Evaluating Directors and Officers Liability Coverage for Emerging ESG-Related Risks

Introduction 

With intensifying demands from regulators, investors, and the public for attention to environmental, social, and governance ("ESG") issues, companies are increasingly focused on ESG considerations and initiatives. Not surprisingly, ESG-related litigation and government investigations have also expanded. Additionally, regulators, both in and outside the United States, have released new rules and enforcement mechanisms for ESG-related conduct. This whirlwind of activity is generating increased exposure and liability risks for companies and their officers and directors. Specifically, shareholders and activist investors are using litigation to target corporate boards for failing to address ESG-related concerns and for misrepresenting ESG-related efforts. At the same time, regulators are devoting increased attention and resources to new ESG-related disclosure requirements and enforcement actions. As a result, companies are faced with the competing concerns of demonstrating their commitment to ESG principles while preventing exposure to litigation and regulatory risks. 

To help mitigate these risks, companies should evaluate how their directors and officers ("D&O") liability insurance may respond to ESG-related claims. Although D&O insurance is marketed and designed to respond to such claims, insurers may attempt to deny or limit coverage, especially where the insurer can point to alleged "green-washing" or "social-washing" in the company's disclosures and public statements. Policyholders facing emerging ESG-related risks should carefully and proactively analyze potential coverage under their existing D&O policies, and be mindful of any restrictive terms introduced upon D&O policy renewal. 

ESG-Related Litigation Risks 

As the types and scope of ESG issues continue to evolve, companies are facing emerging ESG legal risks. In addition to the rise of a myriad of ESG "ratings agencies" issuing reports to investors that purportedly "score" ESG performance under varying and opaque methodologies, litigation is exploding under all three ESG pillars. 

Recent shareholder litigation has sought to hold companies and their directors accountable for alleged "green-washing" misrepresentations. "Green-washing" generally refers to using marketing materials and/or disclosures to exaggerate a company's efforts around sustainability. Shareholders have also brought lawsuits against companies alleging misrepresentations regarding climate change risks and mitigation measures. For example:  

• A recent federal securities class action alleged that the directors and officers of a company that produced biodegradable plastic alternatives made false and misleading statements about the product's biodegradability. 
• Several lawsuits have been filed against consumer brand companies claiming that statements that plastic packaging or plastic products are "100% recyclable" are false and misleading. 
• A recent derivative lawsuit alleged that a company's directors made public statements that misrepresented the climate risks to the business and the cost of greenhouse gas regulation compliance. 
• A class action lawsuit alleged that a company and its officers made misleading statements regarding mitigation of climate change risks, including wildfire risks. 

Investors and shareholders are also increasingly scrutinizing whether companies are complying with their own ESG-related statements relating to diversity and inclusion and other aspects of social justice, and engaging in adequate governance to ensure ESG-related social goals are achieved. Companies have seen increased litigation from shareholders accusing corporate boards of "social-washing," or failing to meet their diversity commitments. Class action securities lawsuits have also been filed relating to disclosures regarding corporate policies on workplace sexual harassment and discrimination. For example: 

• A recent derivative action against a social media company's directors included allegations that the company made false proxy statements regarding its commitment to diversity and inclusion while simultaneously allegedly lacking diversity among the board and employees, using discriminatory hiring practices, and failing to curb hate speech. 
• A derivative action alleged that a company failed to diversify its board, had discriminatory hiring and promotion practices, and made misrepresentations about its diversity efforts in proxy statements. 
• A recent derivative suit against a specialty retailer's board members and officers included allegations of allowing a hostile and abusive environment to develop with widespread sexual harassment that ultimately destroyed the company's goodwill and affected company value. 

As these cases demonstrate, litigation in this area is growing, and companies are likely to continue facing escalating litigation costs and risks in connection with their ESG-related disclosures and measures.

ESG-Related Regulatory Risks 

Government regulators have also signaled a greater emphasis on ESG-related disclosure and enforcement. The European Union's interest in ESG oversight is nothing new—EU regulators have been announcing new ESG reporting requirements over the last several years. The United States is also now taking an aggressive approach to ESG-related issues, and has started issuing regulations and filing significant enforcement actions relating to alleged ESG-related misconduct. For example:  

• In 2021, the EU's Sustainable Finance Disclosure Regulation ("SFDR") went into force and requires that asset managers disclose sustainability considerations within their investment decisions. 
• The EU's Corporate Sustainability Reporting Directive ("CSRD") will be implemented in 2023 and requires substantial nonfinancial reporting on climate considerations and other ESG metrics for EU companies and companies of a certain size with business within the EU.
• In March 2022, the U.S. Securities and Exchange Commission's ("SEC") Climate and ESG Task Force—formed in March 2021—introduced new proposed rules that would require U.S. listed corporations to disclose climate-related information in their registration statements and periodic reports, including their exposure to climate-related risks and the implications of those risks on their financial performance. 
• In May 2022, the SEC voted to propose regulations that will require certain investment advisors and companies to provide additional information regarding their ESG investment practices, including disclosures relating to their consideration of ESG factors in making investment decisions. 
• In April 2022, the SEC brought an action against Vale S.A. ("Vale"), a global mining company, arising out of the January 2019 failure of Vale's Brumadinho dam in Brazil. The SEC alleged, in part, that Vale "manipulated multiple dam safety audits; obtained numerous fraudulent stability certificates; and regularly misled local governments, communities, and investors about the safety of the Brumadinho dam through its [ESG] disclosures." 
• In May 2022, the SEC charged the investment management arm of a U.S. bank with making "misstatements and omissions about [ESG] considerations in making investment decisions for certain mutual funds that it managed." According to the SEC, the bank "represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case." 

This flurry of recent activity demonstrates the EU's and the SEC's increased focus on targeting statements included in ESG disclosures, and companies should not be surprised if regulators use this approach more regularly in the future as a basis for enforcement actions.

Directors and Officers Liability Coverage for ESG-Related Risks 

As litigation and regulatory activity surrounding ESG-related issues continues to grow, policyholders should seek to use their D&O insurance assets to mitigate the substantial costs in defending against and resolving such actions. D&O insurance generally protects companies and their directors and officers against claims for wrongful acts. However, policyholders should be particularly mindful of the limits and sublimits, exclusions, and other potential limitations within D&O policies that insurers may seek to invoke to bar coverage for ESG-related claims. Given the rise in ESG-related regulatory and litigation matters and the magnitude of potential losses, insurers will be financially incentivized to try to avoid paying claims, and policyholders can expect a fight. Policyholders should also exercise care in connection with any ESG-related disclosures and representations during the underwriting of their D&O programs. 

Although D&O insurance should generally apply to ESG-related claims, insurers may seek to raise substantive coverage issues to deny or limit coverage. For example, D&O policies often contain pollution exclusions, and insurers have already improperly sought to rely on such exclusions to deny coverage for lawsuits alleging wrongful acts related to climate change and sustainability misrepresentations. In Sealed Air Corp. v. Royal Indemnity Co., 404 N.J. Super. 363 (App. Div. 2008), an insurer denied coverage under a policyholder's D&O policy for a lawsuit alleging that the company and its directors and officers misrepresented the company's environmental exposure, arguing that the allegations fell under the pollution exclusion. The New Jersey Appellate Division disagreed and held that there was coverage, finding that the proximate cause of the loss was the misrepresentations, not the pollution itself, and thus the exclusion did not apply. Nevertheless, at the time of purchase or renewal, policyholders should consider negotiating the removal of any "directly or indirectly arising out of" language or the addition of any carve-outs to pollution exclusions to maximize coverage.

In addition, D&O policies typically contain so-called conduct exclusions, which purport to preclude coverage for intentional or deliberate wrongful conduct. Insurers may seek to use these exclusions to bar coverage in lawsuits alleging that the company and/or its directors and officers deliberately misrepresented the company's sustainability policies, climate change risks and/or ESG-related disclosures. However, these exclusions typically apply only if there is a final judgment against the policyholder specifically finding such misconduct. Thus, in defending against and/or settling such claims, policyholders should be mindful of the operation of these conduct exclusions for purposes of securing coverage. 

Insurers may also seek to use exclusions within the definition of covered "loss" to limit coverage. For example, some policies may purport to exclude civil fines and penalties asserted in a government action from the definition of covered "loss." Other D&O policies may provide coverage if such civil fines and penalties are based on unintentional conduct or if insurable under applicable law. Even where such civil fines and penalties are excluded from the definition of covered "loss," D&O policies may nevertheless provide for reimbursement of defense costs incurred in connection with defending claims seeking civil fines and penalties, and thus policyholders should again carefully review their policy language and terms. 

It is also worth noting that some insurers have introduced ESG-specific policies and coverages. These are in the nascent stages and need to be examined carefully to ensure appropriate coverage.