ESG is a phenomenon in the business world that is here to stay. It is a broad, amorphous concept that encompasses many areas of concern, and, like it or not, it has become a critical part of corporate counsel’s role in advising clients.
One area of particular concern is the role of ESG in mergers and acquisitions – how do you ensure that you are growing your company and not buying into a series of lawsuits and a reputational nightmare?
Although ESG is an impossibly broad topic to cover, below we will provide an overview of why it is an unavoidable consideration in mergers and acquisitions, including:
- What ESG means,
- Why ESG matters in mergers and acquisitions, and
- How to minimize the risk of ESG-related lawsuits.
What is “ESG?”
“ESG” is a relatively new term that has no agreed-upon definition. The letters stand for “environmental, social, and governance.”
Environmental concerns encompassed by ESG could include:
- Compliance with environmental laws and regulations,
- Concerns with impacts on climate change,
- Corporate sustainability,
- Environmental justice, and
- Other issues that are typically articulated by environmental advocacy groups.
Social concerns encompassed by ESG could include:
- The company’s interactions with people – employees, customers, community, and disadvantaged groups,
- Safety in the workplace,
- Fair compensation to employees,
- Diversity, equity, and inclusion (DEI),
- Anti-slavery,
- Relationships with indigenous peoples,
- Corporate positions on social issues like Black Live Matter, transgender issues, abortion, or the Boycott, Divestment, and Sanctions (BDS) movement against Israeli policies, and
- Other social issues relating to the public’s expectations that companies proactively support social issues even when they are unrelated to the company’s commercial purpose.
Governance concerns encompassed by ESG could include the company’s:
- Policies and procedures,
- Decision-making processes,
- Board, executive, and management composition,
- Risk management,
- Executive compensation, and
- Other aspects of the company’s internal operations.
Why Does ESG Matter in Mergers and Acquisitions?
Although ESG concerns were previously viewed mostly as reputational – complaints by advocacy groups or others were handled as a public relations problem, it has increasingly become a legal problem.
For example, the government has become increasingly involved in legislating and regulating ESG compliance, creating a regulatory minefield for uninformed corporations, and complaints by the public and advocacy groups have evolved from bad press or protests to increasingly creative legal actions filed against corporations, often based on the accuracy of their ESG disclosures.
Reputational Risk
Shareholders and investors care about ESG issues more than ever, and a failure to address ESG concerns can and does result in a negative reputational impact on companies.
Buyers of corporate interests should investigate and consider any ESG concerns connected to the potential transaction, including 1) how to mitigate any reputational issues that may arise from the target company’s prior ESG policies, 2) ensuring that the target has appropriate policies in place, and 3) ensuring that the target company is making appropriate ESG disclosures that are in line with your core corporate values.
Fiduciary Duties
Directors have a fiduciary duty to act in the best interests of their shareholders and must consider the impact of ESG policies and disclosures on the business’s continued commercial viability and shareholder value.
Financial Losses
ESG concerns pose a very real risk to shareholders that includes access to capital – lenders are increasingly demanding that businesses make ESG a priority and are taking ESG ratings and companies’ ESG policies into consideration when deciding whether to finance companies and the terms of financing.
Reputational impacts from bad press can also impact potential investments as investors increasingly look to companies’ ESG policies and reputation when deciding where to invest, and ESG-related lawsuits can have a lasting impact on a company’s reputation as well as its financial stability.
Regulatory Compliance
Governments across the globe are increasingly regulating ESG-related issues and company disclosures. For example, the Securities and Exchange Commission (SEC) is moving to require climate-related disclosures in registration statements and periodic reports, and the Canadian Securities Administrators (CSA) has published guidance for investment funds related to companies’ ESG-related disclosures.
Due Diligence and Avoiding ESG-Related Lawsuits
Buyers must consider ESG concerns as part of their due diligence if they want to minimize regulatory actions, shareholder lawsuits, and lawsuits by third parties including environmental advocacy groups.
Depending on the nature of the businesses and the jurisdictions in which they will be operating, buyers should conduct ESG investigations as part of their due diligence in any merger or acquisition, which may include examination of:
- Corporate sustainability strategies and long-term value of the target,
- ESG-related risks of the target’s assets,
- Media searches to identify any ESG-related risks,
- Any alleged human rights violations, corporate corruption, environmental violations, privacy breaches, allegations of harassment or other workplace misconduct, workplace diversity including gender equity, or other ESG-related issues that may become a target for regulatory agencies or advocacy groups,
- Greenhouse gas emissions and other climate-related issues,
- Community involvement,
- The target’s ESG ratings,
- The target’s ESG-related policies and procedures,
- Any previous non-compliance with regulatory requirements, and
- Any other ESG-related liabilities or cultural concerns that could 1) be a deal-breaker or 2) require substantial effort and expense to correct.
The key is identifying the ESG risks as part of the due diligence process. Once the liabilities, risks, and potential solutions have been identified, and if the deal is still viable, the buyer can address the issues in the transaction agreement by requiring, as appropriate:
- Indemnities,
- Representations and warranties,
- ESG-related representations and disclosures,
- Pre-closing covenants requiring reporting and disclosure of new ESG-related concerns as they arise, and
- Requirements that the target address and resolve specific ESG-related concerns before closing.
Please feel free to contact one of our Murray Lobb attorneys to obtain our legal advice regarding your company’s ESG policies and due diligence in mergers and acquisitions. We also remain available to help you with all your general business, employment, and estate planning needs.