Fights over ESG goals may lead to D&O claims

Recent court rulings and legal challenges highlight how companies pursuing environmental, social and governance initiatives may be open to accusations that they put the ESG goals ahead of their duty to investors. 

In other cases, companies have been accused of “greenwashing” by overstating their ESG commitments.

The lawsuits could lead to claims on directors and officers liability policies and other coverages, experts say.

While ESG programs have become increasingly popular among corporations over the past decade, a backlash from some investors and state officials has raised concerns.

Several Republican state attorneys general, for example, have challenged a U.S. Department of Labor rule that allows ESG factors to be considered when choosing retirement plan investments. 

In addition, they have sought to block the implementation of a U.S. Securities and Exchange Commission rule that would impose stricter guidelines for reporting carbon emissions. 

On March 6, the SEC announced that it adopted new rules requiring companies to disclose climate-related risks that may affect their operations as well as any strategies they have undertaken to mitigate or adapt to a climate risk. The agency said April 4, however, that it was suspending implementation of the rules until lawsuits over their adoption are resolved.

Meanwhile, in February, a federal judge in Texas refused to dismiss Brian P. Spence v. American Airlines Inc. et al., a proposed class action brought by an American Airlines pilot claiming the company and its benefits committee violated the Employee Retirement Income and Savings Act by investing with managers and funds that are strongly devoted to ESG initiatives. The judge concluded that the plaintiff sufficiently stated a claim for breach of prudence. 

Whether such suits over DEI initiatives would trigger a D&O policy will depend on the allegations, said Lisa Campisi, a partner at Blank Rome LLP in Philadelphia, who represents policyholders.

For example, a suit alleging only civil rights violations may not trigger coverage, whereas one alleging that DEI initiatives constituted a breach of fiduciary duty and/or securities law violation could trigger a D&O claim. 

Investigations, enforcement actions and litigation by the SEC for alleged violations of its new rule, if it goes into effect, could have significant implications for D&O coverage, said Geoffrey B. Fehling, a Boston-based insurance recovery partner at Hunton Andrews Kurth LLP.

“Most public company D&O policies will only include investigation coverage for individual directors and officers, although private companies may be afforded broader coverage for subpoenas, civil investigative demands and similar voluntarily and involuntarily requests by the government,” he said.

Areas of disagreement for investigation claims include the breadth of the definition of “claim,” whether investigative documents are for “wrongful acts,” and whether the relief sought falls within the policy’s definition of “loss,” Mr. Fehling said.

The implementation of the SEC’s rule could result in an increase in enforcement actions that will trigger D&O policies, said Raymond A. Mascia Jr., a New York-based insurance recovery attorney and shareholder at Anderson Kill P.C. 

Potential disputes will likely center on whether a subpoena or a civil investigation demand constitutes a claim that is covered by a policy, he said. 

The American Airlines ERISA suit would likely initially trigger coverage under the company’s fiduciary liability policy, rather than D&O, said Ronald P. Schiller, a Philadelphia-based insurer attorney and shareholder at Hangley Aronchick Segal Pudlin & Schiller. 

But shareholder suits accusing a company and its directors of making ESG-related decisions that could have negative effects on its stock price would likely bring challenges under the business judgment rule and, therefore, potentially trigger D&O coverage.

When companies make statements about ESG policies they should be sure to follow through on the message, said Mr. Mascia. 

“If a company is going to implement a policy or an initiative, it should carry through with it, because we’ve seen lawsuits where plaintiffs have used the company’s own statements against them,” he said.

While the push for companies to implement ESG initiatives has the potential for making waves in the courtroom, it has not had a significant impact on the D&O market, experts say. 

“We’re still at a very early point, meaning that the underwriters on the D&O side are still sort of getting their sea legs on this and what impact it’s going to have,” Mr. Schiller said.

Underwriters and policyholders first encountered potential issues with ESG disclosures about three years ago when allegations of greenwashing first emerged, said Manny Padilla, vice president of risk management and insurance at MacAndrews & Forbes Inc., a holding company with diverse investments, and a board member of the Risk & Insurance Management Society Inc.

Underwriters are asking more direct questions to assess whether customers are aware of the various components required to comply with ESG guidelines. 

“Underwriters are not necessarily qualifying a customer’s platform and, in particular, governance activities unless they’re blatantly failing to address the ESG topic at all,” he said.

Governance is a core aspect of D&O risk, said Timothy Fletcher, CEO of Aon PLC’s financial services group. 

“Lack of governance leads to issues, and whether that was 20 years ago or a year ago, it’s clear how important governance is to D&O,” he said.

Companies can temper backlash against ESG by engaging in a balanced approach to implementing initiatives, Mr. Fletcher said.

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Disclosures might help companies

The U.S. Securities and Exchange Commission’s proposed disclosure requirements mandating companies submit information about climate-related risks may lead to more regulatory scrutiny but they may also benefit companies, said the co-author of a recent report from Moody’s Investors Service Inc.

The proposed requirements on environmental, social and governance disclosure, which have long been anticipated by companies, follow other climate-related disclosure rules implemented in the United Kingdom and European Union.

While the SEC’s final rule, which has yet to go into effect due to pending litigation, is not as stringent as some of those outside the U.S., it is intended to serve as a baseline for climate-related disclosure and will likely evolve, said Brendan Sheehan, vice president and senior credit officer of ESG at Moody’s in New York.

“One of the takeaways is that information related to climate risk is clearly considered meaningful or useful by a significant number of market participants,” he said.

Enhanced disclosure rules can aid in credit analysis because they can make the data more consistent and comparable, which in turn can aid in the understanding of an applicable exposure to a particular risk.

“Having greater visibility into the risks and opportunities faced by issuers and being able to more efficiently compare and contrast those data, can help us understand specific credit conditions faced by issuers,” he said.

Companies may also benefit from gathering information about climate-related risks because it can help them develop a deeper understanding of such risks in their own operations, as well as risks posed by their supply chain, Mr. Sheehan said.

The report indicates, though, that complying with disclosure requirements can adversely affect small and mid-size companies, as many of these companies will likely be gathering this information for the first time. Such companies can learn from looking at how larger companies respond to the rule, Mr. Sheehan said.