As a result of changes in the climate, various world governments and non-governmental entities have encouraged corporations to reduce carbon emissions. Corporate executives have been increasingly required to disclose information concerning climate change-related risks as some investors are demanding more accountability. Directors who misrepresent or fail to consider climate risks and take appropriate action may face personal responsibility for related financial losses. Climate change losses are not the type of risk that a directors and officers (D&O) liability policy is traditionally underwritten to cover.
Directors and Officers Climate Risk Liability Exposure
Until recently, corporate directors and officers have not been personally targeted as liable for climate risk losses. There is no precedent in Texas for holding corporate executives liable for losses related to climate change risks. However, law developing in other jurisdictions indicates some courts may be willing to extend liability in certain situations.
Earlier this year in the United Kingdom, an environmental activist organization ClientEarth attempted to file a watershed lawsuit against Shell’s Board of Directors, alleging the Board breached its duties to the corporation by devising and implementing a plan to move away from fossil fuels that did not comply with the Paris Agreement and thus jeopardized the future financial success of the company.
The High Court dismissed ClientEarth’s lawsuit, saying it would not second guess the strategy of Shell’s Board of Directors, who were in a much better position to make decisions on behalf of the mega company. The court was also a bit skeptical of ClientEarth’s ultimate motivation for bringing the action.
In the U.S., a line of cases has been decided in Delaware that is instructive as to where the law in this country may be headed. Known as Caremark cases, the lawsuits seek to impose personal liability on corporate directors for failing to properly oversee the affairs of a company by implementing and monitoring appropriate information management systems.
The Delaware Supreme Court approved the Caremark standards imposing liability on directors for breaching their duties of oversight in Stone vs. Ritter. Director oversight liability can be imposed when directors:
- Utterly fail to implement a reasonable information and reporting system
- Utterly fail to monitor the information and reporting system once implemented
The utter failure of the directors must be in conscious disregard of their duties. Such conscious disregard in the face of known responsibilities is a breach of a director’s duty of loyalty to the corporation. Breaching the duty of loyalty is an act of bad faith.
Duties of Directors and Officers in Texas
The Texas Business Organizations Code requires directors to discharge their responsibilities in good faith, with ordinary care, and in the best interests of the corporation.
Case law has established the fiduciary duties of directors to be:
- Duty of obedience
- Duty of care
- Duty of loyalty
Texas courts have also held that a director’s duty of loyalty includes the duty of oversight. Oversight means paying attention to and monitoring corporate affairs, including identifying and considering potential risks of harm to the company. Oversight liability is based on a director’s failure to take appropriate action.
Proposed SEC Rules Will Increase Director Responsibility for Climate-Related Disclosures
In order to better assist investors seeking more information about climate-related risks, the Securities and Exchange Commission (SEC) has proposed rules changes that would require publicly traded companies to include certain climate-related disclosures in their registrations and periodic reports.
Companies would need to disclose information about climate-related risks that could have a material impact on their business, results of operations, and financial condition. Companies will also need to disclose their emissions of greenhouse gases.
The final rules are expected to be published this fall and take effect in 2024. Compliance with the new disclosure requirements could increase the potential climate risk liability exposure for corporate executives.
Exposure Not Covered by D&O Liability Insurance
Directors’ and officers’ liability insurance is a type of professional liability insurance. The insurance is intended to cover errors and omissions made by corporate directors and officers in the performance of their professional duties.
The policies generally exclude executive conduct that is intentionally criminal or fraudulent. Some policies also contain exclusions for pollution-related losses. Pollution exclusions can exclude coverage for liability related to the discharge, dispersal, seepage, migration, release, or escape of pollutants. Pollutants are often defined broadly and include any gaseous contaminant.
Although the issue has not been litigated in Texas, an insurance company will most likely attempt to use an existing pollution exclusion to avoid paying a claim where the loss is related to a director’s conduct involving climate risk.
How D&O Insurance Companies May Respond to Climate Risk Exposure
Insurance companies underwriting D&O liability insurance are anticipating the possibility that corporate executives may be accused of wrongdoing with regard to a climate risk loss and be looking to their D&O policies for coverage.
Insurance underwriters will be assessing the climate risk exposure and deciding if it is something they can make money on. Depending on their evaluation, D&O liability insurers may choose to do one of the following:
- Cover climate risk exposure in the D&O policy and charge higher premiums
- Exclude the risk completely and provide no coverage for climate risk exposures
- Sublimit climate risk coverage – offer a specific lower limit of coverage in the D&O policy
- Offer a separate policy to cover climate risk liability exposure
Insurance companies will choose the level of risk they are willing to tolerate and offer coverage to directors and officers based on that tolerance. Directors and officers working for corporations with greater exposure to climate change risks will want coverage for any potential liability. It remains to be seen exactly how insurance companies will deal with the climate risk exposure for directors and officers. Contact our Texas liability lawyers to see how we can help your business.
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