D&O Coverage For Climate Change-ESG-Related Liabilities

Key Points:

• New SEC climate risk disclosure requirements are likely to increase companies' climate-related liability risks
• D&O insurance should respond to such liabilities, but policyholders should prepare for a fight
• With respect to liability, ESG programs can be a double-edged sword

Introduction

Climate change arrived on our doorsteps in 2021, in the form of devastating hurricanes, tornadoes and wildfires. Along with escalating property claims, intensifying natural disasters and longer-term effects like drought and coastal erosion are also generating increased liability risks.

For protection against liability stemming from climate-related claims, Directors and Officers ("D&O") policies increasingly come into play. We expect that trend will continue, as the United States Securities and Exchange Commission just recently proposed mandatory reporting of companies' climate risks, including the level of greenhouse gas emissions companies produce, both directly and indirectly, how climate risk affects their business, and their plans to meet climate-related goals. As explained below, a number of lawsuits already have been brought against companies that have been providing such disclosures on a voluntary basis. Should the SEC's new proposal become final, we expect to see to an increase in litigation in this area as well as an increase in disputes with D&O insurance companies over coverage for these suits.

Nature of Underlying Suits Implicating D&O Insurance Policies

A suit recently filed in the United Kingdom illustrates the escalating liability risk. Activist shareholders have sued the directors of Shell Oil. ClientEarth, an environmental law organization, alleges that the directors are personally liable for their failure to prepare for net zero emissions pursuant to the Paris Accords. This is a novel suit and the first of its kind. Activist shareholders are common and will not be limited to Shell Oil, and the Shell Oil litigation may provide a blueprint for investors seeking to force companies to implement climate control measures.

Even before Shell Oil, climate-related litigation was increasingly common. At least 1,375 climate change-related suits have already been brought in the United States, a significant subset of them directed against companies. These include suits filed by local municipalities and states seeking damages because of climate change, and shareholder suits alleging harm to investors stemming from misrepresentations of climate change risks or of actions allegedly taken to mitigate those risks. For example, the Attorneys General of New York, Massachusetts, and the U.S. Virgin Islands launched investigations to determine whether Exxon Mobil Corporation misrepresented to investors how climate change might impact its business. The New York and Massachusetts Attorneys General filed separate suits against Exxon, and these enforcement actions in turn spun off private civil litigation against directors and officers.

D&O Coverage Issues

Climate change suits against D&O insurance companies may present difficult coverage issues. Many D&O policies contain pollution exclusions, and insurance companies already have indicated their intention to rely on pollution exclusions to deny coverage for lawsuits alleging "losses" as a result of D&Os' "wrongful acts" in financial reporting related to climate change. No case law exists as of yet on the effect of pollution exclusions in D&O policies in this context.

Case law on the absolute pollution exclusion in general liability policies is split. Some courts have construed this exclusion very broadly to include almost anything that enters the environment, including for example fumes from a floor sealant. Other courts construe the exclusion to apply only to 'traditional environmental pollution,' a standard the borders of which are unclear: is a suit over climate change a suit concerning 'traditional environmental pollution'?

One issue in this analysis is proximate cause. In Sealed Air Corp. v. Royal Indem. Co., 404 N.J. Super. 363 (App. Div. 2008), shareholders alleged that the company and its directors and officers misrepresented the company's environmental exposure. The insurance company denied coverage under the D&O policy on the basis of a pollution exclusion. The New Jersey Appellate Division disagreed and found coverage, essentially holding that the proximate cause of the loss was not the pollution but the misrepresentations and, therefore, the D&O policy's pollution exclusion did not apply.

Another typical coverage exclusion that D&O policyholders need to be mindful of when seeking coverage for climate change-related suits is the so-called conduct exclusion, which purports to exclude coverage for intentional, willful or deliberate misconduct or criminal acts. This exclusion might limit or eliminate coverage, for example, in lawsuits alleging that the company's directors and officers intentionally implemented a program of regulatory non-compliance, or in lawsuits alleging the deliberate withholding of information relating to the company's climate-change related vulnerabilities. This exclusion, however, is typically subject to a "final adjudication" requirement, so that it is not triggered until there is a final court decision finding such misconduct. Until that point the insurance company must fund defense costs as they are incurred. If a final adjudication does eventually find such misconduct, the insurance company may be able to recover the defense costs it advanced.

ESG: Source of Liability, or Liability Protection?

The rising societal concern over climate change is a major factor in the recent corporate emphasis on ESG - environmental, social and governance issues. One prong of ESG is sustainability and making companies more socially conscious and responsive to climate change. Companies are announcing aggressive programs to reduce their carbon footprint and their emissions, particular favorites of activist investors. A company's failure to meet its goals can result in shareholder suits against the company's officers and directors.

One example is Meyer v. Jinkosolar Holdings Co., 761 F.3d 245 (2d Cir. 2014). In that case, the Second Circuit Court of Appeals held that shareholders could proceed with their "greenwashing" lawsuit - i.e., misrepresenting success in meeting its environment goals - against the company and its officers, directors, and underwriters. Specifically, the shareholders claimed that the company made materially misleading statements in its prospectus issued as part of its public offering regarding its compliance with environmental laws at its production facility in China. Subsequently, the parties settled the shareholders' claims for over $5 million while new motions to dismiss were pending. SeeMeyer v. Jinkosolar Holdings Co., Case No. 11-cv-7133, Dkt. No 100 (S.D.N.Y. Mar. 11, 2016).

The insurance industry's reaction to climate change and ESG is following two paths. The first is to reduce coverage. Climate change-motivated reductions to property insurance in the form of higher "named storm" deductibles, for example, are already in the works. Additionally, some insurance industry commentators have advocated adding a climate change exclusion to D&O policies.

At the same time, the insurance industry is aware that ESG measures can reduce directors' and officers' exposure to suits. Insurance companies are paying increased attention in underwriting to companies' ESG activities. In particular, Marsh has partnered with certain insurance companies to provide more favorable coverage terms to companies that can demonstrate strong ESG programs through a review process.

Conclusion

As regulatory activity and private litigation activity surrounding climate change issues continue to increase, liabilities likely will follow. D&O insurance companies will be called upon to address those liabilities with increasing frequency. Those claims will present complex coverage issues of first impression, and policyholders can expect a fight. Policyholders also should be on the lookout for more restrictive coverage terms on D&O renewals. Policyholders should work with their brokers to obtain the broadest coverage available, and consult with sophisticated coverage counsel in the event that they are faced with climate change-related claims.

Originally published 7 April 2022

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Dennis Artese
Anderson Kill
1251 Avenue of the Americas New York
New York
NY 10020
UNITED STATES

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