Historically, lenders have been mainly concerned with the borrower's ability to service its debt and the indirect environmental risks, relating to existing liabilities and non-compliance of the borrower. However, recent developments in environmental law and finance have seen a growing emphasis on the potential liability of a lender for environmental harm caused by the borrower. The rise of ESG makes it essential for lenders to be aware of lender liability in the context of environmental law.

The concept of "lender liability", namely, the idea that a lender is held liable for the actions or conduct of a borrower that results in environmental harm, currently exists only as a theoretical possibility in South African environmental law. While there is no specific provision for lender liability in South African environmental law, section 28 of the National Environmental Management Act, 1998 ("NEMA") provides for a wide statutory duty of care in respect of the environment.

In terms of section 28 of NEMA, any person who causes significant pollution or degradation of the environment and fails to take reasonable measures to prevent such pollution or degradation from occurring, could be held liable for resultant harm.

The authorities are entitled to recover the costs from persons in control of the land/premises where the harm occurred; persons responsible for or who directly/indirectly contributed to the pollution; or any person that negligently failed to prevent the pollution. In certain circumstances, the authorities may pursue a lender for the recovery of costs.

The risk of exposure is determined by the lender's degree of control over the borrower. Control could be demonstrated in a number of ways, including through contractual terms and structuring in financing agreements, majority shareholding, a power to appoint and control a board, ownership of property (as security) or the use of property. The duty of care is not limited by the corporate veil, which may be pierced to attribute liability.

There is a growing body of international precedents where the courts have been prepared to pierce the corporate veil to attribute liability to a lender or a parent company (the latter of which can be considered an indirect form of lender liability as the parent company operating in another jurisdiction from the subsidiary is held liable for the subsidiary's actions, which resulted in environmental harm).

A highly topical and precedent setting case in the area of lender liability is the case of Budha Ismail Jam, et al v IFC. In Jam v IFC, fishing communities and farmers in Gujarat, India, challenged the International Finance Corporation ("IFC") for its role in funding and enabling the Tata Mundra Ultra Mega coal-fired power plant.

The construction and operation of a 4 150MW power plant along the Gujarat coast was alleged to have destroyed critical natural resources relied on by generations of local families for fishing and farming. The plaintiffs sued the IFC in Washington D.C. for the environmental harm that resulted.

However, the IFC claimed that it had "absolute" immunity from suit. Historically, the principle has shielded the IFC from claims against it in respect of the projects that it has funded in the developing world.

On 27 February 2019, the Supreme Court ruled that in principle, the IFC could be sued (i.e., that it could not rely on a blanket shield of immunity to defend itself against claims brought against it). As with the parent liability cases in the United Kingdom and European Union, this decision was decided purely on a procedural basis and the case had to return to the trial court for further litigation.

The IFC filed a motion to dismiss, arguing that the exceptions to immunity did not apply and in February 2020, this motion was granted. The District Judge found that the IFC was immune under the facts of the case because the relevant acts occurred in India and immunity applied unless the lawsuit was based upon commercial activity in the United States. The plaintiffs tried to show that all relevant actions, including the approval of the loan, took place in Washington, but this argument was dismissed by the court. The plaintiffs unsuccessfully appealed the decision to the D.C. Circuit Court of Appeals and appealed to the US Supreme Court in January 2022.

Although the courts have been sceptical about the strength of the plaintiffs' claim against the IFC, the finding that the IFC, as a lender, does not have absolute immunity may result in the opening of the floodgates for similar claims in future. The theoretical possibility of liability may result in the IFC being more willing to settle with claimants to avoid risk and to take the recommendations of internal IFC accountability mechanisms (including the internal ombudsman) seriously.

This case challenges the traditional notion that lenders stand at a distance from borrowers' activities. Given these developments, lenders should conduct in-depth ESG due diligence at the transaction screening phase and should take care to include appropriate clauses in contracts with borrowers to restrict and mitigate environmental liability risks.

But this is unlikely to be enough: lenders will need to monitor and assess the performance of the borrower throughout the project lifecycle in order to demonstrate that they acted responsibly and reasonably, and to discharge their duty of care.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.