Q&A: How climate-related disclosures are driving a wave of greenwashing litigation
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Claims alleging that companies have harmed their investors by making material misstatements concerning sustainability-related risks are on the rise. So what do businesses need to know?
What do we mean by greenwashing?
“Greenwashing” is the process of conveying a false impression or providing misleading information about either a company’s or a product’s environmental performance to create an overly positive image.
Accusations of greenwashing could relate to statements made by a business in an attempt to revamp its green credentials, or the marketing of “green” bonds, “green” funds, or any other product where environmental credentials are promoted.
In addition, corporates and financial institutions also face risks in ensuring their public statements and disclosures to investors regarding ESG metrics are accurate.
As far as financial products are concerned, greenwashing risks go beyond marketing language – issues may arise if the proceeds of green bonds, for example, are not used to further green goals (for example, green bonds may lack binding covenants requiring issuers to use the proceeds in this way).
Why is greenwashing such a big issue right now?
As investor appetite for green or ESG-branded financial products grows, so does the number of legislative and regulatory initiatives across the world designed to prevent or mitigate greenwashing.
At the same time, a loud counter-movement is developing in certain U.S. states where governors, state legislatures and state treasurers have initiated an “anti-ESG” campaign to restrict the ability of government institutional investors (such as state and local pension funds) to consider ESG factors in their decisions. Some significant investments have been terminated on this basis.
Alongside the rising risk of regulatory enforcement, the threat of civil litigation for issuers, banks and other financial institutions is also on the rise.
Investors who sustain losses could claim that they were misled into investing based on false disclosures – where institutions make positive statements about green products, the scope of claims based on alleged misrepresentations becomes wider, and the investor’s ability to prove that it relied on the climate-related disclosures becomes easier.
Regulatory enforcement and the threat of civil litigation is on the rise for issuers, banks and other financial institutions.
The same is true for corporates, who also face greenwashing risk from incorrect or omitted information in financial reports, non-financial statements and prospectuses, as well as a lack of transparency around the limitations of the methodologies that underpin disclosures. Where those errors or omissions relate to equity or debt securities, the financial institutions that acted as managers and/or underwriters are also potentially exposed under securities laws in some jurisdictions.
According to the United Nations Principles for Responsible Investment (UNPRI), the 2022 proxy season had one of the highest records for majority-supported ESG shareholder proposals in recent years, and the 2023 season is off to a similar start.
Investors and good governance groups are also focused on whether a company has “congruence” between its stated public positions on matters such as the environment, social issues (abortion, LGBTQ+ support, systemic racism and criminal justice, to name a few), and their indirect lobbying, political, and electoral engagement.
Additionally, the legal and regulatory framework around climate-related disclosures is developing rapidly across the world, driven by the recommendations of the Task Force on Climate-Related Disclosures (TCFD).
A number of jurisdictions and authorities, including the U.S. Securities and Exchange Commission, have either proposed or introduced frameworks requiring TCFD-aligned reporting, while EU member states will need to introduce legislation in line with the EU’s Corporate Sustainability Reporting Directive (CSRD) by 2024.
In order to settle regulatory investigations into their sustainability disclosures we have seen a number of corporates agreeing to take on additional, ongoing reporting obligations.
How are climate disclosures driving risk for business?
Greenwashing litigation comes in a variety of forms, with the main threat coming from securities and shareholder lawsuits in the United States.
One of the best-known examples involves a major U.S. oil producer, one of whose stockholders filed a securities fraud class action against it and three of its directors in a Texas district court in 2016.
The complaint alleged the company’s public statements were materially false and misleading because they failed to adequately disclose the impact of climate change on the business, and that as a result, its stock price was artificially inflated.
When the company subsequently announced it might need to write down the value of some of its fossil fuel assets, its share price dropped. While a similar case brought by the New York Attorney General was dismissed, the Texas suit is still live, seven years later.
In Europe we have seen cases brought against energy majors over whether their pledges to be carbon neutral by 2050 are misleading given their fossil fuel investments today, and lawsuits targeting airlines in relation to “responsible flying” campaigns that NGOs claim give consumers “the false impression that … flights won’t worsen the climate emergency.”
These threats may seem remote to many businesses. But there are activities common to a much broader range of companies that also present litigation risks.
It is possible we may see NGOs taking a closer look at corporate offsetting, and in particular whether emissions reduction credits deliver their stated decarbonisation benefits. If they don’t, it could spark complex contractual claims between corporates, offsetting providers, and the bodies that certify them.
While not litigation, we are also seeing NGOs bring complaints against companies through the Organisation for Economic Cooperation and Development’s (OECD) network of National Contact Points (which were established to promote adherence to the OECD’s Guidelines for Multinational Businesses).
In 2017, a group of NGOs filed a complaint in the Netherlands against an international bank alleging it had failed to disclose the quantity of greenhouse gas emissions emitted as a result of its financing activities.
The complaint resulted in the bank making a number of commitments to reduce its climate impact, including by steering its lending portfolio in a direction more compatible with the aims of the Paris Agreement.
Where else is risk coming from?
The principal source of greenwashing liability for businesses stems from prospectuses, where U.S. securities laws and instruments such as the EU Prospectus Regulation and other national instruments present a relatively low bar for claims.
Here we are seeing private parties engage with authorities to put pressure on companies; as an example, in 2017 an NGO asked a Canadian securities regulator to stop an infrastructure company’s initial public offering based on allegations that the prospectus had deficient disclosures around climate-related risks. After the regulator agreed to review the request, the company amended the prospectus.
Where greenwashing claims relate to particular financial products marketed as “green”, claims have been brought on the grounds of mis-selling, misleading advertising and unfair business practices.
It can be challenging for investors to win these cases however, as doing so requires them to demonstrate they have suffered a loss.
The fact a product isn’t as green as it says may not have any impact on its price, and even if there has been a drop, the impact on individual investors may be so small as to make it uneconomic to bring a claim.
As a result, any uptick in mis-selling claims in relation to green financial products is likely to arise in jurisdictions with claimant-friendly class action regimes, such as the U.S. and Australia.
Within the EU, greenwashing investor claims could become class actions under the Representative Actions Directive if the EU were to expressly bring ESG-related regulations within scope, or if member states go beyond the directive’s minimum framework in their national implementations.
What actions can companies and their boards take to reduce the risks they face?
These ESG disclosure-related risks exist now, based on existing legislation, regulation and legal doctrine, and we can expect them to intensify as companies are faced with additional climate-specific legal and regulatory disclosure obligations.
In response, corporates and financial institutions should avoid overstating their ESG-related commitments, and keep abreast of legal and regulatory developments that may impact the need for – and nature of – those disclosures, including applicable legal grounds, regulators’ recommendations and industry standards and guidance.
These standards and guidance will also evolve as more greenwashing cases are dealt with. At the same time, initially non-binding international standards such as the TCFD framework can be incorporated into national law.
Organisations should keep abreast of legal and regulatory developments that may impact the need for disclosures.
On a more granular level, businesses should be clear about which “carbon accounting” methodologies underpin their disclosures and why they are used, and understand the assumptions and weaknesses inherent in the data that informs their disclosures.
They should implement robust internal governance processes around who oversees the creation of disclosures, senior management and employees should be trained regularly to understand ESG fundamentals and the risks of greenwashing, and disclosures should be assured by external counsel.
Finally, it’s important that businesses do not simply copy and paste information from annual reports into prospectuses given the greater liability risks they present.
What can we expect in the future?
To some extent, the risk of greenwashing is no different from the risks inherent in any misleading statement about a product, service or fund.
However, the lack of uniform international standards increases the complexity of the challenge and therefore the potential liabilities for business.
In addition, markets often develop faster than regulation and this vacuum can create exposure. Take the example of a bank taking on the new role of “sustainability agent or coordinator” for sustainability-linked loans, where the performance of the issuer against certain key performance indicators (KPIs) can trigger changes to the loan’s interest rate.
The sustainability agent or coordinator typically negotiates these KPIs with the borrower prior to the syndicated loan being issued, but there are a lot of unanswered questions around the duties that come with the role. What happens if the targets are ineffective for example – could other members of the syndicate bring claims?
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