Climate risk

Climate litigation is on the rise: how can business navigate the legal risk landscape?

The impacts of a changing climate are wide-ranging. They are also happening today, with destructive flood events, unprecedented heatwaves, carbon border adjustment regimes and greenwashing accusations. While Australia’s recent Federal election result has been widely regarded as the election that delivered a mandate for real action to address climate change, global action in the face of growing climate impacts is moving faster, and the need for Australia to catch up may still result in a volatile domestic policy environment.

Businesses face risks, uncertainties and opportunities across all their areas of operation. In the past, climate activism focused on corporates largely took the form of negative publicity to achieve action in a specific direction. Today, climate risk regulation and guidance are increasing, and litigants are turning to the legislative system to drive change in corporate strategies – with success. A number of significant cases have been brought before the courts and in fact, Australia has more climate change litigation per capita than any other nation.[1] These numbers are likely to increase as a more directive approach is legislated by the new Labor Government, recent aspirational company disclosures under current guidance are scrutinised for evidence of material action, and climate related disclosure is mandated.

As the pressure to act grows with emerging laws and guidance, weak governance and a failure to properly manage or disclose climate related risks could draw the spotlight which may leave companies vulnerable to regulatory enforcement and legal action. This article aims to provide insights into different legal risks, the increased use of climate litigation as a tool to effect strategic or operational change, how this impacts boards and directors, and what companies can do now to limit their exposure.

What are climate related legal and liability risks?

Shortly before COP21 kicked off that reached the landmark Paris Agreement in 2015, the ex-Governor of the Bank of England, Mark Carney, delivered a speech outlining how climate change presents financial and environmental risks to corporates and financial institutions[2]. Carney described the three broad channels where global warming affects financial stability: physical risks, transition risks and liability risks, expanding on the risks previously prescribed for TCFD[3].

• Physical: relating to the acute and chronic physical impacts of a changing climate
• Transition: relating to effects of the transition to a low-carbon society
• Liability: relating to the legal implications of the (non-)management of the physical and transition risk portfolio.

Liability risk focuses on the increased potential for litigation if institutions and boards do not adequately consider or respond to their current or emerging climate risks. There is an interpretation question relating to the terminology of ‘liability’ as it can easily be mistakenly defined as very narrow in nature. Liability is typically considered as a backward-looking matter or interpreted as something that affects insurers (ie. addressing historical behaviour). However, such a narrow perception understates the complexity of climate change litigation, as companies may be scrutinised if they don’t have an adequate forward-looking lens on their climate risk management frameworks. This is especially true for organisations with a large carbon footprint or located in areas of heightened physical climate risk.

Energetics recommends adopting broader language such as ‘climate related litigation’ or ‘legal risks’ to not undermine the dynamic nature of this financial risk.

The legal risk landscape

The umbrella term ‘climate related legal risk’ is not officially defined. Without aiming to dive too deeply into the legal foundations and complexities of each, the following table shows a non-exhaustive list of climate disputes that a company could investigate. The impact of risk on reputation is inherent in each of the risks listed below. While difficult to quantify, they should not be overlooked.

The above list illustrates that legal responsibilities in the climate context are expanding. Companies’ or directors’ liability has not been effectively proven at a large scale but will likely be assessed by courts on the principles of ‘foreseeability’ and ‘reasonableness’. It is important to note that the foreseeability criterion is changing as climate science matures, and we see damages attributed to, and judged by, the most recent advances in climate science in the courtroom.

Climate change litigation, legislation, and policy influence company behaviour relating to climate risk management and vary for each of the abovementioned risks. Liability attributed to each risk and any apportionment of that liability may not be immediately known. However, due to the accelerating pace of climate litigation, some of the unquantifiable costs associated with such actions may ultimately reside with directors.

The outcomes of the higher appeal, as well as the liability claims, are undecided to date. Nonetheless, investors, shareholders[7] and the community recognise the high stakes, and Shell is regularly subject to reputational challenges, as well as greenwashing claims against its carbon neutral fuel offerings.[8]

What can directors and executives do to safeguard their business now? Don’t wait to act

Corporate directors should review their potential to be named as a defendant in climate tort claims, class actions or any other climate litigation. This current wave of litigation is only the beginning, as well-funded NGOs and plaintiffs hire lawyers and specialists, and climate scientists enter the courtroom.  

Courts are independent and apply the law to the facts, whether it’s the Intergovernmental Panel on Climate Change’s recent, further scientific confirmation in Assessment Report 6 that climate change is human-induced; the growing appetite for the global energy transition; shifting societal trends on the role of businesses in the fight against climate change; or all of these combined, courts are responding, and legal grounds will become more sophisticated. This can be a risk to those who are unprepared or can translate into value for those who are brave. 

In order to demonstrate that they are acting diligently, as a minimum directors should ask themselves:

• Are there robust climate risk governance framework and skills matrices in place, supported by effective implementation, execution and accountabilities, and adequate resources?
• Is there a clear directive articulated by the board, specifically around managing climate related risks? Is this appetite for action defined as qualitative or quantitative?
• Is there a probative and proactive approach to gathering information reasonably required to inform decision making at the Board level, is this applied properly for climate related risks?
• Is there an established system of regular review of climate related risks, allowing for the dynamic nature of risks, and fostering independence? Is a robust system in place to document the briefing and deliberations of the Board adequately?
• Is there a system in place to ensure that material climate related risks are reported up to the Board, on equal footing with non-climate related financial risks?

Management can reduce key litigation risks by having clear oversight and taking a collaborative approach. They can do this by:

• Conducting a detailed climate risk and opportunity assessment, as well as climate related scenario analysis, before it becomes mandatory, or investors’ scrutiny increases. Do it now and do it well
• Embedding the management of climate related risks as part of core business risk management, which is the key to reducing litigation risk
• Being proactive in directing resources and executives in mitigation and adaptation activities, rather than having to react to negative publicity
• Building in appropriate climate related assessments of probability and materiality into core products and services, particularly if operating in higher-emitting sectors
• Creating an action plan to reduce scope 1, 2 and 3 emissions including setting (interim) targets and ensuring that the board receives ongoing progress reports towards targets in order to revise strategy where needed.

This can all be strong evidence of the company’s due diligence in addressing climate related financial risk.

Navigating the legal climate risk landscape requires a collaborative and forward-looking approach

The rapid rise in the number of climate related lawsuits is not surprising. As global warming intensifies, associated corporate legal risks will increase. The legal climate risk landscape is still in its infancy and requires further interpretation and strengthening, but undoubtedly its impacts on companies will be far-reaching. It can shape future regulations, in Australia and worldwide.

The likelihood of legal risks materialising varies widely depending on a company’s sector, emissions profile, size, the jurisdiction it operates in and the physical location of its assets, as well as its response to climate related risks. For Australian directors key signposts to watch out for are:

• The further integration of climate science as a means of interpreting the law and governance principles (‘attribution science’)
• The increasing number of climate related cases, as well as an increasing understanding of case law and court opinions
• Draft regulations and legal developments globally.

In any case, simply having policies is not enough to avoid future liability risks. Climate policies should be implemented, embedded and actively developed over time. Obtaining a good grasp of these risks and the associated legal implications requires a company-wide lens that includes key scientific/technical input as well as legal assessments. The approach should be measured, based on robust climate science and look at various timeframes (2025, 2030, 2040, 2050, etc). Only a dynamic approach to climate risk management accounts for the uncertain future of our climate.