Post-COVID recovery: an ESG focus on disputes

Summary

As we emerge from the COVID-19 crisis, one issue that has been brought sharply into focus is the impact of business on the society and environment in which it operates. Governments and businesses have been under pressure to ensure that ESG goals form part of any pandemic recovery plans.

We are likely to see a significant re-set of ESG expectations on business from investors, consumers and States alike. For those businesses that adapt to this challenge, there are likely to be significant benefits. For those that do not, we foresee increased regulatory and conduct risks and a greater prospect of civil litigation.

The ESG risk landscape

The COVID-19 crisis has wreaked devastation on the world's markets, on supply chains and on businesses, revealing the need to build resilience across all sectors before the next storm.

As the world moves out of lockdown, the focus is on what form a COVID-19 recovery should take. There have been many requests by industry bodies in all sectors for sustainability conditions to be linked to financial support, and for recovery measures to focus on the need to achieve net zero carbon, and other sustainability and social goals.

In addition, COVID-19 has rapidly accelerated focus on ESG issues from investors, regulators and consumers alike. This builds on the wave of ESG populism that was already being seen prior to COVID-19 (for example the campaigns on single use plastics, climate change and pollution of the oceans). Many businesses are responding by undertaking ESG risk mapping and mitigation exercises to gain a better understanding of their ESG footprint and to mitigate the risks highlighted by such exercises. This, in turn has placed greater scrutiny on ESG policies and procedures and whether these are both fit for purpose and being complied with once published.

The risks of not properly considering, anticipating and managing ESG issues are too great to ignore. Businesses that fail to keep up with these changing demands, or do not address them sufficiently, are likely to face increasing litigation, regulatory and conduct risks. We reflect below on some of the imminent risk issues which we anticipate will come to the fore in the post-COVID environment.

Increased risk of disputes

The most significant regulatory and litigation risks relate to:

• Mis-selling / greenwashing of ESG products
• Directors' liabilities and reporting
• Claims against corporates for breaches of human rights standards, inadequate supply chain due diligence, environmental harm and climate change
• Investor-State claims
• Data breaches
• Financial crime

Misselling/greenwashing risks

Financial institutions, financial advisors and asset managers (and their insurers) may face mis-selling litigation based on the "greenwashing" of financial products and breaches of investment mandates, as set out in more detail in our What to look out for in 2020 piece. We expect the risk of such claims to increase post COVID-19, particularly as more products flood into the market.

There is a growing awareness of environmental issues among investors, financial institutions, asset managers and financial regulators. "Green" products, ranging from ESG funds and green bonds to ethical savings accounts and green home mortgages, are proliferating. COVID-19 has served only to accelerate this already growing trend.

There remains uncertainty around the criteria by which products qualify as socially responsible or ethical, and how those criteria are translated into investment decisions.

Our materials on sustainable financing and ESG investment and our note on the Top 10 Things Asset Managers Need to Know about the EU ESG Initiative may also be of interest when considering these risks.

Regulated entities in the UK will need to be mindful of the regulators' expectations - the Climate Financial Risk Forum (CFRF) has published its guide to climate-related financial risk management.

Directors' liabilities / reporting risks

Historically, companies and their directors in England & Wales were not considered to have a general duty to take into account ESG factors. Rather, they owe duties to pursue a long-term increase in financial value for the company (other than in an insolvency situation).

This is beginning to change. Our piece on ESG factors for directors to consider now looks at key issues for directors of non-FCA regulated companies as the COVID-19 crisis builds the ESG momentum and we see changes in society's priorities and the expectations on directors.

Reporting obligations on ESG issues continue to develop, with the regulatory landscape moving towards far greater transparency on ESG issues. Any information disclosed by a company (and its senior managers) will be scrutinised by regulators and the market (including activist investors). Increased reporting will increase the chances of stakeholders then holding the company to account. This may be through investment decisions, pressure on reputation, shareholders exercising voting rights or through civil liability actions.

Companies and their directors could expose themselves to liability if they fail, adequately or at all, to consider ESG-related financial risk, or fail adequately to manage the risk, having assessed it. There are significant, though not insurmountable, barriers to establishing these duties and/or proving their breach, and proving a causal link may be difficult in practice. Nevertheless, the risk of facing claims is real.

Business and human rights risks

There is increasing focus on whether a business is conducting its operations in a sustainable way, and without violating human rights. There are significant risks here, which will differ depending on the sector in which the business operates. Key issues, currently under scrutiny from the public and press, include: whether a business's supply chain is sustainable, whether it causes environmental harm in its operations (including when products reach end of life), whether it employs victims of modern slavery, uses child labour and/or abuses land rights.

These risks are relevant not only to the operations of the parent company but also to its subsidiaries and wider supply chain. A series of recent cases, culminating in the Supreme Court decision of Vedanta (see our article here), have made it possible to hold a parent company to account in the English Court for the acts of its subsidiaries abroad. This has paved the way for a series of mass tort claims where actions have been launched in the English Court for harms conducted by subsidiaries of a UK parent company overseas. These include claims for environmental damage, use of child labour in the supply chain and human rights violations. Such litigation can cause significant financial and reputational harm for companies.

In order to mitigate such risks, many businesses are now undertaking due diligence of their operations and supply chains. In 2011, the United Nations introduced the Guiding Principles on Business and Human Rights (UNGPs). These (non-binding) standards require businesses to conduct human rights due diligence to seek to detect issues in their operations and to then seek to remediate concerns where found. Businesses should also use their leverage to improve the human rights standards in their suppliers. Many businesses have now pledged to follow the UNGPs in their day to day operations. Where business fail to do so, they expose themselves to risk of civil claims, together with significant brand damage.

Human rights due diligence is particularly relevant in the UK, given the requirements for larger businesses to produce a Modern Slavery Statement pursuant to the UK's Modern Slavery Act. We looked at the UK government's guidance on modern slavery reporting during the pandemic in our article here.

Climate change risks

Climate change risks will impact all sectors. In the UK, the Supreme Court's recent Heathrow Airport decision granted permission to appeal in relation to whether the UK Government would be breaching its obligations under the Paris Agreement 2015 when authorising the building of the new third runway at Heathrow.

"Climate justice" claims against greenhouse gas (GHG) emitters are not new. However, climate litigation is likely to be amplified post-COVID. GHG emitters should prepare for further challenges.

It has always been very difficult for claimants to establish a direct link between an emitting corporate and loss or damage caused by global climate changes or weather events. In Kivalina v ExxonMobil, the US courts said that there was "no realistic possibility of tracing any particular alleged effect of global warming to any particular emissions by any specific person, entity, [or] group at any particular point in time". Developments in emissions data mapping mean, however, that the causal link is becoming easier to establish. Evidence of falls in emissions during the COVID-19 lockdown, with striking comparative satellite images and photos in wide circulation, may increase the possibility of claims.

The impacts of climate change also means an increased risk of adverse weather events, together with the ensuing physical and financial risks. We expect disputes around insurance claims and property design and development. We highlighted in our What to look out for in 2020 piece the increased litigation risk for construction professionals, as well as lenders and investors in this sector. As above, financial regulators in the UK are looking at the financial risks from climate change, in particular through the Climate Change Financial Risk Forum.

Increased risk of investor-State arbitrations

State responses to the challenges posed by the COVID-19 crisis have, necessarily, been rapid, dramatic and often all-encompassing. State intervention may well have been necessary, but different State approaches and the widespread implications for international investors mean that the effectiveness or suitability of the measures taken are now being closely scrutinised. Further, the economic pressure on States may conversely lead some to now withdraw incentive schemes from ESG projects (e.g. in green energy). Investors have suffered significant economic losses and may now face the prospects of further losses to come.

A wave of investor-State disputes may be on its way, alleging breach by States of their public international law obligations. Our article looks at the impact of the COVID-19 Crisis on investor-State arbitration in the renewable energy sector.

Data breaches

Data breach litigation was already a significant risk for 2020, as set out in our Disputes - What to look out for in 2020: Data breach litigation piece. The COVID-19 pandemic caused many companies quickly to increase their technology capabilities to allow business to continue during lock-down. The shutdown has led to an array of issues and an increase in data breaches. Phishing has increased across all sectors, with healthcare organisations being particular targets, raising even greater concerns of leaks of sensitive data. Security issues also arise when staff are not provided access to appropriate security controls, working with data on personal devices, home-based WiFi systems and without an encrypted VPN, leaving devices (and therefore data) more vulnerable to attack.

We considered the ICO's regulatory approach during the COVID-19 emergency here. Employers will now need to take particular care when seeking health information as part of a safe return to work. The ICO released this data protection guidance for organisations to consider as lockdown eases, and we consider the ICO's guidance on employee COVID-19 testing here. The ICO has also issued its expectations in relation to data protection in the context of developing contact tracing apps, but all businesses now collecting and storing customer or visitor data for tracing purposes should be alive to the data risk.

Increased flexibility from the regulators at the height of the crisis does not remove the risk of claims relating to data breaches, including large scale group claims, or ICO fines. Organisations need to be very careful and manage their data protection risks.

Financial crime risks

The impact of corruption and economic crime on the success of companies' ESG efforts is one of the more overlooked elements in the debate around sustainable business practices. COVID-19 has transitioned from a pure public health crisis to a broader economic one. Economic crime, including corruption, tends to surge during and following a recession. Collapsing markets flush out ongoing crime that was hidden from view whilst times were good (see our article here), and increased financial pressure on companies and individuals in turn increases both the incentive and opportunities to engage in economic crime.

More innocently, and obviously, a crisis is distracting. Financial crime governance and processes tend to come under strain during moments of corporate stress.

We expect to see an uptick in regulatory investigations and criminal and civil claims concerning financial crime. As we move out of the immediate crisis phase of the pandemic companies should check that they have an up to date and fit for purpose anti-bribery and corruption policy.

In short, ESG risks for all businesses across all sectors are only going to increase.