Expansive regulatory and claim landscape – Why worry?
- Newly proposed SEC rule – The United States Securities and Exchange Commission (SEC) recently proposed a new rule that, if adopted, would require public companies to report their climate-related risks, including the level of greenhouse gas emissions they produce – both directly and indirectly – and how climate risk affects their business. For those SEC registrants that publicly set climate-related targets or goals, the proposed rule would require those companies to disclose their implementation plans, including the projected time horizon by which those companies intend to achieve those goals.
- SEC investigations and fines – The SEC has demonstrated its commitment to identifying ESG-related misconduct by creating a special task force designed to identify any publicly traded companies’ compliance with ESG strategies and/or misstatements in public disclosures concerning climate risks.
- Liability for misleading statements – Multiple companies ranging from airlines to retailers have been accused of overstating or outright misleading investors, consumers, and regulators with respect to the environmental sustainability of their products or services. For instance, the “fast fashion” clothing retailer H&M has faced criticism for using a scorecard purporting to show that the production of a particular piece of clothing is better for the environment when in fact it is no better than comparable products. H&M, which has since stopped using this scorecard, is not alone: the scorecard used by H&M is a clothing industry-developed metric (known as the “Higg Index”) that has been widely adopted, but now abandoned, by other apparel makers. A Dutch airline, KLM, was recently sued by environmental groups alleging that its advertisements and carbon offset program “give a false impression over the sustainability of its flights and plans to address its climate harm.”
- Increase in ESG-related litigation – The surge in litigation, particularly outside the United States, can be seen as part of a strategy for boosting climate action. Research from the London School of Economics Grantham Research Institute on Climate Change and the Environment “suggests companies should brace for claims focusing on personal responsibility (such as the duties of company directors to manage climate risks) and international lawsuits on loss and damage.” But lawsuits targeted at climate action are not the only recent trends in the wave of ESG-related litigation. Other recent ESG-related shareholder litigation relates to fossil fuels, violations of animal welfare laws, and unaddressed racism and sexual harassment in the workplace, to name just a few issues. All told, the scope of risk for ESG-related litigation is exponentially expanding around the globe and across industries.
- Shareholder resolutions – Companies should be preparing for an increase in 2023 of many more shareholder resolutions addressing the issue of aligning a company’s publicly stated values with its financial donations, according to Bruce Freed, president of the Center for Political Accountability.
D&O coverage considerations in light of trends in ESG regulation and compliance
When procuring directors and officers (D&O) and other professional liability insurance coverage, policyholders will want to address their plans to implement and grow ESG initiatives and carefully answer questions by insurance underwriters in conferences or on applications. Understanding a company’s most likely exposures to regulatory investigations or shareholder derivative litigation may aid a policyholder in obtaining the most favorable D&O coverage to protect against a company’s unique risks and avoid coverage surprises. Policyholders should be cautious, however, to not overstate, misstate, or confuse aspirations with implementation, as insurance applications can be the basis for alleged misrepresentations or omissions in a coverage dispute depending on policy wording. Even policies that preclude rescission of the entire policy may, in certain cases, exclude coverage for a specific claim based on alleged fraud in the application.
D&O policies are traditionally divided into three types of coverage. “Side A” coverage insures defense costs, damages, settlements, and judgments arising from claims made against individual directors and officers when the company cannot or is legally unable to provide indemnification. “Side A” coverage is crucial to settling or paying a judgment in a shareholder derivative lawsuit (although defense costs may be indemnifiable). “Side B” coverage insures the company for amounts it pays as indemnification to individual directors and officers for claims made against them. And “Side C” coverage insures the company for securities claims made against it as an entity. Many D&O policies include coverage for regulatory investigations of directors and officers, and in some cases, this coverage may extend to the company in the event that shareholders bring a related securities action.
The types of “claims” covered by D&O policies include not only civil actions but also criminal actions and shareholder derivative demands. Companies should review their D&O policies carefully to fully understand the scope of matters potentially covered under the policy and how coverage may be triggered in the event of a claim. For example, the definition of “loss” may exclude matters deemed uninsurable under the law but may also be enhanced to provide that the law of the jurisdiction most favorable to coverage should be applied. Virtually all D&O policies exclude non-appealable adjudicated fraudulent conduct in the underlying claim, but some policies exclude “deliberate criminal acts.” Policy language should be scrutinized, deleted, or narrowed to ensure that provisions will not be used to exclude coverage for ESG-related claims.
In addition to guarding against coverage restrictions or exclusions, policyholders should be attuned to any coverage enhancements that insurers may offer aimed at targeting ESG-related exposures. For example, the insurance broker Marsh recently introduced a new “Side D” entity coverage for regulatory investigation costs associated with climate-related financial disclosures by certain companies that are not traded publicly in the United States that score favorably using established ESG risk methodologies, regardless of whether an ESG lawsuit is pending against them. Several insurance companies have already committed to participating in Marsh’s ESG D&O initiative, which is marketed as resulting in “preferred” D&O policy terms and conditions on ESG-related exposures. We anticipate others will follow suit. And on the non-insurance front, investment firms may soon be seeking to reduce exposure to ESG-related claims by instituting anti-greenwashing certifications, which would verify that they are delivering on their ESG promises.
Reed Smith is at the forefront of thought leadership with respect to advising its clients on effectively creating and implementing business operating models to address climate change, sustainability, diversity and inclusion, and a range of other issues of societal consequence. Reed Smith’s Insurance Recovery Group also works with its clients to pursue ESG risk mitigation, including reviewing insurance policies to secure the broadest coverage available when obtaining or renewing policies, as well as assisting clients in accessing coverage for investigations, regulatory actions, and shareholder derivative and other litigation. Please feel free to contact one of the authors of this article or any other member of Reed Smith’s Insurance Recovery Group to discuss how Reed Smith can assist your company with its insurance needs.
Client Alert 2022-185
