Environmental, social and governance (ESG) factors represent a variety of non-financial risks and opportunities that impact company value. ESG reflects the increasingly accepted proposition that pursuing environmentally and socially sustainable corporate governance is not only the right thing to do, but can lead to positive financial outcomes.

Over the last year, the ESG imperative has become even more pronounced, accelerated in part by the COVID-19 pandemic. ESG is at the forefront of corporate thinking but the law has been slower to develop. ESG "law" arises from a matrix of sources, including securities regulation, shareholder activism, domestic and international case law, and disparate legislation. Industry and market standards are also an important source of best practices in the context of ESG and will likely provide the basis for future legislation.

As the law around ESG is constantly evolving, corporations should be tracking ESG developments to ensure they are avoiding ESG risks, taking advantage of ESG opportunities, and ultimately, complying with their legal obligations.

Standards development

There are a variety of standards and frameworks used to measure ESG factors and guide ESG behaviour that use different indicators, metrics, and qualitative judgments. This lack of standardization has created confusion for companies and investors wary of issues like greenwashing. Canadian businesses should be aware of upcoming international and domestic efforts to standardize ESG-related disclosure.

On November 3, 2021, the International Financial Reporting Standards (IFRS) Foundation announced the creation of the new International Sustainability Standards Board (ISSB). The ISSB promises to create unified standards for ESG disclosure to shareholders. It is expected the ISSB will begin its work with a focus on climate reporting, given the pressing need for investors to properly price climate-related financial risks and new investment opportunities. The ISSB will use the IFRS' Technical Readiness Working Group's Climate-related Disclosures Prototype and General Requirements for Disclosure of Sustainability-related Financial Information Prototype as the foundation for its standards. These prototypes leverage the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) - along with other established ESG standards such as the Sustainability Accounting Standards Board (SASB) Standards.1 The ISSB is expected to conduct public consultation "on a timely basis in 2022" and will discuss feedback received in public before any requirements and work plans are finalized.2

The ISSB announcement came on the heels of the Canadian Securities Administrators' (CSA) publication in October 2021, of a Notice and Request for Comment on proposed mandatory climate-related disclosure requirements for reporting issuers, also based largely on the TCFD recommendations.3 The implementation of mandatory climate-related disclosure will mark a significant departure in Canadian securities regulation, which has previously guided issuers to disclose climate change-related risks under existing requirements to disclose material risks to business and the related financial impacts.

As previously discussed by our Dentons Canada colleagues in insights you can read here and here, if implemented, the Climate Disclosure Proposals would require further disclosure related to four core elements identified by the TCFD: governance; strategy; risk management; and metrics and targets. However, as published, the CSA's Proposals depart from TCFD recommendations in two ways:

  • They do not require issuers to describe the resiliency of an organization's strategy to manage the impacts of climate-related risks and opportunities in the context of different climate-related scenarios (e.g., 2 degree Celsius drop in global temperatures); and
  • In adopting a comply-or-explain approach to GHG emissions disclosure.

In keeping with the momentum in the ESG standards space, on January 19, 2022, the CSA also published a Staff Notice containing guidance on ESG-Related Investment Fund Disclosure. This Notice is a response to the growing interest in ESG investing more generally. It provides broad guidance on how existing securities requirements apply to investment funds as they relate to ESG considerations, particularly ESG-Related Funds. The notice covers topics such as investment objectives and fund names, investment strategies disclosure, proxy voting and shareholder engagement policies and procedures, continuous disclosure, ESG-related changes to existing funds, and ESG-related terminology.

The CSA's activity in the ESG standards space is but one example of a major challenge the ISSB will face in achieving its key mandate - reconciling the approaches of different regulators around the world. While it remains to be seen how the ISSB will manage this, the ISSB has announced that offices in Frankfurt, Germany, and Montréal, Québec will be responsible for key functions supporting the ISSB. This will allow Canada to play an integral role in the development of the ISSB's standards.4

Increased litigation risk

As discussed recently by our colleagues in insights you can read here and here, the effects of climate change, greater general interest in ESG among stakeholders, and broader governance by regulatory bodies internationally are increasing the regulatory and litigation risks to international and domestic organizations. While there have only been a handful of Canadian lawsuits dealing with climate change claims, and those claims have either been dismissed or are still in their early stages, it is almost certain that domestic litigation involving both public interest issues and private sector claims relating to ESG issues will increase in the coming years.

Increased reporting requirements will undoubtably create some increased litigation risks for corporations. Some particular risks may arise in respect of misrepresentations of claims, unfair and deceptive trade practices, and securities fraud. Corporations may help themselves avoid running afoul of new reporting requirements if corporations implement ESG strategies proactively and study any new or proposed requirements in advance of implementation by regulators and participate in providing commentary.

Another element of ESG strategy corporations may want consider reviewing to proactively mitigate litigation risk is their oversight of corporate directors and senior officers. There is a growing number of Delaware court decisions which have allowed Caremark5 claims alleging a lack of corporate oversight to survive motions to dismiss. Caremark claims allege liability on corporate directors and officers for failing to exercise oversight, and must meet one of two conditions: (i) either directors utterly failed to implement any reporting or information system or controls; or (ii), having implemented such a system or controls, the directors consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.6 These conditions have historically been difficult to establish. In September 2021, however, the Delaware Court of Chancery held that a derivative action brought by shareholders against directors of the Boeing Company alleging the directors had failed to establish a board-level reporting system for airplane safety, and turned a blind eye to a red flag representing airplane safety problems, could proceed, making it at least the fifth such claim to proceed past pleadings in the last three years. While this particular litigation is at an early stage and would have no binding authority in Canada, it and other similar decisions, suggest that American courts may be expanding the duties owed by corporate board members. In light of the Supreme Court of Canada's decision in Nevsun Resources Ltd. v. Araya, which confirmed that claims grounded in customary international law can be brought against private Canadian corporations, developing international jurisprudence may influence future Canadian decisions and these decisions could foreshadow a similar expansion of directors duties by Canadian courts.

Other developments

The law around ESG is developing rapidly. The Dentons ESG in Canada and ESG: Global Solutions Hub webpages report on the latest developments in this area. Recent ESG-related insights have included:

  • An overview of Extended Producer Responsibility schemes in Canada that place obligations on producers for the collection, disposal or recycling of their products at the end of their life-cycles.
  • The expanding scope of Foreign Investment reviews under the Investment Canada Act, which include issues that touch on sustainability.
  • The Great Energy Transition fuelled by a renewed commitment towards a global transition to green tech and diversely-fueled economies after COP26 and recent Canadian developments.
  • A shift in the rationale for regulating plastics in consumer products illustrated by new federal government authority to enact regulations restricting the use of plastics based on their potential harmful effects on the environment.
  • A BC Supreme Court decision which is likely to set the stage in 2022 and beyond for other Indigenous nations to claim in tort against private entities operating on lands claimed as Aboriginal title lands, and in areas where Aboriginal rights are claimed or exercised.

It will be imperative that corporations engage law firms well-versed in ESG issues to assist them in reviewing their existing ESG strategies, and provide experienced, strategic advice on adapting and expanding these approaches to meet the increasing demands of investors and regulators.

To read other articles in the Dentons' pick of Canadian Regulatory Trends to Watch in 2022 series,  click here.

Footnotes

1. The SASB Standards are maintained by the Value Reporting Foundation a global nonprofit organization created through the amalgamation of the International Integrated Reporting Council (IIRC) and SASB. The SASB Standards provides guidance on how organisations can align their sustainability reporting with the financial needs of investors, recommending topics and metrics for 77 different industries across all three pillars of ESG.

2. "ISSB: Frequently Asked Questions - When will the ISSB issue the climate disclosure standard and which items will it focus on next?" https://www.ifrs.org/groups/international-sustainability-standards-board/issb-frequently-asked-questions/ [ISSB FAQ]

3. Note: comments were initially due for submission on or before January 17, 2022, however on January 12, 2022 CSA extended the comment period to February 16, 2022 as a result of the ongoing impacts of the COVID-19 pandemic. https://asc.ca/issuer-regulation/submit-comments-climate-related-disclosure

4. ISSB FAQ supra note 1, "Where will the ISSB be based?" https://www.ifrs.org/groups/international-sustainability-standards-board/issb-frequently-asked-questions/

5. Named for a 1996 Delaware Court of Chancery decision In re Caremark International Inc. Derivative Litigation, 698 A.2d 971 (Del. Ch. 1996). See Hughes v Hu (Hughes), C.A. No. 2019-0112-JTL, 2020 WL 1987029 (Del. Ch. Apr. 27, 2020); Marchand v Barnhill, 212 A.3d 805 (Del. 2019); In re Clovis Oncology, Inc. Derivative Litigation, C.A. No. 2017-0222-JRS, 2019 WL 4850188 (Del. Ch. Oct. 1, 2019); Inter-Marketing Group USA, Inc. v Armstrong, C.A. No. 2017-0030-TMR, 2020 WL 756965 (Del. Ch. Jan. 31, 2020).

6. In Re Boeing Co. Derivative Litigation, 2019-0907, (Del. Ch. Sept. 7, 2021) https://courts.delaware.gov/Opinions/Download.aspx?id=324120

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