ESG to Have its Day in Court

The writing is on the wall for sustainability laggards as shareholders pursue litigation against investee companies.  

When oil and gas major Shell was ordered by the Dutch court to slash its CO2 emissions by 45% compared to 2019 levels by 2030, it signalled to shareholders that pursuing legal action against large investee companies on their ESG-related commitments and performance can pay off.  

“A successful litigation, where a legal judgement confirms specific wrongdoing, is one of the most effective ways of forcing a company to act, given its legally binding nature,” says Emmet McNamee, Head of Stewardship at the UN-convened Principles for Responsible Investment (PRI). 

“The very act of litigation shines a spotlight on undesirable company practices, creates pressure, and can lead to a swifter resolution than one might expect,” he tells ESG Investor 

ESG litigation refers to legal action that is taken against companies for alleged violations of related laws, regulations or standards, with it increasingly seen by investors as “the sharp end of escalated engagement”, says Steven Friel, CEO at commercial litigation funder Woodsford. 

Litigation is already a “well established” engagement or escalation strategy for shareholders in the US, says Dr Rory Sullivan, CEO at global sustainability advisory firm Chronos Sustainability, adding that, until recently, litigation has been “little used” in Europe.  

This is starting to change.  

Last year, four Swedish pension funds, the Church of England (CoE) Pensions Board and Denmark’s AkademikerPension filed a lawsuit against German car manufacturer Volkswagen, alleging that the company has failed to disclose sufficient information on climate lobbying that may undermine its net zero commitments.  

Volkswagen has since published its first climate lobbying review of its trade associations. 

More recently, environmental law firm ClientEarth issued derivative proceedings against Shell’s 11 directors under the Companies Act 2006, alleging that the company board is breaching its legal duties by failing to properly manage climate risk.  

By May 2021, over 2,000 cases of climate-focused litigation were filed globally, according to the Climate Change Laws of the World (CCLW) database, which is maintained by the London School of Economics’ Grantham Reseach Institute on Climate Change (LSE GRI) and supplemented by the US Climate Litigation Database.

According to PRI’s McNamee, litigation falls into the bucket of robust stewardship.

“The resources required are very significant, and it is inevitably adversarial in nature, so it is never going to be deployed as frequently as more familiar escalation tools. But the upsides should not be underestimated.”  

Diversifying engagement  

Given the growing existential threat of climate change, most ESG litigation has been climate focused. But shareholders are recognising the pervasive impact of social harms, too.  

In October 2022, The Shareholder Commons (TSC), a non-profit advocate for diversified shareholders, filed a lawsuit against social media giant Meta’s board of directors – including Founder and CEO Mark Zuckerberg.  

The lawsuit alleges that the company has violated its fiduciary duty by adopting an algorithm that may be driving more traffic and revenue, but is promoting modern slavery, ethnic violence, sexual exploitation of children, and vaccine disinformation. The platform is exacerbating users’ mental health issues, TSC claims.   

TSC CEO Rick Alexander notes that, as shareholders become more diversified, companies need to put more thought into their economy-wide impacts and be challenged by investors if they are not doing so.  

“A rational diversified shareholder doesn’t want a portfolio company to only be focused on maximising its own value no matter what, because that process involves externalising systemic costs that can bring down the value of the whole portfolio,” he explains.  

Systemic sustainability considerations like climate change or human rights have significant impacts on the economy and portfolio performance overall, meaning that the best way a company can prove its value is to implement policies that mitigate and address these risks.  

“Our argument is that Meta’s approach is actually very harmful to the economy as a whole because it is creating instability,” says Alexander.  

“Meta is able to make a lot of money by ignoring the catastrophic effect it’s having on the system, as those effects are very dangerous to most Meta shareholders, because most of them are diversified.” 

Investors are cognisant of Meta’s social-related risks.  

In 2022, eight shareholder proposals were filed against the company by shareholders, covering its proposed Metaverse, management of human and civil rights abuses, and more. None of these votes came to pass. 

This is largely believed to be down to Meta’s dual class share structure (DCSS). A DCSS allows companies to sell more than one kind of share, with some offering a higher number of votes per share than others. In Meta’s case, Zuckerberg owns 14% of Meta’s total shares, but has control of 58% of the votes, meaning he can easily overrule any shareholder proposal he doesn’t agree with.  

“This just exacerbates the problem,” says Alexander.  

“Those with high vote shares are concentrated owners of that company; they can make the decisions without an equivalent financial stake in the whole system.” 

McNamee points to PRI research which found that, even in instances where shareholder proposals won majority support during the 2022 proxy season, “only 40% of those were being implemented, in the view of the proponents”.  

It’s perhaps reassuring to shareholders that there is another option if escalation through voting fails to prompt change. 

A legal backstop  

The implications of the rise in ESG-related litigation “remain unclear”, says Sullivan from Chronos Sustainability. 

“Litigation has been seen as potentially running counter to the UK and European approach to engagement, which has valued process and good, long-term, enduring relationships between companies and their investors,” he says. 

“In principle – and this argument is being advanced by the legal fraternity – [litigation] could provide investors and other stakeholders with another lever to drive improvements in corporate practice and performance. 

“But the counter-arguments are that it could damage relationships and encourage companies to pull back from making strong commitments to responsible corporate practices,” Sullivan tells ESG Investor 

Indeed, some companies are taking it upon themselves to turn the tables. French energy major TotalEnergies has announced it will be taking legal action against NGO Greenpeace, following the publication of a report which estimated the firm’s carbon emissions at 1.6 billion tonnes of CO2 equivalent in 2019, while it claimed to emit 445 million tonnes. 

Despite concerns litigation will result in a breakdown of the relationship between shareholders and companies, Friel from Woodsford tells ESG Investor that the impact is “ultimately positive”. 

“Litigation is a cleansing process,” he says, noting that it provides institutional investors with an opportunity to hold investee companies accountable, while forcing the defendant to confront its shortcomings which can have long-term, beneficial effects on shareholder value. 

“It’s all well and good for a carrot to be dangled in front of companies through other engagement measures, but there needs to be a stick for the small minority of occasions where they fail,” he says. 

According to Friel, the threat of litigation is enough that companies often capitulate to shareholder demands, noting that almost half of Woodsford’s own engagements resolve amicably before litigation has commenced.  

“Even for matters that go to litigation, thus far, all of them have resolved before trial, as the litigation process itself has proved to be effective enough that both parties can reach an amicable settlement,” he says.  

For institutional investors increasingly challenging companies on their ESG-related commitments and progress, litigation is a reassuring backstop, Friel continues.  

“If that backstop isn’t there, if the directors of these companies don’t understand that they could have their day in court if they don’t do their job properly, then that’s ultimately to the detriment of the relationship between the investor and investee company.” 

Every tool in the toolbox 

Peter Taylor, Head of Engagement at the Institutional Investors Group on Climate Change (IIGCC), says that the investor network “does not believe that all investors will resort to litigation, as other types of engagement can be highly effective”. 

“We encourage IIGCC members to engage constructively with the companies they invest in, using the full set of tools in their arsenal, and litigation is simply one tool among many,” he says, pointing to its Net Zero Stewardship Toolkit as an example of guidance available to investors.  

Developed in partnership with UK pension fund Railpen, the toolkit aims to help asset owners and managers enhance their stewardship practices when engaging with companies on their transition to net zero. It consists of six steps, including setting net zero alignment criteria and introducing a baseline for engagement and voting across all portfolio companies.  

The toolkit does refer to legal recourse, noting it can be “an effective tool and help secure positive outcomes”, such as seeking redress from companies for losses.  

Rather than immediately taking corporate directors to court over ESG-related issues, PRI’s McNamee says that “opposing director re-elections at sustainability laggards is another basic step many investors should be more prepared to take”.  

At oil and gas major ExxonMobil’s annual general meeting (AGM) in 2021, shareholders took this course of action one step further, voting for the election of three climate-conscious members to the firm’s board of directors in a move to accelerate the company’s net zero transition efforts. They were elected from the slate nominated by climate activist shareholder Engine No.1, with the vote backed by asset owners including the California Public Employees Retirement System (CalPERS) and California State Teachers Retirement System (CalSTRS).  

There is also strength in numbers, with collaborative investor-led engagement initiatives like Climate Action 100+ and Nature Action 100 in place to align stewardship strategies and to push companies to be more open to active engagement.  

However, as litigation moves into the public domain, financial institutions will need to practice what they preach or risk legal repercussions.  

A recent survey of over 400 general counsel and in-house litigation counsel leaders in the US and Canada highlighted that the financial services industry has identified legal disputes related to ESG issues as an area of top concern this year. Thirty-seven percent of financial services respondents said that they were “more exposed” to diversity, equity and inclusion (DEI) and social justice disputes in 2022, which is a trend they expect to continue.  

“The key is that we need to properly analyse and review how this rise in litigation shapes corporate governance and corporate sustainability performance,” says Chronos Sustainability’s Sullivan.  

“If it proves to be an effective complement to engagement, then it is a tool that investors can use. But if it doesn’t drive better practices and long-term investment performance, then investors need to withdraw their support for these actions.”  

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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