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ESG litigation risks

Greenwashing around environmental, social and governance matters is about to become risky business.

Wind power versus coal

When it comes to environmental, social and governance (ESG) litigation, there is a tsunami coming to Canada.

ESG encompasses three key factors to capture, measure and evaluate how advanced a company is on the sustainability front — something investors and consumers are increasingly concerned with. To date, ESG reporting has been voluntary in this country. Since consumers and investors have increasingly looked to align with entities that act ethically, companies have used their reporting to demonstrate good things they've done in each of those categories. 

"In doing that, they would often cherry pick from different standards and topics," says Conor Chell, head of MLT Aikins' ESG Practice Group. "They'd pick the ones that best demonstrated how good they were." 

He says this first voluntary wave of ESG reporting was "purely promotional." But a lack of standards and reliability in reporting has led to skepticism about the information getting out. Yet there hasn't been much in the way of litigation holding companies to account over their claims beyond a few cases around climate change and greenwashing, typically brought against governments or ministers by not-for-profit groups. 

But thanks to new mandatory disclosure requirements, a new wave of ESG reporting is coming to Canada and the United States.

This past April, the federal government's budget included measures aimed at achieving a net-zero economy, including mandatory climate-related reporting requirements. The requirements are based on the Task Force on Climate-related Financial Disclosures framework. They will apply to federally regulated banks and insurers, which the budget noted "play a prominent role in shaping Canada's economy." Reporting requirements will be phased in starting in 2024, but will draw on the 2023 financial year.

The Canadian Securities Administrators has also proposed climate-related disclosure requirements, which will apply to any publicly listed company in Canada.

South of the border, the U.S. Securities and Exchange Commission has an even more comprehensive package of climate disclosure rules in the works, which will apply to any company listed on a U.S. stock exchange. Though the rules don't come into effect until the end of this year, Chell notes the SEC has already started enforcing action against greenwashing.

READ MORE: Canada's balancing act on climate disclosure rules

Ultimately, the reporting requirements will impact most companies whether they have a reporting obligation under one of these regimes or not. For instance, a mid-market private company with no securities reporting obligation probably does business with a federally regulated bank or insurance company. Those companies have to report, and by extension, anyone they do business with will also have to collect and disclose that same information to them. 

Once the mandatory reporting requirements are in place, Chell expects a wave of ESG litigation to start building, ultimately to a tsunami, as companies struggle to adjust from the promotional phase of ESG to the mandatory phase. He says sustainability reporting is still "a bit of a Wild West," and he's yet to see a sustainability report that would meet all the requirements in the SEC's proposed rules.

"If we're using weather metaphors, I think it will be a minor tropical storm to start over the next while. But momentum will grow over the next 12 to 18 months," Chell says. 

"I expect a full storm to hit in early 2024 when companies are starting to report on those requirements in Canada and the U.S. I think that's when you'll really start to see it. There will be organizations just waiting for disclosures to come out, and they'll be going through them with a fine tooth comb for any thread to pull on."

The litigation wave will come in two types, Chell says. A sustainability report that's not compliant could see enforcement by regulators or pose a litigation risk. But institutional investors and asset managers will also be targets of litigation given the tendency to date to offer ESG labelled investment products that don't perform as well from an ESG perspective as they claim they do.

Paul Rand, the chief investment officer (Canada) with Omni Bridgeway, says "ESG and litigation go hand in hand," as they both exist to address wrongs. To that end, he sees litigation funding as an ESG tool. 

"We are fundamentally involved in promoting access to recourse to the judicial system to address wrongs. In that sense, we promote rule of law and I don't think any ESG program in society is going to function without robust rule of law," he says. 

But litigation doesn't come cheap and certainly favours those with money. Litigation funding therefore is an essential part of ESG if those without deep pockets are to make their case in court.

"(It) can absolutely help in levelling the playing field when it comes to concerned individuals and public interest groups," Rand says. "As an access to justice proposition, our business has a strong connection to the ESG world. There is absolutely a place for parties looking to address ESG-related wrongs to consider litigation finance."

To that end, Omni Bridgeway is exploring the idea of creating a dedicated fund targeting exclusively ESG litigation opportunities.

While risk assessment figures prominently in his work, Rand says an increase in ESG litigation doesn't necessarily bring higher risk. While there will be novel claims in the mix, he expects a lot will end up looking like conventional commercial litigation infused with ESG considerations — for instance, a company raising concerns with a supplier over ESG conduct or investor claims relating to ESG disclosure.

"I think there's bound to be more conventional litigation with heavy ESG overtones," he says.

ESG is also an increasing area of focus for the Competition Bureau, and Paul-Erik Veel, a partner at Lenczner Slaght, expects that will spill over into private litigation. 

"ESG issues, and climate change in particular, are so much more present on consumers' radar these days," he says. "And the more present they are, the more companies will feel the need to make claims to the market about how environmentally friendly their products are. No doubt most companies will have testing to back up what they do, but there are always going to be some that cut corners for what they see as a market benefit. So as we get more of these claims, we will get more of these class actions."

Once the Bureau gets a complaint, investigates and does something — even if it is just a settlement that doesn't necessarily indicate wrongdoing — the 'where there's smoke, there's fire' theory kicks in among plaintiff's counsel, who see a potentially viable class action.

It's in this consumer class action space that Veel sees a role for litigation funding.

"There's a very competitive market for litigation funding for class actions in Canada. The litigation funders want to understand what the potential damages are and how good the case is," he says. "If you've got a bureau settlement, you've got a reasonable sense that your case is not bad to start with."

He adds: "To be perfectly honest, that's the scariest prospect (for companies) because the damages have the potential to be so large. So that's what I suspect what will help police corporate conduct."