ESG and Related Litigation: what are we talking about?

The renowned concept of ESG, an acronym of the words “Environmental, Social, Governance”,  is gaining momentum as the new paradigm for the sustainable management of business. Despite being so popular, until a few years ago there has scarcely been a commitment by policymakers and regulators to support binding legal duties relating to these topics, with the exception of soft law sources such as the Sustainable Development Goals (SDGs) drafted by the United Nations. Ambiguity in the exact content of the rhetoric of ESG has therefore been largely spreading.

The situation suddenly changed in 2014, with the adoption of EU law sources which – within the path traced by the UN SDGs – started to commitedly deal with ESG matters.

The first of these sources is the so called ‘Non-Financial Reporting Directive’ (NFRD) (2014/95/EU, which amended Directive 2013/34/EU and was enacted in Italy by means of Legislative Decree n. 254 of 2016), concerning the disclosure of non-financial and diversity information by listed and large companies (identifiable in accordance with specified dimensional criteria). NFRD recognises the paramount role of companies operating in the private sector to assure transparency and accountability on relevant factors of their non-financial performance, such as protection of the environment, respect for human rights and social rights, management of employees and prevention of corruption. The NFRD is aimed at ensuring transparency and accountability of the business process.

The second relevant source of EU law is the ‘Taxonomy Regulation’ (2020/852, directly applicable and self-executing in all EU Countries), which sets out certain overarching conditions that an economic activity falling into the scope of application of the NFRD has to meet in order to qualify as environmentally sustainable. The Regulation imposes a disclosure on the impact of the business on six interest areas: (i) climate change mitigation; (ii) climate change adaptation; (iii) the sustainable use and protection of water and marine resources; (iv) the transition to a circular economy; (v) pollution prevention and control; and (vi) the protection and restoration of biodiversity and ecosystems. It also requires companies to disclose how their activities qualified as ‘green’ impact on relevant KPIs such as Revenues, CAPEX and OPEX.

The third relevant source of EU law is the ‘Corporate Sustainability Reporting Directive’ (CSRD) (2022/2464 – still not enacted in Italy – which amended Regulation 537/2014, Directive 2004/109, Directive 2006/43 and Directive 2013/34) concerning corporate sustainability reporting. Starting from 2025 (and thus applying to financial statements for the exercise ending on 31 December 2024) the CSRD introduces stricter transparency obligations concerning the impact of businesses on the environment, human rights and social standards. Companies will be subject to controls and certifications by independent accountants aimed at ensuring that the information divulged is reliable. The CSRD will progressively involve a greater number of companies according to dimensional criteria, including certain SMEs, even if this application will take place starting from 2028.

It is to be noted that, with the passing of time, the obligations described above shall, willy-nilly, bind all kinds of companies, considering that, increasingly, the access to credit and good relationships with public authorities will be conditioned upon the respect of ESG parameters. Moreover, public opinion (e.g., consumers, suppliers, relevant associations), now more than ever, requires that products which are sold on the market are the result of a sustainable supply chain, something which also imposes a form of self-control within the private sector. In other words, increased awareness of the relevance of sustainability will become a driver for the business models of the foreseeable future.

While the goals pursued by the EU are praiseworthy, from an accounting perspective there is still some vagueness and uncertainty due to the lack of any reference in extant regulatory sources for either detailed ESG disclosure obligations or standards to be applied by preparers of non-financial reporting. Extant standards (emanated by the Global Reporting Initiative (GRI), the European Financial Reporting Advisory Group (EFRAG), and the International Sustainability Standards Board (ISSB)) diverge in terms of main declared recipients (investors for the ISSB, stakeholders for the GRI and EFRAG) and focus, with varying degrees of pervasiveness on sector-specific vs general issues, and with different balance on the E, S and G.

Hence, on the one hand, (large) companies are required to produce disclosure which is prospective, risk-based, integrated within the processes of the business, and ‘material’ i.e. it shall have an impact on the sustainability of the business from the ESG perspective insofar as it is apt to influence stakeholders’ choices. On the other hand, the framework within which such disclosure shall be produced is more than fuzzy.

To complicate things, non-financial reporting assertions on the ‘green’ and ‘sustainable’ qualities of any products, services or processes; and their impacts should be based on the principle of representational faithfulness, another slippery and abstracted concept in the context of the new approaches to ESG disclosure.

Here is the (significant) risk of litigation which large companies may incur should they slip up on their non-financial reporting. Several circumstances may well increase the risk of a claim by an individual or a group of stakeholders (including consumers):

• No proof: occurs when a company makes statements about the ESG qualities of a product or a service which are not corroborated by verifiable evidence.
• Vagueness: occurs when the statements made by a company as to the ESG approaches it applies are so generic or imprecise as to be incomprehensible by stakeholders;
• Hidden trade-off: occurs when statements made by a company suggest that a product, service or process reflects ESG characteristics on the basis of a limited number of its features;
• Irrelevance: occurs when the statements made by a company are, or are not, supportive of stakeholders’ choices;
• Lesser of two evils: occurs when, notwithstanding the fact that certain statements may prove true as to a certain category of products, these statements tend to distract stakeholders from the circumstance that the use of such a product, per se, has a significant environmental impact;
• Fibbing: occurs when a company makes false statements;
• Worshiping of false labels: occurs when, in describing a product through words, images or symbols, a company lets consumers presume that it has been certified by an independent advisor.

To provide an example which does not directly pertain to the non-financial reporting but it is still relevant as to what is going on with regard to the potential of ESG litigation, on 25 November 2021 the Court of Gorizia, Italy, upon request by a competitor, condemned a company which made false statements as to the sustainable qualities of its products (so-called ‘greenwashing’) and ordered it to suspend all the misleading advertising that it was putting into place concerning ESG.

On the basis of the developing legal framework concerning ESG, it is likely that cases of correct representation of the application of ESG will significantly increase in the next years and that these cases will not only, as in the past, be based on claims made by competitors, but also by individual and groups of consumers, as well as by other stakeholders in the company.

Next steps

In light of the above, it seems clear that, in the next years, the non-financial reporting and the statements made as to the qualities of their products will increasingly constitute a significant potential source of litigation for companies.

All companies will have to integrate into their culture and business model an adequate respect for ESG and should prevent potential sources of litigation by realising, inter alia, internal control systems, an adequate sharing of roles and competencies, and continuous monitoring of their processes in order to ensure the constant accountability of the same processes.

In this regard, legal support is, of course, essential.

Authored by Andrea Atteritano and Giovanni Zarra.