If one generation plants the trees, another will get the shade1
In its recent landmark decision in Massachusetts v. EPA, the US Supreme Court ruled that the Environmental Protection Agency (EPA) does have the authority to regulate the greenhouse gas (GHG) emissions from new automobiles and underscored the continued convergence of legal and climate change considerations.2 The ruling illustrates the growing importance of climate change over the last few years in various areas, including the courts, the regulatory arena, and the increasing scrutiny of listed companies' public disclosures concerning climate change risks and practices.
This Linklaters client briefing synthesizes these key developments and trends, which are of immediate interest to all public companies and their financial advisers. Part 1 provides an overview of climate change litigation with focus on the US, whose judicial system is likely to be the testing ground for lawsuits targeting "dirty" industries with litigation on a scale comparable to the lawsuits against the tobacco industry. Part 2 focuses on the related topic of growing demand for timely public disclosure by companies of the financial risks of climate change, and the related push for clear guidelines governing climate-related disclosures. The briefing concludes with a discussion of best practices for companies seeking to remain ahead of the climate change curve.
Part 1 – Climate Change in the Courts: Massachusetts v. EPA and Beyond
While the speed and severity of global warming may be open to debate, few dispute that climate change is linked to human activity, particularly in the wake of influential scientific studies like the recently published report by the UN Intergovernmental Panel on Climate Change documenting such a linkage which was agreed at Easter by 130 countries including the US.
Massachusetts v. EPA, which implicitly accepted the reliability of the science behind global warming, is perhaps the most significant US judicial decision to date on the causal link between human activity and a changing climate. The core issue before the Supreme Court was whether automotive GHG emissions are "pollutants" subject to regulation under the Clear Air Act (CAA) and, as a subsidiary issue, whether the plaintiffs in the case (a coalition of public interest and state and local governmental actors) had legal standing to bring the lawsuit.
The case arose after the EPA rejected a rulemaking petition seeking federal regulation of GHG emissions from new motor vehicles on the ground that the agency lacked statutory authority to do so and, even if it had such authority, there was an insufficiently strong causal link between GHG emissions and global warming to justify intrusive regulation. After the petitioners filed a lawsuit challenging the EPA’s determination, the agency further argued that the plaintiffs lacked standing to bring the lawsuit, i.e., the alleged injury of environmental harm was too attenuated to satisfy the constitutional requirement that a plaintiff have a "concrete and particularized injury" that is "fairly traceable to the defendant" and which is capable of redress by favorable court action.
Dispensing first with the EPA’s attack on standing, a 5-4 majority of the Supreme Court ruled that only one of the numerous plaintiffs needed to have standing for the suit to proceed. Noting that the Commonwealth of Massachusetts had a "stake in protecting its quasi-sovereign" interests, and that US states should generally be given a "special solicitude" to claim standing as sovereign entities representing numerous constituents, the Court found standing. Of note, as to the requirement that a plaintiff must allege "concrete and particularized injury," the Court held that "the harms associated with climate change are serious and well recognized" and that the erosion, inundation and temporary flooding of the Massachusetts’ coast attributable to global warming constituted injury for purposes of standing to sue.
On the merits, the Court ruled that by providing a "laundry list of reasons not to regulate," the EPA had transgressed the CAA’s "clear statutory command" that it determine whether GHG were pollutants under the statute. The Court further held that "because greenhouse gases fit well within the Clean Air Act’s capacious definition of ‘air pollutant,’ . . . [the] EPA has the statutory authority to regulate the emission of such gases from new motor vehicles." In this regard, it is important to emphasize what the Supreme Court did not do, i.e., it did not direct the EPA to issue regulations curbing automotive GHG emissions. Rather, the Court directed the EPA to review its earlier determination that GHG emitted by new cars were not encompassed by the CAA. Although the EPA is technically free to reach the same conclusion again, the Court signaled it would be dubious of any finding that there is insufficient scientific consensus on whether GHG contribute to global warming such that regulation is not warranted.
The Court’s decision that GHG fall within the CAA will not yield immediate regulatory action given the stately pace of government rulemaking. While it is possible that Congress may force the EPA to accelerate the pace of its review, or take charge of the process itself, there is no dispute that Massachusetts v. EPA will have a profound ripple effect across the US legal and regulatory system. Several consequences are of particular note:
- The tenor of the Supreme Court’s opinion – which accepts the science underpinning global warming and the "remote" but "real" risk of "catastrophic harm" – strongly suggests that the Court will not stand in the way of aggressive government attempts to curb GHG emissions. In this regard, the Court decisively rejected the EPA’s argument that because other countries like India and China are poised to dramatically increase GHG emissions, modest incremental reductions in the US would be fruitless: "A reduction in domestic emissions would slow the pace of global emissions increases, no matter what happens elsewhere."
- The decision will directly affect other cases that had been stayed pending the Supreme Court’s decision. Chief among them is a similar challenge to the EPA’s refusal to regulate carbon dioxide emissions from power plants in Coke Oven Environmental Task Force, et. al. v. EPA. Given the expansive nature of the Supreme Court’s definition of "air pollutant" under the CAA, it seems unlikely that arguments in Coke Oven and elsewhere for narrow interpretation of "air pollutant" will prevail.
- Prompted by the EPA’s reluctance to regulate GHG emissions, several US states, most notably California, have filled the breach by promulgating state-wide limits on automobile emissions. The Supreme Court’s ruling that the EPA must regulate GHG emissions, or provide a compelling scientific justification for its failure to do so, may paradoxically have the long-term effect of undermining state efforts to vigorously regulate GHG emissions on the ground that state regulation is preempted by comprehensive federal regulation. In the short to medium term that outcome seems unlikely and the Court’s opinion, which suggests in passing that state efforts to reduce "in-state motor vehicle emissions" might only be preempted "in some circumstances," indicates that there is room for well-tailored state initiatives to coexist with the federal regulatory scheme.
- The traditional US federal approach to GHG abatement, which emphasizes voluntary rather than fixed caps, will be difficult to sustain in light of the Supreme Court’s ruling that greenhouse gases are "air pollutants" under the CAA.
Litigation – What’s Around the Corner
While the substantive result in Massachusetts v. EPA may spur the EPA (or Congress) to take concrete action, the procedural portion of the opinion addressing standing, or who may properly bring suit, is likely to have a more profound effect on climate change litigation. The Supreme Court’s acknowledgement that catastrophic future environmental events like coastline erosion could demonstrate "injury" will no doubt embolden other US governmental bodies and private plaintiffs to bring suits on similar theories of standing, although the Court was careful to note Massachusetts’ "semi-sovereign" status warranted a relaxed standing analysis which may hinder attempts to import the Court’s standing analysis into cases brought by private actors.
In conjunction with potentially looser standing requirements, climate change litigation appears poised for a fundamental shift into "for profit" damages-based lawsuits given the increasingly mainstream view that global warming, including destructive weather events, is causally linked to the activities of certain "dirty" industries and given the likelihood that those entities will have carried insurance from which climate change related risks may not have been excluded. By contrast, private sector actors like utilities and auto makers have to date typically been named as defendants by government and public interest groups in lawsuits seeking injunctive relief in the form of a reduction or cap on emissions rather than the award of money damages.
US plaintiffs’ lawyers who specialize in class action litigation on behalf of classes of private plaintiffs (e.g., smokers in suits against Big Tobacco) are undoubtedly mapping out strategies for "privatizing" climate change litigation. In one closely watched case, owners of property damaged by Hurricane Katrina have alleged that the GHG emissions of electric utilities and oil, coal and chemical companies have contributed to global warming, which in turn has caused increasingly volatile weather events, including the destruction to property caused by Hurricane Katrina. While the case is presently subject to defendants’ motion for dismissal, anything short of an outright dismissal may prompt a flurry of climate change litigation that is not tied to a specific weather event like a hurricane but that instead alleges that a discrete group 4 16 April 2007 of plaintiffs (e.g., farmers suffering crop damage) have been harmed by the GHG emissions of a given industry.
The shift to a damages-based method of litigation is already underway in state-sponsored lawsuits, as California has sued car manufacturers alleging that automotive GHG emissions have harmed the health of its citizens and ecosystem such that massive damages are required as restitution. Just as with Big Tobacco litigation, where some states received multi-billion payments for the costs borne by their health care systems due to smoker illness, state politicians are likely to see GHG suits against deep pocket defendants as a way to close off budget shortfalls through litigation, particularly in light of the expansive standing analysis endorsed by the Supreme Court for claims initiated by states.
Although the volume of climate change litigation will increase, defendants will continue to have available compelling defenses, including that:
- Climate change policy is a "political question" that must be addressed by policy making branches of government other than the courts. This defense may take on additional potency if, in the wake of Massachusetts v. EPA, Congress moves to enact comprehensive federal GHG limits.
- Private plaintiffs cannot capitalize on Massachusetts v. EPA’s standing analysis because they are not acting in the name of sovereign interests and the injury they allege is too diffuse and insufficiently generalized.
- Plaintiffs cannot establish that the defendants’ conduct specifically caused their injury, which is a required element of most tort-based claims, e.g., plaintiffs must prove that the actions of a power plant operator or oil company, as opposed to non-defendant emitters of GHG, caused the relevant injury. Indeed, until relatively recently the science was too unclear to render any claimed damages reasonably foreseeable on the part of the defendant. While causation will remain a very significant barrier to recovery, it bears noting that novel theories of causation were accepted in tobacco cases where defendants originally argued that harm to smokers could not be traced to their products (and similar workarounds have been established in the UK in relation to asbestos exposure cases). More broadly, as reflected in Massachusetts v. EPA, courts are increasingly receptive to the proposition that emission of GHG causes global warming and attendant adverse environmental effects, making allegations of causation facially plausible. Moreover, epidemiological research suggests a statistical link between certain types of air pollution and certain types of adverse health conditions. From there, plaintiffs are likely to use sophisticated pollution modeling programs to attempt to demonstrate an individual defendant’s alleged share of airborne pollution in a given area, which could be used as evidence of causation.
Litigation – Global Trends
Increasing climate change litigation is likely in several jurisdictions outside of the US, especially in those countries which do not currently impose mandatory requirements on companies and governments to reduce GHG emissions. Although widespread litigation has not been evident to date, there have been some proceedings, which, together with developments in the US, may pave the way for future litigation. For example, in Australia the New South Wales Land and Environment Court recently delivered a significant decision which held that an environmental assessment for a proposed coal mine was inadequate because it failed to consider the impact of downstream GHG emissions (Gray v. Minister for Planning & Ors). The court thus ruled that the Government’s decision to approve the environmental assessment was void. The case has obvious implications for any proposed development in Australia which requires environmental assessment and will produce GHG emissions.
Climate change litigation in other jurisdictions, however, such as the UK and other European countries has not developed to any great extent to date, although the increasing scientific evidence of climate change (particularly on its causes) makes the threat of significant litigation a continued risk. That said, the structure of the court systems in these jurisdictions (with less recourse to contingent fee arrangements, and relatively modest damages awarded by judges rather than juries) makes litigation a less attractive option. In the UK and Europe, where many businesses are currently subject to increasingly strict regulation of GHG emissions, litigation is more likely to be in the form of regulatory enforcement actions, or challenges against emission allocations, or even the validity of trading schemes. Proposed further domestic and European Union legislation on climate change, such as energy efficiency and product stewardship requirements, will only increase this exposure.
Part 2 –Disclosure of Climate Change Risks: Current Trends and Best Practices
The rising tide of climate change litigation dovetails with recent calls for enhanced public disclosure of the financial and operational risks associated with climate change. As one would expect, the most complete disclosure of climate change risks comes from companies with heavy carbon footprints. But investor demand for such disclosures is not limited to specific sectors,3 and there is now a discernible trend towards disclosure of climate change issues as a risk factor in IPO offering documents.
In the US, public companies that file reports with the SEC are subject to Regulation S-K, Item 303, Management Discussion and Analysis, which obligates issuers to disclose "known uncertainties" that could result in material consequences," including "currently known trends, events and uncertainties that are reasonably expected to have material effects." In addition, SEC Regulation S-K, Item 101, requires issuers to disclose any material effects that the costs of environmental compliance might have on earnings, capital expenditure as well as the financial impact of compliance with local, state or federal environment rules and regulations.
While Regulation S-K is focused on the more readily quantifiable day-to-day impact of environmental compliance, Regulation S-K arguably requires companies to predict the extent to which environmental issues will materially impact operations. Compounding the challenge inherent in predicting the financial impact of climate change, there is no hard and fast rule in the US as to what constitutes "material information" subject to mandatory disclosure.4 Nor has the SEC provided firm guidance on climate disclosure issues, which is problematic given the patchwork of environmental regulations faced by companies operating in multiple jurisdictions.
As a result, US business groups have lobbied the SEC to implement a more concrete disclosure regime in the area of climate change. Of note, the Investor Network on Climate Risk, a prominent coalition of public institutional investors, has repeatedly asked the SEC to make three core changes to its disclosure framework:
- Ensure that the historic underreporting of material risks involving climate change is reversed and that companies understand that there are consequences to omitting material climate-related information from their public filings;
- Provide issuers with interpretive guidance on how to quantify and assess the materiality of risks associated with climate change; and
- Make it easier for shareholders to formally propose a vote on whether companies should regularly report on financial risks associated with climate change.
Making timely and accurate disclosure even more crucial is the possibility that US securities fraud lawsuits could be filed alleging that investors were misled as to the gravity or materiality of climate change issues. This development seems likely, as the same entities that are aggressively promoting sound climate change corporate governance and practices – institutional investors such as public pension funds – are increasingly the entities that are serving as lead plaintiffs in US securities class actions.
Businesses that operate in Europe may also face legislative requirements to disclose relevant climate change risks and impacts.5 For example, in the UK the recently enacted Companies Act 2006 will require all quoted companies from 1 October 2007 to include in their next annual directors’ report an enhanced ‘business review’ which discloses, amongst other things, the main trends and factors likely to affect future development of the company and information on environmental matters (including the company’s impact on the environment). Disclosure is required only to the extent necessary for an understanding of the development, performance or position of the company’s business. Where quoted companies decide they have nothing to report in relation to these issues, they must say so in the review.
The new reporting obligations build on current and continuing disclosure requirements which have been in place since 2005 for all large and medium-sized companies (quoted and non-quoted). Whilst there is no specific requirement in the existing and new legislation to report on relevant climate change impacts and risks, a prudent view would be that such risks and impacts would now generally fall within the scope of required statutory disclosure. This is also the view taken by the UK Government in its voluntary reporting guidelines for UK businesses on reporting requirements.6
Staying Ahead of the Climate Change Curve: Best Practices
In the face of increasing regulation and stakeholder scrutiny, companies in any jurisdiction should carefully consider their approach in managing climate change issues. Best practice considerations include:
- Environmental reporting: Companies need to carefully consider their statutory disclosure obligations and also any voluntary disclosure they undertake. Failure to provide adequate information or the provision of false or misleading information may breach statutory disclosure rules in some jurisdictions and may also lead to third-party litigation and reputational damage. Generally, companies that measure, manage and adequately communicate on climate change matters are inherently well placed. They understand how to improve their processes, reduce their costs, comply with any regulatory requirements and stakeholder expectations and take advantage of new market opportunities.
- Government regulation: Currently, corporate action on climate change exceeds that of government in many jurisdictions. Nevertheless, domestic and international regulation of climate change is high on the regulatory agenda in many countries, and in some jurisdictions (i.e., most of Europe and likely the US) many companies are already subject to increasingly strict regulatory controls on a number of fronts. Transparent, fair and workable regulation will require greater co-operation between supranational and national agencies on the one hand and business on the other. Businesses therefore need to play an active and early role in the regulatory process to ensure its views are accounted for and reflected in binding regulations.
- Stakeholder relations: Companies are coming under increasing scrutiny from key stakeholders (including shareholders, consumers, the general public, and institutional investors) in most jurisdictions in relation to climate change impact. Companies need to actively understand and manage their climate change impact and effectively and accurately communicate their climate change performance and any initiatives they undertake (e.g., carbon offsetting, energy efficiency, renewable energy use, green leases and green procurement, climate change policy).
Linklaters has one of the world’s leading litigation and environment practices. Our global team has internationally recognised capability and experience in advising some of the world’s leading companies on issues attached to their social and environmental profile, including on the challenges and opportunities presented by climate change. We have extensive experience advising clients on major tort claims and also on litigation that is cross-jurisdictional. We believe a preventative approach to litigation based on social or environmental issues is often in the best interests of our clients, from a reputational and financial, as well as from a legal perspective. As a result, Linklaters closely monitors legal and policy developments and aims to keep its clients up to date on how legal developments in the area of corporate responsibility may impact on their operations.
To find out how we could assist your business, please contact us.
1 Chinese proverb
2 A copy of the decision can be found here.
3 For example, The Hartford Financial Services Group and Prudential Financial recently acquiesced to investor and public interest demands that they provide greater disclosure of climate change risks notwithstanding that neither insurer is principally in the business of providing property or casualty insurance of the type that carries significant potential payout risks relating to environmental damage claims.
4 The SEC requires disclosure only to the extent information is considered material. Materiality, however, is a notoriously subjective concept that is typically determined by whether a reasonable investor would attach importance to the information in deciding whether to buy or sell a security.
5 The EU Accounts Modernisation Directive requires large and medium-sized companies to provide an analysis of the development and performance of their business in their annual reports, describing the principal risks and uncertainties they face and providing financial and non-financial performance indicators such as environmental and employee information. Member States may exempt medium-sized companies from certain non-financial requirements. The Directive was required to be implemented by 1 January 2005.
6 ‘Environmental Reporting Guidelines – Key Performance Indicators (KPIs)’ and ‘Guidelines for Company Reporting on Greenhouse Gas Emissions’ both available here.
This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts at Linklaters, or contact the editors.
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