Managing Potential Board Liability for Evolving Environmental Risks

Growing Risks for Directors and Officers

In the third of a series of articles discussing emerging theories of liability for directors and officers Stephanie Resnick, Philadelphia Office Managing Partner and Chair of the Directors’ and Officers’ Liability Practice Group at Fox Rothschild, and John Fuller, an associate and member of the Directors’ and Officers’ Liability Practice Group at Fox Rothschild, examine the emerging risks for directors and officers arising from a company’s response to climate change and environmental risks.

with co-author John Fuller

As discussed in prior articles, new theories of liability for directors and officers relating to social issues have emerged, as shareholder-plaintiffs are increasingly able to demonstrate direct monetary damages resulting from the boards’ purported failure to address these issues.

Environmental issues are no different. Historically, it has been difficult for shareholder-plaintiffs to demonstrate how directors’ and officers’ failures to adopt environmentally conscious policies adversely affected the company’s earnings.  In fact, in many cases, “green” policies decrease profits because they internalize environmental costs for which a company may not otherwise be financially responsible.

However, recent reports regarding the financial ramifications of environmental changes are forming the basis for future shareholder claims. For instance, mutual funds and investment managers have begun examining how environmental concerns and sustainability should be factored into long-term corporate growth plans. The reports and analyses these institutional investors are developing to evaluate the impact of the environment on corporate growth are significant because they connect these issues to a company’s bottom line. Therefore, as these analyses continue to gain mainstream acceptance, they may be used by shareholders to demonstrate that a board’s failure to plan for environmental costs has stifled long-term growth.

Shareholder-plaintiffs may also be emboldened by the findings of the Fourth National Climate Assessment (NCA), issued by the United States’ Global Change Research Program on November 23, 2018. The NCA contains findings that climate change and the resulting environmental affects will have a negative impact on the United States economy of hundreds of billions of dollars by the end of the century. The NCA anticipates that climate change will have direct effects on agriculture, fishing and tourism industries, but also broader effects including increased energy demands (coupled with reduced efficiency in energy production) and potentially significant changes in global import and export balances, which could dramatically effect global supply chains. At the very least, the NCA creates another set of warning flags of potential business impacts of which directors and officers are on notice and which they should evaluate as part of their long-term strategic planning.

Finally, the changing regulatory landscape in response to the NCA and/or other constituent pressures on lawmakers creates two additional types of risk for board members. First, tightening regulations to protect the environment requires constant monitoring to ensure compliance. The second risk, however, may come not from the failure to comply with regulations, but the failure to capitalize on changes in regulations, which may cause competitors to stumble and may come with benefits such as tax credits that companies should be prepared to fully utilize.

With increasing pressure from shareholders for companies to address their environmental impact and be responsive to regulatory shifts, directors and officers should evaluate environmental issues as they do with any business risk.

As noted in the NCA, some industries will be directly impacted by climate and environmental changes in the coming decades – if they have not been already. Companies facing such direct operational impacts must take appropriate steps in the short term to adjust their business model to meet these mounting external risks. The directors and officers of companies facing such direct environmental impacts may consider adding a board member with environmental expertise who can stay informed on salient issues and assume responsibility for educating the board as a whole. Alternatively, boards could invite experts to address the board and provide regular updates.

For companies facing less direct risks from environmental changes, but which may be vulnerable to disturbances in global supply chains or affected by environmentally unsustainable production practices, monitoring – through experts or a designated board committee – may be the appropriate short-term solution.  Boards may also consider creating a staff position tasked with developing responsible approaches to corporate social responsibility or sustainability.

As companies take steps to formalize the monitoring of environmental issues, however, the setting of benchmarks likely creates obligations to meet these established standards. A company’s failure to meet its own standards (or critically address its failures to do so) could be used to support shareholder-plaintiffs’ claims against directors and officers in the future.

Therefore, it is key to ensure that any efforts undertaken to address environmental issues are disclosed and discussed with shareholders. Dialogue with shareholders on these issues will help ensure agreement as to the appropriate steps that should be taken – and corporate resources that shareholders believe should be devoted – in the short term to address the tremendous uncertainty about the long-term effects of environmental change on corporate bottom lines.