The growing threat of ESG-related litigation

Litigation in the area of ESG is on the increase, whether that is related to climate and net transition, greenwashing, human rights, or biodiversity. There is also increasing shareholder activism involving ESG issues. ESG Risk Review spoke to Sarah Hill-Smith, climate risk associate at Clyde & Co about evolving areas of liability in relation to ESG and the increasing use of litigation.

Greenwashing

Hill-Smith notes that greenwashing is one of the fastest growing and rapidly evolving areas of liability facing companies and governments in Europe and around the world, due to several reasons. “As society and consumer preferences move toward favouring more ethical and environmentally friendly businesses and products, companies feel obliged to market themselves as such – often without sufficient, verifiable scientific data to substantiate their claims. If these claims are untrue or even slightly misleading, companies are immediately exposed to greenwashing liability, particularly as consumers are more aware of and likely to scrutinise corporate sustainability claims,” she says.

The second reason for an increase in greenwashing litigation is due to increased legislation and regulatory scrutiny targeting greenwashing. Hill-Smith explains that the EU has introduced several guidelines and frameworks, such as the EU Green Taxonomy and the Sustainable Finance Disclosure Regulation (SFDR), which require greater transparency and accountability in sustainability claims. In January 2024, the European Parliament approved a new Greenwashing Directive, which, alongside the Green Claims Directive, clamps down on unfair commercial practices. Alongside these regulations, industry regulators, such as the UK Financial Conduct Authority (FCA) and Competition and Markets Authority (CMA), have also introduced guidance on greenwashing.

“These directives require EU member states to introduce stricter rules governing environmental claims made by companies; requiring all ‘green claims’ made in the European market to be verified by an independent third party,” she says. “Although the primary purpose of this legislation and guidance is to help companies avoid liability for greenwashing, it also provides a firmer legal basis for claims to be brought when companies do not comply,” says Hill-Smith.

She adds: “Increased legislation and guidance, coupled with increased scrutiny from regulators and consumers, means that more and more greenwashing lawsuits and complaints are expected to be filed. In turn, as greenwashing decisions are handed down, legal precedent is set, emboldening claimants and encouraging yet further litigation.”

Shareholder activism

On shareholder activism over ESG issues, Hill-Smith says there has undoubtedly been an increase across the globe in recent years. “This trend will continue as company positions on ESG become increasingly material to their long-term prospects. Due to the regulatory developments in the EU and US that require companies to make corporate disclosures around ESG, there is more information available for shareholders to scrutinise,” she says.

In the EU, most reported ESG-related shareholder activism is currently pro-ESG, she notes, and this is felt most prominently in ‘mature’ ESG markets in Europe, such as the UK, France, Germany, and the Netherlands. She adds that, increasingly, more institutional investors are taking a more active stance on ESG issues in AGMs, but highlights that not all shareholder activism is pro-ESG – particularly in the US where there is a stark divide between the pro- and anti-ESG movements in all spheres.

Regulations

The EU has seen a number of sustainability and ESG-related directives come into force recently, including the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD). So what impact might these have on ESG-related litigation?

The EU CSRD will provide greater transparency and more data on companies’ ESG performance, as it requires large companies and listed SMEs with significant presence in Europe to disclose ESG-related information against a very detailed framework (the European Sustainability Reporting Standards, or ESRS), explains Hill-Smith.

Furthermore, the CSRD requires for the first time that CSRD-aligned sustainability reports are independently audited, with the objective to bring sustainability reporting in line with financial reporting. This is a welcome development, as it will ensure sustainability reports are credible, objective and verifiable, but places an addition burden on reporting companies.

What’s more, liability risk arises as companies’ reported sustainability information can be compared to companies’ public net zero or transition strategies, adverts and financial statements to identify any inconsistencies and dishonest or misleading statements. “The risk of liability (such as litigation) arises if there are any discrepancies found between a company’s public strategies and statements and the actual data presented in the sustainability reports. In the past, this risk has led to ‘greenhushing’, but the mandatory nature of CSRD means that in-scope companies will be obliged to be transparent – even if the information disclosed is unfavourable. This means that greenhushing is not an option” says Hill-Smith.

“The CSDDD enhances in-scope companies’ due diligence requirements and seeks to level the playing field of human rights and due diligence standards across all EU/EEA states, some of which (namely France, Germany, and the Netherlands) already have due diligence and supply chain legislation in place. This means that companies based in a country without due diligence legislation will have to grapple with Human Rights and Environmental Due Diligence (HREDD) for the first time. The CSDDD will require in-scope companies to identify, prevent, mitigate, and account for adverse human rights and environmental impacts in their direct business operations, those of their subsidiaries, and through business relationships in value chains,” she says.

Companies also need to take measures to implement and integrate HREDD policies and processes in their risk management system. This means that companies will be voluntarily identifying weaknesses and liabilities in their supply chains, which may then be the subject of climate litigation depending on the severity of the impact and the action (if any) taken by the company to address it, says Hill-Smith. As a result, companies will become more exposed to litigation, as they may be held liable for breaches at every level of the value chain.

Hill-Smith says that while climate-related litigation is one of the most well-known ESG-related threats to corporates, it is not necessarily the only one or the biggest. “New regulations, in particular CSRD and CSDDD, will likely give rise to a new wave of ESG-related lawsuits, focusing on the S as well as the E, targeting companies. These may be based on the data that companies collect and report from their entire value chains in compliance with the new regulations, meaning the claims may be broader in scope than claims purely relating to companies’ contributions to climate change (i.e. GHG emissions),” she says.

She notes that there is already an established (and growing) body of case law where claimants allege that their lives, human rights or constitutional rights are impacted by climate change and environmental harms. To date, these have generally been framework cases founded on constitutional and human rights, and so the usual defendants are governments and public authorities.

“With more robust ESG supply chain due diligence coming into force, there will be more claims of this combined ‘E’ and ‘S’ nature directed at corporates. This is because corporates will be monitoring and collecting specific data about the environmental and social impacts of their business throughout their supply chain. With this in mind, there will likely be more ‘S’ based cases relating to labour rights abuses and human rights abuses in value chains, as well as increased litigation around other ‘E’ topics like resource use, pollution, deforestation etc,” she explains.

Nature

Finally, there appears to be a growing threat of nature-related litigation aimed at corporates, that potentially could be a bigger threat to corporates than climate litigation risk. “There are several themes emerging in the rise of nature-related lawsuits targeting companies. Biodiversity litigation against corporate actors has emerged as the potential next frontier of environmental litigation. We are seeing several cases where  a biodiversity-related cause of action is added  to an environmental lawsuit centring around one of the five drivers of biodiversity loss. This pertains to land and sea use change (i.e. deforestation); pollution; climate change; exploitation of species; and the introduction of alien species. Biodiversity ‘add-ons’ usually focus on the harms to the wider ecosystem, rather than the personal injury or property damage to the individuals bringing the claim,” says Hill-Smith.

She adds that indigenous people are often highly dependent on their local ecosystems and biodiversity. As such, indigenous communities may seek to bring claims against corporations that impact their local environment and nature, and the claims may be framed in human rights terms. She notes that a number of cases of the sort have already been brought to courts around the world.