Reducing Legal Exposure on ESG Issues for Corporate Boards


Companies are increasingly focusing on ESG issues, as major institutional and individual investors closely follow and support them. For example, investment managers like BlackRock will no longer invest in shares of companies that do not have and follow their own ESG policies. These days, battle lines have been drawn around the issue of ESG investing; however, because many investors demand that companies behave responsibly, ESG investing is likely here to stay.

ESG stands for environmental, social, and governance. In economic terms, a company can generate externalities—consequences of its economic activities felt by society. Eventually, a company may face legal risks when its actions impose externalities. When companies face consequences for poor governance, their directors may be held personally liable. Shareholders are increasingly turning to these lawsuits to be compensated for alleged losses in connection with companies’ poor ESG performance.

ESG Is Leading to Increasingly Complex Risks for Directors

ESG brings risks for corporate board members in two primary ways. The first is in how the directors manage the company and how they deal with their own ESG risks. The second is in the information their company reports to the public in its financial filings and corporate releases.

As climate change issues move to the forefront, companies must be prepared for how they deal with them. The financial implications of resource scarcity and major storms can be significant for a company. A board of directors should have a reasonable plan for how its company will cope in the event of major climate changes and events.

Further complicating ESG is the fact that on November 22, 2022, the United States Department of Labor (DOL) released a final rule under the Employee Retirement Income Security Act (ERISA) that empowers retirement plan fiduciaries to consider ESG factors when making investment decisions, exercising shareholder rights. This final rule is a change from the two fiduciary rules under the Trump Administration that were adopted in 2020. At that time, the DOL indicated that fiduciaries were to consider only plans’ financial interests rather than any nonpecuniary goals or other policy objectives. Those rules went into effect in January 2021.

Upon taking office President Biden signed Executive Order 13990 which ordered a review of DOL’s rules and also Executive Order 14030, which directed the federal government to identify and assess policies to protect the life savings and pensions of Americans from the threats of climate-related financial risk.

The Final Rule emphasizes that a fiduciary’s determination with respect to an investment must still be based on the risk and return analysis, but that analysis may include the economic effects of climate change and other ESG factors. Relevancy can only be determined by specific facts and circumstances. The Final Rule allows fiduciaries to consider collateral benefits as “tiebreakers” when choosing between competing investments. Under the prior rule, investments had to be “economically indistinguishable” before fiduciaries could consider other factors.

Finally, the Final Rule protects fiduciaries by stating that they will not violate their duty of loyalty solely because they take plan participants’ preferences into account when constructing a menu of investment options for participant-directed individual account plans.

Potential ESG Issues for Corporate Boards

In addition to climate change-related risks, other potential ESG problems include:

  • How a company discloses its diversity practices to shareholders — Companies have been sued numerous times in recent years, including in lawsuits where they have been accused of falsely reporting diversity statistics.
  • The S. Securities and Exchange Commission has taken enforcement actions against companies that have been accused of falsely assuring investors that certain corporate properties are safe.
  • Consumers have been filing ESG lawsuits against companies for allegedly false ESG assurances that compelled them to purchase their products or their stock.

Corporate Directors Can Be Personally Responsible

ESG brings risk for corporate board members as well. In the performance of their responsibilities, corporate board members owe their company a fiduciary duty. This obligation is broken down into the duty of loyalty and the duty of care. Individual board members may be sued if they fail to live up to their fiduciary duties.

A major case in the Delaware Court of Chancery back in 1996 held that corporate directors could be liable for a failure to oversee their company if they “failed to implement any reporting or information system or controls.” This decision takes on even more importance as far as ESG is concerned in light of new SEC reporting requirements regarding climate risks and other social responsibility issues.

ESG Can Invoke the Directors’ Duty of Care

A board of directors has primary responsibility for legal oversight of its company’s ESG matters and reporting. Like any other board responsibility, the individual members must observe their fiduciary duties to the company in carrying them out, or they can face legal repercussions. The SEC has stepped up its enforcement efforts regarding new ESG rules. Now, the SEC will scrutinize corporate filings in order to ensure that companies have made complete and accurate disclosures of ESG issues.

The evolving nature of ESG issues presents distinct challenges for board members. ESG falls under the rubric of a corporate director’s duty of care. A director has a legal obligation to use reasonable diligence in pursuing corporate aims. They are not required to be perfect, but they are expected to use the care and skill of an ordinarily prudent person.

Directors Should Seek Training and Establish Committees

Directors themselves should seek training to ensure they understand ESG issues. In addition, they should ensure their company as a whole has adequate internal training for others. If the company makes a mistake in an ESG-related area, the directors could be personally liable.

One of the major ways that boards of directors fulfill their fiduciary obligations is to have committees under them that provide them with input they need to make sound decisions. For example, the board may have an audit committee or a compensation committee that advises them on audit and compensation issues. Boards should consider what committees may be necessary to cover areas touched by ESG. That said, directors may not be able to blindly rely on whatever a committee reports without exercising some due diligence of their own.

Directors Should Learn All They Can About ESG Issues

At the very minimum, directors need to be familiar with the risks that ESG issues could pose to their company. They should understand the interrelationship of each of the individual risks and how they can affect the company as a whole. Boards should look to a variety of sources to obtain relevant information to assess the risks. Reasonable diligence could mean establishing numerous committees and speaking to multiple stakeholders in order to understand the full picture.

In addition, directors should understand the underpinnings of the individual risks from an ESG perspective that can affect their company. If the company makes ESG-related assurances or reports on any ESG-related issues, a director should have some personal familiarity with the subject matter. They do not need to be a subject matter expert themselves, but they must show that their reliance on others is reasonable.

Both activist investors and the government are lying in wait to take action against a company that makes an ESG misstep. Even if many ESG-related lawsuits have been dismissed by judges, they can still impose costs on a company and cause reputational damage. Directors should retain an experienced attorney who can help them protect themselves and manage their own risks in a rapidly evolving area.