Sustainability liabilities move up the D&O watchlist

A spate of corporate scandals leading up to the Global Financial Crisis in 2008 meant directors and officers (D&O) liability over the past two decades has been driven by governance concerns. Fraudulent accounting at companies such as Enron and WorldCom contributed to a rising tide of regulation and litigation worldwide, sparked by regulatory reforms to improve transparency and corporate accountability, including the Sarbanes-Oxley Act in the US.

However, the nature of corporate accountability is changing. Greater emphasis is being placed upon the ‘E’ in ESG (environmental, social, and governance), with corporate leaders facing scrutiny for their companies’ impacts on nature.

Climate change litigation is increasing, with cases reaching a total of 2,666 in 2023, around 70% of which have been filed since 2015, the year of the Paris Agreement, according to the Grantham Research Institute at the London School of Economics. [1] Primarily associated with the US, this phenomenon is spreading to other countries.

“Pressure is coming from multiple directions: consumers, shareholders, and employees. Directors and officers must respond,” says Gabrielle Durisch, Chief Sustainability Officer at Allianz Commercial.

“From a shareholder perspective, directors and officers must ensure the business is sustainable, addressing emerging and changing risks to remain profitable. Consumers are also more aware of sustainability commitments and are making choices based on that. Finally, sustainability is becoming critical in where people choose to work, particularly among the younger generation.”

The surge in climate change litigation reflects the growing pressure on corporations to account for their environmental impact, as plaintiffs – including non-governmental organizations, activist groups and even investors – use litigation to enforce climate commitments. However, future litigation and regulation could include environmental disasters, deforestation, water, and biodiversity degradation.

“This shift puts significant pressure on D&Os, who are now more accountable for sustainability actions and disclosures,” says Durisch. “When a company makes a public commitment to sustainability, it is being held to that commitment not only by regulators but also by shareholders, who are mindful of the need for balanced corporate strategies.”

Durisch says social media is also playing an outsized role in driving sustainability sentiment. “Brands can lose value overnight if they make a wrong move. There have been several significant examples of this in the last decade where the stock has plummeted within a few days and long-term trust has taken a hit.”

One high-profile example was ‘Dieselgate’ in 2015, when Volkswagen’s stock plummeted by nearly 30% in the days that followed news about the company installing software to cheat emissions tests on its diesel vehicles. Social media played a critical role in amplifying the scandal globally and the company has since faced billions of dollars in fines and settlements.

With the shift in corporate accountability, businesses now find themselves navigating a shifting regulatory landscape that is raising the stakes for compliance with sustainability-related disclosures and standards. The European Union is a strong driver with a raft of laws and policies introduced recently to promote climate change resilience and mitigation.

However, other jurisdictions are also introducing legislation applying stricter oversight of corporate sustainability practices, with broad implications for multinational companies that operate across borders. The Australian Prudential Regulation Authority (APRA), the regulator for financial institutions, has issued guidance requiring firms to manage climate-related financial risks, and the US Securities and Exchange Commission (SEC) has proposed a rule requiring publicly traded companies to disclose climate-related risks, including greenhouse gas emissions, and how these risks might impact their business operations.

In Canada, the Net-Zero Emissions Accountability Act is influencing corporate sustainability strategies, particularly for companies in energy, mining, and heavy industries, while in Japan, the Tokyo Stock Exchange’s requirement that companies provide climate-related disclosures puts pressure on international firms listed in the country to adhere to sustainability standards.

“Europe is pressing forward with sustainability disclosures, which means D&Os there must navigate an increasingly complex landscape, made even more challenging by the differing standards across regions,” explains Vanessa Maxwell, Chief Underwriting Officer at Allianz Commercial.

“But companies operating globally face varying regulatory demands, depending on where their subsidiaries are based. A UK company, for example, might have an Australian subsidiary subject to different sustainability standards. At Allianz, we underwrite these exposures, understanding that our clients operate in multiple jurisdictions.”

As sustainability becomes more intertwined with business strategy, organizations must stay ahead of evolving legislation and ensure compliance to mitigate risks and capitalize on opportunities in this new regulatory landscape, says Maxwell. “Companies should take a robust approach to assessing their climate and sustainability risk exposure.”

D&O insurance, which protects company executives from personal liability arising from their role as fiduciaries, is becoming more crucial as sustainability risks elevate legal and financial exposures. For example, climate-related risk can be a significant financial and reputational factor for D&Os, especially in a stringent regulatory landscape focusing on detailed disclosures.

“We have always considered the disclosures made by our insureds, but given the complexity and varying levels set by each regulator in different countries around climate, we are having to underwrite the board’s oversight, education, and what services they receive from third-party experts before they make disclosures on a topic such as climate,” comments Dan Holloway, Head of Global Management Liability at Allianz Commercial.

Managing long-term sustainability risks presents a unique challenge for companies as these goals often extend beyond the tenure of current executives and boards. Unlike typical business cycles, sustainability targets require particularly forward-looking strategies. To mitigate potential future litigation, companies are increasingly relying on scenario analysis, assessing short-, medium- and long-term risks.

“By incorporating these projections into regular reporting, businesses can show they are proactively addressing emerging risks, even if the full impact of their sustainability efforts might not be visible in the near term. This approach demonstrates accountability and builds a foundation for managing the uncertainties of evolving regulatory and environmental landscapes,” Holloway says.

The critical lesson for organizations is the need to back up sustainability statements with verifiable data, measurable goals, and, above all, transparency. For directors and officers, this means taking extra care to ensure every public statement about sustainability is valid and can withstand scrutiny.

Yet, such sustainability reporting can be overwhelming. Durisch says companies can make the process easier by focusing on ‘materiality.’ In reporting, materiality refers to identifying information significant enough to impact stakeholders’ decisions about a company.

“It focuses on issues that could influence the company’s financial performance, reputation, or long-term value, ensuring disclosures remain relevant and meaningful,” Durisch explains.

This helps companies focus on what is most relevant to their business. For example, a manufacturer using large amounts of water would prioritize water management in their reporting.

Insurers, for their part, are playing an increasingly important role in guiding companies through this maze, helping safeguard leadership from the risks associated with overpromising and underdelivering on sustainability goals. Allianz helps organizations understand their material risks through its materiality assessments and by providing tools that survey customers, employees, and suppliers.

Maxwell concludes that while ESG trends can evolve, companies must realize sustainability is not going away: “I’d like to convey the importance of board oversight and education. There’s room for improvement in ensuring boards are well-educated on these issues. This is where underwriting is focused today: on gaining comfort around board governance and disclosures. A distinct lack of education and governance is what gives rise to the low-hanging fruit for future actions by regulators, investors, and other stakeholders.”

As the demand for environmentally responsible practices grows, so does the expectation for businesses to communicate initiatives accurately. Yet, one of the hurdles for many organizations is the lack of infrastructure, resources, or expertise to meet external reporting demands – particularly in non-financial reporting, which is a far more recent field than traditional financial reporting.

For many companies, especially smaller ones, this means they are underprepared for the administrative burden and risk exposure that comes with the new regulatory landscape. Failing to meet these standards can result in litigation, reputational damage, and loss of investor confidence, further intensifying the pressure on directors and officers (D&Os) to ensure compliance with evolving sustainability norms.

One of the most significant risks rising on the D&O liabilities agenda is greenwashing, where companies are accused of overstating or falsely advertising their sustainability efforts. Greenwashing is a severe concern for D&O insurers as regulators and shareholders are increasingly holding companies accountable for misleading environmental, social, and governance (ESG) claims. Several high-profile cases have brought this issue to the forefront, with some outcomes still pending in the courts.

In 2022, Swedish clothing giant H&M faced a class-action lawsuit over “misleading” marketing claims about its Conscious Choice product line [2]. Although the company avoided liability, it has remained a focus for ongoing discussions about transparency in fashion sustainability.

“Greenwashing is not always intentional,” notes Dan Holloway, Head of Global Management Liability at Allianz Commercial. “Sometimes companies believe they are acting responsibly but lack the necessary oversight and data to substantiate their claims. This unintentional greenwashing is just as dangerous, exposing directors and officers to significant legal risks.”

Greenwashing claims can be a significant focus for plaintiff lawyers. The legal defense costs can be substantial even if directors are not ultimately held liable. D&O insurance helps cover these situations.

Another layer of complexity is the phenomenon of greenhushing. In contrast to greenwashing, greenhushing occurs when companies refrain from making public sustainability commitments in response to criticism over past claims, or due to fear of a backlash from either side of the sustainability debate.

 In some parts of the US such as Texas, for example, political tensions around ESG have led to a backlash against companies perceived to prioritize environmental goals over shareholder returns, leading some firms to tone down their ESG-related communications. Holloway notes that while this may shield companies from short-term political risks, it could create a longer-term reputational risk among investors and stakeholders seeking alignment with environmental goals.