A company’s “ESG” or “environmental, social and governance” indicators are increasingly used by investors to benchmark companies and identify material risks and opportunities for growth. Not yet mainstream, companies are increasingly choosing to voluntarily disclose these metrics in annual reports or standalone sustainability reports. But should companies be wary of the representations they make of their ESG references? Can investors hold them to account if such statements turn out to be false or exaggerate reality?
- ESG measures are increasingly popular with investors and consumers when benchmarking companies
- Companies should be wary of bold claims about ESG measures that actually have no basis
- When companies deliberately publish misleading statements regarding ESG measures, they risk being the subject of a claim for fraudulent misrepresentation.
- Companies must ensure that third parties, such as suppliers, are engaged in ESG measures
- It is generally recommended to know your suppliers well in order to ensure that your ethical and environmental standards are in line.
What are ESG metrics?
ESG measures are a measure (or an attempt to measure) of a company’s success or standing in the areas of environmental, social and governance. In order to assess a company’s ESG criteria, investors consider a wide range of behaviors. Here are some examples of ESG factors:
Some of them are difficult to measure, while others lend themselves better to quantification. Either way, companies are increasingly making claims about these areas and investors are beginning to use this information to inform their investment decisions. In today’s world, a company that has questionable environmental practices will pose a much greater financial risk than a company that has a clean sheet on the environment. Likewise, businesses that rely heavily on fossil fuels may not be a wise investment given global carbon emissions targets, while investing in clean energy-based businesses would be a wiser choice.
But what if a company deliberately misrepresents its ESG credentials and an investor based their investment decision on a certain statement or set of results? Alternatively, a company may have mistakenly misled investors, lacking the expertise required to calculate its own ESG metrics, but making hopeful bold claims about its ESG status. Perhaps the statements were made during contract negotiations with another company or potential joint venture partner to make the deal more attractive?
During contract negotiations, whether it is an investment contract, a supply contract or a partnership/joint venture agreement, many pre-contractual representations and assurances will be made verbally or in writing. Some will become terms of the contract, while others will be representations that may have caused the other party to enter into the contract, but which do not form part of its terms. The intent of the parties and the timing and significance of the statement will determine the category to which the statement belongs. A successful UK misrepresentation claim requires the following:
- a misrepresentation of fact or law
- on which the recipient relies to decide whether or not to conclude the contract
- which causes a loss
- to qualify as a fraudulent misrepresentation, the misrepresentation must have been made knowingly, without believing in its veracity or recklessly as to its veracity
Obviously, the representation must be false. This is judged by reference to how the representation would be understood by a reasonable person in the factual context. Given the difficulties in measuring ESG metrics, it can be difficult to prove that a representation made by a company is in fact false. For example, there are many different ways to calculate carbon emissions, so it can be difficult to prove that a company’s carbon emissions have been misrepresented.
However, there are certain circumstances where the falsity of a representation may be obvious. For example, if a company claims that its products are not tested on animals, when there is in fact clear evidence that products are tested on animals, or if a company states that it does not support or does not contribute to deforestation, yet its products contain palm oil.
Many factors will contribute to an investor’s decision to invest in a company. ESG metrics are becoming increasingly important, however, other performance-related information needs to be considered. You might think this would be a barrier to a claim for misrepresentation, i.e. where ESG representations were not the primary factor in the investor’s decision-making. However, it has been established that the issue of trust comes down to whether the recipient was influenced by the misrepresentation.
Representation need not be the only or even the dominant influencing factor. The beneficiary may have other reasons for entering into the contract or buying the shares. What is required is evidence that the representation in question was “actively present in his mind”. Additionally, there is no obligation on the recipient’s part to complete any inquiries or exercise due diligence and even doing so will not frustrate a claim. This makes a claim of this nature much more feasible.
However, to succeed in a claim for fraudulent misrepresentation, the person making the statement should know that the statement is false or made without an honest belief in its truth, or recklessly without caring whether it is true. or false.
Key points to remember
Companies should be wary of bold statements about ESG measures that actually have no basis. It should also be ensured that third parties, such as suppliers and partners, are engaged in ESG measurables. For example, contracts may contain stipulations regarding employment conditions, human rights or animal welfare. This can be particularly important when contracting with foreign parties where the legal regulations in these areas can be very different. Knowing your suppliers well is key to ensuring that your ethical and environmental standards are aligned.