More ESG Class Actions Are Coming. Economic Analysis Can Help

As pressure to make ESG disclosures rises, business leaders open themselves to significant legal risk. Here’s what they should know.

Are environmental, social, and governance (ESG) disclosures corporate America’s latest double-edged sword?

Even supportive business leaders face mounting pressure—from regulators, investors, shareholders, and consumers—to be proactive and transparent about ESG issues. Yet doing so can make them vulnerable to legal and reputational risks.

Proof positive, ESG-related class actions are now being filed regularly across virtually all business sectors. According to a recent survey of general counsel and in-house litigators, nearly one-third saw their ESG dispute exposure grow in 2022; another 24 percent expect it to deepen in the year ahead.

Most cases revolve around misleading claims or statements about a company’s ESG-related actions, from advertisements saying a product is “100 percent earth-friendly” to aspirational disclosures about diversity efforts, or—in the case of securities fraud—material misstatements about ESG efforts intended to create profit or value. The Securities and Exchange Commission’s 2021 launch of a Climate and ESG Task Force to proactively identify ESG-related misconduct likely will ratchet up the pressure further.

Comprehensive economic analyses will be key to proving (or disproving) class-action claims and tangible harms related to ESG disclosures. Here’s what executives and general counsel should know.

ESG Litigation: Track Record, Types, Themes

Though ESG-related class actions have increased across the US, success so far has been mixed.

Misrepresentation and breach-of-warranty claims often have been dismissed as nonactionable “opinions” or “aspirational statements.” Meanwhile, consumer protection laws leveraged to address greenwashing claims have fared somewhat better, with many cases resulting in an entity being restricted from certain actions.

Securities fraud suits also have been hit or miss; the challenge, as discussed below, has been for plaintiffs to demonstrate tangible and/or quantifiable damages or harm. However, as these types of class actions mature, plaintiffs’ cases will strengthen. For example, an assessment of stock price changes can be a convincing indicator of overstated value and can provide a basis for potential damages to investors. The more data investors have on these indicators over time, the stronger their cases could be.

To prepare for ESG class actions, organizations should keep in mind the following risk areas:

Environmental Accidents and Pollution Control

Following voluntary disclosure of environmental safety and pollution mitigation activities, companies will face greater scrutiny for aligning public statements with actual events, both planned and accidental—and regular inconsistencies can lead to class-action litigation from investors and affected communities. This is especially true in the context of highly visible environmental incidents.

For instance, in 2016, a shareholder class-action suit was brought in US federal court against Vale SA following the 2015 Mariana mining dam accident in Brazil, alleging that the company repeatedly ignored warnings about safety violations while publicizing its commitment to health, safety, and the environment in disclosed sustainability reports. Investors sued under the antifraud provisions of relevant securities laws, and Vale settled the case for $25 million.

Greenwashing

Unquestionably, another increasing area of class-action litigation concerns claims associated with greenwashing, which generally involves challenges to a company’s ESG disclosures and/or when a business misrepresents that its practices or products are socially beneficial or responsibly manufactured.

On the consumer side, a growing number of greenwashing filings have involved allegations of fraud or negligent misrepresentation related to ESG practices of manufacturers and service providers. In many cases, the claims are based on not so much the products themselves, but the failure of the manufacturer to adhere to its ESG representations.

For instance, in the Vital Farms case, an egg producer that marketed itself as treating animals in an ethical, humane, and transparent manner was alleged to “allow in its chain of commerce practices that are inhumane, unethical, outrageous, and unconscionable.”

Diversity, Equity, and Inclusion

Investors, activists, and employees have made it clear they want companies to start prioritizing not only their enterprise value and financial profits, but also their workers. Since the summer of 2020, shareholders have filed more than a dozen derivative actions accusing public companies of failing to follow through with diversity commitments in their proxy statements and other public disclosures.

Similarly, plaintiffs have filed securities fraud lawsuits following a drop in stock price and disclosures of claims alleging sexual harassment or gender discrimination. In the Signet Jewelers Limited matter, the plaintiffs alleged that the company allowed pervasive sexual harassment of female employees at all levels of the corporation, and that the defendant failed to disclose material and relevant information related to the investigation of these allegations. The plaintiffs also alleged that the disclosure of the allegations led to an 8.3 percent drop in the company’s stock price.

While the court dismissed the allegations regarding sexual harassment (ruling that plaintiffs failed to show that the company’s statements were false or misleading), the parties reached a settlement at mediation regarding all other allegations.

ESG Disclosures and Class Actions: Economic Analysis Is Key

As previously noted, a key consideration for both sides in most ESG-related class-action suits is whether plaintiffs can demonstrate tangible damages or harm. Economic analyses can play a central role.

For instance, in the wake of a negative environmental event, ESG disclosures may contribute to media attention surrounding the event; however, in and of themselves these disclosures are not necessarily reliable measures of regional economic impacts and damages. Other factors contributing to or mitigating the economic losses caused by the accident for individual plaintiffs and the region need to be evaluated.

Realized impacts from environmental events can be alleviated by substitute resources and activities, as well as interregional connectivity. These factors can vary across economic sectors, geographies, and individual plaintiffs. In virtually every case, economic analysis is necessary to determine common impact across class members and the feasibility of measuring the damages based on information common to said class.

At this early stage of ESG disclosures, the materiality of missed expectations also matters for certifying shareholder or stakeholder classes—particularly when it comes to consumer class actions related to greenwashing, where certification follows a more traditional process of examining the commonality of reliance and damages. Correspondingly, class plaintiffs have fared well in greenwashing cases where these elements are supported through accepted economic methodologies and analyses.

In these instances, it is critical to assess whether:

1. The alleged statements (assuming they are false) were relied on by the putative class. It has frequently been held that, absent evidence of a market-wide price premium for the misleading label, plaintiffs must show that all putative class members relied upon the specific misrepresentations at issue in deciding to purchase the product or service at hand.

   For example, where class representatives seek to establish common misrepresentations by basing their case on statements made in advertisements, plaintiffs will want to show that every class member not only was exposed to it, but also affirmatively relied on the misstatement in making their purchasing decision. Consumer surveys, focus-group interviews, and other forms of market research are often used—and misused—to accomplish this. Careful consideration should be given to both the economic and factual foundations of the alleged misstatements.

2. The class suffered a common detriment or compensable damages as result of its reliance. An additional challenge facing plaintiffs in class-action greenwashing cases involves the establishment of a price premium associated with the alleged false or misleading claims. For example, the Ninth Circuit upheld decertification in a recent case involving Dole Foods because the plaintiff “did not explain how this premium could be calculated with proof common to the class.”

   Conversely, in the Wesson Oil case, class certification was granted based in part on consideration of hedonic regression and conjoint analysis studies, which considered “twenty product attributes, including the brand of oil, the ‘natural’ claim at issue in this litigation, other product label claims, oil variety (e.g., canola, corn, blend, or vegetable), the size of the bottle of oil, promotional prices, and time period.”

   As suggested by the cases above, both plaintiffs and defendants should carefully consider what evidence can be gathered from their records or developed through survey evidence and expert testimony in bringing or defending greenwashing cases.

To Disclose or Not to Disclose?

For most organizations, the original greenwashing sin—articulated in a 1986 essay about how hotels’ “save-a-towel” campaigns were driven by cost savings rather than the environment—is more relevant now than ever. In a variety of instances, organizations may seek credit—whether it’s related to greenhouse gas emissions, labor practices, or investment activities—for virtuous reasons only to be shown that the primary drivers were far less noble. The major difference now is that companies, officers, directors, and executives are increasingly being held accountable.

ESG disclosures today are a balancing act: on the one hand, voluntary disclosures present a growing value to relevant stakeholders; on the other hand, the potential exposure for failing to meet expectations based on these disclosures—and the class-action suits that can follow—are also increasing. In both cases, sound economic assessment can be a powerful tool.