Thomson Reuters Attorney Analysis
a Climate Risk Unit that will focus on the role of derivatives in understanding , pricing and addressing climate risk ; and U . S . Customs and Border Protection is utilizing withhold release orders to prevent materials produced with forced labor from being imported into the United States . State agencies and attorneys general are also involved , suing companies like Exxon for allegedly failing to adequately disclose climate change risk and Activision , mentioned above , over workplace harassment allegations .
While there is no way to completely guard against these risks , companies can take steps to avoid them . For example , contracts should contain representations and warranties and commitments regarding relevant ESG matters .
This investor focus on ESG issues and the resulting regulatory dragnet make clear that companies should develop identifiable and measurable ESG initiatives . Critically , companies must implement , or reinforce , compliance programs to ensure the company is taking steps to comply with those initiatives , and to ensure the accuracy of public disclosures about ESG , whether within formal SEC filings , or less formal sustainability reports or marketing materials . Firms must also be careful not to engage in “ greenwashing ,” where companies deceptively try to persuade the market that an organization ’ s products and practices are more environmentally friendly than they are .
Importantly , a failure of a company ’ s ESG compliance and faulty disclosure could result not only in regulatory enforcement action , but also securities class action lawsuits by investors alleging they were misled , as well as derivative claims by shareholders seeking to implement ESG reform through litigation . Regardless of the merits of these claims , they often prove costly , both for a company ’ s finances and reputation .
Business partners ’ ESG failures a potential landmine
Given these regulatory enforcement and shareholder litigation risks , companies must be aware of and evaluate their exposure to ESG risks from other parties in the value chain , including contractual counterparties and acquisitions , for those parties ’ failure to meet ESG commitments or comply with contractual or statutory ESG requirements .
For example , Company A states in its annual Form 10-K that it has policies and procedures in place to prevent illegal activity as to human capital , like forced labor , anywhere in its production chain . The market eventually learns , however , that Company A ’ s largest supplier of manufacturing components , Company B , uses forced labor to assemble parts . Not only is Company A sure to face regulatory enforcement action and shareholder litigation , in addition to reputational risk , but it must also address the breakdown of its ESG compliance with respect to its relationship with Company B , potentially through commercial litigation or arbitration .
Moreover , Company A ’ s inability to secure needed components could impact the success of the underlying investment , project or transaction , such that it may cause significant delays in delivery , construction , operation , loss of revenue or other consequential effects . Financing considerations may be implicated at any stage .
While there is no way to completely guard against these risks , companies can take steps to avoid them . For example , contracts should contain representations and warranties and commitments regarding relevant ESG matters , and companies should consider an audit right allowing them to review the adequacy of compliance programs within its value chain . Similar principles apply to M & A transactions , where enhanced due diligence may be necessary , and appropriately tailored ESG reps and warranties , as well as other material provisions , should be considered as part of the deal structure .
Commercial ESG risks are not just for public companies or large transactions . ESG issues affect all companies , and they should consider how ESG factors into everyday business . For example , given the evolving nature of the ESG regulatory environment , companies might consider such issues as whether a change in ESG-related regulations should be carved out of a contract ’ s force majeure or termination provisions .
In sum , in light of all the current sources of ESG enforcement and litigation risk , it is not enough to focus solely on ESG risk within an organization , as it is equally important to manage ESG-related risk outside the organization and allocate that risk accordingly .
2 | November 19 , 2021 © 2021 Thomson Reuters