There is an increasing desire amongst PE firms to publicise value creation through the use of bespoke metrics to measure improvements and value derived from (ESG) policies including improved reputational risk management; better and more transparent governance; better health, environmental and safety standards; heightened efficiency; less disruption as a result of sanctions and protest; etc.
These and other opportunities inherent in a robust ESG strategy are generally well-understood by PE firms. However, commensurate appreciation of growing legal risks for buyout firms that communications around ESG strategy and commitments entail, is less evident.
There is more to this evolving area than simply general compliance and being a good corporate citizen. Real reputational, legal, political and financial consequences can arise from failing to align business practice with ESG statements and policies. Such statements and policies often contain laudable public commitments and pledges around ESG, and acknowledgements of control of, and responsibility for, such matters by private equity management and boards. However, these statements and policies have legal content and significance that must not be overlooked; they potentially create misstatement litigation exposure at board, operating and portfolio company levels.
We are seeing the mass tort litigation environment becoming increasingly active with claims sponsored by non-governmental organisations and no-win, no-fee lawyers trawling for cases using public literature in which broad statements around ESG commitments and control structures are made. For now, multinationals are in the spotlight, but attention may not stop there. In addition, litigation against parent companies based on overseas human rights and environmental impacts has passed threshold admissibility challenges in British, Canadian and Dutch courts. This has brought the issue of fund and portfolio company separateness into sharp focus. The litigation risk level for buyout firms is increasing as these developments in litigation practice align with heightened transparency and reporting of ESG issues. For example, buyout firms frequently publish various ESG reports for investors, which can create liability issues where standards are not met. Further, deal teams frequently consider issues such as modern slavery, anti-bribery and environmental factors during diligence. However, firms must be careful about sharing information with non-lawyer consultants or NGOs as this will not be protected by the cloak of legal privilege and could be used against the firm in future litigation, should adverse ESGimpacts materialize.
What can deal teams do to minimise the risk of ESG based litigation? In our view, prospective portfolio investments should be assessed and current portfolio investments should be monitored, in light of fund ESG commitments. Buyout firms’ claims must be supported by appropriate diligence that matches up to internationally recognised standards. Structured, systematic and precise internal control systems with appropriate and expert legal input are required.
There is enormous opportunity for those focused on sustainable investment but there is a real and increasing need to approach this as a fundamental risk mitigation issue.