct or policies, and cases brought with the intention of reaching financial redress for damages associated with climate change or other alleged wrongdoing.
In the first category there are no damages to quantify as cases are being brought, often by climate activists, with the aim of raising awareness and influencing change in government or corporate behaviour and policies. An example is the landmark case brought in 2021 by environmental group Milieudefensie against Royal Dutch Shell plc. Milieudefensie alleged that Shell’s environmental contributions were violating its duty of care under Dutch law. Shell was ordered to reduce its CO2 emissions by at least 45 percent by 2030 compared to 2019 levels and all eyes will be on the outcome of the appeal.
In the second category there are several different types of claims that have been brought for compensation or damages in relation to ESG issues.
Lliuya v RWE
Brought in 2015, this case is an example of a claim against an energy company for its contributions to climate change. A Peruvian farmer has alleged that RWE, Germany’s largest energy company, has contributed to climate change, which has led to the melting of a glacial lake above his village and created the need for flood defences. The case is ongoing. However, a German court has already agreed that RWE would be liable for damages if it can be proved that the glacier poses a flood risk and that climate breakdown had caused it to melt. The challenge in this and similar cases is to prove causation, however climate science is continually developing, and if the case is successful many more similar claims may be brought.
So far, a small number of claims have been filed against UK parent companies regarding environmental damage resulting from the actions of their overseas subsidiaries.
In the landmark case of Lungowe and Ors. v Vedanta Resources Plc (Vedanta) and Konkola Copper Mines Plc (KCM), the Supreme Court found that the case could be heard against Vedanta, the English parent company. It was claimed that wastewater discharged from a copper mine owned and operated by KCM had polluted local waterways, causing personal injury to the local residents, as well as damage to property and loss of income. The case settled in December 2020. Similarly, cases may be brought against companies in relation to the actions of their suppliers or joint venture partners and therefore better controls and due diligence may be required to mitigate against the litigation risk posed.
In the UK, sections 90 and 90A of the Financial Services and Markets Act 2000 (FSMA) give investors the right to sue public companies if they have suffered loss as a result of relying upon untrue or misleading statements, or omissions, from prospectuses or listing particulars (section 90) or other information published by the company, or as a result of a dishonest delay by the company in publishing information (section 90A). Greenwashing claims can be expected through class actions on behalf of groups of investors under FSMA section 90/90A.
What loss has been suffered?
The losses are easier to identify and quantify in some types of cases than in others. For example, it is more straightforward in instances where claims are for direct impact and measurable costs. According to the Carbon Majors Database, RWE has caused 0.47 percent of the global post-Industrial Revolution carbon emissions, so Lliuya is suing for that proportion of the costs of flood prevention, which amounts to EUR 17,000.
In more complex claims expert analysis of market value and hypothetical scenarios may be required, and this is likely to be the case where there has been some form of greenwashing. Depending on the circumstances this could lead to a misrepresentation claim, a breach of contract claim or an FSMA section 90/90A claim.
In a misrepresentation claim there is a right to rescind the contract whether the misrepresentation was fraudulent, negligent, or innocent. If a loss has been suffered, a claim for damages may also be made unless the representor can prove that they reasonably believed the facts they represented were true.
Damages can also be claimed in a breach of contract claim and are intended to put the wronged party in the position it would have been in if the contract had been fulfilled as intended.
In order to quantify damages, a counterfactual needs to be established. The counterfactual represents the position the claimant would have been in ‘but for’ the actions of the defendant, i.e., the greenwashing. The counterfactual position is then compared to the factual position at a point in time, and the loss is calculated as the difference between the two.
If it is claimed that the value of a private company has been affected, then a traditional business valuation may be required along with an assessment of what the business would have been worth had the greenwashing not taken place.
In an FSMA section 90/90A claim the company must pay 'compensation' to the shareholder. However, the statute is silent on how much compensation and how that compensation should be calculated, and until further case law emerges the exact meaning of 'compensation' will remain uncertain. In the case of a listed company, an event study is the most likely method to be used to quantify damages, with an assessment of the impact that the greenwashing or other event has had on the share price, and what the share price might have been if that event had not taken place.
Challenges arising from a turbulent market and the application of hindsight
We can see that there are several challenges that may arise in the quantification of damages in ESG litigation. The main one is that it is quite possible that the counterfactual position may be worse than the actual. For instance, over the past year, in circumstances where an investment was made in a ‘green’ fund that turned out to hold an investment in an oil company (i.e, not green), it is possible that this fund performed better than a legitimately ‘green’ fund did over the same period. The customer was misled and would have chosen to make an alternative investment if the full information had been available to them, however they did not suffer a financial loss. There may be a question as to whether a claim for damages for distress can be brought in such cases where no financial loss has occurred.
Event study analysis is commonly used in securities litigation in the US and is likely to be the method that would be used to calculate quantum for an FSMA section 90/90A claim. There are a number of issues to consider when carrying out this analysis, such as whether the fall in the share price has been caused by a number of factors, what data is available and how that may limit the analysis, whether the loss is sustained or the share price bounces back and recovers and therefore what the relevant time period is, and when shares were bought or sold by the claimants and whether their decisions were impacted by the event.
There is also potential for a claim for loss of opportunity where a party is claiming it would have disposed of a shareholding during the period in which there was a loss in value and reinvested the funds elsewhere. Demonstrating that such an opportunity was being pursued at the time, and not just with the benefit of hindsight, can be challenging.
In conclusion, for corporate defendants, while paying out in respect of ESG claims can clearly be costly in itself, the costs of management time, loss of employee pride and engagement, and the ongoing harm to a firm’s reputation of being associated with such actions in the press can be significant and long-lasting. It is therefore important for businesses to carefully consider their ESG strategy and disclosures, as well as the controls that are in place to monitor the actions of subsidiaries and suppliers, in order to reduce the litigation risk.
This article first appeared in Financier Worldwide’s eBook - Managing & Resolving Commercial Disputes. © 2023 Financier Worldwide. All rights reserved. Reproduced here with permission from the Publisher. https://www.financierworldwide.com/ebook-managing-and-resolving-commercial-disputes-2023