The concept of environmental, social and governance (ESG) has become almost ubiquitous. ESG generally refers to the environmental, social, and governance factors that can affect company value and investor decisions. In this article, we briefly outline some key considerations for managing litigation and regulatory risk for Canadian companies making ESG claims and highlight some relevant cases.
What you need to know
- Strong ESG performance is valued by many shareholders and consumers, and can be a way to differentiate your brand.
- Failure to take sufficient action on ESG matters can risk proxy contests and harm to a company's business. Businesses should be aware of and understand the legal obligations to disclose information relating to ESG, as failure to abide by them can result in enforcement and other sanctions.
- Companies should routinely audit and revise their ESG frameworks to ensure that they are up to date with their operations and ever-evolving industry best practices. Companies should ensure that they choose an appropriate ESG framework for their intended audience.
- To reduce the risk of misstatements or inconsistent statements boards and management should have a proactive process for reviewing and approving ESG disclosure prior to its public release. A robust legal review is also advisable.
- Canadian businesses should be careful to scrutinize their ESG disclosure to ensure it aligns with their operations.
- ESG disclosures should be relevant to the specific entity measurable, and grounded in verifiable data.
ESG overview
Although similar to the concept of corporate social responsibility, ESG relates to factors that are financially material to a company's business and includes such wide-ranging considerations as climate change, modern slavery, diversity, equity, and inclusion. Recent years have seen growing market and shareholder demand for businesses to implement and report on their ESG commitments and performance.
In response to this demand, companies are increasingly identifying, measuring, and disclosing ESG factors that are material to their operations. While in the past this disclosure was largely voluntary, recent years have seen many levels of government adopt ESG factors as part of their mandatory reporting requirements, which has inevitably led to an expanded risk of litigation and other attempts to hold companies accountable for their claims.
ESG litigation
ESG litigation and regulatory risks generally fall into two broad categories. The first category includes allegations of false ESG claims or misrepresentations in a company's ESG disclosure. Companies risk both regulatory action and consumer- or investor-led class actions related to alleged misrepresentations.1 The second category of litigation risk includes claims directly challenging a company's ESG-related conduct or perceived lapses in ESG action. Recent trends in Canada, and globally, include attempts to hold companies accountable for conduct by suppliers or subsidiaries in foreign jurisdictions2 and subject companies to litigation for the contribution of their greenhouse gas emissions to climate change.3
Even if a company can successfully defend a claim on the merits, being forced to defend an ESG record can be costly and lead to reputational harm. Historically, many ESG programs and reports have had little legal oversight or input. To manage the risk of litigation and regulatory or administrative sanctions, businesses should proactively involve experienced legal assistance to review how they are addressing ESG issues while guarding against overstating their commitments and actions.
Key considerations
Failure to take sufficient action on ESG matters can risk proxy contests and harm to a company's business.
The recent proxy contest between ExxonMobil and Engine No. 1 demonstrates the growing power of ESG to alter even the largest of public companies.4 In May 2021, Engine No. 1, an activist hedge fund with only 0.02 per cent ownership in ExxonMobil, argued that there were shortcomings in oil and gas experience on ExxonMobil's board, slow strategic transitioning to a low carbon economy, and historic underperformance and overleverage relative to peers. Engine No. 1 proposed four board director candidates, three of whom were elected to the 12-member board, ousting three sitting board members. Engine No. 1's campaign gained the support of three large investors in ExxonMobil - Vanguard, BlackRock, and State Street.
Engine No. 1's success within ExxonMobil may be a harbinger of things to come for Canadian public companies, particularly those in natural resources sectors. Large institutional investors in Canada are increasingly expecting businesses to take action on ESG matters. On November 25, 2020, CEOs of eight Canadian pension plan investment managers, representing approximately $1.6 trillion of assets under management, issued a joint statement calling on companies to measure and disclose their performance on material and industry-relevant ESG factors.
Two leading proxy advisory firms, Glass Lewis and Institutional Shareholders Services (ISS), have publicly stated they may recommend voting against certain board members if a company does not adequately address or disclose ESG matters. As outlined in their 2022 Policy guidelines, Glass Lewis will "generally recommend" voting against the governance chair of a company in the S&P/TSX 60 index that does not to their satisfaction provide clear disclosure concerning board-level oversight afforded to environmental and/or social issues. Likewise, ISS has stated that under "extraordinary circumstances" it will recommend voting against or withholding a vote for directors, committee members, or an entire board where there has been demonstrably poor risk oversight of environmental and social issues, including expressly climate change. Considering the guarded language used in these policy guidelines (i.e., "generally recommend" and "extraordinary circumstances"), there is a considerable grey area as to if, and when, they will be invoked. Nevertheless, the guidelines signify a shift and increased consideration of ESG by institutional advisors.
Mandatory legal obligations to disclose information relating to ESG already apply to many Canadian businesses, and new disclosure obligations are forthcoming. It is imperative that businesses be aware of and understand these requirements, as failure to abide by them can result in enforcement and other sanctions.
For example, under Canadian securities legislation and instruments, reporting issuers must disclose material information in their continuous disclosure documents and in other contexts.5 Environmental, social, and governance factors may already be material to an issuer, and may also be subject to specific existing or forthcoming disclosure obligations.
In response to the public company accounting crisis of 2002 and 2003, modern corporate governance rules and practices were...
