Potential pitfalls of environmental disclosures

Large companies are increasingly assessing the environmental impact of their operations and disclosing the results to stakeholders in conjunction with remediation plans. These disclosures have already triggered a variety of lawsuits and investigations. The learnings can help board members mitigate the risk for themselves and their own organisations.

Recent high profile court cases have shown that improper reporting and misleading advertising can leave businesses vulnerable to governmental scrutiny, litigation, reputational damage and revenue losses in an increasingly climate conscious world. Incorrect reporting, or failure to uphold stated aims and goals can also leave directors open to personal claim of false or misleading statements.

Growing environmental disclosure requirements

Businesses are not only voluntarily making environmental disclosures, but they are also having to comply with a growing number of environmental reporting frameworks, some of which are mandatory.

Among them is The Task Force on Climate-related Financial Disclosures (TCFD), established by the G20 in 2015. It contains recommendations on the types of information that companies should disclose to support investors, lenders, and insurance underwriters, as well as how to appropriately assess and quantify a specific set of risks related to climate change. In the UK, the recommendations have become mandatory for listed companies and large commercial businesses (opens a new window). Member states of the G20 are rolling out implementations that differ slightly in scope and time frames. Similar directives apply in the EU (opens a new window) for large public-interest companies with more than 500 employees.

Furthermore, in the UK, claims of environmental impact, or mitigating efforts, in the production of goods and services must comply with the Competition and Markets Agency’s (CMA) green claims checklist. Before making an environmental claim, the business must be able to answer ‘yes’ to a number of qualifying statements (opens a new window), including that:

  • The claim is accurate and clear for all to understand

  • The claim clearly tells the whole story of a product or service; or relates to one part of the product or service without misleading people about the other parts or the overall impact on the environment

  • There’s up-to-date, credible evidence to show that the green claim is true

  • The claim doesn’t exaggerate its positive environmental impact, or contain anything untrue – whether clearly stated or implied

In addition, a raft of EU directives is set to be implemented in Europe over the coming years. These include:

  • Unfair Commercial Products Directive - these guidelines will crack down on any business using unsubstantiated and overly general claims as it pertains to terms such as ‘sustainability’ and ‘green’ without proper evidence

  • Product Environmental Footprint - due in 2026, this will require products to have a stated A-E sustainability score, similar to nutritional value rankings on food and drink products

  • Ecodesign for Sustainable Products Regulation - due in 2026, all products sold in the EU must hit minimum standards of environmental impact

  • Corporate Sustainability Reporting Directive - due in 2024, all companies with a net turnover over €150m must report non-financial ESG performance across all subsidiaries

While potentially indirectly exposed to the risks described above through their holdings, the finance sector has its own environmental disclosure requirements including:

  • Sustainable Finance Disclosure Regulation (SFDR),

  • the EU Corporate Sustainability Reporting Directive (CSRD),

  • and the formation of the International Sustainability Standards Board (ISSB).

Scrutiny over environmental disclosures

The growing environmental disclosure requirements for companies around the world increase the risk to businesses.

The Dutch Authority for Consumers & Markets has investigated (opens a new window) 170 companies for their environmental reporting, and launched two full scale investigations into companies for non-compliance. Regulatory investigations can lead to fines and reputational damage for the companies involved. Similar ombudsmen operate in Denmark and Norway, requiring businesses to have credibly sourced data to back up their sustainability claims.

The UK government has formally launched a new taskforce to tackle greenwashing and develop measures to support UK companies in their plans to transition to net-zero carbon emissions. Large companies and certain financial sector firms will be required to publish a transition plan from 2023.

And it’s not just regulators taking a close look at companies’ environmental disclosures. Non-governmental organisations (NGOs) are increasingly looking for new and innovative ways to hold businesses to account. In March 2022, environmental shareholder group ClientEarth announced (opens a new window) it would be taking legal action against the international board of energy group Shell. Using its knowledge of the company’s stated climate goals to hold its feet to the fire, ClientEarth alleges that Shell is failing to implement its stated commitment to reduce greenhouse gas emissions in line with the UN’s Paris Climate Accord.

Lawyers for ClientEarth have brought a derivative action against Shell in the UK courts. This is a claim on behalf of shareholders that alleges a breach of duty by the board of directors. In essence, ClientEarth is pursuing legal action against its directors for their stewardship of its operations, in order to enforce action on its sustainability goals.

Several large corporations have also been hit with allegations of ‘greenwashing’ (claiming their products are sustainably sourced without proof to back up these assertions).

High street retailer H&M for example is facing a class action lawsuit (opens a new window) in the state of New York for claims its advertising is “designed to mislead consumers about its products’ environmental attributes”. It sold several items under its “conscious choice” range, claiming those products are made with “at least 50% more sustainable materials”.

The Norwegian Consumer Agency (NCA, Forbrukertilsynet) has brought a similar claim (opens a new window) against the retailer, as well as against outdoor clothing brand Norrøna. The NCA alleges the brand’s use of the sustainability index HIGG MSI is insufficient proof of its stated sustainability credentials.

Potential disclosure pitfalls

The three biggest risks in falling foul of regulation can be broadly broken down into three categories:

  1. Inaccurate reporting of environmental impact, either by accident, or by intent

  2. Misleading claims to stakeholders, clients, or customers on the sustainability credentials of a product or service

  3. Environmental impact in the supply chain

It's important to note that the intent in these endeavours is irrelevant for regulatory bodies, or the actors likely to sue a company. It is therefore important for company directors to ensure proper reporting is taking place, that any claim made in the marketing of products is substantiated and voraciously checked, and that suppliers have the same commitment to sustainability and have the data and credentials to prove it.

Insurance implications

Companies are beholden to the disclosures they make. They may be held liable for any misstatements or false representations made to investors. They could also face legal action, further into the future, if they were to miss climate related targets.

Any inaccuracies in the disclosures can therefore have profound implications on the businesses’ directors’ and officers’ (D&O) liabilities. A fiduciary breach by an executive leaves them personally liable to claims by their shareholders, customers, clients, competitors and any other relevant stakeholder. Back in May, the Bank of England warned (opens a new window) that specialist D&O policies were particularly exposed to climate-related litigation, noting that potential claims could relate to greenwashing, alleged breaches of fiduciary duties, and to the financing of emission heavy industries.

Climate-related legal action, independently of being successful or not, may push corporate insurance costs higher. Insurers underwriting D&O policies are essentially taking a view of how a business is run by its leadership team. Any environmental breach can be a major risk, as it shows either a lack of internal control, or an attempt to manipulate data and messaging.

Underwriters are increasingly asking potential clients questions such as whether their net zero strategy had been independently reviewed or requesting information about climate policies. Insurers will also be keenly aware of how the board of a company is managing the risks associated with climate change. Indeed, large scale insurers now have their own environmental, social, and governance (ESG) marks to hit and covering the activities of a business that hides its environmental impact might be too big a risk to take on. Demonstrating that proper environmental reporting procedure is followed will assuage the fears of insurers and make your business far less of a risk to cover.

For further information, please contact:

Michael Lea, Partner, Head of Management Liability

T: +44 (0)20 7933 2669

E: Michael.lea@lockton.com

Dominic Pilgrim, Vice President, Global Professional & Financial Risks

M: +44 (0)750 076 4812

E: dominic.pilgrim@lockton.com

Andrew Young, Assistant Vice President; Global Professional & Financial Risks

M: +44 (0)7425 616561

E: andrew.young@lockton.com

Richard Ellis, Vice President, Global Professional & Financial Risks

T: +442079331127

E: richard.ellis@lockton.com