Why climate litigation increasingly poses a risk to a company’s value
Climate litigation is rapidly taking root in Europe and elsewhere, with many of these cases no longer just brought against governments but more and more against corporates and their shareholders
That climate change is an issue with a global reach and an increasingly palpable impact, that is nothing new.
But what is a relatively new phenomenon is that more and more investors are forced to closely scrutinise any climate-related lawsuits and other legal claims before they opt to acquire a stake in a particular company. Simply because the rapidly growing pile of climate litigation has the potential to profoundly impact a corporate's value.
And it is not merely settled or pending lawsuits that pose a financial risk: asset owners' legal teams are growing fast because, before an investment is made, any looming legal risks and potential future claims need to be examined, scrutinised and valued as dozens of cases in recent years have demonstrated that what initially seems to be a tiny legal misstep can ultimately grow into a major financial claim with the potential to eat heavily into a company's value, and thus into its profits and dividends.
Taking root
The phenomenon of climate litigation is well-established in the US. It is rapidly taking root elsewhere, including in Europe, Asia and other key markets.
Many of these cases have been brought against governments but the focus is shifting: an increasing number are now brought against corporate entities.
Indeed, it is not only the so-called carbon majors that are targets but, for example, the transport industry, plastics industry, and financial institutions.
"Unlike traditional litigation where damages or compensation is the primary aim, climate litigation can be a means to an end to strategically advance effective action on climate change worldwide," explained Anna Varga, counsel at international law firm Ashurst in the City of London.
"Claimants may use the courts to try to force a company to move more quickly to decarbonise or otherwise reduce its environmental impact," she told Net Zero Investor.
The prospect of negatively impacting a company's market value is a powerful lever to affect change.
Climate litigation cases usually seek a variety of outcomes, enforcing climate standards based on corporate responsibility, fiduciary duties, or 'failure to adapt' or using arguments based on the concept of 'greenwashing'.
They rely on various legal avenues including public law, environmental law, tort, human rights, constitutional, securities and international law and there have been some ground-breaking decisions from national courts.
For example, in Milieudefensie v Royal Dutch Shell plc in the Netherlands, an international energy company was ordered to reduce its group greenhouse gas emissions.
"Not all cases are successful, but those that are generate precedents and momentum, building a body of judicial decisions that reinforce, or provide new, avenues for challenge. Cases are diversifying and evolving rapidly," Varga noted.
Impact of climate suits on company values
Last month, the Grantham Research Institute on Climate Change and the Environment published a report, titled "Impacts of climate litigation on firm value" .
It was the first to construct a comprehensive database of filings and decisions relating to 108 climate change lawsuits worldwide against US and European-listed companies between 2005 - 2021.
The report found that "a filing or an unfavourable court decision in a climate case reduced a firm value by -0.41% on average, relative to expected values."
While there is no agreed legal definition of greenwashing, it has become a central concept in climate litigation.
The document observed larger market reactions for "novel" cases involving a new form of legal argument or in a new jurisdiction. It also noted no statistically significant effect on firm value in cases brought against non-carbon majors.
"Such modest impact may surprise some, but cases against non-carbon majors remain less prevalent. As such, there are fewer decided cases to illustrate the impact climate litigation has on those companies' values," Tom Cummins, since 2015 a partner at Ashurst, explained.
In addition, the report did not consider regulatory action and the impact that may have on a company's value.
"This is an increasing area of risk for companies. The UK and the EU have been gradually introducing laws to standardise and regulate climate related claims," he continued.
"This is particularly apparent with allegations of greenwashing. While there is no agreed legal definition of greenwashing, it has become a central concept in climate litigation," Cummins added.
Greenwashing claims
As reported by Net Zero Investor earlier this week, each of the European Supervisory Authorities on 31 May 2023 published progress reports on greenwashing in response to the European Commission's request for input on "greenwashing risks and the supervision of sustainable finance policies".
The ESA's progress reports provide initial findings which will form the basis of the final report due in May of next year.
The European Banking Authority's progress report notes that alleged cases of greenwashing have increased and environmental and social related issues are the most prominent topics subject to greenwashing.
The progress report's analysis indicates a rising focus on climate accountability: "increased public attention to climate change has led companies being held accountable for their environmental policies, climate impact and disclosures" .
Cummins stressed that "it further notes that greenwashing has the most impact on reputational risk, followed by operational and strategic/business risks of banks and investment firms."
He noted that "at present, the materiality of greenwashing risk is perceived as rather low, but it is expected to increase, potentially significantly. In part, that may be due to the potential regulatory enforcement risk as existing and future regulation and supervision takes effect."
Bold is the company that ignores the risk to value that climate litigation or regulatory investigations pose.
Unlike private litigation, regulatory enforcement does not always seek compensation for consumers, Cummins pointed out.
"The deterrence factor of such investigations and ensuring orderly markets can of itself attract regulatory fines and/or sanction."
The early signs are already apparent. For a starter, the UK's Advertising Standards Agency has recently issued a spate of rulings banning advertising held to have mislead the public on environmental grounds. Recent high-profile cases include bans on adverts by HSBC and Shell.
Similarly, the Competition and Markets Authority has launched investigations into Boohoo, Asda and ASOS over fashion 'green' claims.
Also, the Financial Conduct Authority’s anti-greenwashing rule comes into force during 2023, and the FCA is conducting a probe into sustainable loans following concerns that environmental targets in such deals are too easy for companies to meet.
"The impact of such regulatory rulings and decisions is yet to be quantified," Cummins said.
"Although it may be some years before we have an enforcement outcome which demands hefty fines, such action likely will have an impact on the value of the targeted institution," he concluded.
"Conceivably, it may also provide the springboard for private litigation – as has been seen in other sectors."
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