MITIGATION OF ESG RELATED LITIGATION

The purpose of this article is to present a brief overview of the emerging ESG trends and the impact that various ESG factors have had on companies. Furthermore, the article delves into instances of potential ESG-related disputes that a company may be exposed to for their failure to adopt ESG-centric policies. In this manner, the article brings out the necessity for companies to adapt to emerging ESG trends and constantly monitor, identify and mitigate legal risks associated with ESG

Introduction

Profitability and sustainability have often been considered as incongruous to one another in relation to the objectives of a company. As a result, activities towards promoting sustainability have largely been ignored by companies. Moreover, the absence of any legal or regulatory oversight to enforce sustainable measures by companies, has bolstered the idea of profitability over sustainability.

However, with the global community acknowledging the need to mitigate climate change in the Conference of Parties (CoP 26)¹ combined with the drastic effects of the COVID-19 pandemic on the existence of businesses, ESG-related factors have emerged as a catalyst to compel companies to internalize their negative externalities and maximize their long-term value in society.

For the unacquainted, ESG refers to "environment, social and (corporate) governance" and serves as the whetting stone upon which a company can create long-term value rather than short-term profits. It also is used as a benchmark of business efficiency for a company in the eyes of investors and shareholders.

Impact of ESG on companies

The emergence of ESG factors has increased the scrutiny on the business activities of a company by investors, regulators and the general public. The market regulator and watchdog, Securities and Exchange Board of India ("SEBI") has jumped on the ESG wave and pursuant to India's pledge to achieve net-zero carbon emissions by 2070, introduced the 'Business Responsibility and Sustainability Reporting' ("BRSR") under Regulation 34(2)(f) of the SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015. As per the BRSR, SEBI has mandated that the top 1000 listed companies by market capitalization to include ESG disclosures as part of their annual report from the coming financial year. SEBI has further nudged companies in India to maintain transparency in their ESG disclosures by imposing legal sanctions² against a company and its directors for their failure to comply with the BRSR.

Furthermore, directors of companies have been tasked with the duty of balancing the interest of the shareholders of a company with that of the larger stakeholders involved, including the environment under Section 166(2) of the Companies Act, 2013. In a recent case³, the Supreme Court of India analyzed the responsibility and accountability of directors of a company to the wider stakeholders under the Companies Act, 2013 and held that the expression "environment" would include the "inter-relationship which exits among and between water, air and land and human-beings, other living creatures, plants, microorganism and property".

As a result, companies have been compelled to shift their policies towards promoting the interest of all the stakeholders of a company rather than only the shareholders.

ESG factors have also provided an opportunity to companies to showcase their good work and increase their business efficiency. For instance, Fab India Ltd., a clothing and furniture retail based on traditional Indian crafts has been able to reap the benefits of ESG-centric policies to increase its value among investors and potentially raise around $500 million in its up-coming IPO⁴.

Instances of ESG related litigation

While the emergence of ESG has provided an opportunity to companies to showcase their good-work, it has also brought into the forefront the companies that have been evading ESG practices. The companies that have failed to adopt ESG-centric policies are vulnerable to ESG-related litigation. The objective of such litigation is two-fold –

a. To seek monetary compensation from a company for any damage caused to the environment or person or business,

b. To compel a company to change its business policies in tune with the ESG factors.

In India, ESG-related litigation remains largely underdeveloped as no court has had the opportunity to delve into ESG-related issues in a holistic manner. However, courts have dealt with ESG-related issues individually like minority protection, gender justice, labor welfare, CSR and environment-related issues.

In particular, companies in India have faced litigation since the 1980's for causing environmental damage and violating environmental norms. For instance, in the case of Tirupur Dyeing Factory Owners Association v. Noyyal River Ayucutadars Protection Association⁵, the Petitioners filed the petition to protect and conserve the Noyyal river in Tamil Nadu. In particular, the claim was made against the Tirupur Dyeing factory for discharging their effluents into the Noyyal river and thereby polluting the river. The Supreme Court ordered the factory to shutdown as it had breached emission standards. Companies have also been ordered to compensate persons affected by their business actions if there was evidence of environmental harm by a company⁶.

While most ESG-related litigation has been synonymous with environmental claims, the COVID-19 pandemic has however sharpened the focus on various social and corporate governance issues within a company, such as – maintenance of a healthy work environment, diversity among the workforce, transparency and accountability among the company management, and conduct and behavior of the management. In recent instances such as the dispute between BharatPe and its former CEO⁷, and the claims of breach of corporate governance norms against the Board of the National Stock Exchange⁸; the conduct and affairs of the board of directors of a company has come under increased scrutiny by regulators. This has severely affected the goodwill and reputation of the companies and resulted in a mass exodus of employees as well. Furthermore, the companies are at an increased risk of a long-drawn litigation that will severely reduce their revenue and profitability.

Conclusion:

Mitigation of ESG-related litigation

ESG is a benchmark of business efficiency vis-à-vis sustainability. A company that adopts ESG-centric policies and remains proactive to ESG-related risks, will be able to maximize their profitability and revenue. However, companies that fail to adopt ESG-related policies will be exposed to legal claims for non-compliance of ESG norms. Such litigation has a debilitating effect on the reputation and goodwill of a company as it brings the breaches of the company under the public eye. Furthermore, it can result in great financial loss for a company as a result of fines, damages, and legal expenses. Moreover, a company facing such litigation will also have to spend huge amount of time and resources to rebuild the tarnished reputation of the company.

This collectively reduces the profitability and productivity of a company. Therefore, it is imperative for a company to conduct regular risk assessments, identify potential risks, seek advice from experts, and comply with ESG related norms across borders to mitigate the risks associated with ESG-related litigation.

Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.